01—Abstract
Summary
Summary of the 10-K filed February 16, 2012. Cited figures are marked; the original filing is the authoritative source.
Quest Diagnostics (DGX) enters 2012 as the world's largest commercial clinical testing company, reporting 2011 net revenues of $7.51 billiona (up 1.9%, with the Athena and Celera acquisitions contributing 2.2 points) on roughly 146 million test requisitions.
Underlying performance weakened: clinical testing volume was essentially flat, revenue per requisition rose only 1.1%, and operating income fell 23% to $995 millionb (13.2% of revenue vs. 17.6% in 2010). Diluted EPS from continuing operations declined 27.8% to $2.93, though that figure absorbs a $236 million pre-tax charge (about $1.22 per share) to settle the California Medi-Cal lawsuit, plus restructuring, acquisition and CEO-succession costs. Excluding these one-time items, the decline reflects softer physician office visits, higher employee compensation costs and investments in sales and service.
Capital allocation is the main shift in strategy. Management plans to use most free cash flow in 2012 to pay down debt, targeting a debt/EBITDA ratio of 2 to 2.25 times, and expects to return a majority of free cash flow to shareholders afterward. The quarterly dividend was raised 70% to $0.17c, and a further $1.0 billion repurchase authorization brings the total to $1.1 billion.
Total debt rose to about $4.0 billiond after roughly $1.1 billion of acquisitions and $935 million of buybacks in 2011, and the company announced a $500 million operating cost reduction program through 2014. Management says large acquisitions are unlikely near term.
Key risks for investors include continued reimbursement pressure from health plans and government payers (Medicare clinical lab fees were cut 1.75% for five years under healthcare reform), growing FDA scrutiny of laboratory-developed tests, billing and fraud enforcement, including a Senate inquiry and several qui tam and state Medicaid suits, and the lack of a permanent CEO at the time of filing. The company reports effective internal controls, and PricewaterhouseCoopers issued an unqualified opinion dated February 16, 2012.
02—Key points
Key Highlights
- Revenue of $7.51B in 2011, up 1.9%; Athena and Celera acquisitions added 2.2 points, while clinical testing volume was essentially flat.
- Operating income fell 23% to $995M (13.2% margin vs. 17.6%), driven by the $236M Medi-Cal settlement charge and $52M of restructuring and integration costs.
- Diluted EPS from continuing operations was $2.93, down 27.8% from $4.06, with about $1.60 per share of net one-time items; share buybacks added $0.28.
- Capital return reset: quarterly dividend raised 70% to $0.17, with a $1.0B buyback authorization (total $1.1B) and a plan to prioritize debt reduction to reach 2 to 2.25x debt/EBITDA in 2012.
- Total debt rose to $4.02B at year-end 2011, up from $2.99B, after the $1.25B senior notes offering and about $1.1B of acquisitions.
- $500M cost reduction program targeted by end of 2014, with meaningful savings expected starting in 2012.
- Regulatory and legal exposure remains elevated: FDA guidance on laboratory-developed tests, a Senate Finance/Judiciary inquiry, multiple qui tam and Medicaid overcharge suits, and a Corporate Integrity Agreement.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2011, Quest Diagnostics Inc kept $0.06.
- Revenue$7.39B100.0%
- Cost of revenue−$4.36B59.0%
- Gross profit$3.03B41.0%
- Operating costs−$2.04B27.6%
- Operating income$987.0M13.4%
- Interest, other & tax−$516.0M7.0%
- Net income$471.0M6.4%
Where FY2011 revenue went
$7.39B- Cost of revenue: $4.36B, 59% of revenue
- SG&A: $1.74B, 24% of revenue
- Net income: $471.0M, 6.4% of revenue
- Other operating costs: $299.0M, 4.0% of revenue
- Interest, other & tax: $516.0M, 7.0% of revenue
Kept 6.4% as net incomeNet income $471.0M · 6.4%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2011filed February 16, 2012Financial Statements
FY2011 against FY2010
| Line item | FY2011FY2010 | Change |
|---|---|---|
| Revenue | $7.39B$7.26B | +1.8% |
| Cost of Revenue | $4.36B$4.28B | +2.0% |
| Gross Profit | $3.03B$3.05B | −0.7% |
| SG&A Expenses | $1.74B$1.66B | +5.1% |
| Operating Expenses | $6.41B$5.98B | +7.2% |
| Operating Income | $987.00M$1.28B | −23.1% |
| Interest Expense | $173.35M$147.50M | +17.5% |
| Net Income | $471.00M$720.89M | −34.7% |
| EPS (Basic) | $2.95$4.08 | −27.7% |
| EPS (Diluted) | $2.92$4.05 | −27.9% |
| Shares Outstanding (Basic) | 159.00M175.68M | −9.5% |
| Shares Outstanding (Diluted) | 160.00M177.32M | −9.8% |
05—Questions
Frequently Asked Questions
How did Quest Diagnostics perform in 2011 excluding one-time charges?
Reported results include a $236M Medi-Cal settlement charge, $52M of restructuring and integration costs, $16.9M of acquisition transaction costs, and $5.6M of CEO-succession costs, together about $1.60 per diluted share. Excluding these, operating performance still declined year over year because of flat testing volume, a weaker physician office environment, higher compensation and benefit costs, and sales and service investments. Management's own commentary attributes the weakness to reduced revenue before acquisitions and cost growth, not to a one-time event.
What is the new capital allocation policy and what does it mean for shareholders?
In 2012 the company expects to use most of its free cash flow to reduce debt and reach a debt/EBITDA ratio of 2 to 2.25x while keeping an investment-grade rating. After that target is met, it plans to return a majority of free cash flow through dividends and buybacks. The dividend was raised to $0.17 per quarter from $0.10, and a $1.1B total repurchase authorization is available. Near-term capital spending is expected to be lower, at $225M to $250M, and large acquisitions are considered unlikely.
What are the biggest risks to Quest's revenue and margins?
The main risks are reimbursement pressure from Medicare, Medicaid, and health plans; continued consolidation of payers, which can lead to capitated or single-network contracts; potential shifts of testing to physician offices and hospitals as point-of-care tests grow; and declining healthcare utilization. Regulatory risk is also significant: the FDA plans guidance on laboratory-developed tests, the molecular code (CPT) transition could affect payment levels, and ICD-10 implementation by October 2013 may create coding and reimbursement issues. Legal exposure includes government inquiries and qui tam suits, but management does not currently believe losses are probable for most pending matters.
How concentrated is Quest's revenue among payers and customers?
Healthcare insurers account for roughly half of clinical testing net revenue, and the two largest health plans together represent about 12% of consolidated revenue (the largest about 8%). Traditional Medicare and Medicaid represent about 18% of net revenue, and the Clinical Laboratory Fee Schedule alone accounts for about 12%. Patients make up a larger share of accounts receivable (about 21% of clinical testing receivables), which creates collection risk that management manages through allowances and reserves.
What is the balance sheet picture after the 2011 acquisitions?
Total assets were $9.3B and stockholders' equity was $3.7B at year-end 2011, down from $4.05B the prior year because of buybacks and the reduction in retained earnings from distributions. Goodwill rose to $5.8B and intangible assets to $1.0B after the Athena and Celera acquisitions. Cash fell to $165M, and short-term borrowings plus current debt reached $654M. Management expects cash flow and about $1.2B of available credit capacity to cover working capital, capital expenditures, debt service, and dividends.
06—Continue