10-QPeriod: Q2 FY2006

QUEST DIAGNOSTICS INC Quarterly Report for Q2 Ended Jun 30, 2006

Filed July 31, 2006For Securities:DGX

Summary

Quest Diagnostics Inc. reported solid top-line growth for the second quarter of 2006, with net revenues increasing by 15% year-over-year to $1.58 billion. This growth was primarily driven by the clinical laboratory testing business, which saw a 10.3% increase, supported by both volume and a shift towards more complex, higher-value esoteric tests. The recent acquisition of LabOne also contributed significantly to revenue, adding approximately 10% to the consolidated growth. However, net income saw a decrease due to the significant underperformance and planned discontinuation of the NID test kit manufacturing subsidiary. NID's issues, including quality problems and wind-down charges, negatively impacted earnings by $0.12 per diluted share for the quarter and $0.17 per diluted share year-to-date. Despite the drag from NID, Quest Diagnostics is implementing strategic initiatives like Six Sigma and standardization to drive operating efficiencies. The company also adopted new accounting standards for stock-based compensation (SFAS 123R), which resulted in increased expense but is now recognized according to fair value. Management expects to realize approximately $40 million in annual synergies from the LabOne integration by the end of 2007. The company also made progress on its capital allocation strategies, including continued share repurchases and a consistent dividend payout.

Key Highlights

  • 1Net revenues increased 15.0% to $1.58 billion for Q2 2006, driven by strong performance in the core clinical laboratory testing business and contributions from the LabOne acquisition.
  • 2The core clinical laboratory testing business saw revenue growth of 10.3%, fueled by a 5.7% increase in volume and a favorable shift towards higher-value esoteric tests.
  • 3Net income decreased to $132 million ($0.66/share) in Q2 2006 from $149 million ($0.72/share) in Q2 2005, primarily due to the underperformance and discontinuation of the NID subsidiary.
  • 4The company recorded $28 million in pre-tax charges related to the wind-down of NID's operations in Q2 2006.
  • 5Adoption of SFAS 123R for stock-based compensation increased expenses, with $20 million recognized for Q2 2006.
  • 6Quest Diagnostics continues its share repurchase program, buying back 2.6 million shares for $150 million in Q2 2006.
  • 7Subsequent to quarter-end, the company completed the acquisition of Focus Diagnostics, Inc. for $206 million.

Frequently Asked Questions

The decrease in net income was primarily due to the significant underperformance of the NID test kit manufacturing subsidiary. NID faced quality issues, resulting in product holds and ultimately the decision to discontinue its operations. The wind-down charges and ongoing losses from NID negatively impacted earnings.

The acquisition of LabOne, completed in November 2005, contributed to revenue growth, adding approximately 10% to consolidated revenue. While LabOne's risk assessment business has lower margins than the core business, the company expects to realize approximately $40 million in annual synergies from its integration by the end of 2007.

Quest Diagnostics adopted SFAS 123R effective January 1, 2006. This standard requires companies to recognize stock-based compensation expense based on its fair value. For the second quarter of 2006, the company recorded $20 million in stock-based compensation expense under SFAS 123R, which increased operating expenses compared to prior periods that used the intrinsic value method.

The company is involved in various legal proceedings, including investigations related to billing practices and subpoenas from government authorities. While management believes these matters will not materially adversely affect the company's financial condition, they could impact results of operations or cash flows in the period they are resolved or paid. The NID subsidiary is also subject to an ongoing government investigation and regulatory review.