Quest Diagnostics Incorporated — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Comparisons are with Q1 2018 unless otherwise noted. Dollar amounts are in millions, except per-share data.
Business context
Quest provides diagnostic information services (DIS), including clinical and anatomic pathology testing, and Diagnostic Solutions (DS), including life-insurance risk assessment and healthcare IT. DIS generated 95.8% of Q1 revenue; substantially all services and assets were in the United States.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net revenue | $1,891 | $1,884 | Up 0.4% |
| Operating income | $248 | $272 | Down 8.7% |
| Operating margin | 13.2% | 14.5% | Down 1.3 percentage points |
| Net income attributable to Quest | $164 | $177 | Down 7.3% |
| Diluted EPS | $1.20 | $1.27 | Down 5.4% |
| Net cash from operations | $275 | $180 | Up $95 |
DIS revenue rose 0.5% to $1,812; DS revenue fell 2.8% to $79, primarily reflecting weakness in risk assessment services. DIS requisition volume increased 3.6% (2.4% organic and 1.2% acquisition-related), while revenue per requisition declined 3.0%. Management cited reimbursement pressure, including PAMA-related and other unit price reductions of approximately 2.5%, increased denials, and higher patient concessions.
Cost of services increased 1.4% and selling, general and administrative expense increased 5.8%; total operating costs rose 1.9%, faster than revenue. Higher acquisition and operating costs, depreciation, deferred-compensation-related expense, and other factors contributed to lower operating income. Net interest expense increased to $44 from $41. Other non-operating income improved to $9 from expense of $2, mainly due to gains on deferred-compensation plan investments.
Cash, debt and liquidity
- Cash and cash equivalents were $464 at March 31, versus $135 at December 31, 2018. Q1 operating cash flow was $275; investing outflow was $110 and financing inflow was $164. The operating cash flow increase primarily reflected lower performance-based compensation payments and working-capital timing, partly offset by lower operating income.
- Total debt carrying value was $4,239, including $1,108 classified as current; cash less debt implies net debt of approximately $3,775. Debt fair value was estimated at $4.4 billion. Operating lease liabilities were $538 and finance lease liabilities $35, separately reported within the relevant balance-sheet lines.
- Quest issued $500 of 4.20% senior notes due June 2029 in March. It repaid the April 2019 notes on April 1, 2019 using part of the proceeds. At quarter-end, no borrowings were outstanding under either the secured receivables facility or the $750 revolving facility; approximately $1.3 billion of borrowing capacity was available.
- Management reported compliance with debt covenants and said cash, operating cash flow and available borrowing capacity should fund foreseeable operating, investment and shareholder-return needs. Current assets were $1,778 versus current liabilities of $2,282.
Material changes, outlook and notable items
- Quest acquired certain Boyce & Bynum clinical laboratory assets on February 11 for $61, including $55 cash consideration and an estimated $6 contingent consideration; the contingent amount depends on testing-volume benchmarks. The acquisition contributed to DIS growth.
- The company adopted lease accounting on January 1, recognizing approximately $500 of operating lease assets and $550 of lease liabilities at adoption. Adoption did not materially affect results or cash flows. At March 31, operating lease right-of-use assets were $497.
- The multi-year Invigorate program targets annual cost savings of approximately 3%; management said the 2018 target was achieved. Q1 incurred $14 of pre-tax cash systems-conversion and integration costs under the program. Separately, results included $22 of pre-tax restructuring/integration charges and a $9 operating gain related to a hurricane insurance claim, partly offset by $2 of noncash asset impairment charges. Management reported that specified items reduced diluted EPS by a net $0.20.
- Management estimated 2019 capital expenditures of $350–$400 million. No specific revenue or EPS guidance is provided in the filing text.
- The quarterly dividend declared was $0.53 per share. Quest repurchased $50 of stock in Q1, with $542 remaining under repurchase authorizations at March 31.
Risks and contingencies
Management highlighted reimbursement and pricing pressure, billing complexity, denials, patient concessions, competition, regulatory changes, customer and payer relationships, and potential government investigations and litigation. The company faces healthcare billing-related legal matters, including qui tam claims; management did not consider material legal losses probable at March 31, but noted outcomes could materially affect results or cash flows in the period determined or paid. Legal reserves were $1; reserves for general and professional liability claims were $125. A put right held by UMass Memorial could require purchase of its subsidiary interest at fair value beginning July 1, 2020; the recorded redeemable noncontrolling interest was $77. Unrecognized tax-benefit liabilities were approximately $109.
Important facts for investors to verify
- Whether volume gains can offset continued reimbursement pressure and the decline in revenue per requisition, particularly PAMA-related price reductions, denials and patient concessions.
- Whether Invigorate savings and productivity gains can restore operating margins amid acquisition, labor, technology and other cost increases.
- Debt refinancing and repayment needs, including 2020 maturities, and the effect of variable-rate debt and interest-rate swaps on interest expense and liquidity.
- Execution, integration and contingent-payment outcomes for Boyce & Bynum and other acquisitions; the contingent consideration is benchmark-dependent.
- Developments in legal, government-investigation, tax and insurance matters, and the potential timing or financial impact of the UMass put right.
- Delivery of the stated 2019 capital expenditure plan and the expected availability of cash and credit facilities to meet commitments and shareholder returns.