Quest Diagnostics Incorporated — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Amounts are in millions except per-share data. Quest provides diagnostic information services (DIS), which generated 97% of revenue, and Diagnostic Solutions (DS). Results are unaudited.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $2,774 | $2,786 | $8,044 | $6,435 |
| Operating income | $652 | $718 | $1,845 | $1,176 |
| Operating margin | 23.5% | 25.8% | 22.9% | 18.3% |
| Net income attributable to Quest | $505 | $568 | $1,605 | $852 |
| Diluted EPS | $4.02 | $4.14 | $12.41 | $6.25 |
| Operating cash flow | $561 | $862 | $1,752 | $1,464 |
Q3 revenue declined 0.4%; DIS revenue fell 0.2%, while DS revenue fell 8.0%. DIS requisition volume rose 5.3% (organic growth 3.2%), but revenue per requisition declined 5.4%, primarily reflecting lower COVID-19 testing and a greater contribution from lower-revenue-per-requisition Professional Laboratory Services work. Base-business volume was 3.8% above Q3 2019, excluding recent acquisitions. For the nine months, revenue grew 25.0%, reflecting COVID-19 testing demand, recovery in the base business and acquisitions; diluted EPS rose 98.5%.
Q3 operating margin contracted as operating costs increased faster than revenue: cost of services rose 5.6% and SG&A rose 7.9%. Nine-month margin improved versus 2020. Net income and EPS comparisons also reflect non-operating gains and lower weighted-average shares following share repurchases.
Cash, debt and liquidity
- Cash and cash equivalents were $987 at September 30, 2021, versus $1,158 at year-end 2020. Net cash decreased $171 during the first nine months.
- Nine-month operating cash flow was $1,752; investing activities provided $248, including $755 of proceeds from the Q2 Solutions sale; financing activities used $2,171, including $1,910 of treasury-stock purchases and $232 of dividends paid.
- Debt carrying value was approximately $4,007, including $1 current and $4,006 long-term, versus $4,015 at year-end 2020. No borrowings were outstanding under the $600 secured receivables facility or $750 revolving credit facility. The company reported $1.3 billion of available borrowing capacity and compliance with applicable covenants.
- Quarterly dividend declared was $0.62 per share, compared with $0.56 in 2020. The company repurchased 12.5 million shares for $1.6 billion during the first nine months; $1.3 billion remained authorized at September 30.
Material changes and unusual items
- Quest sold its 40% Q2 Solutions interest to IQVIA on April 1 for $760 cash and recorded a $314 pretax gain, contributing materially to nine-month other income. Quest remains a preferred laboratory provider under a multiyear agreement.
- Q3 other income included $42 of gains from strategic investments that became publicly traded. Management said listed items increased Q3 diluted EPS by a net $0.06 and nine-month diluted EPS by a net $1.50; the nine-month figure includes the Q2 Solutions gain.
- The June 2021 Mercy Health outreach laboratory acquisition cost $225 and added $188 of goodwill and $54 of customer-related intangible assets under a preliminary purchase-price allocation.
- The Invigorate cost program incurred $47 of pretax charges in the first nine months, primarily systems conversion and integration costs. Management targets annual savings of approximately 3% of costs.
Outlook, risks and contingencies
- Management expected COVID-19 testing demand to trend down through the remainder of 2021. It described base testing volume as recovering, though the recovery stalled somewhat in August and resumed in September. No specific revenue or EPS guidance is provided in the filing.
- Management estimated approximately $400 of 2021 capital expenditures and stated that cash, operating cash flow and available credit should support operations, debt service, dividends, repurchases and growth for the foreseeable future.
- Results remain sensitive to COVID-19 severity, testing demand and reimbursement rates, healthcare-system activity, payer and customer relationships, supply conditions and government actions. Management cautioned that interim results may not indicate full-year performance.
- In August 2021, subsidiary ReproSource experienced a ransomware-related security incident in which patient health and personal information may have been accessed or acquired; the filing says other Quest systems were not affected. The filing also discusses pending AMCA-related class actions and government inquiries, a 401(k) plan lawsuit, and other legal matters. Management did not believe material legal losses were probable at September 30, but outcomes could affect results or cash flows.
- General and professional liability reserves were $153; legal reserves were $6. Management believed existing liability reserves and insurance were sufficient for currently estimated exposures. Losses on certain legal matters could not be estimated clearly.
- In October 2021, Quest amended its secured receivables facility to extend underlying commitment maturities by one year without changing aggregate capacity.
Key investor verification points
- Assess whether COVID-19 testing declines and reimbursement changes are offset by durable base-business volume and revenue-per-requisition trends.
- Separate recurring operating performance from the Q2 Solutions disposal gain, strategic-investment gains, restructuring costs and share-repurchase effects when evaluating earnings.
- Review the final settlement of the $1.5 billion accelerated share repurchase agreements, including the remaining shares and final purchase price.
- Monitor cash conversion, working capital, capital spending, debt maturities and continued capacity for dividends and buybacks.
- Follow developments in the ReproSource security incident, AMCA proceedings, the 401(k) litigation and other legal contingencies.