Quest Diagnostics Incorporated — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; comparative Q1 2017 revenue figures were retrospectively restated for the new revenue-recognition standard. Amounts are in millions except per-share data.
Business context
Quest provides diagnostic information services (DIS), including clinical and anatomic pathology testing, and Diagnostic Solutions (DS), including life-insurance risk assessment and healthcare IT. DIS generated 95.7% of Q1 revenue. The company reports DIS as its only reportable segment.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenue | $1,884 | $1,817 | +3.7% |
| Operating income | $272 | $279 | −2.5% |
| Operating margin | 14.5% | 15.4% | −0.9 percentage points |
| Net income attributable to Quest | $177 | $164 | +8.2% |
| Diluted EPS | $1.27 | $1.16 | +9.5% |
| Operating cash flow | $180 | $196 | −$16 |
| Capital expenditures | $73 | $42 | +$31 |
- DIS revenue increased 4.1% to $1,803; DS revenue declined 5.3% to $81, primarily due to risk assessment services.
- DIS requisition volume rose 2.2% and revenue per requisition rose 1.6%. Management attributed DIS growth to acquisitions and hospital relationships; organic growth was approximately 0.7% and acquisitions contributed approximately 3.4%.
- Net income was $189, including $12 attributable to noncontrolling interests. The effective tax rate fell to 22.5% from 31.8%, primarily reflecting the lower corporate tax rate under the Tax Cuts and Jobs Act (TCJA).
- Net interest expense increased to $41 from $36, primarily due to higher rates on variable-rate debt. Cost of services rose 5.2%, faster than revenue.
Cash, debt and liquidity
- Cash and cash equivalents were $124 at March 31, 2018, down from $137 at year-end. Operating cash flow was $180; investing cash outflow was $204, including $130 net cash used for acquisitions and $73 of capital expenditures. Financing provided $11; cash decreased $13 overall.
- Operating cash flow declined mainly due to working-capital timing. Accounts receivable increased to $1,026 from $924; days sales outstanding were 48, versus 47 at year-end and 46 a year earlier.
- Balance-sheet debt was $3,859 ($141 current and $3,718 long-term). The filing separately reports $3,911 of outstanding debt in its contractual-obligations table. Debt fair value was estimated at $4.1 billion. Q1 included $935 of cumulative borrowings and $830 of repayments under the secured receivables facility.
- At quarter-end, $135 was drawn on the $600 secured receivables facility, with a 2.61% borrowing rate; no borrowings were outstanding on the $750 revolving facility, amended to mature in March 2023. The company reported $1.1 billion of available borrowing capacity and compliance with credit covenants.
- Management said cash, operating cash flow and available credit should be sufficient for working capital, capital spending, debt service, dividends, repurchases and growth opportunities. Planned 2018 capital expenditures were $350–$400.
Material changes, outlook and risks
- Weather reduced estimated revenue growth by 0.6%; PAMA reimbursement reductions reduced DIS growth by an estimated 0.5%. Management expected PAMA to reduce revenue from affected Clinical Laboratory Fee Schedule tests by approximately 4% in 2018 and 10% in each of 2019 and 2020; those tests represented 12% of 2017 consolidated revenue. Further reductions after 2020 may occur.
- Q1 operating income was lower due primarily to weather and higher restructuring costs. Q1 results included $31 of pre-tax charges, reducing diluted EPS by $0.17, partly offset by $8 of excess stock-compensation tax benefits, adding $0.06 per diluted share; the net effect reduced diluted EPS by $0.11. Separately, the filing reports $12 of restructuring charges and $27 of Invigorate charges for the quarter, the latter including $11 of employee separation costs. Additional restructuring charges may occur.
- Invigorate is a multiyear cost-reduction and performance program. Management reported more than $1.3 billion of run-rate savings versus 2011 by the end of 2017.
- Quest acquired MedXM in February for $142, including estimated contingent consideration, and agreed to acquire Cape Cod Healthcare’s outreach laboratory business, subject to customary closing conditions. MedXM’s contingent consideration may be up to $30 based on revenue targets.
- Legal proceedings and government reviews may result in adverse judgments, settlements, fines or other relief. Management did not believe material legal losses were probable at March 31, but said outcomes could materially affect results or cash flow in the period determined or paid. Legal reserves were $2; reserves for general and professional liability claims were $113. The company is substantially self-insured for a significant portion of such claims.
- Other exposures include variable interest rates, reimbursement and pricing pressure, competition, customer and payer relationships, and contingent obligations. The filing says contingent lease obligations have no recorded liability. The adoption of the revenue standard reduced reported Q1 2017 revenue by $82, with no change to reported net income; it reclassified patient-responsibility uncollectibles from SG&A to a reduction of revenue.
Important facts for investors to verify
- Whether DIS volume and organic growth can strengthen, and whether DS weakness persists.
- The realized revenue and earnings impact of PAMA’s 2018–2020 reimbursement cuts and any subsequent rate changes.
- Whether acquisition contributions, including MedXM, deliver expected growth and whether contingent consideration is earned.
- Whether cost inflation, restructuring and acquisition-related expenses continue to pressure operating margins.
- Working-capital and receivables trends, planned capital spending, debt levels and variable-rate interest costs.
- Developments in legal, government-investigation, professional-liability and contingent-obligation matters.