Quest Diagnostics Incorporated — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results. Quest provides diagnostic information services (DIS), which generated more than 90% of revenue, and Diagnostic Solutions (DS).
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $1.943bn | $1.906bn | $3.842bn | $3.769bn |
| Operating income | $319m | $422m | $598m | $679m |
| Operating margin | 16.4% | 22.1% | 15.6% | 18.0% |
| Net income attributable to Quest | $193m | $195m | $357m | $298m |
| Diluted EPS | $1.37 | $1.37 | $2.53 | $2.08 |
| Operating cash flow | Not separately stated by quarter | $490m | $464m |
- Q2 revenue rose 1.9%; DIS revenue increased 2.5%, with requisition volume up 1.8% and revenue per requisition up 0.7%. Management cited hospital-system relationships and non-routine testing growth; modest pricing pressure remained below 1%.
- Q2 DS revenue fell 9.0%, primarily reflecting the 2016 sale of Focus Diagnostics products. The sale reduced total revenue growth by 0.4 percentage points in Q2 and 0.7 points for the first half.
- First-half net income and diluted EPS rose 19.8% and 21.6%, respectively. Comparability was affected by the 2016 Focus sale, the 2016 debt-retirement loss, and lower 2017 tax expense; 2016 also included a $118m disposition gain.
- Management identified Q2 items that together benefited diluted EPS by $0.02: $13m of excess stock-compensation tax benefits, restructuring/integration charges, and a $7m investment-sale gain partly offset by legal costs. First-half items together benefited EPS by $0.05. These are management’s identified items, not a substitute for reported GAAP results.
Balance sheet, cash flow and capital
- At June 30, cash was $314m, down from $359m at year-end 2016. Current assets were $1.50bn and current liabilities $917m.
- Balance-sheet debt was $3.737bn ($5m current and $3.732bn long-term); estimated fair value was about $4.0bn. Interest expense, net, was $74m for the first half versus $70m a year earlier.
- First-half operating cash flow of $490m was $26m higher year over year, with improved collections and operating performance cited as drivers. Investing used $192m, including $112m for acquisitions and $107m of capital expenditures; financing used $343m, including $300m in share repurchases and $124m in dividends paid. Cash declined $45m.
- Days sales outstanding improved to 43 days from 47 at both December 31, 2016 and June 30, 2016. No borrowings were outstanding under the $600m secured receivables facility or $750m revolving credit facility; reported available borrowing capacity was approximately $1.3bn. The company said it was compliant with debt covenants.
- First-half repurchases were 3.0m shares for $300m; $1.1bn remained under authorizations. The quarterly dividend declared in 2017 was $0.45 per share, versus $0.40 in the first three quarters of 2016.
Outlook, strategic developments and risks
- No specific revenue or earnings guidance was provided. Management said it remained on track for $1.3bn of Invigorate program run-rate savings by year-end 2017, compared with 2011; savings exceeded $1.1bn at the end of 2016. Estimated 2017 program charges were $60m–$80m, including systems conversion and integration costs; $32m had been incurred in the first half.
- Quest estimated 2017 capital expenditures of $250m–$300m. Management stated cash, operating cash flow and credit capacity should fund working capital, investment, debt service, dividends, repurchases and growth opportunities.
- Quest acquired PeaceHealth’s outreach laboratory business on May 1 for $102m. The Med Fusion and Clear Point acquisitions, agreed for $150m, closed July 14, 2017, after quarter-end. Quest also announced a collaboration with Walmart to launch co-branded sites initially offering laboratory testing.
- Key risks include reimbursement and pricing pressure, competition, governmental regulation and investigations, customer and payer relationships, and litigation. Management said material legal losses were not considered probable at June 30 but noted outcomes could affect results or cash flows. General and professional liability reserves were $119m; other legal reserves were $2m.
- Florida Medicaid pricing litigation was subject to an agreement in principle, with terms still under negotiation. A separate federal False Claims Act matter involving Berkeley HeartLab was finalized and dismissed. An $80m redeemable noncontrolling interest gives UMass a right, beginning July 1, 2020, to require purchase at fair value.
- Future accounting changes include revenue-recognition adoption planned for Q1 2018 using the full retrospective method; management expected most patient-responsibility bad debt expense to reduce revenue. Lease accounting adoption in 2019 is expected to significantly increase balance-sheet assets and liabilities; the amount had not been quantified.
Important facts for investors to verify
- How much revenue and margin growth is sustainable after separating organic DIS performance from acquisitions, pricing, and the Focus sale comparison.
- Whether the Invigorate savings target is achieved and how the remaining program charges affect margins and cash flow.
- Debt maturities, interest-rate exposure, the $80m UMass redemption feature, and the capacity to maintain repurchases and dividends alongside acquisitions and capital spending.
- Final purchase accounting and integration outcomes for the post-quarter Med Fusion and Clear Point acquisitions, and the status and potential cost of legal and regulatory matters.
- The eventual revenue-recognition and lease-accounting impacts; the filing states the lease balance-sheet effect is significant but not yet quantified.