01—Abstract
Summary
Summary of the 10-K filed February 22, 2008. Cited figures are marked; the original filing is the authoritative source.
Quest Diagnostics (DGX) closed 2007 as the largest U.S. clinical testing provider, with net revenues of $6.70 billiona, up 7.0% from $6.27 billion in 2006.
Growth was driven by the May 2007 AmeriPath acquisition (about 8 points of revenue growth) and the HemoCue, Focus Diagnostics and Enterix acquisitions (about 1.7 points). These gains were offset by the loss of its contracted-provider status with UnitedHealthcare (UNH), which reduced clinical testing volume about 7%b and revenue growth by about 5%. Requisition volume fell 4.1% for the year.
Operating margin fell to 16.3% from 18.0%, and diluted EPS from continuing operations dropped to $2.84c from $3.14. The headline GAAP figure is weaker than the continuing-operations results. Net income fell to $340 million ($1.74 diluted EPS) from $586 million, mainly because of a $241 million pre-tax reserve (about $214 million after tax, $1.10 per share) for the government investigation related to its former NID test-kit subsidiary (the parathyroid hormone matter).
The company says eventual losses could substantially exceed that reserve. Management also reported an effective internal control assessment, though it excluded AmeriPath and HemoCue from scope. The balance sheet changed materially.
Long-term debt rose to $3.38 billiond from $1.24 billion, funding about $1.5 billion in acquisitions. Goodwill reached $5.22 billion, roughly 61% of total assets of $8.57 billion. Operating cash flow was steady at $927 million, and capital expenditures were $219 million.
Management guided to $280-300 million of 2008 capital spending, a $500 million cost-reduction program announced in July 2007, and a focus on debt reduction and integration rather than large acquisitions. Key risks include Medicare competitive bidding (a San Diego pilot starting July 2008), payer consolidation, and the open government investigations.
02—Key points
Key Highlights
- Revenue grew 7.0% to $6.70 billion, driven mainly by AmeriPath (about 8 points) and other acquisitions (about 1.7 points), partly offset by the UNH contract loss (about -5 points).
- Requisition volume declined 4.1%, while revenue per requisition rose 10.2%, reflecting AmeriPath, higher UNH non-contracted reimbursement and a more esoteric test mix.
- Operating income was $1.09 billion, or 16.3% of revenue, versus 18.0% in 2006; income from continuing operations fell to $554 million ($2.84 diluted EPS) from $626 million ($3.14).
- Net income fell to $340 million ($1.74 diluted EPS) after a $241 million pre-tax reserve (about $1.10 per share) tied to the NID government investigation; losses could exceed the reserve.
- Long-term debt rose to $3.38 billion from $1.24 billion after the AmeriPath (about $2.0 billion) and HemoCue (about $450 million) acquisitions; the company reduced total debt by $417 million after the May 2007 peak.
- Goodwill of $5.22 billion (61% of total assets) raises impairment sensitivity if volumes or payer economics weaken further.
- Management launched a program targeting $500 million of additional cost reductions over several years, and reported $927 million of operating cash flow and $1.0 billion of unused credit capacity.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2007, Quest Diagnostics Inc kept $0.05.
- Revenue$6.70B100.0%
- Cost of revenue−$3.97B59.2%
- Gross profit$2.74B40.8%
- Operating costs−$1.64B24.5%
- Operating income$1.09B16.3%
- Interest, other & tax−$751.4M11.2%
- Net income$339.9M5.1%
Where FY2007 revenue went
$6.70B- Cost of revenue: $3.97B, 59% of revenue
- SG&A: $1.61B, 24% of revenue
- Net income: $339.9M, 5.1% of revenue
- Interest, other & tax: $751.4M, 11% of revenue
Kept 5.1% as net incomeNet income $339.9M · 5.1%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2007filed February 22, 2008Financial Statements
05—Questions
Frequently Asked Questions
Why did net income fall so sharply in 2007 when revenue grew?
Two main factors. First, the loss of UNH as a contracted provider cut clinical testing volume about 7% and pressured margins, and operating margin fell to 16.3% from 18.0%. Second, a $241 million pre-tax reserve for the government's NID investigation was recorded in discontinued operations, which pushed net income down to $340 million from $586 million. Excluding that reserve, the company's continuing operations still declined, with EPS of $2.84 versus $3.14.
How significant is the NID investigation risk?
It is material. The government has disclosed legal theories under the False Claims Act and the Food, Drug and Cosmetic Act, and could seek penalties, exclusion from federal healthcare programs or criminal action. The $241 million reserve reflects only the company's estimate of minimum probable loss, and the filing says eventual losses may substantially exceed it. Settlement talks with the U.S. Attorney's Office for the Eastern District of New York are ongoing, but timing and terms are uncertain.
What does the AmeriPath acquisition add, and what has it cost?
AmeriPath, acquired May 31, 2007 for about $2.0 billion including roughly $780 million of assumed debt, adds leading anatomic pathology and dermatopathology capabilities, about $800 million of annual revenue, roughly 400 pathologists and 40 outpatient pathology labs. It contributed about 8 points of 2007 revenue growth but carries a higher bad-debt rate and lowered margins. Management expects revenue growth and cost synergies over time and said the integration was substantially complete by year-end.
What are the main risks to reimbursement going forward?
The main risks are Medicare competitive bidding (a San Diego demonstration project beginning July 1, 2008, with a second site not yet selected), possible cuts to the Medicare clinical lab fee schedule (with the physician fee schedule increase only through June 2008), the loss of independent lab direct billing for hospital pathology technical components, and continued consolidation among health insurers that pushes for capitated or discounted fee arrangements. The company also notes that Medicare and Medicaid represent about 17% of revenue.
How leveraged is Quest after its 2007 acquisitions, and can it manage the debt?
Total debt was $3.54 billion at year-end 2007, up from $1.56 billion, and interest expense rose to $178 million from $91 million. Management said operating cash flow of $927 million and about $1.0 billion of available credit capacity provide sufficient liquidity, and the company reduced debt by $417 million after its May 2007 peak. Its investment-grade ratings support access to capital, but the filing also warns that ratings could be lowered and that borrowing costs would rise if they were.
06—Continue