Quest Diagnostics Incorporated — Q1 2020 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2020, compared with Q1 2019. Quest primarily provides diagnostic information services (DIS), which generated 95.7% of revenue; Diagnostic Solutions (DS) generated the remainder. The quarter reflects a sharp COVID-19-related decline in testing volumes during March.
Key financial results
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net revenue | $1.822 billion | $1.891 billion | Down 3.7% |
| Operating income | $175 million | $248 million | Down 29.6% |
| Operating margin | 9.6% | 13.2% | Down 3.6 percentage points |
| Net income attributable to Quest | $99 million | $164 million | Down 39.9% |
| Diluted EPS | $0.73 | $1.20 | Down 39.6% |
| Operating cash flow | $247 million | $275 million | Down $28 million |
DIS revenue was $1.744 billion, down 3.8%; DS revenue was $78 million, down 1.9%. DIS requisitions fell 2.4% overall (organic volume down approximately 2.7%) and revenue per requisition fell 1.2%. Management estimated COVID-19 reduced quarterly testing volumes by approximately 8.2%, inclusive of COVID-19 testing. Cost of services rose 2.1% to $1.270 billion, while SG&A fell 9.6% to $347 million. Lower operating income and $25 million of additional non-operating expense—primarily investment losses associated with deferred compensation plans—contributed to lower earnings. The effective tax rate was 22.0%, versus 23.7%.
Cash, debt and liquidity
- Cash and cash equivalents were $342 million at March 31, 2020, down from $1.192 billion at year-end 2019. Q1 cash flows were $247 million from operations, $(206) million from investing and $(891) million from financing; the financing outflow mainly reflected $801 million of debt repayments.
- Capital expenditures were $83 million, versus $47 million a year earlier; net cash used for acquisitions was $108 million, versus $56 million.
- Long-term debt was $4.036 billion gross, including $3 million current; the filing estimated debt fair value at $4.3 billion. At quarter-end, the company reported $1.3 billion of available capacity under credit facilities and no outstanding facility borrowings. Its stated senior revolving-credit-facility leverage covenant limit was 3.5 times EBITDA, and the company was in compliance at March 31.
- After quarter-end, Quest borrowed $200 million under its facilities and amended its revolving-credit covenant to allow higher leverage limits through Q2 2021, after which the limit reverts to 3.5 times EBITDA. The amendment also imposes additional restrictions, including on repurchases and acquisitions.
- Quarterly dividend declared was $0.56 per share. Quest repurchased $75 million of shares in Q1, then temporarily suspended further repurchases through year-end 2020.
Material changes, outlook and risks
- DIS revenue and volume grew through February: year-to-date revenue was up 4.2% and volume up 6.3%, including favorable calendar and prior-year weather effects. March volumes fell more than 40% in the last two weeks, including COVID-19 tests; April declines were reported at 50%–60% versus the prior year.
- Quest said the pandemic’s effect on results, financial position and cash flows would likely be material, but it could not reasonably estimate the impact because it depended on the pandemic’s severity and duration, economic and healthcare-system effects, and government responses. Management also warned of possible weaker collections and supply-chain disruption. No specific full-year financial guidance is provided in the filing.
- Quest reported capacity for more than 50,000 COVID-19 tests and approximately 150,000 antibody tests per day. It received approximately $65 million in April from the initial CARES Act provider-funding distribution. CARES Act measures also included a delay in Medicare laboratory reimbursement cuts and temporary suspension of Medicare sequestration.
- Management took liquidity-preservation measures, including workforce cost actions and the share-repurchase suspension. It terminated interest-rate swaps in April, receiving $40 million, to be amortized as a reduction of interest expense.
- Blueprint Genetics was acquired in January for $108 million net of cash acquired. The Memorial Hermann outreach laboratory acquisition closed April 6 for $120 million. Invigorate cost-saving efforts incurred $11 million of pre-tax charges in Q1; management said it was assessing the pandemic’s effect on its annual target of saving approximately 3% of costs.
- Q1 results included items that reduced diluted EPS by a net $0.21, including amortization, restructuring and integration costs, and COVID-19-related costs and asset impairments, partly offset by excess tax benefits. No goodwill impairment test was deemed necessary at quarter-end, but management warned worse-than-expected pandemic effects could lead to future impairment charges.
- AMCA-related litigation and government inquiries remain outstanding. Quest said a loss was reasonably possible but could not estimate any loss or range; insurance coverage is limited and subject to a deductible. Other legal matters and self-insured general and professional liability reserves were also disclosed.
Most important facts for investors to verify
- Subsequent-quarter testing volumes, revenue, margins and cash collections, including the balance between routine testing declines and COVID-19 testing demand.
- Liquidity, borrowing, covenant compliance and the restrictions tied to the amended leverage covenant.
- Whether CARES Act funding, cost actions and Invigorate savings offset pandemic-related pressure, and whether the dividend remains supportable.
- Potential outcomes and financial exposure from AMCA litigation and investigations, the UMass redemption right beginning July 2020, and any impairment or credit-loss charges.