01—Abstract
Summary
Summary of the 10-K filed February 27, 2013. Cited figures are marked; the original filing is the authoritative source.
Quest Diagnostics (DGX) reported 2012 net revenues of $7.38 billiona, essentially flat versus 2011 ($7.39 billion), with diagnostic information services (DIS) at about 92% of revenue.
Operating income rose 22% to $1.20 billionb (16.3% margin vs. 13.4%), but the improvement is largely the result of comparison effects: 2011 included a $236 million Medi-Cal settlement charge. Income from continuing operations increased 37% to $630 million, or $3.92 diluted EPS, while net income attributable to Quest fell to $556 million ($3.46 diluted) after a $74 million loss from discontinued operations, mainly the $78 million HemoCue goodwill impairment. Underlying organic volume was roughly flat (requisitions up 0.2%), so the year's earnings gains depended more on cost reduction than on top-line growth.
Management launched a five-point strategy centered on refocusing on core diagnostic information services, the Invigorate cost program ($600 millionc run-rate savings by the end of 2014, with an aspiration of $1 billion), and Project Restore to restore revenue growth. The company is simplifying its organization by eliminating three management layers and roughly 400 to 600 management positions by the end of 2013. It sold OralDNA and agreed in February 2013 to sell HemoCue for about $300 million, with proceeds earmarked for roughly $300 million of share repurchases.
Leverage was reduced to a target debt/EBITDA of 2 to 2.25 times, and the quarterly dividend was raised 76% to $0.30d per share, which the company expects to grow over time. Key risks include continued reimbursement pressure (the 2013 Medicare Clinical Laboratory Fee Schedule decreases 2.95%, before sequestration), potential FDA regulation of laboratory-developed tests, competition from hospital-affiliated labs, health plan consolidation, ongoing government and qui tam investigations, and execution risk in the restructuring. Total debt was about $3.4 billion at year-end, and the company remains investment grade.
02—Key points
Key Highlights
- 2012 net revenues of $7.38B, roughly flat year over year; requisition volume up only 0.2%, so growth was driven mainly by price and mix
- Operating income up 22% to $1.20B (16.3% margin), largely because 2011 included a $236M Medi-Cal settlement charge
- Diluted EPS from continuing operations of $3.92 (up 37%); net income attributable to Quest of $3.46 diluted after a $74M loss from discontinued operations (HemoCue impairment)
- Invigorate cost program targets $600M run-rate savings by end of 2014 (about $200M achieved as of year-end 2012), with an aspiration of up to $1B
- Quarterly dividend raised 76% to $0.30 (annual $1.20, three times the 2011 rate); $865M remained under buyback authorization at year-end
- Debt reduced to a target leverage of 2.0 to 2.25x debt/EBITDA; total debt of about $3.4B; HemoCue sale (~$300M) expected to fund ~$300M of buybacks
- Key risks: 2013 Medicare clinical lab fee schedule cut of 2.95%, potential FDA regulation of LDTs, hospital and health plan pricing pressure, and open government and qui tam investigations
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2012, Quest Diagnostics Inc kept $0.08.
- Revenue$7.38B100.0%
- Cost of revenue−$4.37B59.1%
- Gross profit$3.02B40.9%
- Operating costs−$1.82B24.6%
- Operating income$1.20B16.3%
- Interest, other & tax−$645.0M8.7%
- Net income$556.0M7.5%
Where FY2012 revenue went
$7.38B- Cost of revenue: $4.37B, 59% of revenue
- SG&A: $1.75B, 24% of revenue
- Net income: $556.0M, 7.5% of revenue
- Other operating costs: $72.0M, 1.0% of revenue
- Interest, other & tax: $645.0M, 8.7% of revenue
Kept 7.5% as net incomeOther operating costs $72.0M · 1.0%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2012filed February 27, 2013Financial Statements
FY2012 against FY2011
| Line item | FY2012FY2011 | Change |
|---|---|---|
| Revenue | $7.38B$7.39B | −0.1% |
| Cost of Revenue | $4.37B$4.36B | 0.0% |
| Gross Profit | $3.02B$3.03B | −0.4% |
| SG&A Expenses | $1.75B$1.74B | +0.1% |
| Operating Expenses | $6.18B$6.41B | −3.5% |
| Operating Income | $1.20B$987.00M | +21.7% |
| Net Income | $556.00M$471.00M | +18.0% |
| EPS (Basic) | $3.49$2.95 | +18.3% |
| EPS (Diluted) | $3.46$2.92 | +18.5% |
| Shares Outstanding (Basic) | 159.00M159.00M | 0.0% |
| Shares Outstanding (Diluted) | 160.00M160.00M | 0.0% |
05—Questions
Frequently Asked Questions
Why did operating income rise 22% if revenue was flat?
Most of the increase reflects the absence of the $236 million Medi-Cal charge recorded in 2011, along with savings from the Invigorate program. Those gains were partly offset by $106 million of 2012 restructuring and integration charges, costs tied to the CEO succession, and expenses from the Athena, Celera and S.E.D. acquisitions.
What happened with the HemoCue business?
Quest committed in late 2012 to sell HemoCue, its point-of-care testing business, and agreed in February 2013 to sell it for about $300 million plus cash on hand at closing. HemoCue is reported as discontinued operations, and a $78 million goodwill and asset impairment was recorded in 2012. Proceeds are planned for about $300 million of share repurchases.
Is the dividend increase sustainable?
Management says the $1.20 annual dividend can grow over time, in line with earnings and cash flow. The payout is funded from operating cash flow, which was $1.19B in 2012 and benefited from a one-time deferral of roughly $70M in taxes and $72M from terminating interest rate swaps. Dividend payments in 2012 were $108M.
What are the biggest regulatory risks?
The FDA has claimed authority over laboratory-developed tests and has announced initiatives that could increase regulation, which the company says could significantly affect its business. Medicare reimbursement is also under pressure, including a 2.95% cut to the 2013 Clinical Laboratory Fee Schedule and a 2% sequestration reduction delayed to April 2013. Government inquiries include a Senate Finance and Judiciary inquiry, subpoenas, and qui tam suits.
How is the company reducing costs and simplifying?
Under Invigorate, Quest targets $600M in run-rate savings versus 2011 by the end of 2014, with about $200M achieved by year-end 2012. A 2012 voluntary retirement program is expected to yield about $40M of annualized savings, and a restructuring is expected to eliminate three management layers and 400 to 600 positions by the end of 2013. Total pre-tax Invigorate charges are estimated at $170M to $250M through 2014.
06—Continue