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DGX > SEC Filings for DGX > Form 10-Q on 1-May-2014All Recent SEC Filings

Show all filings for QUEST DIAGNOSTICS INC

Form 10-Q for QUEST DIAGNOSTICS INC


1-May-2014

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 14 to the interim consolidated financial statements.

First Quarter Highlights

During the first quarter we completed the acquisition of Solstas Lab Partners Group ("Solstas"), signed a definitive agreement to acquire Summit Health, Inc. ("Summit Health") and signed a laboratory professional services agreement with an integrated delivery network. Additionally, new legislation was announced that, among other things, delayed potential decreases to the Clinical Laboratory Fee Schedule until 2017, which is a positive development for our industry. The legislation also provides for a rule making process to define new rates based on a market weighted median of commercial rates from a broad range of labs and restricts the authority of the Centers for Medicare and Medicaid Services to make discretionary cuts. We believe that the impact of the Affordable Care Act on our company will be neutral to slightly positive in 2014.

Our total net revenues of $1.7 billion were 2.3% below the prior year period. DIS revenues of $1.6 billion were 2.1% below the prior year period. DIS volume, measured by the number of requisitions, increased 0.7% compared to the prior year period. Our acquisitions since the first quarter of 2013 added approximately 2.5% to DIS revenue growth and 3.5% to DIS volume compared to the prior year period. We estimate that the unseasonably harsh winter reduced DIS revenues and volume by about 2%. Excluding the impact of acquisitions and weather, DIS volume was lower by less than 1% compared to the prior year period. Diagnostic Solutions ("DS") revenues were $132 million and 4.3% below the prior year period, with approximately half of that impact related to the sale of our Enterix business in September 2013 and the remainder due to lower revenues in our products and clinical trial businesses. Income from continuing operations attributable to Quest Diagnostics' stockholders was $104 million for the three months ended March 31, 2014. The decrease over the prior year period was primarily due to lower net revenues, partially offset by lower operating costs associated with our ongoing efforts to drive operational excellence and reduce our overall cost structure. Earnings per diluted share from continuing operations was $0.71 for the three months ended March 31, 2014.

Five-point Strategy

We continued our progress on the execution of our five-point strategy during the first quarter of 2014 as follows:

We completed the acquisition of Solstas for $572 million.

We entered into a definitive purchase agreement to acquire Summit Health and completed the acquisition in April 2014 and signed a laboratory professional services agreement with an integrated delivery network.

We increased our quarterly cash dividend 10% from $0.30 to $0.33 per common share.

We repurchased $32 million of our common stock as part of our Common Stock repurchase program.

Invigorate Program

We are engaged in a multi-year program called Invigorate which is expected to deliver $700 million in run rate savings versus 2011 by the time we exit 2014. We expect to deliver approximately $200 million in realized savings in 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 quality and operating profitability.

In connection with our Invigorate program, we launched multiple management restructuring initiatives aimed at
driving operational excellence and restoring growth. These restructuring initiatives were primarily undertaken to eliminate multiple layers from the organization, migrate certain aspects of our support functions to an outsourcing model and optimize the use of our facilities and infrastructure. As of March 31, 2014, we have recorded approximately $143 million of pre-tax employee separation costs and other restructuring related costs associated with these initiatives.


Table of Contents

Our remaining high-level estimates of total pre-tax charges expected to be incurred in 2014 in connection with our Invigorate program consist of $20 million to $30 million of employee separation costs; $30 million to $40 million of facility-related costs; $2 million to $5 million of asset impairment charges; and $20 million to $30 million of systems conversion and integration costs. Of the total estimated pre-tax charges expected to be incurred in 2014, we estimate that $70 million to $100 million are anticipated to result in cash expenditures. The actual charges incurred in connection with the Invigorate program 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, 2014, the cumulative charge recorded in connection with the Invigorate program was approximately $198 million.

For additional information on the Invigorate program and associated costs, see Note 4 to the interim consolidated financial statements.

Recent Acquisitions

Acquisition of Solstas Lab Partners Group

On March 7, 2014, we completed the acquisition of Solstas in an all-cash transaction valued at $572 million, or $563 million net of cash acquired. Solstas is a full-service commercial laboratory based in Greensboro, North Carolina and operates in nine states throughout the Southeastern United States, including the Carolinas, Virginia, Tennessee, Georgia and Alabama. See Note 5 to the interim consolidated financial statements for additional information associated with the Solstas acquisition.

Acquisition of Summit Health

On March 11, 2014, we announced that we entered into a definitive purchase agreement to acquire Summit Health, a leading provider of on-site prevention and wellness programs. We completed the acquisition of Summit Health on April 18, 2014.

Acquisition of Steward Health Care Systems, LLC

On April 16, 2014, we completed the acquisition of the outreach laboratory service operations of Steward Health Care Systems, LLC.

Critical Accounting Policies

There have been no significant changes to our critical accounting policies from those disclosed in our 2013 Annual Report on Form 10-K.


Table of Contents

Results of Operations

The following table sets forth certain results of operations data for the
periods presented:
                                                              Three Months Ended March 31,
                                                                                 Increase      % Increase
                                                  2014             2013         (Decrease)     (Decrease)
                                                    (dollars in millions, except per share amounts)

Net revenues:
DIS business                                  $    1,614       $    1,649      $      (35 )        (2.1 )%
DS businesses                                        132              138              (6 )        (4.3 )
Total net revenues                            $    1,746       $    1,787      $      (41 )        (2.3 )%

Operating costs and expenses:
Cost of services                              $    1,101       $    1,092      $        9           0.8  %
Selling, general and administrative                  415              448             (33 )        (7.4 )
Amortization of intangible assets                     22               19               3          15.8
Other operating expense, net                           -                1              (1 )      (100.0 )
Total operating costs and expenses            $    1,538       $    1,560      $      (22 )        (1.4 )%

Operating income                              $      208       $      227      $      (19 )        (8.4 )%

Other income (expense):
Interest expense, net                         $      (39 )     $      (40 )    $        1          (2.5 )%
Equity in earnings of equity method investees          6                6               -             -
Other income, net                                      1                4              (3 )          NM
Total non-operating expenses, net             $      (32 )     $      (30 )    $       (2 )         6.7  %

Income tax expense                            $       65       $       73      $       (8 )       (11.0 )%
Effective income tax rate                           36.9 %           37.3 %          (0.4 )%         NM

Income from discontinued operations, net of
taxes                                         $        -       $       20      $      (20 )      (100.0 )%

Income from continuing operations
attributable to Quest Diagnostics'
stockholders                                  $      104       $      116      $      (12 )       (10.3 )%

Diluted earnings per common share from
continuing operations attributable to Quest
Diagnostics' common stockholders              $     0.71       $     0.72      $    (0.01 )        (1.4 )%

NM - Not Meaningful


Table of Contents

The following table sets forth certain results of continuing operations data as a percentage of net revenues for the periods presented:

                                      Three Months Ended March 31,
                                         2014               2013

Net revenues:
DIS business                               92.4 %              92.3 %
DS businesses                               7.6                 7.7
Total net revenues                        100.0 %             100.0 %


Operating costs and expenses:
Cost of services                           63.1 %              61.1 %
Selling, general and administrative        23.8                25.1
Amortization of intangible assets           1.2                 1.1
Other operating expense, net                  -                   -
Total operating costs and expenses         88.1 %              87.3 %

Operating income                           11.9 %              12.7 %

Continuing Operations

Results for the three months ended March 31, 2014 were affected by certain items that impacted earnings per diluted share $0.13. During the three months ended March 31, 2014, we recorded pre-tax charges of $24 million, or $0.11 per diluted share, related to restructuring costs primarily associated with workforce reductions, integration costs and professional fees associated with the further restructuring of our business (including $6 million of pre-tax integration and transaction costs associated with acquisitions). In addition, we recorded a pre-tax charge of $4 million, or $0.02 per diluted share, principally associated with the settlement of a legal matter.

Results for the three months ended March 31, 2013 included $45 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 the further restructuring and integrating of our business.

Net Revenues

Net revenues for the three months ended March 31, 2014 were 2.3% below the prior year level.

DIS revenue, which accounted for over 90% of our consolidated net revenues, decreased by 2.1% for the three months ended March 31, 2014 compared to the prior year period. Our acquisitions since the first quarter of 2013 have added approximately 2.5% to DIS revenue growth in the quarter. We estimate that the impact of the unseasonably harsh winter in the first quarter of 2014 adversely affected net revenues by approximately 2%.

DIS volume, measured by the number of requisitions, increased 0.7% for the three months ended March 31, 2014 compared to the prior year period. Our recent acquisitions contributed approximately 3.5% to DIS volume in the quarter and we estimate that the impact of the unseasonably harsh winter negatively impacted DIS volume by approximately 2% in the quarter. After considering the impact of our recent acquisitions and harsh winter weather, underlying DIS volume was less than 1% lower than prior year period.

Revenue per requisition for the three months ended March 31, 2014 decreased 2.8% from the prior year level. This decrease is primarily associated with expected changes in reimbursement and an increase in lower priced drugs-of-abuse testing, primarily driven by the impact of the Advance Toxicology Network ("ATN") acquisition in May 2013.

For the three months ended March 31, 2014, combined revenues in our DS businesses decreased by approximately 4.3%, compared to the prior year period. This decrease was impacted by the sale of our Enterix business in September 2013. The sale of Enterix accounted for approximately 2% of this overall decrease in net revenues.


Table of Contents

Cost of Services

Cost of services consists principally of costs for obtaining, transporting and testing specimens as well as facility costs used for the delivery of our services.

Cost of services increased $9 million for the three months ended March 31, 2014 as compared to the prior year period. This increase includes $12 million that is principally due to the allocation of certain facility costs between cost of services and selling, general and administrative expenses for those facilities that support both service delivery and administrative functions, in order to reflect our current operations. Additionally, the increase in cost of services is due to higher operating costs associated with acquisitions since the first quarter of 2013. These increases were partially offset by lower overall compensation and benefit costs resulting from reduced headcount and lower restructuring and integration costs in 2014 as compared to the prior year period.

The change in allocation of facility costs and decreased net revenues are the primary factors for the increase in cost of services as a percentage of net revenues in 2014 compared to the prior year period.

Selling, General and Administrative Expenses ("SG&A")

SG&A consist principally of the costs associated with our sales and marketing efforts, billing operations, bad debt expense and general management and administrative support as well as administrative facility costs.

SG&A decreased $33 million for the three months ended March 31, 2014 as compared to the prior year period. This decrease includes $12 million that is principally due to the allocation of certain facility costs between cost of services and selling, general and administrative expenses for those facilities that support both service delivery and administrative functions, in order to reflect our current operations. Additionally, the decrease in SG&A is due to lower overall compensation and benefit costs resulting from reduced headcount and lower restructuring and integration costs in 2014 as compared to the prior year period. These decreases were partially offset by higher operating costs associated with acquisitions since the first quarter of 2013 and higher bad debt expense.

Our bad debt expense as a percentage of revenues increased 30 basis points as compared to the prior year period to 4.3% for the three months ended March 31, 2014. Our bad debt expense is typically the highest in the first quarter due to increased patient responsibility associated with unmet deductible amounts. We expect employers to shift more costs to individuals and are seeing a continued increase in the prevalence of high deductible plans.

Amortization of Intangible Assets

The increase in amortization of intangible assets for the three months ended March 31, 2014, compared to the prior year period, primarily reflects the impact of amortization of intangible assets acquired as part of our acquisitions since the first quarter of 2013 (Solstas, ATN, Dignity Health and ConVerge).

Operating Income

Operating income as a percentage of net revenues decreased to 11.9% in the three months ended March 31, 2014, as compared to 12.7% in the prior year period. The diagnostic testing industry is labor intensive. Employee compensation and benefits constitute approximately one-half of our total costs and expenses. In addition, performing diagnostic testing involves significant fixed costs for facilities and other infrastructure required to obtain, transport and test specimens. Therefore, we have limited ability to remove costs in response to adverse changes in volume from short-term events like a harsh winter and as a result we experienced a decrease in our operating income percentage in the three months ended March 31, 2014.

Interest Expense, net

Interest expense, net for the three months ended March 31, 2014 decreased $1 million, compared to prior year period.


Table of Contents

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, 2014 and 2013, other income, net includes gains of $1 million and $3 million, respectively, associated with investments held in trusts pursuant to our supplemental deferred compensation plans.

Income Tax Expense

The decrease in the effective income tax rate for the three months ended March 31, 2014, compared to the prior year period, is due primarily to certain discrete tax credits realized in the first quarter of 2014.

Discontinued Operations

Discontinued operations includes HemoCue, which was sold in April 2013, OralDNA, which was sold in December
2012, and NID, a test kit manufacturing subsidiary. The results of operations for HemoCue, OralDNA and NID have been
classified as discontinued operations for all periods presented. See Note 13 to the interim consolidated financial statements for further details. Income from discontinued operations, net of taxes for the three months ended March 31, 2013, includes discrete tax benefits of $20 million associated with favorable resolution of certain tax contingencies related to our NID business.

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

                                                             Three Months Ended March 31,
                                                                                      Increase
                                                           2014          2013        (Decrease)
                                                                 (dollars in millions)
Net revenues                                           $        -     $      25     $     (25 )
Income from discontinued operations before taxes                -             1            (1 )
Income tax benefit                                              -            19           (19 )

Income from discontinued operations, net of taxes      $        -     $      20     $     (20 )

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