The Company has a line of credit with a financial institution totaling $85 million for the issuance of letters of credit (the “Letter of Credit Line”). The Letter of Credit Line, which is renewed annually, matures on November 19, 2011 and is guaranteed by the Subsidiary Guarantors.
In support of its risk management program, to ensure the Company’s performance or payment to third parties, $63 million in letters of credit were outstanding at June 30, 2011. The letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments. In addition, $6 million of bank guarantees were outstanding at June 30, 2011 in support of certain foreign operations.
The Company is subject to contingent obligations under certain leases and other instruments incurred in connection with real estate activities and other operations associated with LabOne, Inc., which the Company acquired in 2005, and certain of its predecessor companies. No liability has been recorded for any of these potential contingent obligations. See Note 15 to the Consolidated Financial Statements contained in the Company’s 2010 Annual Report on Form 10-K for further details.
The Company is involved in various legal proceedings. Some of the proceedings against the Company involve claims that are substantial in amount.
In 2006 and 2008, the Company and several of its subsidiaries received subpoenas from the California Attorney General’s Office (the “Attorney General”) seeking documents relating to the Company’s billings to Medi-Cal, the California Medicaid program. The Company cooperated with the government’s requests. Subsequently, the State of California intervened as plaintiff in a civil lawsuit, California ex rel. Hunter Laboratories, LLC v. Quest Diagnostics Incorporated., et al. (the “California Lawsuit”), filed in California Superior Court against a number of clinical laboratories, including the Company and several of its subsidiaries. The complaint was originally filed by a competitor laboratory in California under the whistleblower provisions of the California False Claims Act. The complaint was unsealed on March 20, 2009.
The plaintiffs alleged, among other things, that the Company overcharged Medi-Cal for testing services and violated the California False Claims Act. Specifically, the plaintiffs alleged, among other things, that the Company violated certain regulations that govern billing to Medi-Cal (“Comparable Charge” regulations). A liability finding could have lead to an injunction, fines or penalties, and exclusion from Medi-Cal, as well as claims by third parties.
In the third quarter of 2010, the California Department of Health Care Services (the “Department”) conducted an audit of the Company’s billing to Medi-Cal. The Department contended that the Company’s billings were not consistent with applicable California regulations, as then interpreted by the Department. While the Company believes it was in compliance in all material respects with California requirements applicable to billing for clinical laboratory testing, the Company entered into an interim agreement under which it agreed to temporarily suspend billing Medi-Cal for a period of up to six months through March 1, 2011, during which it continued to provide services. The agreement was subsequently extended. The Company continued to recognize revenue from Medi-Cal for services provided in accordance with its interpretation of California regulations related to billing for clinical laboratory testing.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
The Company engaged in discussions in an attempt to resolve the matters described above. Agreement with both the Attorney General and the Department was required to settle this matter. During the fourth quarter of 2010, the Company reached an understanding, which was highly conditioned, to settle these matters pursuant to which the Company would pay $241 million. Conditions included, but were not limited to, reaching an agreement regarding the manner in which the Company’s future billings would be treated by the Department. In subsequent discussions during the fourth quarter of 2010, the Attorney General and the Department rejected the Company’s proposals that would have addressed these outstanding issues. As a result, as of the issuance of the Company’s financial statements for 2010, settlement discussions had reached an impasse. Based on these facts and circumstances, the Company concluded that a liability was not probable as of December 31, 2010.
In the first quarter of 2011, settlement discussions resumed. On May 9, 2011, the Company announced an agreement in principle to resolve these matters. On May 19, 2011, the Company finalized a settlement and release with the Attorney General, the Department and thequi tam relator. While denying liability, in order to avoid the uncertainty, expense and risks of litigation, the Company agreed to resolve these matters for $241 million. The Company agreed to the settlement to resolve the Comparable Charge allegations; the Company received a full release of these and all other allegations in the complaint. The Company also agreed to certain reporting obligations regarding its pricing for a limited time period and, at the option of the Company in lieu of such obligations for a transitional period, to provide Medi-Cal with a discount (the “Transitional Discount”) until the end of July 2012. The Transitional Discount, to the extent provided, is not expected to have a material impact on the Company’s consolidated revenues or results of operations.
As provided for in the settlement agreement, the Company resumed billing for unbilled services and expects to be reimbursed for all services provided prior to the effective date of the settlement agreement. Such reimbursement is expected to be consistent with the related amounts accrued.
As a result of the agreement in principle, the Company recorded a pre-tax charge to earnings in the first quarter of 2011 of $236 million, which represented the cost to resolve the matters noted above and related claims, less amounts previously reserved for related matters. The Company funded the $241 million payment in the second quarter of 2011 with cash on hand and borrowings under its existing credit facilities.
Other Legal Matters
In 2005, the Company received a subpoena from the U.S. Department of Health and Human Services, Office of the Inspector General, seeking business records including records regarding the Company’s relationship with health maintenance organizations, independent physician associations, group purchasing organizations, and preferred provider organizations relating back to 1995. The Company has cooperated with the investigation. Subsequently, in November 2009, the U.S. District Court for the Southern District of New York partially unsealed a civil complaint, U.S. ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Incorporated, filed against the Company under the whistleblower provisions of the federal False Claims Act. The complaint alleges, among other things, violations of the federal Anti-Kickback Statute and the federal False Claims Act in connection with the Company’s pricing of laboratory services. The complaint seeks damages for alleged false claims associated with laboratory tests reimbursed by government payors, treble damages and civil penalties. In March 2011, the district court granted the Company’s motion to dismiss the relators’ complaint and disqualified the relators and their counsel from pursuing an action based on the facts alleged in the complaint; the relators filed a notice of appeal. The government was given additional time to decide whether to join the case. In July 2011, the government filed a notice declining to intervene in the action and the Court entered a final judgment in the Company’s favor. The relators’ appeal is pending.
In April 2010, a putative class action was filed against the Company and NID in the U.S. District Court for the Eastern District of New York on behalf of entities that allegedly purchased or paid for certain of NID’s test kits. The complaint alleges that certain of NID’s test kits were defective and that defendants, among other things, violated RICO and state consumer protection laws. The complaint alleges an unspecified amount of damages.
In August 2010, a shareholder derivative action was filed in the Superior Court of New Jersey, Morris County, on behalf of the Company against the directors and certain present officers of the Company. The complaint alleges that the defendants breached their fiduciary duties in connection with, among other things, alleged overcharges by the Company to Medi-Cal for testing services, and seeks unspecified compensatory damages and equitable relief. The action was dismissed without prejudice. On July 21, 2011, the action was re-filed.
In November 2010, a putative class action was filed against the Company and certain present and former officers of the Company in the Superior Court of New Jersey, Essex County, on behalf of the Company’s sales people nationwide who were over forty years old and who either resigned or were terminated after being placed on a performance improvement plan. The complaint alleges that the defendants’ conduct violates the New Jersey Law Against Discrimination, and seeks, among other things, unspecified damages. The defendants removed the complaint to the United States District Court for the District of New Jersey.
22
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
In June 2011, a shareholder derivative action was filed in the Superior Court of New Jersey, on behalf of the Company against the current directors and a former director of the Company. The complaint alleges that the defendants breached their fiduciary duties, wasted corporate assets and were unjustly enriched in connection with, among other things, alleged overcharges by the Company to Medi-Cal for testing services, and seeks unspecified compensatory damages and equitable relief.
In addition, the Company and certain of its subsidiaries have received subpoenas from state agencies in five states and from the Office of the Inspector General of the U.S. Department of Health and Human Services which seek documents relating to the Company’s billing practices. The Company is cooperating with the requests.
The federal or state governments may bring claims based on new theories as to the Company’s practices which management believes to be in compliance with law. In addition, certain federal and state statutes, including the qui tam provisions of the federal False Claims Act, allow private individuals to bring lawsuits against healthcare companies on behalf of government or private payers. The Company is aware of certain pending individual or class action lawsuits, and has received several subpoenas, related to billing practices filed under the qui tam provisions of the Civil False Claims Act and/or other federal and state statutes, regulations or other laws. The Company understands that there may be other pending qui tam claims brought by former employees or other “whistle blowers” as to which the Company cannot determine the extent of any potential liability.
These matters are in different stages. Some of these matters are in their early stages. Matters may involve responding to and cooperating with various government investigations and related subpoenas. As of June 30, 2011, the Company does not believe that any losses related to these matters are probable. While the Company believes that a reasonable possibility exists that losses may have been incurred, based on the nature and status of the matters, potential losses, if any, cannot be estimated.
Reserves for Legal Matters
Management has established reserves in accordance with generally accepted accounting principles for the matters discussed above. Such reserves totaled approximately $2 million and $10 million as of June 30, 2011 and December 31, 2010, respectively. Management cannot predict the outcome of such matters. Although management does not anticipate that the ultimate outcome of such matters will have a material adverse effect on the Company’s financial condition, given the high degree of judgment involved in establishing accruals for loss estimates related to these types of matters, the outcome of such matters may be material to the Company’s results of operations or cash flows in the period in which the impact of such matters is determined or paid.
Reserves for General and Professional Liability Claims
As a general matter, providers of clinical testing services may be subject to lawsuits alleging negligence or other similar legal claims. These suits could involve claims for substantial damages. Any professional liability litigation could also have an adverse impact on the Company’s client base and reputation. The Company maintains various liability insurance coverages for, among other things, claims that could result from providing, or failing to provide, clinical testing services, including inaccurate testing results, and other exposures. The Company’s insurance coverage limits its maximum exposure on individual claims; however, the Company is essentially self-insured for a significant portion of these claims. Reserves for such matters, including those associated with both asserted and incurred but not reported claims, are established by considering actuarially determined losses based upon the Company’s historical and projected loss experience. Such reserves totaled approximately $137 million and $130 million as of June 30, 2011 and December 31, 2010, respectively. Management believes that established reserves and present insurance coverage are sufficient to cover currently estimated exposures. Management cannot predict the outcome of any claims made against the Company. Although management does not anticipate that the ultimate outcome of any such proceedings or claims will have a material adverse effect on the Company’s financial condition, given the high degree of judgment involved in establishing accruals for loss estimates related to these types of matters, the outcome may be material to the Company’s results of operations or cash flows in the period in which the impact of such claims is determined or paid.
| |
13. | DISCONTINUED OPERATIONS |
Summarized financial information for the discontinued operations of NID, a test kit manufacturing subsidiary which was closed in 2006, is set forth below:
23
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
| | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | Six Months Ended
June 30, | |
| |
| |
| |
| | 2011 | | 2010 | | 2011 | | 2010 | |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | |
Net revenues | | $ | — | | $ | — | | $ | — | | $ | — | |
| | | | | | | | | | | | | |
Income (loss) from discontinued operations before income taxes | | | (190 | ) | | 280 | | | (282 | ) | | 295 | |
Income tax expense | | | (317 | ) | | (546 | ) | | (599 | ) | | (613 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Loss from discontinued operations, net of taxes | | $ | (507 | ) | $ | (266 | ) | $ | (881 | ) | $ | (318 | ) |
| |
|
| |
|
| |
|
| |
|
| |
The remaining balance sheet information related to NID was not material at June 30, 2011 and December 31, 2010.
| |
14. | BUSINESS SEGMENT INFORMATION |
Clinical testing is an essential element in the delivery of healthcare services. Physicians use clinical tests to assist in the detection, diagnosis, evaluation, monitoring and treatment of diseases and other medical conditions. Clinical testing is generally categorized as clinical laboratory testing and anatomic pathology services. Clinical laboratory testing is performed on whole blood, serum, plasma and other body fluids, such as urine, and specimens such as microbiology samples. Anatomic pathology services are principally for the detection of cancer and are performed on tissues, such as biopsies, and other samples, such as human cells. Customers of the clinical testing business include patients, physicians, hospitals, employers, governmental institutions and other commercial clinical laboratories. The clinical testing business accounted for greater than 90% of net revenues from continuing operations in 2011 and 2010.
All other operating segments include the Company’s non-clinical testing businesses and consist of its risk assessment services, clinical trials testing, healthcare information technology and diagnostics products businesses. The Company’s risk assessment business provides underwriting support services to the life insurance industry including teleunderwriting, specimen collection and paramedical examinations, laboratory testing, medical record retrieval, case management, motor vehicle reports, telephone inspections, prescription histories and credit checks. The Company’s clinical trials testing business provides clinical testing performed in connection with clinical research trials on new drugs, vaccines and certain medical devices. The Company’s healthcare information technology business is a developer and integrator of clinical connectivity and data management solutions for healthcare organizations, physicians and clinicians than can help improve patient care and medical practice. The Company’s diagnostics products business manufactures and markets products that enable healthcare professionals to make healthcare diagnoses, including products for point-of-care testing for the professional market. During the second quarter of 2011, the Company acquired Athena and Celera (see Note 4 for further details). Athena is included in the Company’s clinical laboratory testing business. The majority of Celera’s operations are included in the Company’s clinical laboratory testing business, with the remainder in other operating segments.
On April 19, 2006, the Company decided to discontinue NID’s operations and results of operations for NID have been classified as discontinued operations for all periods presented (see Note 13).
At June 30, 2011, substantially all of the Company’s services are provided within the United States, and substantially all of the Company’s assets are located within the United States.
The following table is a summary of segment information for the three and six months ended June 30, 2011 and 2010. Segment asset information is not presented since it is not used by the chief operating decision maker at the operating segment level. Operating earnings (loss) of each segment represents net revenues less directly identifiable expenses to arrive at operating income for the segment. General management and administrative corporate expenses, including amortization of intangible assets and the charge to earnings in the first quarter of 2011 of $236 million related to the settlement of the California Lawsuit (see Note 12), are included in general corporate expenses below. The accounting policies of the segments are the same as those of the Company as set forth in Note 2 to the Consolidated Financial Statements contained in the Company’s 2010 Annual Report on Form 10-K and Note 2 to the interim consolidated financial statements.
24
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
| | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | Six Months Ended
June 30, | |
| |
| |
| |
| | 2011 | | 2010 | | 2011 | | 2010 | |
| |
| |
| |
| |
| |
Net revenues: | | | | | | | | | | | | | |
Clinical laboratory testing business | | $ | 1,726,948 | | $ | 1,715,112 | | $ | 3,389,113 | | $ | 3,372,179 | |
All other operating segments | | | 176,253 | | | 159,615 | | | 335,665 | | | 308,051 | |
| |
|
| |
|
| |
|
| |
|
| |
Total net revenues | | $ | 1,903,201 | | $ | 1,874,727 | | $ | 3,724,778 | | $ | 3,680,230 | |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | |
Operating earnings (loss): | | | | | | | | | | | | | |
Clinical laboratory testing business | | $ | 373,748 | | $ | 390,216 | | $ | 684,032 | | $ | 731,101 | |
All other operating segments | | | 14,766 | | | 16,944 | | | 22,625 | | | 18,506 | |
General corporate expenses | | | (71,660 | ) | | (41,266 | ) | | (358,843 | ) | | (85,151 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Total operating income | | | 316,854 | | | 365,894 | | | 347,814 | | | 664,456 | |
Non-operating expenses, net | | | (39,058 | ) | | (36,101 | ) | | (67,080 | ) | | (58,080 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations before taxes | | | 277,796 | | | 329,793 | | | 280,734 | | | 606,376 | |
Income tax expense | | | 105,762 | | | 125,651 | | | 154,988 | | | 231,029 | |
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations | | | 172,034 | | | 204,142 | | | 125,746 | | | 375,347 | |
Loss from discontinued operations, net of taxes | | | (507 | ) | | (266 | ) | | (881 | ) | | (318 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net income | | | 171,527 | | | 203,876 | | | 124,865 | | | 375,029 | |
Less: Net income attributable to noncontrolling interests | | | 8,384 | | | 9,261 | | | 15,583 | | | 17,966 | |
| |
|
| |
|
| |
|
| |
|
| |
Net income attributable to Quest Diagnostics | | $ | 163,143 | | $ | 194,615 | | $ | 109,282 | | $ | 357,063 | |
| |
|
| |
|
| |
|
| |
|
| |
On July 14, 2011, the Company adopted a restructuring plan that it expects to complete within the third quarter of 2011. The Company anticipates incurring a charge of approximately $20 million before tax (approximately $12 million after tax) in the third quarter of 2011, principally associated with workforce reduction costs, consisting primarily of severance and related benefits. The Company expects that the full amount of the charge will result in future cash expenditures.
| |
16. | SUMMARIZED FINANCIAL INFORMATION |
The Company’s Senior Notes due 2011, Floating Rate Senior Notes due 2014, Senior Notes due 2015, Senior Notes due 2016, Senior Notes due 2017, Senior Notes due 2020, Senior Notes due 2021, Senior Notes due 2037 and Senior Notes due 2040 are fully and unconditionally guaranteed, jointly and severally, by the Subsidiary Guarantors. With the exception of Quest Diagnostics Receivables Incorporated (“QDRI”) (see paragraph below), the non-guarantor subsidiaries are primarily foreign subsidiaries and less than wholly-owned subsidiaries.
In conjunction with the Company’s secured receivables credit facility, the Company maintains a wholly-owned non-guarantor subsidiary, QDRI. The Company and certain of its Subsidiary Guarantors transfer certain domestic receivables to QDRI. QDRI utilizes the transferred receivables to collateralize borrowings under the Company’s secured receivables credit facility. The Company and the Subsidiary Guarantors provide collection services to QDRI. QDRI uses cash collections principally to purchase new receivables from the Company and the Subsidiary Guarantors.
The following condensed consolidating financial data illustrates the composition of the combined guarantors. Investments in subsidiaries are accounted for by the parent using the equity method for purposes of the supplemental
25
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
consolidating presentation. Earnings (losses) of subsidiaries are therefore reflected in the parent’s investment accounts and earnings. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions.
26
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2011
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | |
Net revenues | | $ | 203,321 | | $ | 1,577,305 | | $ | 189,592 | | $ | (67,017 | ) | $ | 1,903,201 | |
| | | | | | | | | | | | | | | | |
Operating costs and expenses: | | | | | | | | | | | | | | | | |
Cost of services | | | 121,342 | | | 909,681 | | | 73,371 | | | — | | | 1,104,394 | |
Selling, general and administrative | | | 35,526 | | | 342,577 | | | 92,150 | | | (7,464 | ) | | 462,789 | |
Amortization of intangible assets | | | 543 | | | 16,048 | | | 2,001 | | | — | | | 18,592 | |
Royalty (income) expense | | | (104,418 | ) | | 104,418 | | | — | | | — | | | — | |
Other operating expense (income), net | | | 28 | | | 585 | | | (41 | ) | | — | | | 572 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total operating costs and expenses | | | 53,021 | | | 1,373,309 | | | 167,481 | | | (7,464 | ) | | 1,586,347 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income | | | 150,300 | | | 203,996 | | | 22,111 | | | (59,553 | ) | | 316,854 | |
Non-operating (expense) income, net | | | (45,706 | ) | | (53,301 | ) | | 396 | | | 59,553 | | | (39,058 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations before taxes | | | 104,594 | | | 150,695 | | | 22,507 | | | — | | | 277,796 | |
Income tax expense | | | 40,382 | | | 59,578 | | | 5,802 | | | — | | | 105,762 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations | | | 64,212 | | | 91,117 | | | 16,705 | | | — | | | 172,034 | |
Loss from discontinued operations, net of taxes | | | — | | | (507 | ) | | — | | | — | | | (507 | ) |
Equity earnings from subsidiaries | | | 98,931 | | | — | | | — | | | (98,931 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | | 163,143 | | | 90,610 | | | 16,705 | | | (98,931 | ) | | 171,527 | |
Less: Net income attributable to noncontrolling interests | | �� | — | | | — | | | 8,384 | | | — | | | 8,384 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income attributable to Quest Diagnostics | | $ | 163,143 | | $ | 90,610 | | $ | 8,321 | | $ | (98,931 | ) | $ | 163,143 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2010
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
Net revenues | | $ | 218,419 | | $ | 1,540,722 | | $ | 181,373 | | $ | (65,787 | ) | $ | 1,874,727 | |
| | | | | | | | | | | | | | | | |
Operating costs and expenses: | | | | | | | | | | | | | | | | |
Cost of services | | | 129,236 | | | 886,783 | | | 62,952 | | | — | | | 1,078,971 | |
Selling, general and administrative | | | 21,273 | | | 312,465 | | | 93,236 | | | (7,562 | ) | | 419,412 | |
Amortization of intangible assets | | | 18 | | | 7,601 | | | 1,651 | | | — | | | 9,270 | |
Royalty (income) expense | | | (105,316 | ) | | 105,316 | | | — | | | — | | | — | |
Other operating (income) expense, net | | | (1,346 | ) | | 233 | | | 2,293 | | | — | | | 1,180 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total operating costs and expenses | | | 43,865 | | | 1,312,398 | | | 160,132 | | | (7,562 | ) | | 1,508,833 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income | | | 174,554 | | | 228,324 | | | 21,241 | | | (58,225 | ) | | 365,894 | |
Non-operating (expense) income, net | | | (39,974 | ) | | (54,940 | ) | | 588 | | | 58,225 | | | (36,101 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations before taxes | | | 134,580 | | | 173,384 | | | 21,829 | | | — | | | 329,793 | |
Income tax expense | | | 52,577 | | | 67,331 | | | 5,743 | | | — | | | 125,651 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations | | | 82,003 | | | 106,053 | | | 16,086 | | | — | | | 204,142 | |
Loss from discontinued operations, net of taxes | | | — | | | (266 | ) | | — | | | — | | | (266 | ) |
Equity earnings from subsidiaries | | | 112,612 | | | — | | | — | | | (112,612 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | | 194,615 | | | 105,787 | | | 16,086 | | | (112,612 | ) | | 203,876 | |
Less: Net income attributable to noncontrolling interests | | | — | | | — | | | 9,261 | | | — | | | 9,261 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income attributable to Quest Diagnostics | | $ | 194,615 | | $ | 105,787 | | $ | 6,825 | | $ | (112,612 | ) | $ | 194,615 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
27
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2011
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | |
Net revenues | | $ | 401,810 | | $ | 3,080,649 | | $ | 380,879 | | $ | (138,560 | ) | $ | 3,724,778 | |
| | | | | | | | | | | | | | | | |
Operating costs and expenses: | | | | | | | | | | | | | | | | |
Cost of services | | | 244,933 | | | 1,817,071 | | | 139,388 | | | — | | | 2,201,392 | |
Selling, general and administrative | | | 73,962 | | | 654,306 | | | 197,203 | | | (14,824 | ) | | 910,647 | |
Amortization of intangible assets | | | 706 | | | 24,197 | | | 3,538 | | | — | | | 28,441 | |
Royalty (income) expense | | | (206,774 | ) | | 206,774 | | | — | | | — | | | — | |
Other operating expense (income), net | | | 236,306 | | | 371 | | | (193 | ) | | — | | | 236,484 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total operating costs and expenses | | | 349,133 | | | 2,702,719 | | | 339,936 | | | (14,824 | ) | | 3,376,964 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income | | | 52,677 | | | 377,930 | | | 40,943 | | | (123,736 | ) | | 347,814 | |
Non-operating (expense) income, net | | | (84,126 | ) | | (110,455 | ) | | 3,765 | | | 123,736 | | | (67,080 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) from continuing operations before taxes | | | (31,449 | ) | | 267,475 | | | 44,708 | | | — | | | 280,734 | |
Income tax expense | | | 36,768 | | | 105,743 | | | 12,477 | | | — | | | 154,988 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income (loss) from continuing operations | | | (68,217 | ) | | 161,732 | | | 32,231 | | | — | | | 125,746 | |
Loss from discontinued operations, net of taxes | | | — | | | (881 | ) | | — | | | — | | | (881 | ) |
Equity earnings from subsidiaries | | | 177,499 | | | — | | | — | | | (177,499 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | | 109,282 | | | 160,851 | | | 32,231 | | | (177,499 | ) | | 124,865 | |
Less: Net income attributable to noncontrolling interests | | | — | | | — | | | 15,583 | | | — | | | 15,583 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income attributable to Quest Diagnostics | | $ | 109,282 | | $ | 160,851 | | $ | 16,648 | | $ | (177,499 | ) | $ | 109,282 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2010
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
Net revenues | | $ | 429,640 | | $ | 3,023,312 | | $ | 373,709 | | $ | (146,431 | ) | $ | 3,680,230 | |
| | | | | | | | | | | | | | | | |
Operating costs and expenses: | | | | | | | | | | | | | | | | |
Cost of services | | | 251,823 | | | 1,766,570 | | | 126,951 | | | — | | | 2,145,344 | |
Selling, general and administrative | | | 44,351 | | | 626,583 | | | 194,104 | | | (14,893 | ) | | 850,145 | |
Amortization of intangible assets | | | 35 | | | 15,232 | | | 3,362 | | | — | | | 18,629 | |
Royalty (income) expense | | | (206,808 | ) | | 206,808 | | | — | | | — | | | — | |
Other operating (income) expense, net | | | (321 | ) | | 466 | | | 1,511 | | | — | | | 1,656 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total operating costs and expenses | | | 89,080 | | | 2,615,659 | | | 325,928 | | | (14,893 | ) | | 3,015,774 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Operating income | | | 340,560 | | | 407,653 | | | 47,781 | | | (131,538 | ) | | 664,456 | |
Non-operating (expense) income, net | | | (70,533 | ) | | (121,385 | ) | | 2,300 | | | 131,538 | | | (58,080 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations before taxes | | | 270,027 | | | 286,268 | | | 50,081 | | | — | | | 606,376 | |
Income tax expense | | | 104,062 | | | 113,078 | | | 13,889 | | | — | | | 231,029 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Income from continuing operations | | | 165,965 | | | 173,190 | | | 36,192 | | | — | | | 375,347 | |
Loss from discontinued operations, net of taxes | | | — | | | (318 | ) | | — | | | — | | | (318 | ) |
Equity earnings from subsidiaries | | | 191,098 | | | — | | | — | | | (191,098 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income | | | 357,063 | | | 172,872 | | | 36,192 | | | (191,098 | ) | | 375,029 | |
Less: Net income attributable to noncontrolling interests | | | — | | | — | | | 17,966 | | | — | | | 17,966 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net income attributable to Quest Diagnostics | | $ | 357,063 | | $ | 172,872 | | $ | 18,226 | | $ | (191,098 | ) | $ | 357,063 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
28
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
Condensed Consolidating Balance Sheet
June 30, 2011
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
Assets | | | | | | | | | | | | | | | | |
Current assets: | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 138,157 | | $ | 2,484 | | $ | 43,577 | | $ | — | | $ | 184,218 | |
Accounts receivable, net | | | 22,222 | | | 163,482 | | | 743,668 | | | — | | | 929,372 | |
Other current assets | | | 75,339 | | | 186,666 | | | 102,360 | | | — | | | 364,365 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 235,718 | | | 352,632 | | | 889,605 | | | — | | | 1,477,955 | |
Property, plant and equipment, net | | | 169,607 | | | 609,465 | | | 41,521 | | | — | | | 820,593 | |
Goodwill and intangible assets, net | | | 155,529 | | | 6,260,302 | | | 483,309 | | | — | | | 6,899,140 | |
Intercompany (payable) receivable | | | (461,060 | ) | | 739,576 | | | (278,516 | ) | | — | | | — | |
Investment in subsidiaries | | | 7,788,982 | | | — | | | — | | | (7,788,982 | ) | | — | |
Other assets | | | 274,555 | | | 43,974 | | | 50,321 | | | (135,347 | ) | | 233,503 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 8,163,331 | | $ | 8,005,949 | | $ | 1,186,240 | | $ | (7,924,329 | ) | $ | 9,431,191 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | |
Current liabilities: | | | | | | | | | | | | | | | | |
Accounts payable and accrued expenses | | $ | 786,734 | | $ | 161,246 | | $ | 50,702 | | $ | — | | $ | 998,682 | |
Short-term borrowings and current portion of long-term debt | | | 763,683 | | | 144,699 | | | 86,293 | | | — | | | 994,675 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current liabilities | | | 1,550,417 | | | 305,945 | | | 136,995 | | | — | | | 1,993,357 | |
Long-term debt | | | 2,989,123 | | | 18,378 | | | 325,430 | | | — | | | 3,332,931 | |
Other liabilities | | | 194,641 | | | 541,596 | | | 53,417 | | | (135,347 | ) | | 654,307 | |
Stockholders’ equity: | | | | | | | | | | | | | | | | |
Quest Diagnostics stockholders’ equity | | | 3,429,150 | | | 7,140,030 | | | 648,952 | | | (7,788,982 | ) | | 3,429,150 | |
Noncontrolling interests | | | — | | | — | | | 21,446 | | | — | | | 21,446 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total stockholders’ equity | | | 3,429,150 | | | 7,140,030 | | | 670,398 | | | (7,788,982 | ) | | 3,450,596 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 8,163,331 | | $ | 8,005,949 | | $ | 1,186,240 | | $ | (7,924,329 | ) | $ | 9,431,191 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
29
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
Condensed Consolidating Balance Sheet
December 31, 2010
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
Assets | | | | | | | | | | | | | | | | |
Current assets: | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 392,525 | | $ | 928 | | $ | 55,848 | | $ | — | | $ | 449,301 | |
Accounts receivable, net | | | 15,913 | | | 135,417 | | | 693,969 | | | — | | | 845,299 | |
Other current assets | | | 55,723 | | | 165,099 | | | 96,183 | | | (6,188 | ) | | 310,817 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current assets | | | 464,161 | | | 301,444 | | | 846,000 | | | (6,188 | ) | | 1,605,417 | |
Property, plant and equipment, net | | | 179,624 | | | 616,114 | | | 38,638 | | | — | | | 834,376 | |
Goodwill and intangible assets, net | | | 155,596 | | | 5,279,371 | | | 463,376 | | | — | | | 5,898,343 | |
Intercompany receivable (payable) | | | 84,107 | | | 231,268 | | | (315,375 | ) | | — | | | — | |
Investment in subsidiaries | | | 6,195,557 | | | — | | | — | | | (6,195,557 | ) | | — | |
Other assets | | | 227,822 | | | 10,090 | | | 48,319 | | | (96,737 | ) | | 189,494 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total assets | | $ | 7,306,867 | | $ | 6,438,287 | | $ | 1,080,958 | | $ | (6,298,482 | ) | $ | 8,527,630 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | |
Current liabilities: | | | | | | | | | | | | | | | | |
Accounts payable and accrued expenses | | $ | 623,610 | | $ | 190,334 | | $ | 57,516 | | $ | (6,188 | ) | $ | 865,272 | |
Current portion of long-term debt | | | 203,659 | | | 144,004 | | | 1,333 | | | — | | | 348,996 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total current liabilities | | | 827,269 | | | 334,338 | | | 58,849 | | | (6,188 | ) | | 1,214,268 | |
Long-term debt | | | 2,295,709 | | | 19,342 | | | 326,109 | | | — | | | 2,641,160 | |
Other liabilities | | | 150,409 | | | 512,681 | | | 51,724 | | | (96,737 | ) | | 618,077 | |
Stockholders’ equity: | | | | | | | | | | | | | | | | |
Quest Diagnostics stockholders’ equity | | | 4,033,480 | | | 5,571,926 | | | 623,631 | | | (6,195,557 | ) | | 4,033,480 | |
Noncontrolling interests | | | — | | | — | | | 20,645 | | | — | | | 20,645 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total stockholders’ equity | | | 4,033,480 | | | 5,571,926 | | | 644,276 | | | (6,195,557 | ) | | 4,054,125 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total liabilities and stockholders’ equity | | $ | 7,306,867 | | $ | 6,438,287 | | $ | 1,080,958 | | $ | (6,298,482 | ) | $ | 8,527,630 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
30
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2011
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | | | | | | | | |
Net income | | $ | 109,282 | | $ | 160,851 | | $ | 32,231 | | $ | (177,499 | ) | $ | 124,865 | |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | | | | | | | | | | | | | | |
Depreciation and amortization | | | 22,889 | | | 104,703 | | | 8,492 | | | — | | | 136,084 | |
Provision for doubtful accounts | | | 2,376 | | | 27,950 | | | 115,659 | | | — | | | 145,985 | |
Provision for special charge | | | 236,000 | | | — | | | — | | | — | | | 236,000 | |
Other, net | | | (195,421 | ) | | 67,472 | | | (3,824 | ) | | 177,499 | | | 45,726 | |
Changes in operating assets and liabilities | | | (151,255 | ) | | (161,149 | ) | | (156,173 | ) | | — | | | (468,577 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net cash provided by (used in) operating activities | | | 23,871 | | | 199,827 | | | (3,615 | ) | | — | | | 220,083 | |
Net cash used in investing activities | | | (1,059,870 | ) | | (169,185 | ) | | (5,315 | ) | | 226,404 | | | (1,007,966 | ) |
Net cash provided by (used in) financing activities | | | 781,631 | | | (29,086 | ) | | (3,341 | ) | | (226,404 | ) | | 522,800 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net change in cash and cash equivalents | | | (254,368 | ) | | 1,556 | | | (12,271 | ) | | — | | | (265,083 | ) |
Cash and cash equivalents, beginning of period | | | 392,525 | | | 928 | | | 55,848 | | | — | | | 449,301 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents, end of period | | $ | 138,157 | | $ | 2,484 | | $ | 43,577 | | $ | — | | $ | 184,218 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2010
| | | | | | | | | | | | | | | | |
| | Parent | | Subsidiary
Guarantors | | Non-
Guarantor
Subsidiaries | | Eliminations | | Consolidated | |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | | | | | | | | |
Net income | | $ | 357,063 | | $ | 172,872 | | $ | 36,192 | | $ | (191,098 | ) | $ | 375,029 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | | | | |
Depreciation and amortization | | | 24,331 | | | 93,907 | | | 8,069 | | | — | | | 126,307 | |
Provision for doubtful accounts | | | 3,006 | | | 24,669 | | | 120,728 | | | — | | | 148,403 | |
Other, net | | | (131,368 | ) | | (6,194 | ) | | (17,401 | ) | | 191,098 | | | 36,135 | |
Changes in operating assets and liabilities | | | 82,079 | | | (196,396 | ) | | (123,173 | ) | | — | | | (237,490 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net cash provided by operating activities | | | 335,111 | | | 88,858 | | | 24,415 | | | — | | | 448,384 | |
Net cash provided by (used in) investing activities | | | 11,063 | | | (68,458 | ) | | (2,763 | ) | | (31,886 | ) | | (92,044 | ) |
Net cash used in financing activities | | | (424,511 | ) | | (26,208 | ) | | (23,875 | ) | | 31,886 | | | (442,708 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net change in cash and cash equivalents | | | (78,337 | ) | | (5,808 | ) | | (2,223 | ) | | — | | | (86,368 | ) |
Cash and cash equivalents, beginning of period | | | 464,958 | | | 17,457 | | | 51,841 | | | — | | | 534,256 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Cash and cash equivalents, end of period | | $ | 386,621 | | $ | 11,649 | | $ | 49,618 | | $ | — | | $ | 447,888 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
31
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions and select accounting policies that affect our reported financial results and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
While many operational aspects of our business are subject to complex federal, state and local regulations, the accounting for most of our business is generally straightforward with net revenues primarily recognized upon completion of the testing process. Our revenues are primarily comprised of a high volume of relatively low dollar transactions, and about one-half of our total costs and expenses consist of employee compensation and benefits. Due to the nature of our business, several of our accounting policies involve significant estimates and judgments. These accounting policies have been described in our Annual Report on Form 10-K for the year ended December 31, 2010.
Initiatives to Improve Operating Efficiency
The diagnostic testing industry is labor intensive. Employee compensation and benefits constitute approximately one-half of our total costs and expenses. Cost of services consists principally of costs for obtaining, transporting and testing specimens. Selling, general and administrative expenses consist principally of the costs associated with our sales and marketing efforts, billing operations, bad debt expense and general management and administrative support. In addition, performing diagnostic testing involves significant fixed costs for facilities and other infrastructure required to obtain, transport and test specimens. Therefore, relatively small changes in volume can have a significant impact on profitability in the short-term.
A large portion of our costs are fixed, making it more challenging to fully mitigate the profit impact of reduced volume in the short term. In response to reduced volume levels, as a result of a temporary slowdown in healthcare utilization, we have implemented a number of actions in July 2011 to align our costs with reduced volume levels. These cost actions, which are broad in nature and affect most parts of our business, will result in a charge to earnings in the third quarter of 2011 estimated at approximately $20 million, comprised principally of employee separation costs.
In addition, in July 2011 we announced a multi-year program designed to reduce our cost structure by $500 million over the next three years. This effort is intended to address continued reimbursement pressures and labor and benefit cost increases, free up additional resources to invest in science and innovation, and enable us to improve operating profitability. As detailed plans to implement these opportunities are approved and executed, it likely will result in charges to earnings associated with the implementation. These charges may be material to the results of operations and cash flows in the periods recorded or paid.
Acquisitions
Acquisition of Athena Diagnostics
On February 24, 2011, we signed a definitive agreement to acquire Athena Diagnostics (“Athena”) from Thermo Fisher Scientific, Inc., in an all-cash transaction valued at approximately $740 million. Athena is the leading provider of advanced diagnostic tests related to neurological conditions, and generated revenues of approximately $110 million in 2010. We completed the acquisition of Athena on April 4, 2011 (see Note 4 to the interim consolidated financial statements for further details).
32
Acquisition of Celera Corporation
On March 17, 2011, we entered into a definitive merger agreement with Celera Corporation (“Celera”) under which we agreed to acquire Celera for $8 per share, in a transaction valued at approximately $341 million, net of $326 million in acquired cash and short-term marketable securities. Additionally, we expect to utilize Celera’s available tax credits, net operating loss carryforwards and capitalized tax research and development expenditures to reduce our future tax payments by approximately $110 million. Celera is a healthcare business delivering personalized disease management through a combination of products and services incorporating proprietary discoveries. Celera generated revenues of $128 million in 2010. We completed the acquisition of Celera on May 17, 2011.
Of the total purchase price of $667 million to acquire Celera, $508 million was paid through June 30, 2011. Accounts payable and accrued expenses at June 30, 2011 included a liability of $159 million representing the remaining merger consideration related to shares of Celera which had not been surrendered as of June 30, 2011. We expect to fund the payment of the remaining merger consideration with cash on hand and existing credit facilities. See Note 4 to the interim consolidated financial statements for further details.
Results of Operations
Our clinical testing business currently represents our one reportable business segment. In both 2011 and 2010, our clinical testing business accounted for greater than 90% of net revenues. Our other operating segments consist of our risk assessment services, clinical trials testing, healthcare information technology and diagnostic products businesses. Our business segment information is disclosed in Note 14 to the interim consolidated financial statements.
Settlement Related to the California Lawsuit
As a result of settlement discussions which resumed in the first quarter of 2011, on May 9, 2011, we announced an agreement in principle to resolve a previously disclosed civil lawsuit brought by a California competitor in which the State of California intervened (the “California Lawsuit”). In the lawsuit, the plaintiffs alleged, among other things, that we overcharged Medi-Cal for testing services and violated the California False Claims Act. Specifically, the plaintiffs alleged, among other things, that we violated certain regulations that govern billing to Medi-Cal (“Comparable Charge” regulations). While denying liability, in order to avoid the uncertainty, expense and risks of litigation, we agreed to resolve these matters for $241 million. On May 19, 2011, we finalized a settlement agreement and release with the California Department of Health Care Services, the California Attorney General’s Office and thequi tam relator. We agreed to the settlement to resolve claims pertaining to the Comparable Charge allegations; we received a full release of these and all other allegations in the complaint. We also agreed to certain reporting obligations regarding our pricing for a limited time period and, at our option in lieu of such obligations for a transitional period, to provide Medi-Cal with a discount (the “Transitional Discount”) until the end of July 2012. The Transitional Discount, to the extent provided, is not expected to have a material impact on our consolidated revenues or results of operations.
As provided for in the settlement agreement, we have resumed billing for unbilled services and expect to be reimbursed for all services provided prior to the effective date of the final settlement agreement. Such reimbursement is expected to be consistent with the related amounts accrued.
As a result of the agreement in principle, we recorded a pre-tax charge to earnings in the first quarter of 2011 of $236 million (the “Medi-Cal charge”), or $1.20 per diluted share, which represented the cost to resolve the matters noted above and related claims, less amounts previously reserved for related matters.
We funded the $241 million payment in the second quarter of 2011 with cash on hand and borrowings under our existing credit facilities. See Note 12 to the interim consolidated financial statements for further details.
33
Three and Six Months Ended June 30, 2011 Compared with Three and Six Months Ended June 30, 2010
Continuing Operations
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | % Change
Increase
(decrease) | | Six Months Ended
June 30, | | % Change
Increase
(decrease) | |
| |
| | |
| | |
| | 2011 | | 2010 | | | 2011 | | 2010 | | |
| |
| |
| |
| |
| |
| |
| |
| | (dollars in millions, except per share data) | |
| | | | | | | | | | | | | | | | | | | |
Net revenues | | $ | 1,903.2 | | $ | 1,874.7 | | | 1.5 | % | $ | 3,724.8 | | $ | 3,680.2 | | | 1.2 | % |
Income from continuing operations | | | 163.6 | | | 194.9 | | | (16.1 | )% | | 110.2 | | | 357.4 | | | (69.2 | )% |
Earnings per diluted share | | $ | 1.02 | | $ | 1.07 | | | (4.7 | )% | $ | 0.68 | | $ | 1.96 | | | (65.3 | )% |
Results for the three months ended June 30, 2011 included pre-tax charges of $21.2 million, or $0.10 per diluted share, associated with the acquisitions of Athena and Celera. Of these costs, $20.4 million, primarily related to professional fees and integration charges, were recorded in selling, general and administrative expenses and $0.8 million of financing related costs were included in interest expense, net.
Results for the six months ended June 30, 2011 were affected by a number of items which impacted earnings per diluted share by $1.44. During the first quarter of 2011, we recorded the Medi-Cal charge of $236 million, or $1.20 per diluted share, in “other operating expense, net.” In addition, results for the six months ended June 30, 2011 included pre-tax charges of $25.8 million, or $0.12 per diluted share, associated with the acquisitions of Athena and Celera. Of these costs $22.7 million, primarily related to professional fees and integration charges, were recorded in selling, general and administrative expenses and $3.1 million of financing related costs were included in interest expense, net. Results for the six months ended June 30, 2011 also included $13.3 million of pre-tax charges, or $0.05 per diluted share, principally associated with workforce reductions. Of these costs, $9.0 million and $4.3 million were included in cost of services and selling, general and administrative expenses, respectively. In addition, we estimate that the impact of severe weather during the first quarter of 2011 adversely affected operating income for the six months ended June 30, 2011 by $18.5 million, or $0.07 per diluted share.
Results for the six months ended June 30, 2010 were affected by a number of items which impacted earnings per diluted share by $0.11. During the first quarter of 2010, we recorded pre-tax charges of $17.3 million, or $0.06 per diluted share, principally associated with workforce reductions. Of these costs, $4.5 million and $12.8 million were included in cost of services and selling, general and administrative expenses, respectively. In addition, we estimate that the impact of severe weather during the first quarter of 2010 adversely affected operating income for the six months ended June 30, 2010 by $14.1 million, or $0.05 per diluted share.
Net Revenues
Net revenues for the three months ended June 30, 2011 were 1.5% above the prior year level with the Athena and Celera acquisitions contributing 2.5% revenue growth in the quarter.
Clinical testing revenue, which accounted for over 90% of our consolidated revenues, increased by 0.7% for the three months ended June 30, 2011 over the prior year period. The acquisitions of Athena and Celera contributed about 2.2% to the clinical testing revenue growth in the quarter. Clinical testing volume, measured by the number of requisitions, decreased by 0.9% for the second quarter of 2011 compared to the prior year period due to continued market softness, as measured by physician office visits in the second quarter of 2011. The clinical testing volume contributed by the Athena and Celera acquisitions had a modest positive impact in the quarter. Pre-employment drug testing volume, which has continued to rebound, grew about 6% in the quarter.
Revenue per requisition for the three months ended June 30, 2011 was 1.6% above the prior year period, with the improvement driven by an increase in esoteric testing mix from the acquired operations of Athena and Celera. While revenue per requisition is benefiting from an increased mix in gene-based and esoteric testing, it continues to be pressured by business and payer mix changes, the 1.75% Medicare fee schedule decrease, which went into effect January 1, 2011,
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and pricing changes in connection with several large contract extensions executed in the first half of last year. The business and payer mix changes, which continue to pressure revenue per requisition, include the further rebound in our lower-priced drugs-of-abuse testing, and continued weakness in our higher priced anatomic pathology testing services.
Net revenues for the six months ended June 30, 2011 were 1.2% above the prior year level with the Athena and Celera acquisitions contributing 1.3% to consolidated revenue growth.
Clinical testing revenue, which accounted for over 90% of our consolidated revenues, grew 0.5%. The acquisitions of Athena and Celera contributed about 1.1% to the clinical testing revenue growth for the six months ended June 30, 2011. Clinical testing volume, measured by the number of requisitions, increased by 0.5% compared to the prior year period. Pre-employment drug testing volume, which has continued to rebound, grew about 8% during the six months ended June 30, 2011.
Revenue per requisition for the six months ended June 30, 2011 approximated the prior year level. Revenue per requisition continues to benefit from an increased mix in gene-based and esoteric testing, particularly from the impact of the acquired operations of Athena and Celera. Offsetting this benefit was business and payor mix changes including: an increase in lower priced drugs-of-abuse testing and a decrease in higher priced anatomic pathology testing; price changes in connection with several large contract extensions executed in the first half of last year; and the 1.75% Medicare fee schedule decrease, which went into effect January 1, 2011.
Our businesses other than clinical laboratory testing accounted for approximately 9% of our net revenues for the three and six months ended June 30, 2011 and 2010. These businesses include our risk assessment services, clinical trials testing, healthcare information technology, and diagnostic products businesses. For the three and six months ended June 30, 2011, revenue in our non-clinical testing businesses, which contain most of our international operations, grew by approximately 10% and 9%, respectively, and benefited from the impact of the Celera acquisition and foreign currency exchange rates.
Operating Costs and Expenses
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended June 30, | |
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| |
| | 2011 | | 2010 | | Change Increase (decrease) | |
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| | $ | | % Net
Revenue | | $ | | % Net
Revenue | | $ | | % Net
Revenue | |
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| | (dollars in millions) | |
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Cost of services | | $ | 1,104.4 | | | 58.0 | % | $ | 1,078.9 | | | 57.6 | % | $ | 25.5 | | | 0.4 | % |
Selling, general and administrative expenses (SG&A) | | | 462.8 | | | 24.3 | % | | 419.4 | | | 22.4 | % | | 43.4 | | | 1.9 | % |
Amortization of intangible assets | | | 18.6 | | | 1.0 | % | | 9.3 | | | 0.5 | % | | 9.3 | | | 0.5 | % |
Other operating expense, net | | | 0.6 | | | 0.1 | % | | 1.2 | | | — | % | | (0.6 | ) | | 0.1 | % |
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Total operating costs and expenses | | $ | 1,586.4 | | | 83.4 | % | $ | 1,508.8 | | | 80.5 | % | $ | 77.6 | | | 2.9 | % |
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Bad debt expense (included in SG&A) | | $ | 68.6 | | | 3.6 | % | $ | 72.1 | | | 3.8 | % | $ | (3.5 | ) | | (0.2 | )% |
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| | | | | | | | | | | | | | | | | | | |
| | Six Months Ended June 30, | |
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| |
| | 2011 | | 2010 | | Change Increase (decrease) | |
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| | | | | | | | | | | | | |
| | $ | | % Net
Revenue | | $ | | % Net
Revenue | | $ | | % Net
Revenue | |
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| | (dollars in millions) | |
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Cost of services | | $ | 2,201.4 | | | 59.1 | % | $ | 2,145.3 | | | 58.3 | % | $ | 56.1 | | | 0.8 | % |
Selling, general and administrative expenses (SG&A) | | | 910.6 | | | 24.4 | % | | 850.1 | | | 23.1 | % | | 60.5 | | | 1.3 | % |
Amortization of intangible assets | | | 28.5 | | | 0.8 | % | | 18.6 | | | 0.5 | % | | 9.9 | | | 0.3 | % |
Other operating expense, net | | | 236.5 | | | 6.4 | % | | 1.7 | | | — | % | | 234.8 | | | 6.4 | % |
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Total operating costs and expenses | | $ | 3,377.0 | | | 90.7 | % | $ | 3,015.7 | | | 81.9 | % | $ | 361.3 | | | 8.8 | % |
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Bad debt expense (included in SG&A) | | $ | 146.0 | | | 3.9 | % | $ | 148.4 | | | 4.0 | % | $ | (2.4 | ) | | (0.1 | )% |
Total Operating Costs and Expenses
For the second quarter of 2011, the impacts of the higher costs associated with employee compensation and benefits, investments we have made in our sales force and service capabilities, the addition of the Athena and Celera operations, as well as costs related to the Athena and Celera transactions, served to increase total operating expenses as a percent of net revenues compared to the prior year period. Partially offsetting these increases was a year-over-year reduction in costs associated with actions we have taken to adjust our cost structure, primarily associated with workforce reductions. Results for the second quarter of 2011 included pre-tax charges of $20.4 million, primarily related to professional fees and integration charges associated with the acquisitions of Athena and Celera, which served to increase operating expenses as a percent of net revenues by 1.1%.
For the six months ended June 30, 2011, the impacts of the Medi-Cal charge, severe weather, higher costs associated with employee compensation and benefits, and investments we have made in our sales force and service capabilities, as well the impact of the Athena and Celera acquisitions, served to increase total operating expenses as a percent of net revenues compared to the prior year period. Partially offsetting these increases was a year-over-year reduction in costs associated with actions we have taken to adjust our cost structure, primarily associated with workforce reductions. Results for the six months ended June 30, 2011 included the Medi-Cal charge of $236 million recorded in connection with the California Lawsuit. In addition, results for the six months ended June 30, 2011 and 2010 included pre-tax charges, principally associated with workforce reductions, of $13.3 million ($9.0 million in cost of services and $4.3 million in selling, general and administrative expenses) and $17.3 million ($4.5 million in cost of services and $12.8 million in selling, general and administrative expenses), respectively. Selling, general and administrative expenses for the six months ended June 30, 2011 also included $22.7 million of pre-tax charges, primarily related to professional fees and integration charges associated with the acquisitions of Athena and Celera.
Also, year-over-year comparisons for both the three and six months ended June 30, 2011 were unfavorably impacted by approximately $4 million associated with gains on investments in our supplemental deferred compensation plans. Under our supplemental deferred compensation plans, employee compensation deferrals, together with Company matching contributions, are invested in a variety of investments held in trusts. Gains and losses associated with the investments are recorded in earnings within “other (expense) income, net.” A corresponding and offsetting adjustment is also recorded to the deferred compensation obligation to reflect investment gains and losses earned by the employee. Such adjustments to the deferred compensation obligation are recorded in earnings principally within “selling, general and administrative expenses” and offset the amount of investment gains and losses recorded in “other (expense) income, net.” Results for the three and six months ended June 30, 2011 included an increase in operating costs of $0.2 million and $2.3 million, respectively, representing increases in the deferred compensation obligation to reflect investment gains earned by employees participating in our deferred compensation plans. Results for the three and six months ended June 30, 2010 included a reduction in operating costs of $3.9 million and $1.4 million, respectively, representing decreases in
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the deferred compensation obligation to reflect investment losses incurred by employees participating in our deferred compensation plans.
Cost of Services
The increase in cost of services as a percentage of net revenues for the three months ended June 30, 2011 compared to the prior year period primarily reflects higher costs associated with employee compensation and benefits, and investments we have made in service capabilities, partially offset by an increase in revenue per requisition, attributable to the acquired operations of Athena and Celera.
The increase in cost of services as a percentage of revenues for the six months ended June 30, 2011 compared to the prior year period reflects the impact of severe weather in the first quarter, a $4.5 million increase in pre-tax charges associated with workforce reductions and higher costs associated with employee compensation and benefits, and investments we have made in service capabilities. These increases have been partially offset by the acquired operations of Athena and Celera, which served to reduce the percentage.
Selling, General and Administrative Expenses
The increase in selling, general and administrative expenses as a percentage of net revenues for the three months ended June 30, 2011 compared to the prior year period primarily reflects pre-tax charges of $20.4 million, primarily related to professional fees and integration charges, associated with the acquisitions of Athena and Celera, higher costs associated with employee compensation and benefits, investments we have made in our sales force and the impact of the Celera operations.
The increase in selling, general and administrative expenses as a percentage of net revenues for the six months ended June 30, 2011 compared to the prior year period primarily reflects the impact of severe weather, higher costs associated with employee compensation and benefits and investments we have made in our sales force. In addition, selling, general and administrative expenses for the six months ended June 30, 2011 included pre-tax charges of $22.7 million, primarily related to professional fees and integration charges associated with the acquisitions of Athena and Celera. These increases were partially offset by an $8.5 million decrease in pre-tax charges associated with workforce reductions.
For the three months and six months ended June 30, 2011, bad debt expense as a percentage of net revenues improved compared to the prior year periods, primarily reflecting continued strong performance in our billing operations and collection metrics.
Amortization of Intangible Assets
The increase in amortization of intangible assets for the three and six months ended June 30, 2011 compared to the prior year periods reflects the impact of amortization of intangible assets acquired as part of the Athena and Celera acquisitions.
Other Operating Expense, net
Other operating expense, net includes special charges, and miscellaneous income and expense items related to operating activities. For the six months ended June 30, 2011, other operating expense, net included the Medi-Cal charge of $236 million recorded in connection with the California Lawsuit.
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Operating Income
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| | Three Months Ended
June 30, | | Change
Increase
(decrease) | | Six Months Ended
June 30, | | Change
Increase
(decrease) | |
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| | 2011 | | 2010 | | | 2011 | | 2010 | | |
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Operating income | | $ | 316.9 | | $ | 365.9 | | $ | (49.0 | ) | $ | 347.8 | | $ | 664.5 | | $ | (316.7 | ) |
Operating income % of net revenues | | | 16.6 | % | | 19.5 | % | | (2.9 | )% | | 9.3 | % | | 18.1 | % | | (8.8 | )% |
For the second quarter of 2011, the impacts of the higher costs associated with employee compensation and benefits, investments we have made in our sales force and service capabilities, and the addition of the operations of Athena and Celera, as well as costs related to the Athena and Celera transactions, served to decrease operating income as a percent of net revenues compared to the prior year period. Partially offsetting these decreases was a year-over-year reduction in costs associated with actions we have taken to adjust our cost structure.
For the six months ended June 30, 2011, the impacts of the Medi-Cal charge, severe weather, higher costs associated with employee compensation and benefits, and investments we have made in our sales force and service capabilities, as well as costs related to the Athena and Celera transactions, served to decrease operating income as a percent of net revenues compared to the prior year period. Partially offsetting these decreases was a year-over-year reduction in costs associated with actions we have taken to adjust our cost structure.
Interest Expense, net
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | Change
Increase
(decrease) | | Six Months Ended
June 30, | | Change
Increase
(decrease) | |
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| | 2011 | | 2010 | | | 2011 | | 2010 | | |
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| | (dollars in millions) | |
Interest expense, net | | $ | 46.6 | | $ | 36.4 | | $ | 10.2 | | $ | 84.5 | | $ | 72.3 | | $ | 12.2 | |
Interest expense, net for the three and six months ended June 30, 2011 increased from the prior year period primarily due to incremental debt of approximately $1.3 billion, used to partially fund $835 million of share repurchases and approximately $1 billion paid for acquisitions. In addition, for the three and six months ended June 30, 2011, interest expense, net included $0.8 million and $3.1 million, respectively, of financing commitment fees related to the acquisition of Celera which were expensed. See Note 8 to the interim financial statements for further details regarding our senior notes offering.
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Other (Expense) Income, net
Other (expense) income, net represents miscellaneous income and expense items related to non-operating activities, such as gains and losses associated with investments and other non-operating assets. For the three and six months ended June 30, 2011 and 2010, other (expense) income, net consisted of the following:
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | Change
Increase
(decrease) | | Six Months Ended
June 30, | | Change
Increase
(decrease) | |
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| | 2011 | | 2010 | | | 2011 | | 2010 | | |
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Investment gains (losses) associated with our supplemental deferred compensation plans | | $ | 0.2 | | $ | (3.9 | ) | $ | 4.1 | | $ | 2.3 | | $ | (1.4 | ) | $ | 3.7 | |
(Loss) gain on an investment | | | — | | | (3.3 | ) | | 3.3 | | | (0.2 | ) | | 0.7 | | | (0.9 | ) |
Other (expense) income items, net | | | (0.5 | ) | | 0.1 | | | (0.6 | ) | | (0.2 | ) | | (0.4 | ) | | 0.2 | |
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Total other (expense) income, net | | $ | (0.3 | ) | $ | (7.1 | ) | $ | 6.8 | | $ | 1.9 | | $ | (1.1 | ) | $ | 3.0 | |
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Income Tax Expense
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| | Three Months Ended
June 30, | | Change
Increase
(decrease) | | Six Months Ended
June 30, | | Change
Increase
(decrease) | |
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| | 2011 | | 2010 | | | 2011 | | 2010 | | |
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Effective income tax rate | | | 38.1 | % | | 38.1 | % | | — | | | 55.2 | % | | 38.1 | % | | 17.1 | % |
The increase in the effective income tax rate for the six months ended June 30, 2011 is primarily due to the Medi-Cal charge recorded in the first quarter of 2011 associated with the California Lawsuit (see Note 12 to the interim consolidated financial statements), a portion for which a tax benefit has not been recorded.
Discontinued Operations
Loss from discontinued operations, net of taxes, for the three months ended June 30, 2011 and 2010 was $0.5 million and $0.3 million, respectively, with no impact on diluted earnings per share. Loss from discontinued operations for the six months ended June 30, 2011 was $0.9 million, or $0.01 per diluted share. For the six months ended June 30, 2010, loss from discontinued operations was $0.3 million with no impact on diluted earnings per share. See Note 13 to the interim consolidated financial statements for further details.
Quantitative and Qualitative Disclosures About Market Risk
We address our exposure to market risks, principally the market risk of changes in interest rates, through a controlled program of risk management that includes the use of derivative financial instruments. We do not hold or issue derivative financial instruments for trading purposes. We believe that our exposures to foreign exchange impacts and changes in commodity prices are not material to our consolidated financial condition or results of operations. See Note 9 to the interim consolidated financial statements for additional discussion of our financial instruments and hedging activities.
At June 30, 2011 and December 31, 2010, the fair value of our debt was estimated at approximately $4.6 billion and $3.1 billion, respectively, using quoted market prices and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. At June 30, 2011 and December 31, 2010, the estimated fair value exceeded the carrying value of the debt by $228 million and $80 million, respectively. A hypothetical 10% increase in interest rates (representing 41 basis points and 45 basis points at June 30, 2011 and December 31, 2010, respectively) would potentially reduce the estimated fair value of our debt by approximately $119 million and $89 million at June 30, 2011 and December 31, 2010, respectively.
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Borrowings under our floating rate senior notes due 2014, our term loan due May 2012, our senior unsecured revolving credit facility and our secured receivables credit facility are subject to variable interest rates. Interest on our secured receivables credit facility is based on rates that are intended to approximate commercial paper rates for highly-rated issuers. Interest on our term loan due May 2012 and our senior unsecured revolving credit facility are subject to a pricing schedule that can fluctuate based on changes in our credit ratings. As such, our borrowing cost under these credit arrangements will be subject to both fluctuations in interest rates and changes in our credit ratings. At June 30, 2011, the borrowing rates under these debt instruments were: for our floating rate senior notes due 2014, LIBOR plus 0.85%; for our term loan due May 2012, LIBOR plus 0.40%; for our senior unsecured revolving credit facility, LIBOR plus 0.40%; and for our secured receivables credit facility, 1.10%. At June 30, 2011, the weighted average LIBOR was 0.2%. As of June 30, 2011, $200 million, $742 million, and $85 million were outstanding under our floating rate senior notes due 2014, our term loan due May 2012, and our $525 million secured receivables credit facility, respectively. There were no borrowings outstanding under our $750 million senior unsecured revolving credit facility as of June 30, 2011.
We seek to mitigate the variability in cash outflows that result from changes in interest rates by maintaining a balanced mix of fixed-rate and variable-rate debt obligations. In order to achieve this objective, we have entered into interest rate swaps. Interest rate swaps involve the periodic exchange of payments without the exchange of underlying principal or notional amounts. Net settlements are recognized as an adjustment to interest expense.
In March 2011, we entered into various fixed-to-variable interest rate swap agreements which have a notional amount totaling $200 million and a variable interest rate based on six-month LIBOR plus 0.54%. These derivative financial instruments are accounted for as fair value hedges of a portion of our senior notes due 2016. In addition, in previous years we entered into various fixed-to-variable interest rate swap agreements with a notional amount of $350 million and a variable interest rate based on one-month LIBOR plus 1.33% that were accounted for as fair value hedges of a portion of our senior notes due 2020. Based on our net exposure to interest rate changes, a hypothetical 10% change in interest rates on our variable rate indebtedness (representing 3 basis points) would impact annual interest expense by approximately $0.4 million, assuming no changes to the debt outstanding at June 30, 2011.
The fair value of the fixed-to-variable interest rate swap agreements related to our senior notes due 2016 and our senior notes due 2020 was an asset of $18.9 million at June 30, 2011. A hypothetical 10% change in interest rates (representing 25 basis points) would potentially change the fair value of the asset by $10 million.
For further details regarding our outstanding debt, see Note 10 to the consolidated financial statements included in our 2010 Annual Report on Form 10-K for the year ended December 31, 2010 and Note 8 to the interim consolidated financial statements. For details regarding our financial instruments, see Note 9 to the interim consolidated financial statements.
Risk Associated with Investment Portfolio
Our investment portfolio includes equity investments in publicly held companies that are classified as available-for-sale securities and other strategic equity holdings in privately held companies. These securities are exposed to price fluctuations and are generally concentrated in the life sciences industry. The carrying values of our available-for-sale equity securities and privately held securities were $15.1 million at June 30, 2011.
We regularly evaluate the fair value measurements of our equity investments to determine if losses in value are other than temporary and if an impairment loss has been incurred. The evaluation considers whether the security has the ability to recover and, if so, the estimated recovery period. Other factors that are considered in this evaluation include the amount of the other-than-temporary decline and its duration, the issuer’s financial condition and short-term prospects, and whether the market decline was caused by overall economic conditions or conditions specific to the individual security.
We do not hedge our equity price risk. The impact of an adverse movement in equity prices on our holdings in privately held companies cannot be easily quantified, as our ability to realize returns on investments depends on, among other things, the enterprises’ ability to raise additional capital or derive cash inflows from continuing operations or through liquidity events such as initial public offerings, mergers or private sales.
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Liquidity and Capital Resources
Cash and Cash Equivalents
Cash and cash equivalents at June 30, 2011 totaled $184 million, compared to $449 million at December 31, 2010. Cash and cash equivalents consist of cash and highly liquid short-term investments. For the six months ended June 30, 2011, cash flows from operating activities of $220 million, together with cash on hand and cash flows from financing activities of $523 million, were used to fund investing activities of $1.0 billion. Cash and cash equivalents at June 30, 2010 totaled $448 million, compared to $534 million at December 31, 2009. For the six months ended June 30, 2010, cash flows from operating activities of $448 million, together with cash on hand, were used to fund investing and financing activities of $92 million and $443 million, respectively.
Cash Flows from Operating Activities
Net cash provided by operating activities for the six months ended June 30, 2011 was $220 million compared to $448 million in the prior year period. For the six months ended June 30, 2011, cash flows from operating activities included the second quarter payment to Medi-Cal, the California Medicaid program, of $241 million in connection with the settlement of the California Lawsuit (see Note 12 to the interim consolidated financial statements), or $194 million net of an associated reduction in second quarter estimated tax payments. In addition, 2011 cash flows from operating activities were reduced by $25 million of payments related to transaction and integration costs associated with the acquisitions of Athena and Celera, or $18 million net of an associated reduction in estimated tax payments. After giving consideration to the net settlement and transaction and integration payments, underlying cash flows from operating activities for the six months ended June 30, 2011 decreased by $16.7 million in comparison to the prior year. This decrease was primarily driven by operating performance and an increase in interest payments, partially offset by a reduction in estimated tax payments. Days sales outstanding, a measure of billing and collection efficiency, were 44 days at both June 30, 2011 and December 31, 2010, compared to 42 days at June 30, 2010.
Cash Flows from Investing Activities
Net cash used in investing activities for the six months ended June 30, 2011 was $1.0 billion, consisting principally of $740 million related to the acquisition of Athena and $396 million net of cash acquired related to the acquisition of Celera, or $183 million net of cash and $213 million of short-term marketable securities acquired. A liability of $159 million, representing merger consideration related to shares of Celera which had not been surrendered, is included in accounts payable and accrued expenses at June 30, 2011. Proceeds from the sale of the short-term marketable securities, acquired as part of the Celera acquisition, were used to repay borrowings outstanding under our secured receivables credit facility and our unsecured revolving credit facility in the second quarter of 2011. In addition, cash flows from investing activities for the six months ended June 30, 2011 included capital expenditures of $79 million. Net cash used in investing activities for the six months ended June 30, 2010 was $92 million, and consisted principally of capital expenditures.
Cash Flows from Financing Activities
Net cash provided by financing activities for the six months ended June 30, 2011 was $523 million, consisting primarily of net increases in debt of $1.3 billion, and proceeds from the exercise of stock options and related tax benefits totaling $102 million, partially offset by purchases of treasury stock of $835 million, dividend payments of $33 million, distributions to noncontrolling interests of $17 million and $10 million of payments primarily related to debt issuance costs incurred in connection with our senior notes offering in the first quarter of 2011. The net increase in debt consists of $2.4 billion of borrowings and $1.1 billion of repayments.
In February 2011, borrowings of $500 million under our secured receivables credit facility and $75 million under our senior unsecured credit facility, together with $260 million of cash on hand, were used to fund purchases of treasury stock totaling $835 million. In addition, we completed a $1.25 billion senior notes offering in March 2011 (the “2011 Senior Notes”). We used $485 million of the $1.24 billion in net proceeds from the 2011 Senior Notes offering, together with $90 million of cash on hand, to fund the repayment of $500 million outstanding under our secured receivables credit facility, and the repayment of $75 million outstanding under our unsecured revolving credit facility. The remaining portion of the net proceeds from the 2011 Senior Notes offering were used to fund our acquisition of Athena in April 2011 (see Note 4 and Note 8 to the interim financial statements for further details).
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During the second quarter of 2011, $585 million and $30 million of borrowings under our secured receivables credit facility and our unsecured revolving credit facility, respectively, together with cash on hand, were used to fund the acquisition of Celera in May 2011 (see Note 4 to the interim financial statements for further details). During the second quarter of 2011, proceeds from the sale of short-term marketable securities acquired as part of the Celera acquisition totaling $214 million, together with cash on hand, were used to fund $500 million and $30 million of debt repayments under our secured receivables credit facility and our unsecured revolving credit facility, respectively.
Net cash used in financing activities for the six months ended June 30, 2010 was $443 million, consisting primarily of purchases of treasury stock totaling $426 million, dividend payments of $36 million and distributions to noncontrolling interests of $17 million, partially offset by $40 million in proceeds from the exercise of stock options, including related tax benefits.
Dividends
During each of the quarters of 2011 and 2010, our Board of Directors declared a quarterly cash dividend of $0.10 per common share. We expect to fund future dividend payments with cash flows from operations, and do not expect the dividend to have a material impact on our ability to finance future growth.
Share Repurchases
In January 2011, our Board of Directors authorized $750 million of additional share repurchases of our common stock, increasing our total available authorization at that time to $1 billion. The share repurchase authorization has no set expiration or termination date.
For the six months ended June 30, 2011, we repurchased 15.4 million shares of our common stock from SB Holdings Capital Inc., a wholly-owned subsidiary of GlaxoSmithKline plc., at an average price of $54.30 per share for a total of $835 million. At June 30, 2011, $165 million remained available under the share repurchase authorizations.
For the three months ended June 30, 2010, we repurchased 3.3 million shares of our common stock at an average price of $53.36 per share for $175 million. For the six months ended June 30, 2010, we repurchased 7.7 million shares of our common stock at an average price of $55.00 per share for $426 million, including 4.5 million shares purchased in the first quarter at an average price of $56.21 per share for $251 million under an accelerated share repurchase transaction with a bank.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations as of June 30, 2011:
| | | | | | | | | | | | | | | | |
| | Payments due by period | |
| |
| |
| | (in thousands) | |
Contractual Obligations | | Total | | Remainder
of 2011 | | 1-3 years | | 3-5 years | | After 5 years | |
| |
| |
| |
| |
| |
| |
| | | | | | �� | | | | | | | | | | |
Outstanding debt | | $ | 4,286,269 | | $ | 426,269 | | $ | 560,000 | | $ | 700,000 | | $ | 2,600,000 | |
Capital lease obligations | | | 47,042 | | | 4,164 | | | 15,941 | | | 12,179 | | | 14,758 | |
Interest payments on outstanding debt | | | 2,235,864 | | | 85,825 | | | 308,932 | | | 302,872 | | | 1,538,235 | |
Operating leases | | | 639,741 | | | 96,620 | | | 256,605 | | | 134,453 | | | 152,063 | |
Purchase obligations | | | 71,890 | | | 24,997 | | | 36,693 | | | 9,444 | | | 756 | |
Merger consideration obligation | | | 158,560 | | | 158,560 | | | — | | | — | | | — | |
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|
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|
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|
| |
|
| |
|
| |
Total contractual obligations | | $ | 7,439,366 | | $ | 796,435 | | $ | 1,178,171 | | $ | 1,158,948 | | $ | 4,305,812 | |
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Interest payments on our long-term debt have been calculated after giving effect to our interest rate swap agreements, using the interest rates as of June 30, 2011 applied to the June 30, 2011 balances, which are assumed to remain outstanding through their maturity dates.
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A full description of the terms of our indebtedness and related debt service requirements and our future payments under certain of our contractual obligations is contained in Note 10 to the Consolidated Financial Statements in our 2010 Annual Report on Form 10-K, as updated in Note 8 to the interim consolidated financial statements. A full discussion and analysis regarding our minimum rental commitments under noncancelable operating leases and noncancelable commitments to purchase product or services at December 31, 2010 is contained in Note 15 to the Consolidated Financial Statements in our 2010 Annual Report on Form 10-K. See Note 4 to the interim consolidated financial statements for a discussion with respect to merger consideration related to shares of Celera which had not been surrendered as of June 30, 2011.
As of June 30, 2011, our total liabilities associated with unrecognized tax benefits were approximately $213 million, which were excluded from the table above. We believe it is reasonably possible that these liabilities may decrease by up to $26 million within the next twelve months, primarily as a result of the expiration of statutes of limitations, settlements and/or the conclusion of tax examinations on certain tax positions. For the remainder, we cannot make reasonably reliable estimates of the timing of the future payments of these liabilities. See Note 5 to the Consolidated Financial Statements in our 2010 Annual Report on Form 10-K for information regarding our contingent tax liability reserves.
Our credit agreements and our term loan due May 2012 contain various covenants and conditions, including the maintenance of certain financial ratios, that could impact our ability to, among other things, incur additional indebtedness. As of June 30, 2011, we were in compliance with the various financial covenants included in our credit agreements and we do not expect these covenants to adversely impact our ability to execute our growth strategy or conduct normal business operations.
Unconsolidated Joint Ventures
We have investments in unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and Dayton, Ohio, which are accounted for under the equity method of accounting. We believe that our transactions with our joint ventures are conducted at arm’s length, reflecting current market conditions and pricing. Total net revenues of our unconsolidated joint ventures equal less than 6% of our consolidated net revenues. Total assets associated with our unconsolidated joint ventures are less than 2% of our consolidated total assets. We have no material unconditional obligations or guarantees to, or in support of, our unconsolidated joint ventures and their operations.
Requirements and Capital Resources
We estimate that we will invest approximately $200 million during 2011 for capital expenditures, including assets under capitalized leases, to support and expand our existing operations, principally related to investments in information technology, equipment and facility upgrades. We expect to fund the repayment of the current portion of our long-term debt using cash on hand and existing credit facilities.
Accounts payable and accrued expenses at June 30, 2011 included a liability of $159 million representing merger consideration related to shares of Celera which had not been surrendered as of June 30, 2011. We expect to fund the payment of the remaining merger consideration with cash on hand and existing credit facilities.
As of June 30, 2011, $1.2 billion of borrowing capacity was available under our existing credit facilities, consisting of $440 million available under our secured receivables credit facility and $750 million available under our senior unsecured revolving credit facility.
We believe the banks participating in our various credit facilities are predominantly highly-rated banks, and that the borrowing capacity under the credit facilities described above is currently available to us. Should one or several banks no longer participate in either of our credit facilities, we would not expect it to impact our ability to fund operations. We expect that we will be able to replace our existing secured receivables credit facility and our senior unsecured revolving credit facility with alternative arrangements prior to their expiration.
We believe that cash and cash equivalents on hand and cash from operations, together with our borrowing capacity under our credit facilities, will provide sufficient financial flexibility to meet seasonal working capital requirements, capital expenditures, debt service requirements and other obligations, cash dividends on common shares, share repurchases and additional growth opportunities for the foreseeable future. We believe that our credit profile should
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provide us with access to additional financing, if necessary, to fund growth opportunities that cannot be funded from existing sources.
Impact of New Accounting Standards
In May 2011, the Financial Accounting Standards Board (“FASB”) issued an amendment to the accounting standards related to fair value measurements. In June 2011, the FASB issued an amendment to the accounting standards related to the presentation of comprehensive income. The impact of these accounting standards is discussed in Note 2 to the interim financial statements.
Forward-Looking Statements
Some statements and disclosures in this document are forward-looking statements. Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan” or “continue.” These forward-looking statements are based on our current plans and expectations and are subject to a number of risks and uncertainties that could significantly cause our plans and expectations, including actual results, to differ materially from the forward-looking statements. Risks and uncertainties that may affect our future results include, but are not limited to, adverse results from pending or future government investigations, lawsuits or private actions, the competitive environment, changes in government regulations, changing relationships with customers, payers, suppliers and strategic partners and other factors discussed in “Business,” “Risk Factors,” “Cautionary Factors That May Affect Future Results,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Quantitative and Qualitative Disclosures About Market Risk” in our 2010 Annual Report on Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk” in our 2011 Quarterly Reports on Form 10-Q and other items throughout the 2010 Form 10-K and our 2011 Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
During the second quarter of 2011, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note 12 to the interim consolidated financial statements for information regarding the status of legal proceedings involving the Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The table below sets forth the information with respect to purchases made by or on behalf of the Company of its common stock during the second quarter of 2011.
| | | | | | | | | | | | | |
ISSUER PURCHASES OF EQUITY SECURITIES |
|
| | | | | | | | | | | | | |
Period | | Total Number of
Shares
Purchased | | Average Price
Paid per Share | | Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs | | Approximate
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans
or Programs
(in thousands) | |
| |
| |
| |
| |
| |
April 1, 2011 – April 30, 2011 | | | | | | | | | | | | | |
Share Repurchase Program (A) | | | — | | $ | — | | | — | | $ | 165,049 | |
Employee Transactions (B) | | | 1,258 | | $ | 56.67 | | | N/A | | | N/A | |
May 1, 2011 – May 31, 2011 | | | | | | | | | | | | | |
Share Repurchase Program (A) | | | — | | $ | — | | | — | | $ | 165,049 | |
Employee Transactions (B) | | | 3,532 | | $ | 57.23 | | | N/A | | | N/A | |
June 1, 2011 – June 30, 2011 | | | | | | | | | | | | | |
Share Repurchase Program (A) | | | — | | $ | — | | | — | | $ | 165,049 | |
Employee Transactions (B) | | | — | | $ | — | | | N/A | | | N/A | |
Total | | | | | | | | | | | | | |
Share Repurchase Program (A) | | | — | | $ | — | | | — | | $ | 165,049 | |
Employee Transactions (B) | | | 4,790 | | $ | 57.08 | | | N/A | | | N/A | |
| | |
| (A) | In January 2011, our Board of Directors authorized the Company to repurchase an additional $750 million of the Company’s common stock, increasing the total available authorization at that time to $1 billion. Since the share repurchase program’s inception in May 2003, our Board of Directors has authorized $4.5 billion of share repurchases of our common stock through June 30, 2011. The share repurchase authorization has no set expiration or termination date. |
| | |
| (B) | Includes: (1) shares delivered or attested to in satisfaction of the exercise price and/or tax withholding obligations by holders of stock options (granted under the Company’s Amended and Restated Employee Long-Term Incentive Plan and its Amended and Restated Non-Employee Director Long-Term Incentive Plan, collectively the “Stock Compensation Plans”) who exercised options; (2) restricted common shares withheld (under the terms of grants under the Stock Compensation Plans) to offset tax withholding obligations that occur upon vesting and release of the restricted common shares; and (3) shares withheld (under the terms of grants under the Stock Compensation Plans) to offset tax withholding obligations that occur upon the delivery of common shares underlying restricted stock units and performance share units. |
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Item 6. Exhibits
Exhibits:
| | |
| 31.1 | Rule 13a-14(a) Certification of Chief Executive Officer |
| | |
| 31.2 | Rule 13a-14(a) Certification of Chief Financial Officer |
| | |
| 32.1 | Section 1350 Certification of Chief Executive Officer |
| | |
| 32.2 | Section 1350 Certification of Chief Financial Officer |
| | |
| 101.INS | dgx-20110630.xml |
| | |
| 101.SCH | dgx-20110630.xsd |
| | |
| 101.CAL | dgx-20110630_cal.xml |
| | |
| 101.DEF | dgx-20110630_def.xml |
| | |
| 101.LAB | dgx-20110630_lab.xml |
| | |
| 101.PRE | dgx-20110630_pre.xml |
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
July 27, 2011
Quest Diagnostics Incorporated
| | |
By | /s/ Surya N. Mohapatra | |
|
| |
| Surya N. Mohapatra, Ph.D.
Chairman of the Board, President and
Chief Executive Officer |
| |
By | /s/ Robert A. Hagemann | |
|
| |
| Robert A. Hagemann
Senior Vice President and
Chief Financial Officer |
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