Quest Diagnostics Incorporated — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; amounts are in U.S. dollars, millions except per-share data. Quest’s diagnostic information services (DIS) business generated more than 95% of revenue.
Financial performance
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net revenue | $1,827 | $1,953 | $3,649 | $3,844 |
| Operating income | $283 | $307 | $458 | $555 |
| Operating margin | 15.5% | 15.7% | 12.5% | 14.4% |
| Continuing income attributable to Quest | $185 | $206 | $284 | $370 |
| Diluted EPS from continuing operations | $1.36 | $1.51 | $2.09 | $2.71 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $602 | $596 |
- Q2 revenue fell 6.4%; DIS revenue declined 5.7% and Diagnostic Solutions revenue declined 21.8%. First-half revenue decreased 5.1%.
- Q2 DIS requisitions fell 17.7% year over year; base-business testing volume, excluding COVID-19 molecular and antibody tests, fell about 34%. Revenue per requisition rose 15.3%, largely due to COVID-19 molecular testing reimbursement.
- Cost of services declined 3.5% in Q2, less than the revenue decline; cost of services was 66.8% of revenue versus 64.8% a year earlier. Operating margin was nearly flat in Q2 but contracted for the first half.
- Q2 continuing income attributable to Quest declined 10.1%. First-half continuing income declined 23.3%. 2019 reported net income also included $20 million of discontinued-operation income from a tax benefit.
- First-half cash from operations was up $6 million year over year, but included $65 million of CARES Act provider funds and $40 million received on termination of interest-rate swaps. Investing cash outflow was $411 million, including $228 million for acquisitions and $165 million of capital expenditures; financing cash outflow was $395 million.
Balance sheet, debt and liquidity
- At June 30, cash and cash equivalents were $988 million, down from $1.192 billion at year-end 2019. Current assets were $2.380 billion and current liabilities $1.843 billion.
- Debt carrying value was $4.575 billion, including $555 million current and $4.020 billion long-term; debt fair value was estimated at $5.1 billion. Cash exceeded no debt; the company reported $1.3 billion of available credit capacity and no outstanding credit-facility borrowings.
- Quest issued $550 million of 2.80% notes due 2031 in May. It amended its revolving-credit covenant to allow higher leverage limits through June 2021, with added restrictions during that period; the company reported covenant compliance at quarter-end.
- The quarterly dividend was raised to $0.56 per share from $0.53 in 2019. Share repurchases were suspended through year-end 2020; $1.2 billion remained authorized.
Material changes, outlook and risks
- COVID-19 caused sharp base-testing volume declines amid reduced physician visits and elective procedures. Volumes began recovering in May and June, while demand for COVID-19 testing grew. Quest said it could perform up to 130,000 molecular tests and approximately 200,000 antibody tests daily; rising molecular-test demand and global supply constraints challenged capacity and turnaround times. Management expected near-term molecular capacity of approximately 150,000 tests daily.
- The $100 Medicare reimbursement rate for certain high-throughput molecular tests is temporary and tied to the public health emergency; absent renewal, it reverts to $51. Management could not reasonably estimate the pandemic’s ultimate financial impact and gave no specific full-year earnings or revenue guidance in the provided filing text.
- Quest recognized $65 million of CARES Act provider funding as Q2 and first-half other operating income. Related COVID-19 costs included employee support payments, asset impairments and health-and-safety expenses. Additional requested government funding had not been approved at quarter-end.
- Management expects 2020 capital expenditures of $375–$400 million. The multi-year Invigorate cost program targets annual savings of approximately 3% of costs, but management was assessing the pandemic’s effect on the 2020 objective.
- Other risks include possible weaker cash collections, reimbursement pressure, supply disruption or price increases, and potential future goodwill or investment impairments if pandemic conditions worsen. The company reported no impairment test was necessary at June 30.
- Acquisitions completed in the period included Blueprint Genetics for $108 million net of cash acquired and Memorial Hermann outreach laboratory assets for $120 million. Quest agreed to buy the remaining 56% of Mid America Clinical Laboratories, with closing expected in Q3 and a potential gain on remeasurement of its existing interest.
- Legal matters include the AMCA data-security incident litigation and related government inquiries, a new 401(k) putative class action, and other proceedings. Management said material legal losses were not considered probable at June 30, though outcomes could affect results or cash flows. UMass could require Quest to buy its 18.9% subsidiary interest at fair value beginning July 1, 2020; the recorded fair value was $77 million.
Investor verification priorities
- Track the recovery in non-COVID testing volume, COVID-19 test demand, capacity, turnaround times and supply availability.
- Verify whether the public health emergency and the $100 Medicare reimbursement rate are extended, and how testing mix affects revenue per requisition and margins.
- Separate recurring operating performance and cash generation from the $65 million CARES Act payment and other pandemic-related items.
- Monitor collections, credit-loss allowances, cash balances, debt maturities and compliance with the temporarily relaxed leverage covenants.
- Confirm the MACL acquisition outcome and any gain, and monitor the UMass put right and the AMCA and 401(k) legal matters.