Quest Diagnostics Incorporated — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited consolidated results. Quest provides diagnostic information services (DIS), which generated more than 90% of revenue, and Diagnostic Solutions (DS).
Financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net revenue | $1.899 billion | $1.863 billion | +1.9% |
| Operating income | $279 million | $257 million | +8.7% |
| Operating margin | 14.7% | 13.8% | +0.9 percentage points |
| Net income attributable to Quest | $164 million | $103 million | +58.8% |
| Diluted EPS | $1.16 | $0.71 | +63.4% |
| Cash from operating activities | $196 million | $153 million | +$43 million |
DIS revenue increased 3.2% to $1.812 billion; requisition volume rose 3.5%, while revenue per requisition fell 0.2%, reflecting moderate unit-pricing pressure and lower revenue per requisition from professional lab services. Organic growth and acquisitions contributed approximately 2.4% and 0.9% to DIS revenue growth, respectively. DS revenue declined 19.0% to $87 million, primarily following the 2016 sale of the Focus Diagnostics products business. That sale reduced consolidated revenue growth by 1.1 percentage points.
Cost of services increased $21 million, mainly from compensation, benefits and supplies associated with higher testing volume; SG&A declined $5 million. Cost of services was 61.3% of revenue versus 61.4%; SG&A was 23.0% versus 23.7%. The effective tax rate fell to 31.8% from 38.9%, including $16 million of excess stock-compensation tax benefits in 2017 versus $2 million in 2016.
Cash, debt and liquidity
- Cash and cash equivalents were $367 million at March 31, 2017, up from $359 million at year-end; approximately 16% was held outside the United States and considered indefinitely reinvested.
- Operating cash flow was $196 million. Investing activities used $22 million, including $42 million of capital expenditures and $25 million of escrow proceeds related to the Focus sale. Financing activities used $166 million, including $150 million of share repurchases and $62 million of dividends paid.
- Balance-sheet debt was $3.731 billion, comprising $6 million current and $3.725 billion long-term. Estimated fair value was approximately $3.9 billion. No borrowings were outstanding under the secured receivables or senior unsecured revolving facilities; approximately $1.3 billion of borrowing capacity was available.
- Current assets were $1.558 billion and current liabilities $985 million. The company reported compliance with credit-agreement covenants.
- Quest repurchased 1.6 million shares for $150 million and declared a quarterly dividend of $0.45 per share. $1.2 billion remained under its repurchase authorization.
Comparative changes and unusual items
Reported earnings growth reflects, in part, prior-year comparison effects. Q1 2016 included a $48 million loss on retirement of debt, among other restructuring and other charges; total items cited by management reduced 2016 diluted EPS by $0.31. Q1 2017 included $18 million of pre-tax restructuring, systems-conversion and integration charges, reducing diluted EPS by $0.08, partly offset by $16 million of stock-compensation tax benefits, adding $0.11 per diluted share. Management said these 2017 items benefited diluted EPS by $0.03 net.
Operating cash flow increased partly because Q1 2016 included $47 million of debt-retirement payments. Investing cash use fell substantially versus 2016, primarily because of lower acquisition spending and the 2017 escrow proceeds. Financing cash flow shifted from $32 million provided to $166 million used, mainly due to lower net borrowing and increased repurchases.
Outlook, risks and contingencies
- No specific full-year revenue or earnings guidance is stated in the provided filing text. Management expects 2017 capital expenditures of approximately $250 million to $300 million.
- Quest reported more than $1.1 billion in Invigorate run-rate savings at the end of 2016 and said it was on track for its $1.3 billion target exiting 2017, compared with 2011. It estimated $60 million to $80 million of 2017 pre-tax program charges, including $60 million to $70 million for systems conversion and integration; $16 million was incurred in Q1. Management expects further cost savings beyond 2017.
- An agreement to acquire PeaceHealth Laboratories’ outreach laboratory services was expected to close in Q2 2017, subject to customary conditions.
- Management believes cash, operating cash flow and available borrowing capacity will fund working capital, capital expenditures, debt service, dividends, repurchases and growth opportunities for the foreseeable future. Contractual obligations totaled $8.098 billion, including $3.775 billion of outstanding debt and related interest, operating leases and purchase obligations.
- Risks include healthcare reimbursement and pricing pressure, competition, customer and payer relationships, regulatory changes, and governmental investigations and litigation. The company had reached an agreement in principle to resolve a False Claims Act matter involving its Berkeley HeartLab subsidiary, subject to final terms and governmental approvals. Management said material losses on described legal matters were not considered probable at March 31, but possible losses for certain matters could not be estimated. Professional and general liability reserves were $122 million.
- Other items to monitor include the $78 million fair value of a redeemable noncontrolling interest, exercisable by UMass beginning July 2020; $98 million of unrecognized tax-benefit liabilities; and adoption of the new revenue standard in Q1 2018, which management expected to reduce reported revenue presentation for amounts historically classified primarily as patient-responsibility bad-debt expense, without a material effect on financial position or cash flows. The lease standard is expected to significantly increase balance-sheet assets and liabilities; the impact had not yet been quantified.
Key investor verification points
- Assess whether DIS volume growth can continue to offset pricing pressure and lower revenue per requisition.
- Separate underlying earnings performance from the prior-year debt-retirement charge and current-period tax benefits and restructuring costs.
- Track delivery of the $1.3 billion Invigorate savings target, associated cash charges, and the projected $250 million to $300 million capital expenditure program.
- Review progress on the PeaceHealth acquisition and the operational and financial effects of the Focus sale and outsourced billing arrangement.
- Monitor debt maturities, contractual obligations, cash held overseas, capital returns, and developments in legal, reimbursement and regulatory matters.