Quest Diagnostics Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; unaudited. Comparisons are with the corresponding 2018 periods. Quest’s Diagnostic Information Services (DIS) business generated more than 95% of revenue.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $1.953bn (+1.8%) | $1.919bn | $3.844bn (+1.1%) | $3.803bn |
| Operating income | $307m | $305m | $555m | $577m |
| Operating margin | 15.7% | 15.9% | 14.4% | 15.2% |
| Income from continuing operations attributable to Quest | $206m | $219m | $370m | $396m |
| Diluted EPS from continuing operations | $1.51 | $1.57 | $2.71 | $2.84 |
| Net income attributable to Quest, including discontinued operations | $226m | $219m | $390m | $396m |
Q2 DIS revenue rose 2.0%; requisition volume increased 4.4%, while revenue per requisition fell 2.3%. Management cited organic volume growth and acquisitions, including expanded in-network access, offset by reimbursement pressure, denials and higher patient concessions. DS revenue declined 3.4%. For the first half, DIS revenue grew 1.3%; volume increased 4.0%, but revenue per requisition declined 2.6%.
For the six months, operating cash flow was $596m, up from $503m; investing cash outflow was $202m versus $330m; and financing cash outflow was $256m versus $178m. Operating cash flow benefited from working-capital timing, lower incentive compensation payments and a $28m tax refund, partly offset by higher tax payments and lower operating income. Capital expenditures were $132m.
At June 30, cash and equivalents were $273m, versus $135m at year-end 2018. Debt was $3.976bn, including $807m current; reported long-term debt excluding the current portion was $3.169bn. Operating lease liabilities were $559m. Current assets were $1.566bn and current liabilities $1.904bn. The company reported $1.3bn of available borrowing capacity and stated it was in compliance with debt covenants.
Material changes and notable items
- Revenue growth was modest, while continuing-operations earnings and diluted EPS declined year over year. First-half operating income fell 3.9%.
- Revenue per requisition pressure reflected PAMA and other price reductions, increased denials and patient concessions. Management also cited favorable test mix, partly related to acquisitions.
- Q2 income from discontinued operations included a $20m tax benefit from favorable resolution of legacy Nichols Institute Diagnostics tax contingencies. The first-half cash flow also included a related $28m tax refund.
- Quest acquired certain Boyce & Bynum clinical laboratory assets in February for $61m, including estimated $6m contingent consideration tied to testing volumes.
- Quest issued $500m of 4.20% senior notes due 2029, using proceeds in part to repay 2019 notes and secured receivables facility borrowings. Debt fair value was estimated at $4.2bn, above carrying value by $251m.
- Lease accounting adoption added approximately $500m of operating lease assets and $550m of lease liabilities at January 1, 2019; it did not materially affect reported results or cash flows.
Outlook, management commentary and risks
Management estimated 2019 capital expenditures of $350m–$400m. Its multi-year Invigorate program targets annual cost savings of approximately 3%; the company said it achieved that target in 2018. First-half 2019 included $36m of pre-tax Invigorate charges, primarily systems conversion and integration costs, with further restructuring charges possible. Management stated that cash, operating cash flow and available credit should fund operations, debt service, capital spending, dividends, buybacks and growth opportunities. The filing provides no specific full-year revenue or EPS guidance in the supplied text.
Key risks include reimbursement and pricing pressure, payer denials, billing and collection challenges, healthcare regulation, competition, and litigation or government investigations. The AMCA data security incident involved a third-party debt collector’s systems, not Quest’s or Optum360’s systems; affected information included financial, medical and personal data, but not test results. Approximately 31 putative class actions and government inquiries were reported. Quest said the incident had no material Q2 financial impact to date, but future costs or collection disruption could affect results; any potential loss could not be estimated. Insurance coverage is limited and subject to a deductible.
Other notable Q2 items: management reported items that reduced diluted EPS by a net $0.22, including amortization, systems conversion/integration charges, a contingent-consideration gain and stock-based compensation tax benefits. The six-month net EPS reduction from listed items was $0.42. The effective tax rate was 23.6% in both 2019 periods; the 2018 comparisons benefited from a $15m tax-method benefit. The board declared quarterly dividends of $0.53 per share in the first two quarters of 2019; $492m remained authorized for repurchases at June 30.
Important facts for investors to verify
- Whether volume growth can continue to offset falling revenue per requisition, including PAMA-related and other reimbursement pressure.
- Whether Invigorate savings offset labor, benefit, acquisition and operating cost increases, and how much additional program spending or restructuring is required.
- Developments in AMCA-related litigation and investigations, insurance recovery, and any effects on collections, reputation or financial results.
- Upcoming debt maturities, refinancing terms, interest expense and liquidity; $803m of debt maturities were scheduled for 2020.
- Whether reported cash generation is sustainable apart from working-capital timing and the one-time $28m tax refund; also monitor receivables and days sales outstanding (51 days at June 30).
- The realization of acquisition-related volume and synergies, and the potential UMass noncontrolling-interest redemption right beginning July 1, 2020; its June 30 fair value was $76m.