How much did Quest Diagnostics' earnings improve in 2002?

Net income was $322 million, or $3.23 per diluted share, compared with $162 million, or $1.66 per diluted share, in 2001. The 2001 results included a $36 million pre-tax extraordinary loss and a $6 million special charge. Goodwill amortization also ended in 2002 under SFAS 142, which lifted reported earnings.

What is the Unilab acquisition and what does it mean for shareholders?

Quest acquired Unilab, the leading independent clinical lab in California, on February 28, 2003. It paid about $297 million in cash, issued about 7.4 million shares, and plans to repay most of Unilab's debt. Management expects $25-30 million in annual synergies by 2005, with up to $20 million in integration costs during 2003-2004, and must divest some northern California assets to LabCorp.

What are the main risks facing Quest's business?

Key risks include pricing pressure from managed care contracts, which make up about half of revenue; the possibility of losing major managed care agreements; government reimbursement cuts or changes to Medicare billing rules; potential liabilities from billing-related investigations and qui tam lawsuits; integration risk from multiple acquisitions; and possible FDA regulation of laboratory-developed genetic tests.

How is Quest's financial position and cash generation?

Operating cash flow was $596 million in 2002, up $131 million from 2001. Long-term debt was $797 million at year-end, and stockholders' equity increased to $1.77 billion. The company had $325 million in unsecured revolving credit and $250 million in secured receivables capacity available at year-end. Quest has never paid cash dividends and does not plan to do so in the foreseeable future.

What growth does management expect for the clinical lab industry and for Quest?

Management expects industry revenue to grow about 5% to 7% per year over the long term, with growth near the low end of that range in the short term. Drivers include an aging population, genomics and proteomics research, infectious disease testing, and greater consumer demand for testing. Quest's strategy centers on gene-based testing, which it estimates at about $400 million in revenue growing more than 20% annually, plus anatomic pathology and selective regional acquisitions.

DGX 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 28, 2003. Cited figures are marked; the original filing is the authoritative source.

Quest Diagnostics (DGX) reported a strong 2002: net revenues rose 13.2% to $4.11 billion, and net income more than doubled to $322 million^a ($3.23 diluted EPS), up from $162 million in 2001.

Management attributes the improvement to revenue growth from higher testing volume and better average revenue per requisition, the AML acquisition, Six Sigma and standardization efficiencies, lower bad debt (5.3% of revenue vs. 6.0%), and lower net interest expense. Adjusted for the end of goodwill amortization under SFAS 142, 2002 earnings still rose about 44% over the adjusted 2001 figure. Operating cash flow reached $596 million^b, and days sales outstanding fell to 49 from 54, while debt stayed near $800 million and stockholders' equity climbed to $1.77 billion.

The major forward-looking event is the February 28, 2003 acquisition of Unilab Corporation, California's leading independent clinical lab. The deal involved about 7.4 million shares, $297 million^c in cash, and repayment of most of Unilab's debt through a new $450 million term loan. Management expects $25-30 million in annual synergies by end-2005 against up to $20 million in integration costs during 2003-2004.

A required divestiture of certain northern California assets to LabCorp, worth about $27 million^d in annual revenue, is a partial offset. The filing also flags meaningful risks: roughly half of revenue depends on managed care contracts that are becoming more price-competitive, Medicare and Medicaid make up about 15% of revenue under complex billing rules, and the company has a history of government investigations and qui tam claims. Management guides to industry revenue growth of about 5-7% annually, with the low end expected in the near term.

02—Key points

Key Highlights

Net revenues grew 13.2% to $4.11 billion in 2002, with the AML acquisition contributing roughly half of the increase and clinical testing volume up 9.7%.
Net income rose to $322 million ($3.23 diluted EPS) from $162 million in 2001; excluding the 2001 extraordinary loss and special charge, earnings grew about 44% on a pro forma basis.
Bad debt fell to 5.3% of net revenues from 6.0%, and SG&A declined to 26.2% of revenues from 28.1%, reflecting Six Sigma and standardization gains.
Operating cash flow reached $596 million, and days sales outstanding improved to 49 from 54, while year-end cash was $97 million.
The February 2003 Unilab acquisition added about 7.4 million shares, $297 million in cash, and a $450 million term loan, with $25-30 million in targeted annual synergies by end-2005.
Managed care organizations account for about half of testing volume and revenue, with capitated contracts and non-exclusive arrangements increasing price pressure.
Medicare and Medicaid represent about 15% of revenue, and the company faces ongoing billing-related investigations, qui tam suits, and FDA regulatory uncertainty for lab-developed genetic tests.

03—Questions

Frequently Asked Questions

How much did Quest Diagnostics' earnings improve in 2002?
Net income was $322 million, or $3.23 per diluted share, compared with $162 million, or $1.66 per diluted share, in 2001. The 2001 results included a $36 million pre-tax extraordinary loss and a $6 million special charge. Goodwill amortization also ended in 2002 under SFAS 142, which lifted reported earnings.
What is the Unilab acquisition and what does it mean for shareholders?
Quest acquired Unilab, the leading independent clinical lab in California, on February 28, 2003. It paid about $297 million in cash, issued about 7.4 million shares, and plans to repay most of Unilab's debt. Management expects $25-30 million in annual synergies by 2005, with up to $20 million in integration costs during 2003-2004, and must divest some northern California assets to LabCorp.
What are the main risks facing Quest's business?
Key risks include pricing pressure from managed care contracts, which make up about half of revenue; the possibility of losing major managed care agreements; government reimbursement cuts or changes to Medicare billing rules; potential liabilities from billing-related investigations and qui tam lawsuits; integration risk from multiple acquisitions; and possible FDA regulation of laboratory-developed genetic tests.
How is Quest's financial position and cash generation?
Operating cash flow was $596 million in 2002, up $131 million from 2001. Long-term debt was $797 million at year-end, and stockholders' equity increased to $1.77 billion. The company had $325 million in unsecured revolving credit and $250 million in secured receivables capacity available at year-end. Quest has never paid cash dividends and does not plan to do so in the foreseeable future.
What growth does management expect for the clinical lab industry and for Quest?
Management expects industry revenue to grow about 5% to 7% per year over the long term, with growth near the low end of that range in the short term. Drivers include an aging population, genomics and proteomics research, infectious disease testing, and greater consumer demand for testing. Quest's strategy centers on gene-based testing, which it estimates at about $400 million in revenue growing more than 20% annually, plus anatomic pathology and selective regional acquisitions.

04—Continue

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