Quest Diagnostics Incorporated — Q3 2017 Form 10-Q
Business context and reporting period. The unaudited filing covers the three and nine months ended September 30, 2017. Quest provides diagnostic information services (DIS), which generated more than 90% of revenue, and smaller Diagnostic Solutions (DS) businesses.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenues | $1.931 billion | $1.885 billion | $5.773 billion | $5.654 billion |
| Operating income | $298 million | $322 million | $896 million | $1.001 billion |
| Net income attributable to Quest | $161 million | $192 million | $518 million | $490 million |
| Diluted EPS | $1.15 | $1.34 | $3.68 | $3.42 |
| Operating margin | 15.5% | 17.1% | 15.5% | 17.7% |
- Revenue mix and growth: Q3 DIS revenue rose 2.8% to $1.850 billion; requisition volume increased 1.6% and revenue per requisition 1.2%. DS revenue fell 5.1% to $81 million. For nine months, DIS revenue increased 2.8%, while DS revenue decreased 11.6%, principally reflecting the 2016 Focus Diagnostics products sale.
- Costs and earnings: Q3 operating income declined 7.4%; nine-month operating income declined 10.5%. Q3 operating costs rose 4.5%, faster than revenue growth. Nine-month attributable net income and diluted EPS increased despite lower operating income, with lower tax expense contributing; the 2016 comparison included the Focus Sale gain and related tax effects.
- Cash flow: Nine-month operating cash flow was $852 million, up from $765 million. Investing used $439 million, including $299 million for acquisitions and $170 million in capital expenditures. Financing used $422 million, including $350 million of treasury-stock purchases and $186 million of dividends paid. Cash declined $9 million from year-end to $350 million.
- Balance sheet and liquidity: September 30 cash was $350 million; current assets were $1.544 billion and current liabilities $1.052 billion. Debt was $3.764 billion, including the current portion, versus $3.734 billion at year-end. The company reported $1.3 billion of available borrowing capacity and no borrowings under its two credit facilities; it was in compliance with credit covenants.
- Shareholder returns: Quarterly dividend was $0.45 per share, up from $0.40 in the first three quarters of 2016. Quest repurchased 3.6 million shares for $365 million during the first nine months of 2017; $1.0 billion remained authorized.
Material changes, outlook, risks and unusual items
- Management estimated hurricanes reduced Q3 revenue growth by about 1.3%, operating income by $21 million, and diluted EPS by about $0.09. Nine-month revenue growth was estimated to be reduced by 0.4%.
- Q3 results included $23 million of restructuring and systems-conversion/integration charges and $9 million of other charges, including impairment and hurricane-related costs. These items, net of a $7 million excess stock-compensation tax benefit, reduced Q3 EPS by $0.10. Nine-month results included $64 million of restructuring/integration-related charges and other net charges; specified items, including $36 million of excess tax benefits, reduced EPS by $0.05 overall.
- Quest completed acquisitions of PeaceHealth Laboratories ($101 million), Med Fusion/Clearpoint ($150 million), and two Hartford HealthCare outreach laboratory businesses ($30 million). It agreed to acquire Shiel Medical Laboratory for $170 million plus up to $15 million contingent consideration, with closing expected in Q4 2017, and agreed in October to acquire Cleveland HeartLab for $94 million, subject to customary closing conditions.
- Management said it remained on track for $1.3 billion in Invigorate program run-rate savings by year-end 2017, versus 2011, and expected $60–$80 million of 2017 program charges; $52 million had been incurred through September. It also estimated 2017 capital expenditures of $250–$300 million. No specific revenue or earnings guidance was provided in the filing.
- CMS had proposed 2018 Medicare clinical laboratory fee schedule rates under PAMA. The filing says affected tests represent approximately 12% of consolidated revenue and that payment reductions for most affected tests are capped at 10% annually for 2018–2020; Quest was reviewing the proposal.
- Other risks include reimbursement and pricing pressure, competition, government investigations and litigation, and clinical testing liability. Management said material legal losses were not considered probable at September 30, though outcomes could affect results or cash flows. Professional and general liability reserves were $120 million. The Florida Medicaid pricing/billing matter was settled.
- Revenue-recognition guidance scheduled for adoption in Q1 2018 was expected to reclassify patient-responsibility uncollectibles from SG&A to a reduction of revenue. For 2016, Quest estimated a $301 million reduction to both revenue and SG&A, with no net income effect. Lease accounting adoption in 2019 is expected to significantly increase reported assets and liabilities, not yet quantified.
Important facts for investors to verify
- Whether underlying DIS volume and revenue-per-requisition trends persist, and how acquisitions contribute to reported growth.
- Actual hurricane-related impact and whether operating margins recover as integration and restructuring costs evolve.
- Final Medicare reimbursement rates under PAMA and the resulting exposure for Quest’s test mix.
- Progress toward the $1.3 billion savings target, expected program charges, and 2017 capital spending.
- Acquisition closing, integration, and performance—particularly Shiel and Cleveland HeartLab—and their effects on debt and cash generation.
- Debt service, interest-rate exposure, legal and liability reserves, and the effects of upcoming accounting-standard changes.