Business context and reporting period
Quest Diagnostics Incorporated filed this Form 10-K for the fiscal year ended December 31, 2017. The company is a leading provider of diagnostic information services; its Diagnostic Information Services business generated more than 90% of consolidated revenue. The filing also reports unaudited fourth-quarter results.
Financial performance and key metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Net revenue | $7.709 billion | $7.515 billion |
| Operating income | $1.165 billion | $1.277 billion |
| Operating margin | 15.1% | 17.0% |
| Net income attributable to Quest | $772 million | $645 million |
| Diluted EPS | $5.50 | $4.51 |
| Cash from operating activities | $1.175 billion | $1.069 billion |
| Capital expenditures | $252 million | $293 million |
| Cash and cash equivalents at year-end | $137 million | $359 million |
| Total debt at year-end | $3.784 billion | $3.734 billion |
Revenue rose 2.6%. Diagnostic Information Services revenue increased 3.3% to $7.370 billion, with requisition volume up 2.3% and revenue per requisition up 1.0%. The company reported gross profit of $2.990 billion. Fourth-quarter 2017 revenue was $1.936 billion, compared with $1.861 billion in fourth-quarter 2016; net income attributable to Quest was $254 million versus $155 million, and diluted EPS was $1.82 versus $1.09.
Liquidity included $1.2 billion of available borrowing capacity under credit facilities; no borrowings were outstanding on the $750 million unsecured revolver at year-end. The company generated $923 million of operating cash flow after capital expenditures. Days sales outstanding improved to 45 from 47. Debt agreements contain financial covenants, which the company reported it was meeting.
Material changes versus the prior comparable period
- Operating income fell 8.8%, and operating margin declined 1.9 percentage points, despite higher revenue. Cost of services and SG&A increased, including acquisition and restructuring/integration costs.
- Net income attributable to Quest increased 19.8%, and diluted EPS increased 22.0%; the increase was primarily tax-driven, not solely from operating growth. A provisional $106 million tax benefit from the Tax Cuts and Jobs Act (TCJA) and $37 million of excess stock-compensation tax benefits supported 2017 earnings.
- Revenue growth was partly offset by the 2016 sale of Focus Diagnostics and by hurricanes; management estimated impacts of 0.3% and 0.4%, respectively, on 2017 revenue growth, and an approximately $0.14 negative effect on diluted EPS from hurricanes.
- Investing cash outflow rose to $805 million, mainly reflecting $581 million of acquisition spending, net of cash acquired. Five 2017 acquisitions included PeaceHealth outreach labs, Med Fusion/Clearpoint, Hartford HealthCare outreach operations, Cleveland HeartLab and Shiel.
- Share repurchases declined to $465 million from $590 million; dividends paid rose to $247 million from $223 million.
Outlook, management commentary, risks and unusual items
Management expects long-term industry growth and is pursuing revenue growth through health-system and payer partnerships, advanced testing, consumer access, analytics and selective acquisitions. It also emphasizes operational efficiency. Invigorate cost initiatives had generated more than $1.3 billion of annualized run-rate savings by the end of 2017, compared with 2011.
The filing does not provide specific 2018 revenue or EPS guidance. Quest estimated 2018 capital expenditures of $350–$400 million, including technology, laboratory and facility investments and a planned multi-year New Jersey laboratory construction project. Management expects the lower federal corporate tax rate to benefit earnings and operating cash flow, partly offsetting PAMA-related reimbursement reductions.
Management estimated that PAMA reductions would lower reimbursement on Clinical Laboratory Fee Schedule revenue by approximately 4% in 2018 and 10% in each of 2019 and 2020. CLFS revenue represented 12% of 2017 consolidated revenue. Excluding PAMA, management expected 2018 Diagnostic Information Services reimbursement pressure to remain below 1%; it estimated PAMA would add 0.5% pressure.
Key risks include reimbursement and pricing pressure, payer consolidation and narrower networks, patient collection risk, competition and testing internalization, regulatory changes (including FDA oversight of laboratory-developed tests), billing compliance, acquisition integration, quality and professional liability, and cybersecurity/privacy exposure. The company disclosed a 2016 cyberattack involving theft of certain patient data; it said the accessed data did not include Social Security numbers, payment-card or insurance/financial information and reported no indication of misuse. Ongoing legal matters include billing-related investigations and claims; management did not consider material losses probable at year-end, but outcomes could affect results or cash flows.
Unusual 2017 items include the TCJA tax benefit, restructuring and integration charges, hurricane-related costs and impairment charges. The company recorded approximately $106 million of pre-tax restructuring/integration charges and $10 million of other net pre-tax charges; reported results also included the $106 million provisional TCJA benefit. A 2018 revenue-recognition accounting change was expected to reclassify about $307 million of 2017 patient-related bad debt expense as a reduction of revenue, with no expected effect on net income or cash flows.
Important facts for investors to verify
- How much of 2017 EPS growth reflects the TCJA and stock-compensation tax benefits, and how results trend excluding these items.
- Actual PAMA reimbursement effects in 2018–2020 and any subsequent changes to Medicare payment policy or coverage.
- Whether organic volume, pricing, and revenue per requisition sustain growth as acquisition contributions and test mix change.
- Progress on integrating 2017 acquisitions, realizing cost savings, and maintaining service quality while investing in systems and facilities.
- Patient receivable collectability, bad-debt trends, and the effects of the 2018 revenue-recognition presentation change.
- Debt maturities, refinancing costs, covenant headroom, and the company’s ability to sustain dividends, repurchases and planned investment.
- Developments in billing-related legal matters, regulatory reviews, and cybersecurity/privacy exposure.