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Leading diagnostics player Quest Diagnostics (DGX - Analyst Report) has entered an agreement to settle a civil lawsuit associated with California’s Medicaid program, MediCal.

The company has agreed to pay $241 million against the allegation that it failed to comply with California's "comparable charge" regulations, thereby overpaying for its tests. Quest has also agreed to provide pricing details for a limited period and also a discount to MediCal until July, 2012.

As a result of this in-principle agreement, Quest has recorded a pre-tax charge of $236 million ($195 million after tax) or $1.19 per share in the first quarter of 2011. Consequently, the company restated its first quarter results, which were declared on April 20, 2011.

Adjusted EPS remains unchanged at $1.00, which does not consider the charge associated with the MediCal settlement and other factors such as severe weather, costs associated with workforce reduction and some recent transactions. However, on a reported basis, these charges result in  a loss per share of 33 cents.

In 2006 and 2008, Quest was subpoenaed by the California Attorney General’s Office, seeking documents relating to its Medical billing. During the third quarter of fiscal 2010, the California Department of Health Care Services audited the company's billing to MediCal and arrived at the view that it was not in compliance with the California regulations. The complaint was originally filed by a competitor laboratory in California and the State of California intervened.

Subsequently, Quest entered an interim agreement under which it had agreed to temporarily suspend billing MediCal for a period of up to six months through March 1, 2011, during which it continued to provide services. This agreement was extended further till May 2, 2011. The litigation was an overhang for the company since California is responsible for the bulk of Medicaid revenues ($66 million in 2009, a little over 25% of total Medicaid revenue).

Quest also updated its guidance for fiscal 2011. The company expects to report an adjusted EPS of $4.25-$4.45 ($2.92−$3.12 on a reported basis) banking on a 2% growth in revenue. Moreover, the company now expects to generate $900 million in cash from operations, down from the previous guidance of $1.1 billion after considering the charge associated with the proposed MediCal settlement.

We are currently ‘Neutral’ on Quest Diagnostics.

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