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DGX > SEC Filings for DGX > Form 10-Q on 24-Apr-2013All Recent SEC Filings

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Form 10-Q for QUEST DIAGNOSTICS INC


24-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Our Company

Quest Diagnostics is the world's leading provider of diagnostic information services ("DIS") providing insights that empower and enable patients, physicians, hospitals, integrated delivery networks, health plans, employers and others to make better healthcare decisions. Over 90% of our revenues are derived from DIS with the balance derived from risk assessment services, clinical trials testing, diagnostic products and healthcare information technology. Our business segment information is disclosed in Note 13 to the interim consolidated financial statements.

Initiatives to Improve Operating Efficiency and Restore Growth

The diagnostic testing industry is labor intensive. Employee compensation and benefits constitute approximately one-half of our total costs and expenses. Cost of services consists principally of costs for obtaining, transporting and testing specimens. Selling, general and administrative expenses consist principally of the costs associated with our sales and marketing efforts, billing operations, bad debt expense and general management and administrative support. In addition, performing diagnostic testing involves significant fixed costs for facilities and other infrastructure required to obtain, transport and test specimens. Therefore, relatively small changes in volume can have a significant impact on profitability in the short-term.

We are engaged in a multi-year program called Invigorate which is designed to deliver $600 million in annual run-rate cost savings versus 2011 by the time we exit 2014. We are continuing to seek additional opportunities to increase the savings from Invigorate, to as much as $1 billion over time, and where practical to accelerate the savings. The Invigorate program is intended to address continued reimbursement pressures and labor and benefit cost increases, free up additional resources to invest in science, innovation and other growth initiatives, and enable us to improve operating profitability and quality. We anticipate approximately 35% of the savings to come from laboratory operations and specimen acquisition by driving process standardization across all laboratory operations and by creating a new logistics operating platform; approximately 25% of the savings to come from procurement and supply chain by further automating and standardizing technology platforms with suppliers and by building global sourcing capabilities; approximately 25% of the savings from selling, general and administrative expenses, including information technology, by reducing management layers and increasing spans of control, centralizing and selective outsourcing of certain activities, and migrating to standard information technology systems and data bases; and approximately 15% of the savings from client support/billing by increasing the utilization of electronic billing, creating one standard billing system and partnering with payers to improve efficiency.

In connection with our Invigorate program, we launched a voluntary retirement program to certain eligible employees that qualified for the program. This program, which was essentially completed at the end of the first quarter of 2013, will contribute an estimated $40 million in annualized savings. Of the $50 million of pre-tax employee separation costs initially expected to be incurred in connection with the voluntary retirement program, approximately $47 million has been incurred through March 31, 2013.

In October 2012, as part of Invigorate, we launched a major management restructuring aimed at driving operational excellence and restoring growth. In connection with these changes, we expect to eliminate three management layers and approximately 400 to 600 management positions by the end of 2013, contributing about $65 million of the $600 million in expected savings associated with our Invigorate program. In the first quarter of 2013, we recorded approximately $18.1 million of employee separation costs associated this management restructuring initiative, and are on-track to meet our expected savings in 2013.

As a result of actions we have taken to accelerate our Invigorate program, we exited 2012 with approximately $200 million of run-rate cost savings, and we are expecting to achieve the remaining annual run-rate savings of $400 million in 2013 and 2014.

Our high-level estimates of the pre-tax charges expected to be incurred through 2014 in connection with our Invigorate program remain unchanged. The total estimated pre-tax charges range from $170 million to $250 million and consist of $90 million to $135 million of employee separation costs; $30 million to $45 million of facility-related costs; $10 million to $20 million of asset impairment charges; and $40 million to $50 million of systems conversion and integration costs. Of the total estimated pre-tax charges expected to be incurred, we estimate that $160 million to $230 million are anticipated to result in cash expenditures. The actual charges incurred in connection with the multi-year course of action could be materially different from these estimates. As detailed plans to implement the multi-year course of action are approved and executed, it will result in charges to earnings. Through March 31, 2013, the cumulative charge recorded in connection with the Invigorate program totaled $118.1 million.


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For additional information on the Invigorate program and associated costs, see Note 4 to the Consolidated Financial Statements.

Divestiture of Business

During the fourth quarter of 2012, we committed to a plan to sell HemoCue, our diagnostic point-of-care testing business, and in February 2013, we entered into an agreement to sell HemoCue. As of March 31, 2013 and December 31, 2012, the applicable assets and liabilities of HemoCue have been classified as held for sale in the accompanying consolidated balance sheets. HemoCue is reported as discontinued operations in our consolidated statements of operations as no significant involvement or continuing cash flows are expected from, or to be provided to HemoCue following the consummation of the sale transaction. For all periods presented, our consolidated statements of operations have been recast to reflect the presentation of discontinued operations. See Note 18 to the Consolidated Financial Statements in the Company's 2012 Annual Report on Form 10-K and Note 12 to the interim consolidated financial statements for additional information.

On April 9, 2013, we completed the sale of HemoCue for approximately $300 million plus customary adjustments for cash balances.

Recent Acquisitions

Acquisition of Business from Dignity Health

On April 17, 2013, the Company entered into a definitive agreement to acquire certain lab-related clinical outreach service operations of Dignity Health, a hospital system in California.

Acquisition of Businesses from UMass Memorial Medical Center

On January 2, 2013, we completed the acquisition of the clinical outreach and anatomic pathology businesses of UMass Memorial Medical Center ("UMass"). This purchase is the first step in a series of transactions between the parties whereby the two organizations expect to eventually have a financial stake in a new entity that will perform diagnostic information testing services in a defined territory within the state of Massachusetts.

Critical Accounting Policies

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 our reported financial results and the disclosure of contingent assets and liabilities. 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 most of 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 our total 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. There have been no significant changes to our critical accounting policies from those disclosed in our 2012 Annual Report on Form 10-K.


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Results of Operations

Three Months Ended March 31, 2013 Compared with Three Months Ended March 31,
2012

Continuing Operations
                                                                  Three Months Ended March 31,
                                                                                                % Increase
                                                              2013                 2012         (Decrease)
                                                          (dollars in millions, except per share data)
Net revenues                                          $       1,786.6         $     1,908.7         (6.4 )%
Income from continuing operations                               115.5                 156.1        (26.0 )%
Earnings per diluted share                            $          0.72         $        0.97        (25.8 )%

Results for the three months ended March 31, 2013 included $44.5 million of pre-tax charges, or $0.17 per diluted share, related to restructuring and integration costs primarily associated with workforce reductions and professional fees associated with further restructuring and integrating our business.

Results for the three months ended March 31, 2012 were affected by certain items that reduced earnings per diluted share by $0.08. During the first quarter of 2012, we incurred costs of $13.1 million, or $0.05 per diluted share, primarily associated with professional fees and other costs associated with further restructuring and integrating our business. Results for the quarter also included $7.1 million, or $0.03 per diluted share, principally associated with severance and other separation benefits as well as accelerated vesting of certain equity awards in connection with the succession of our prior CEO.

Net Revenues

Net revenues for the three months ended March 31, 2013 were 6.4% below the prior year level.

DIS revenue, which accounted for over 90% of our consolidated revenues, decreased by 6.7% for the three months ended March 31, 2013 compared to the prior year period. DIS volume, measured by the number of requisitions, decreased 3.4% for the first quarter of 2013, compared to the prior year period. This decrease was principally due to fewer business days during the quarter, and to a lesser extent, the impact of weather, as compared to the prior year period, which combined to reduce DIS volume by about 2.5%. Partially offsetting those factors was about a 1% volume contribution associated with the UMass acquisition. The resulting underlying volume was about 2% below the prior year.

Revenue per requisition for the three months ended March 31, 2013 decreased 3.4% from the prior year level. This decrease is primarily associated with a Medicare fee schedule reduction, including pathology reimbursement reductions, as well as certain commercial fee schedule changes, all of which went into effect at the beginning of the quarter. Favorable test mix was essentially offset by business mix changes including an increase in lower priced drugs-of-abuse testing, and a decrease in higher priced anatomic pathology testing. We expect reimbursement pressures to impact our revenue per requisition by about 3% for the full year in 2013.

Our Diagnostic Solutions ("DS") business accounted for approximately 8% of our net revenues for the three months ended March 31, 2013 and 2012. For the three months ended March 31, 2013, combined revenues in these businesses decreased by approximately 2%, compared to the prior year period.


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Operating Costs and Expenses

                                                    Three Months Ended March 31,
                                                                                        Increase
                                      2013                      2012                   (Decrease)
                                             % Net                     % Net                    % Net
                                  $         Revenue         $         Revenue        $         Revenue
                                                        (dollars in millions)
Cost of services             $ 1,091.8        61.1 %   $ 1,109.2        58.1 %   $  (17.4 )       3.0  %
Selling, general and
administrative expenses
(SG&A)                           447.9        25.1         483.3        25.3        (35.4 )      (0.2 )
Amortization of intangible
assets                            19.3         1.1          18.8         1.0          0.5         0.1
Other operating expense, net       0.7           -          (0.4 )         -          1.1           -
Total operating costs and
expenses                     $ 1,559.7        87.3 %   $ 1,610.9        84.4 %   $  (51.2 )       2.9  %
Bad debt expense (included

in SG&A) $ 71.9 4.0 % $ 80.7 4.2 % $ (8.8 ) (0.2 )%

Total Operating Costs and Expenses

For the three months ended March 31, 2013, total operating costs and expenses were $51.2 million below the prior year level, primarily driven by actions we have taken to reduce our cost structure under our Invigorate program and lower testing volumes in our DIS business. The savings associated with Invigorate have served to mitigate some of the earnings impact from the year over year revenue decrease. These savings were partially offset by higher costs primarily associated with workforce reductions and professional fees incurred in connection with further restructuring and integrating our business. These costs totaled $44.5 million ($17.4 million in cost of services and $27.1 million in selling, general and administrative expenses).

Cost of Services

The decrease in cost of services for the three months ended March 31, 2013 is primarily due to the impact of actions we have taken to reduce our cost structure under the Invigorate program and lower testing volumes in our DIS business. This was partially offset by higher costs associated with restructuring and integration activities in 2013, compared to the prior year period. The decrease in net revenues was the primary factor for the increase in cost of services as a percentage of net revenues in 2013 compared to the prior year period.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentage of net revenues for the three months ended March 31, 2013 decreased slightly compared to the prior year period. This decrease was primarily related to actions we have taken to reduce our cost structure under the Invigorate program and lower testing volumes in our DIS business. This decrease was partially offset by higher costs associated with restructuring and integration activities in 2013, compared to the prior year period.

Amortization of Intangible Assets

The increase in amortization of intangible assets for the three months ended
March 31, 2013, compared to the prior year period, primarily reflects the impact
of amortization of intangible assets acquired as part of the UMass acquisition.

Operating Income
                                              Three Months Ended March 31,
                                                                      Increase
                                            2013          2012       (Decrease)
                                                  (dollars in millions)
Operating income                        $   227.0       $ 297.8     $    (70.8 )
Operating income as a % of net revenues      12.7 %        15.6 %         (2.9 )%


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The decrease in operating income as a percentage of net revenues for the three months ended March 31, 2013, compared to the prior year period, is primarily a function of reduced revenues and higher costs associated with restructuring and integration activities, partially offset by savings realized from our Invigorate program.

Interest Expense, net
                               Three Months Ended March 31,
                                                          Increase
                              2013             2012      (Decrease)
                                  (dollars in millions)
Interest expense, net $     39.9              $ 42.1    $     (2.2 )

Interest expense, net for the three months ended March 31, 2013 decreased, compared to prior year period, primarily due to lower average outstanding debt balances in 2013.

Other Income, net

Other income, 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 months ended March 31, 2013 and
2012, other income, net includes gains of $3.4 million and $4.8 million,
respectively, associated with investments held in trusts pursuant to our
supplemental deferred compensation plans.

Income Tax Expense
                                Three Months Ended March 31,
                                                        Increase
                             2013           2012       (Decrease)
                                    (dollars in millions)
Income tax expense        $   73.3       $  102.6     $    (29.3 )
Effective income tax rate     37.3 %         38.3 %         (1.0 )%

The decrease in the effective income tax rate for the three months ended March 31, 2013, compared to the prior year period, is due primarily to certain tax credits reflected in the effective income tax rate for 2013.

Discontinued Operations

Discontinued operations for the three months ended March 31, 2013 include HemoCue and NID, a test kit manufacturing subsidiary. Discontinued operations for the three months ended March 31, 2012 include HemoCue, NID and OralDNA, a salivary-diagnostics business ("OralDNA"), which was sold during the fourth quarter of 2012. The results of operations for HemoCue and NID have been classified as discontinued operations for all periods presented. The results of operations for OralDNA have been classified as discontinued operations for the three months ended March 31, 2012. See Note 12 to the interim consolidated financial statements for further details.

The following table summarizes our income from discontinued operations, net of taxes:

                                                              Three Months Ended March 31,
                                                                                      Increase
                                                            2013          2012       (Decrease)
                                                                 (dollars in millions)
Net revenues                                            $     25.0     $   27.8     $     (2.8 )
Income from discontinued operations before taxes               1.0          2.5           (1.5 )
Income tax benefit                                            19.3          0.5           18.8

Income from discontinued operations, net of taxes       $     20.3     $    3.0     $     17.3


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For the three months ended March 31, 2013, income from discontinued operations, net of taxes includes discrete tax benefits of $19.8 million due to new information resulting in changes in estimates for certain tax contingencies related to NID.

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