Quest Diagnostics Incorporated — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing. Quest provides clinical laboratory testing and related diagnostic information services, primarily in the U.S.; its Diagnostic Information Services business generated about 96% of consolidated revenue.
Financial results and liquidity
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net revenue | $7.531 billion | $7.402 billion | +1.7% |
| Operating income | $1.101 billion | $1.165 billion | -5.5% |
| Operating margin | 14.6% | 15.7% | -1.1 percentage points |
| Net income attributable to Quest | $736 million | $772 million | -4.7% |
| Diluted EPS | $5.29 | $5.50 | -3.8% |
| Operating cash flow | $1.200 billion | $1.175 billion | +$25 million |
| Capital expenditures | $383 million | $252 million | +$131 million |
| Cash and cash equivalents | $135 million | $137 million | -$2 million |
| Total debt | $3.893 billion | $3.784 billion | +$109 million |
Gross profit was $2.605 billion, or approximately 34.6% of revenue. Operating cash flow less capital expenditures was approximately $817 million. Interest expense, net, rose to $167 million from $151 million. The company reported $1.1 billion of available borrowing capacity under credit facilities and said it expected cash, operating cash flow and borrowing capacity to fund foreseeable requirements.
At year-end, current debt was $464 million, including $300 million of notes due in April 2019; long-term debt was $3.429 billion. The company was in compliance with credit covenants. Its $600 million secured receivables facility had $160 million drawn, while its $750 million revolver was undrawn.
Material changes and unusual items
- Diagnostic Information Services revenue increased 1.9% to $7.204 billion, while Diagnostic Solutions revenue declined 2.3% to $327 million, primarily because royalty revenue received in 2017 had expired.
- DIS volume, measured by requisitions, rose 2.5%; revenue per requisition fell 1.2%, reflecting pricing pressure, PAMA, increased denials and higher patient concessions. Acquisitions contributed 3.2% to DIS revenue growth, while organic revenue declined 1.3%.
- Operating margin declined to 14.6% from 15.7%. Management cited acquisition-related costs and amortization, before full cost synergies, as factors in the decline.
- FY 2018 results included $122 million of pre-tax restructuring, systems-conversion and integration charges. The company reported these items reduced diluted EPS by a net $0.45 after specified tax benefits and other items.
- In the fourth quarter, Quest increased revenue and receivable reserves by approximately $35 million due to higher denials and increased patient responsibility. Q4 revenue was $1.839 billion versus $1.865 billion a year earlier; net income attributable to Quest was $127 million versus $254 million, and diluted EPS was $0.92 versus $1.82.
- Quest acquired businesses including MedXM, Cape Cod Healthcare’s outreach laboratory business, ReproSource and Oxford Immunotec’s U.S. laboratory services business. Acquisitions completed in 2018 generated $84 million of revenue during the year. A further acquisition, Boyce & Bynum, closed in February 2019 for $55 million plus potential contingent consideration.
- Revenue-recognition rules were adopted retrospectively: prior-period revenue and SG&A were both restated, with no change to net income. The filing cautions that revenue and collection estimates depend on judgments about payer denials and patient concessions.
Outlook, management commentary and risks
- Management’s strategy emphasizes growth through acquisitions, payer and health-system partnerships, advanced testing, consumer access, population-health services and operating efficiency. It raised its acquisition growth objective to a compound annual revenue growth rate of more than 2%.
- Management expects 2019 Medicare clinical laboratory reimbursement pressure, including PAMA effects, to exceed 2.5%. Medicare CLFS reimbursement had been reduced in 2018 and was scheduled for reductions of approximately 10% in each of 2019 and 2020.
- Quest began 2019 with access to approximately 43 million additional insured lives through UnitedHealthcare and other payer arrangements, bringing access to about 90% of U.S. insured lives. The revenue and earnings impact was not quantified in the filing.
- The company targeted approximately 3% annual cost savings and said it achieved that goal in 2018. It estimated 2019 capital expenditures of $350 million to $400 million, including investment in a new New Jersey laboratory.
- Key risks include reimbursement and pricing pressure, payer denials and patient collection concessions, increased patient cost-sharing, competition and hospital internalization of testing, possible FDA regulation of laboratory-developed tests, privacy and cybersecurity threats, acquisition integration, and complex billing and healthcare regulation.
- Quest disclosed a 2016 cyberattack that resulted in theft of certain patient data; it reported no indication of misuse. It also described ongoing legal proceedings and government inquiries, including billing-related matters, and said material losses were not considered probable at December 31, 2018. Professional-liability reserves were $125 million. Contingent legacy lease obligations could total several hundred million dollars, but management considered performance remote and recorded no liability.
- The company raised its quarterly dividend from $0.50 to $0.53 per share in the fourth quarter. FY 2018 dividends paid were $266 million; share repurchases were $325 million.
Most important facts for investors to verify
- Whether volume growth and new payer access can offset lower revenue per requisition, PAMA reimbursement cuts and rising denials or patient concessions.
- Whether the $35 million reserve increase adequately reflects collection experience and whether days sales outstanding, which rose to 54 days from 47, improves.
- Whether acquisitions deliver expected growth and cost synergies, and how they affect margins, goodwill and debt.
- Debt maturities, interest-rate exposure and the company’s ability to maintain cash generation while funding capital spending, dividends and buybacks.
- Developments in FDA/LDT regulation, legal proceedings, cybersecurity and other contingencies. The filing’s financial statements received an unqualified audit opinion, and management and the auditor concluded internal control over financial reporting was effective.