Quest Diagnostics Incorporated — Q3 2020 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2020. Quest provides diagnostic information services (DIS), which generated more than 95% of revenue, and smaller Diagnostic Solutions (DS) businesses. COVID-19 testing materially affected results.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $2.786 billion | $1.956 billion | $6.435 billion | $5.800 billion |
| Operating income | $718 million | $313 million | $1.176 billion | $868 million |
| Operating margin | 25.8% | 16.0% | 18.3% | 15.0% |
| Net income attributable to Quest | $568 million | $215 million | $852 million | $605 million |
| Diluted EPS from continuing operations | $4.14 | $1.56 | $6.25 | $4.27 |
| Operating cash flow | Not separately provided here | Not separately provided here | $1.464 billion | $895 million |
Q3 revenue rose 42.5% year over year; nine-month revenue rose 11.0%. Q3 DIS revenue increased 44.3%, while DS revenue declined 1.9%. For Q3, DIS requisitions increased 19.7%; base-business testing volume declined 5%, while COVID-19 testing drove growth and a 20.9% increase in revenue per requisition. For the nine-month period, base-business volumes declined approximately 14.4%.
At September 30, cash and cash equivalents were $1.605 billion, versus $1.192 billion at year-end 2019. Total debt was $4.573 billion, including $555 million current and $4.018 billion long-term. The company reported $1.3 billion of available borrowing capacity and no outstanding credit-facility borrowings. Current assets were $3.348 billion and current liabilities $2.389 billion.
Nine-month investing cash outflow was $604 million, including $329 million net cash used for acquisitions and $256 million of capital expenditures. Financing cash outflow was $447 million, including $253 million of net debt repayments and $222 million of dividends paid. Days sales outstanding were 47 days, compared with 54 at December 31, 2019.
Material changes and unusual items
- Q3 results included a $70 million non-operating gain from remeasuring Quest’s previously held interest in Mid America Clinical Laboratories (MACL), following its acquisition of the remaining 56% interest. This was a nonrecurring contributor to earnings.
- Quest received $138 million in CARES Act provider funds. It reversed the $65 million previously recognized in Q2 and, by September 30, had recorded the full $138 million as a payable. In October, it announced plans to return the funds. The receipts nevertheless increased nine-month operating cash flow.
- Quest acquired Blueprint Genetics, Memorial Hermann Diagnostic Laboratories’ outreach business, and the remaining MACL interest. Net cash used for acquisitions was $329 million for the nine months.
- Q3 diluted EPS was reduced by $0.17 on a net basis by specified items, including the CARES Act reversal and other pandemic-related costs, amortization and restructuring/integration costs, partially offset by the MACL gain and stock-based compensation tax benefits.
Outlook, risks and contingencies
- Management gave no specific revenue or earnings guidance in the filing. It estimated approximately $400 million of 2020 capital expenditures and said it targets annual Invigorate cost savings of approximately 3%, while assessing the pandemic’s effect on achieving that objective.
- Quest said it could perform more than 200,000 COVID-19 molecular tests and approximately 200,000 antibody tests per day. Management cautioned that pandemic duration, healthcare activity, government responses and the broader economy could continue to affect base testing volumes, cash collections and results.
- CMS announced that, from January 1, 2021, Medicare’s base reimbursement for high-throughput COVID-19 diagnostic tests would be $75 per test, with an additional $25 subject to specified requirements. The impact was under review.
- In October 2020, Quest gave notice to redeem $550 million of 4.70% notes due April 2021, intending to use proceeds from its 2.80% 2031 notes and cash on hand. The filing said the redemption would result in a debt-extinguishment loss.
- The company was in compliance with credit covenants. Temporary leverage-covenant relief imposes additional restrictions, including on share repurchases, acquisitions, secured debt and dividends. Share repurchases were suspended in April; the quarterly dividend was $0.56 per share.
- Legal matters include the AMCA data-security incident litigation and government inquiries, a consolidated 401(k) plan lawsuit, and other healthcare-related proceedings. Management said material legal losses were not considered probable at September 30, but outcomes may affect results or cash flows. General and professional liability reserves were $134 million.
- UMass Memorial may require Quest to buy its subsidiary interest at fair value; the redeemable noncontrolling interest was valued at $80 million, and payment timing was not estimable. Quest also disclosed $79 million of liabilities for unrecognized tax benefits.
Important facts for investors to verify
- Whether COVID-19 testing demand and base-business volumes persist or change, and the resulting effect on revenue mix and margins.
- The implementation and financial impact of the 2021 CMS COVID-19 test reimbursement rates and requirements.
- Return of the $138 million CARES Act funds and the effect of working-capital timing on reported operating cash flow.
- The November 2020 note redemption, related extinguishment charge, and resulting debt, interest expense and covenant headroom.
- Collection trends, credit-loss allowances, and resolution of the AMCA, 401(k), professional-liability and other legal matters.
- Acquisition integration, purchase-price allocations and realization of expected savings from the Invigorate program.