Quest Diagnostics Incorporated — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Quest provides diagnostic information services (DIS), which generated more than 90% of revenue, and Diagnostic Solutions (DS). Financial amounts are in millions of dollars except per-share data.
Financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $1,880 | $1,904 | $5,644 | $5,552 |
| Operating income | $631 | $256 | $1,160 | $726 |
| Net income attributable to Quest | $342 | $129 | $521 | $366 |
| Diluted EPS | $2.35 | $0.88 | $3.58 | $2.51 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $539 | $635 |
- Q3 revenue fell 1.3%; DIS revenue was essentially flat at $1,764, with requisitions down 0.2% and revenue per requisition up 0.2%. DS revenue declined 16.7%, largely reflecting the transfer of clinical-trials testing to Q² Solutions. Nine-month revenue grew 1.7%, with acquisitions contributing nearly 1.6%.
- Q3 operating margin was 33.6%, versus 13.4% a year earlier; nine-month margin was 20.5%, versus 13.1%. These reported margins include the $334 gain on the clinical-trials joint venture contribution. SG&A declined year over year, while cost of services increased for the nine-month period.
- Q3 diluted EPS included a net benefit of $1.17 from specified unusual items, principally the joint-venture gain, partly offset by restructuring and integration charges. Nine-month EPS included a net benefit of $0.27 from specified items, including the gain and debt-retirement and restructuring charges.
- Interest expense, net was $35 in Q3 and $117 for nine months, down from $41 and $122, respectively. Nine-month other expense included a $144 loss on early debt retirement.
- Nine-month operating cash flow fell $96 to $539, attributed mainly to cash costs of debt retirement, a $45 tax-contingency payment, and higher incentive compensation; improved operating performance and working capital partly offset these factors. Investing cash use was $237, versus $934, mainly because of lower acquisition spending. Financing used $371, versus $282 provided in the prior-year period.
- Cash was $123 at September 30, 2015, versus $192 at year-end 2014. Total debt was approximately $3.7 billion; current debt was $160 and long-term debt, net of current portion, was $3,571. Available capacity under credit facilities was approximately $1.2 billion; no borrowings were outstanding under the $750 revolving facility. The company reported compliance with debt covenants.
- Current assets were $1,648 and current liabilities $1,133. The filing does not provide a separate current-ratio measure.
Material changes and notable transactions
- On July 1, Quest contributed clinical-trials testing assets and $37 cash to Q² Solutions, a joint venture with Quintiles, for a 40% interest. It recorded a non-cash pretax gain of $334; the investment had a $422 carrying value at quarter-end.
- Quest issued $1.2 billion of senior notes in March and used proceeds and other borrowing to retire or redeem several existing notes. Nine-month debt repayments were $2,235 and borrowings were $2,214. Debt fair value was estimated at $3.8 billion, $116 above carrying value.
- Quest acquired MemorialCare’s laboratory outreach business for $35 in August. Certain non-core assets, including $113 of goodwill, were classified as held for sale.
- Nine-month share repurchases were $174; $522 remained authorized at September 30. The quarterly dividend increased to $0.38 per share from $0.33 in 2014.
Outlook, risks and contingencies
- Management continued its Invigorate cost program: it reported more than $700 of run-rate savings exiting 2014 and targeted an additional $600 by exiting 2017, for $1.3 billion versus 2011. It estimated approximately $300 of total pretax charges for the current multi-year course of action; 2015 charges were estimated at $35–$40 for employee separations, up to $5 for facilities and impairment, and $60–$70 for systems conversion and integration. Estimates could differ materially.
- Management estimated 2015 capital expenditures of approximately $275 and said cash, operating cash flow, and available credit were expected to fund working capital, investment, debt service, dividends, repurchases, and growth needs for the foreseeable future. No specific revenue or earnings guidance is provided in the supplied filing text.
- CMS had proposed changes under PAMA that were expected to refresh the clinical laboratory fee schedule in 2017; Quest was reviewing the proposal. Risks cited include reimbursement and regulatory changes, competition, customer and payer relationships, and government investigations and litigation.
- Legal matters include a Florida Medicaid pricing and billing suit and a False Claims Act case involving subsidiary Berkeley HeartLab, in which the U.S. intervened against that subsidiary. Management said losses were not considered probable as of September 30, but potential losses could not be estimated; outcomes could affect results or cash flows. Professional-liability reserves were approximately $121.
- Quest disclosed $63 of liabilities for unrecognized tax benefits and a redeemable noncontrolling interest valued at $69, with UMass able to require repurchase beginning in 2020. It also had $67 of letters of credit outstanding.
Most important facts for investors to verify
- How much of reported earnings and margin growth reflects the one-time $334 Q² Solutions gain, and what ongoing contribution the 40% investment may provide.
- Whether DIS volume, revenue per requisition, and organic growth improve, and how acquisitions and the clinical-trials transfer affect comparisons.
- Progress toward the $600 additional Invigorate savings target, including actual cash charges and implementation costs.
- Cash-flow conversion, debt maturities and refinancing, and continued compliance with credit covenants.
- Developments in PAMA reimbursement rules, government investigations, and litigation whose potential losses are not presently estimable.