Quest Diagnostics Incorporated — FY2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. This is an annual report, not a standalone fourth-quarter filing; fourth-quarter figures are unaudited. Dollar amounts are in U.S. dollars.
Business context
Quest provides clinical testing and diagnostic information services, with Diagnostic Information Services (DIS) accounting for 93% of 2015 revenue. It processed approximately 157 million test requisitions. On July 1, the company contributed its clinical-trials testing business to Q² Solutions, a joint venture in which it retained a 40% interest.
Key financial metrics
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Revenue | $7.493 billion | $7.435 billion | +0.8% |
| Operating income | $1.399 billion | $983 million | +42.3% |
| Income attributable to Quest | $709 million | $556 million | +27.5% |
| Diluted EPS | $4.87 | $3.81 | +27.8% |
| Cash from operations | $810 million | $938 million | −$128 million |
| Capital expenditures | $263 million | $308 million | −$45 million |
- Revenue mix and growth: DIS revenue was $6.965 billion, up 1.3%; DIS volume rose 1.2% and revenue per requisition rose 0.1%. Acquisitions contributed nearly 1.3 percentage points of DIS growth. Diagnostic Solutions revenue fell 6.1%, substantially reflecting the clinical-trials contribution.
- Margins: Reported operating margin was 18.7% versus 13.2%; 2015 included a $334 million gain on the joint-venture contribution. Gross profit was $2.836 billion, approximately 37.8% of revenue, versus $2.798 billion, approximately 37.6%, in 2014.
- Cash generation: Operating cash flow less capital expenditures was $547 million in 2015, compared with $630 million in 2014; this is a simple cash-flow proxy, not a company-defined free-cash-flow measure. Operating cash flow fell partly because of debt-retirement cash costs, an additional payroll cycle, and tax payments, partly offset by improved operating performance and working capital.
- Debt and liquidity: Year-end total debt was approximately $3.651 billion, down from $3.742 billion; cash was $133 million, down from $192 million. Current assets were $1.501 billion and current liabilities $1.173 billion. The company reported $1.3 billion of available borrowing capacity and compliance with debt covenants.
- Capital returns: Quest repurchased $224 million of shares and paid $212 million in dividends during 2015. It returned 80% of free cash flow to investors, as described by management. The quarterly dividend was raised from $0.38 to $0.40 beginning with the April 2016 payment.
Material changes versus comparable periods
- Revenue growth slowed to 0.8% from 4.0% in 2014. DIS growth was supported by acquisitions and volume, while modest per-requisition growth reflected esoteric testing gains partly offset by reimbursement pressure.
- Operating income and EPS increased, but results include the $334 million noncash Q² Solutions gain. The company also recorded $150 million of pretax debt-retirement and related refinancing charges, $105 million of restructuring and integration charges, and other costs. Management said the net effect of specified 2015 items benefited diluted EPS by $0.48.
- In the fourth quarter, revenue was $1.849 billion versus $1.883 billion a year earlier; income attributable to Quest was $188 million versus $190 million, and diluted EPS was $1.29 versus $1.26.
- Cash from operations declined year over year. Total debt decreased modestly, while the company refinanced and retired debt, including issuing $1.2 billion of senior notes and retiring or tendering older notes.
Outlook, risks and unusual items
- Management expected a stable business environment in 2016 and moderate DIS reimbursement pressure through 2017. It anticipated revised Medicare laboratory reimbursement under PAMA could take effect as early as 2017. No specific consolidated revenue or EPS guidance is provided in the supplied filing text.
- Management targeted an additional $600 million of Invigorate run-rate savings by the end of 2017, for $1.3 billion cumulative savings compared with 2011; it reported more than $200 million of realized savings in 2015. Estimated 2016 pretax program charges were $80–$100 million, principally systems conversion and integration costs.
- Planned 2016 capital expenditures were approximately $250–$300 million. Management also described strategically aligned acquisitions as a potential source of 1–2% annual revenue growth.
- Principal risks include reimbursement reductions and payer bargaining power, competitive pressure and testing internalization, patient collection and bad-debt exposure, potential FDA regulation of laboratory-developed tests, PAMA changes, legal and billing-compliance matters, cybersecurity and system-conversion disruption, and acquisition integration.
- Quest disclosed Florida Medicaid pricing and billing litigation and a federal False Claims Act matter involving its Berkeley HeartLab subsidiary. Management said material losses were not believed probable at year-end, but potential losses could not be estimated. Professional and general liability reserves were $124 million.
- Other notable items include $176 million of assets held for sale, a $58 million deferred tax benefit related to winding down a subsidiary, and a $145 million deferred tax expense associated with the Q² Solutions gain. Management reported effective disclosure controls and internal control over financial reporting; the auditor issued an unqualified opinion.
Most important facts for investors to verify
- How much of DIS growth is organic, and whether volume and revenue per requisition can improve without acquisitions.
- The sustainability of earnings after excluding the Q² Solutions gain, debt-retirement charges, restructuring costs, and tax items.
- Actual cash conversion, working-capital needs, and the company’s definition of free cash flow relative to dividends and buybacks.
- Timing and financial impact of PAMA reimbursement revisions and any increased FDA oversight of laboratory-developed tests.
- Progress toward the 2017 cost-savings target, related cash charges, and execution risks from systems standardization.
- Developments in the disclosed legal matters and the adequacy of related reserves, alongside debt maturities and refinancing needs.