Quest Diagnostics Incorporated (DGX) — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing, not a standalone fourth-quarter report; quarterly figures are unaudited. Amounts are in U.S. dollars unless stated otherwise.
Business context
Quest is a leading provider of clinical laboratory testing and diagnostic information services. Diagnostic Information Services (DIS) generated 95.8% of 2019 revenue; Diagnostic Solutions includes life-insurance risk assessment and healthcare information technology services. The company processed approximately 175 million test requisitions in 2019.
Financial and operating performance
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net revenue | $7.726 billion | $7.531 billion | +2.6% |
| Operating income | $1.231 billion | $1.101 billion | +11.8% |
| Operating margin | 15.9% | 14.6% | +1.3 percentage points |
| Continuing income attributable to Quest stockholders | $838 million | $736 million | +13.8% |
| Diluted continuing-operations EPS | $6.13 | $5.29 | +15.9% |
| Operating cash flow | $1.243 billion | $1.200 billion | +$43 million |
- Revenue drivers: DIS revenue rose 2.8% to $7.405 billion, while Diagnostic Solutions revenue fell 1.8% to $321 million. DIS requisition volume increased 4.3% (3.1% organic, 1.2% acquisitions); revenue per requisition decreased 1.3%.
- Margins and costs: Cost of services was 65.2% of revenue versus 65.4% in 2018. Management attributed operating improvement partly to productivity and cost initiatives, including leveraging higher volume across its fixed-cost base.
- Cash, investment and debt: Cash and equivalents were $1.192 billion at year-end, versus $135 million a year earlier. Total debt was approximately $4.770 billion, including $804 million current; cash-adjusted debt was approximately $3.578 billion. Capital expenditures were $400 million. Operating cash flow less capital expenditures was approximately $843 million.
- Liquidity: The company reported $1.3 billion of available capacity under credit facilities and compliance with debt covenants. It expects cash, operating cash flow and borrowing capacity to fund operations, debt service, capital spending, dividends, repurchases and growth opportunities.
- Capital returns: Quest paid $286 million in dividends and repurchased $350 million of stock during 2019. It announced a quarterly dividend increase from $0.53 to $0.56 per share, effective with the April 2020 payment.
Fourth-quarter context and changes versus 2018
Unaudited fourth-quarter revenue was $1.926 billion, compared with $1.839 billion in 2018. Continuing-operations income was $265 million versus $139 million, and diluted continuing-operations EPS was $1.86 versus $0.92. The quarter included a $73 million gain on a property sale-leaseback; quarterly results should therefore be assessed alongside the identified unusual items.
For the full year, revenue growth reflected higher DIS volume and acquisitions, partly offset by reimbursement pressure and increased denials. Operating income grew faster than revenue, while income tax expense rose to $247 million from $182 million and net interest expense increased to $175 million from $167 million. Full-year continuing-operations EPS growth also reflected a smaller net per-share reduction from specified items in 2019 than in 2018: $0.43 versus $1.02.
Outlook, management commentary and material items
- Management expects total reimbursement rate pressure in 2020 to exceed 2%; PAMA and related impacts are estimated at $80–$85 million. It expects a similar PAMA impact in 2021. Medicare clinical laboratory fee schedule revenue represented 11% of 2019 consolidated revenue; scheduled 2020 reductions vary by test and are approximately 10% overall under the filing’s description.
- Management said the LAB Act delays the next PAMA data collection and reporting period until January 1, 2021 and requires a study of ways to improve market-rate data collection. The company is also a member of the laboratory industry association involved in litigation challenging CMS’s PAMA implementation.
- Quest achieved its annual Invigorate cost-savings goal of approximately 3% of costs. It incurred $60 million of pre-tax Invigorate charges in 2019, primarily for systems conversion and integration; further restructuring charges may occur. Management plans 2020 capital expenditures of $375–$400 million, including laboratory, facility and information-technology investments.
- Unusual 2019 items included $78 million of pre-tax systems-conversion and integration charges and a net $89 million pre-tax gain, primarily from the property sale-leaseback, acquisition contingent-consideration revaluation and a hurricane-insurance claim, partly offset by data-incident costs and impairment charges. Continuing-operations EPS effects of all specified items netted to a $0.43 reduction, as reported by the company.
- The AMCA data security incident involved a third-party debt collection agency’s system, not Quest’s or Optum360’s systems; test results were not included. The filing reports lawsuits and government inquiries and says a possible loss range could not be estimated. Management said the incident’s 2019 effect on results and cash flow was not material, but future costs or collection disruption could have an adverse effect.
- Other key risks include reimbursement and payer-denial pressure, competition and testing internalization, privacy/cybersecurity and third-party vendor risks, regulatory changes affecting laboratory-developed tests, complex billing and revenue estimates, and legal or compliance proceedings. The company reported approximately $4.8 billion of debt and noted that credit-rating changes could raise borrowing costs.
- Subsequent events: Quest completed its approximately $110 million acquisition of Blueprint Genetics in January 2020 and agreed to acquire Memorial Hermann’s outreach laboratory business, subject to customary closing conditions.
Investor facts to verify
- Whether DIS organic volume growth and expanded health-plan access can continue to offset lower revenue per requisition, reimbursement cuts and denials.
- The realized 2020 and subsequent PAMA-related revenue and earnings effects versus the $80–$85 million 2020 estimate, and any changes resulting from LAB Act reforms or litigation.
- How much of 2019 operating-income and EPS improvement reflects sustainable operations versus the property gain, contingent-consideration gains, insurance recovery, tax benefits and restructuring costs.
- The development and financial impact of AMCA-related litigation, investigations, insurance recoveries and any disruption to receivables collections; the filing does not provide a clear estimated loss range.
- Debt maturities, refinancing and cash deployment after the January 2020 redemption of $800 million of notes, including the balance among dividends, repurchases, capital investment and acquisitions.
- Accounts-receivable contractual allowances and patient price concessions: the auditor identified valuation of DIS receivables and contractual allowances as a critical audit matter. The auditor gave unqualified opinions on the financial statements and internal control over financial reporting.