10-QPeriod: Q3 FY2006

QUEST DIAGNOSTICS INC Quarterly Report for Q3 Ended Sep 30, 2006

Filed October 27, 2006For Securities:DGX

Summary

Quest Diagnostics (DGX) reported solid financial results for the nine months ended September 30, 2006, with income from continuing operations increasing to $474 million, or $2.37 per diluted share, up from $424 million, or $2.06 per diluted share, in the prior year. This growth was primarily driven by improvements in the core clinical testing business, benefiting from organic revenue growth and operational efficiencies gained through Six Sigma, standardization, and consolidation initiatives. The company successfully integrated the acquisitions of LabOne, Inc. and Focus Diagnostics, Inc., which contributed significantly to revenue growth, although these integrations also incurred associated costs. Investors should note the impact of adopting SFAS 123R for stock-based compensation, which resulted in higher reported expenses. Additionally, the company announced it would not be a national contracted provider for UnitedHealthcare Group starting January 1, 2007, representing approximately 7% of its revenue, though efforts are underway to retain business as an out-of-network provider. While the company is managing its debt obligations, including senior notes for the LabOne acquisition, and continues its share repurchase program, the financial impact of the UnitedHealthcare contract termination remains to be seen.

Key Highlights

  • 1Income from continuing operations rose to $474 million ($2.37/share) for the first nine months of 2006, an increase from $424 million ($2.06/share) in the same period of 2005.
  • 2Net revenues grew by 17.1% to $4.7 billion for the first nine months of 2006, significantly boosted by the acquisitions of LabOne and Focus Diagnostics.
  • 3The company adopted SFAS 123R for stock-based compensation, leading to increased expense recognition, with $53 million in pre-tax expenses for the nine months ended September 30, 2006.
  • 4The integration of LabOne, Inc. and Focus Diagnostics, Inc. is progressing, with expected annual synergies of $40 million from LabOne, anticipated by the end of 2007.
  • 5Quest Diagnostics announced it will not be a national contracted provider for UnitedHealthcare Group starting January 1, 2007, a client representing approximately 7% of consolidated net revenues.
  • 6Cash flow from operations was strong at $646 million for the first nine months of 2006, supporting investing and financing activities, including share repurchases and dividends.
  • 7The company is continuing its share repurchase program, with $446 million remaining under authorization as of September 30, 2006, and paid dividends of $57 million during the nine-month period.

Frequently Asked Questions

UnitedHealthcare (UNH) accounts for approximately 7% of Quest Diagnostics' consolidated net revenues. While the company will no longer be a national contracted provider starting January 1, 2007, it expects to continue servicing UNH members in certain markets as a contracted or out-of-network provider. The company is developing plans to retain UNH business and reduce costs, but cannot estimate the financial impact at this time, with further information expected in January 2007.

Quest Diagnostics adopted SFAS 123R ('Share-Based Payment') effective January 1, 2006. This requires the expensing of stock-based compensation. For the nine months ended September 30, 2006, this resulted in $53 million in pre-tax expenses, impacting both the cost of services and selling, general, and administrative expenses, and reducing operating income as a percentage of net revenues by approximately 1.0%.

The acquisition of LabOne, Inc. for approximately $947 million and Focus Diagnostics, Inc. for $208 million have significantly contributed to revenue growth. The integration of LabOne is ongoing, with $23 million in costs recognized in Q1 2006, and the company anticipates realizing approximately $40 million in annual synergies by the end of 2007. Integration costs for LabOne were accounted for as charges to earnings and goodwill, while Focus Diagnostics was financed through borrowings and cash on hand.

Quest Diagnostics has a total debt of approximately $1.6 billion at September 30, 2006. Interest expense has increased due to the $900 million senior notes issued to fund the LabOne acquisition. The company's cash flow from operations is strong, and it maintains significant borrowing capacity under its credit facilities. Management believes its cash from operations and credit facilities will be sufficient to meet its obligations and fund future growth, including capital expenditures, dividends, and share repurchases.