01—Abstract
Summary
Summary of the 10-K filed February 23, 2018. Cited figures are marked; the original filing is the authoritative source.
Quest Diagnostics' 2017 10-K shows a company growing revenue steadily while absorbing a large one-time tax benefit.
Net revenues rose 2.6% to $7.71 billiona, driven by the Diagnostic Information Services (DIS) business, which grew 3.3% on a 2.3% rise in requisition volume and a 1.0% gain in revenue per requisition. Diluted EPS increased 22% to $5.50, but this was flattered by a provisional $106 million net tax benefit from the Tax Cuts and Jobs Act and $37 million of excess stock-comp tax benefits. Excluding these items, earnings growth was materially slower, and operating income actually declined 8.8% to $1.165 billion, reflecting Invigorate restructuring and systems-conversion costs and the absence of the 2016 Focus Diagnostics gain.
The filing's key forward-looking concern is reimbursement. PAMA revisions to the Medicare Clinical Laboratory Fee Schedule are expected to cut CLFS-based revenue by roughly 4%b in 2018 and about 10% in each of 2019 and 2020, which management estimates will weigh on DIS reimbursement by about 0.5% in 2018. Management also flagged the FDA's possible regulation of laboratory-developed tests and a draft CMS policy on next-generation sequencing coverage as risks to the advanced diagnostics growth strategy.
The company continues to pursue 1-2% annual growth through acquisitions, completed several in 2017 (about $587 millionc total), and announced an 11% dividend increase to $0.50 per quarter. Balance sheet leverage is manageable but notable: total debt was about $3.8 billion at year-end, cash was $137 million, and the company repurchased $465 million of stock while returning a majority of free cash flow to shareholders. Operating cash flow of $1.18 billion gives coverage of dividends and capex, though the margin of safety depends on maintaining investment-grade ratings and on continued cost savings from Invigorate, which reached over $1.3 billion in run-rate savings.
02—Key points
Key Highlights
- Net revenues rose 2.6% to $7.709 billion; DIS revenues grew 3.3% to $7.370 billion, while the DS businesses fell 10% to $339 million largely due to the Focus Diagnostics sale.
- Diluted EPS of $5.50 (up 22% from $4.51) was boosted by a $106 million provisional TCJA tax benefit (about $0.77 per share) and $37 million of excess stock-compensation tax benefits (about $0.27 per share).
- Operating income fell 8.8% to $1.165 billion, with operating margin compressing to 15.1% from 17.0%, reflecting $105 million of restructuring and systems-conversion charges and the prior-year Focus gain.
- PAMA Medicare fee schedule cuts are expected to reduce CLFS revenue (12% of 2017 revenue) by about 4% in 2018 and about 10% in each of 2019 and 2020.
- Six acquisitions in 2017 (PeaceHealth outreach, Med Fusion, Hartford HealthCare outreach, Cleveland HeartLab, Shiel) totaled about $587 million, adding precision oncology and cardiovascular diagnostics capabilities.
- Invigorate cost program exceeded its target with over $1.3 billion in run-rate savings versus 2011 as of year-end 2017.
- Total debt of $3.8 billion and cash of $137 million; the company repurchased $465 million of stock and raised the quarterly dividend 11% to $0.50 per share.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2017, Quest Diagnostics Inc kept $0.10.
- Revenue$7.40B100.0%
- Cost of revenue−$4.72B63.8%
- Gross profit$2.68B36.2%
- Operating costs−$1.52B20.5%
- Operating income$1.17B15.7%
- Interest, other & tax−$393.0M5.3%
- Net income$772.0M10.4%
Where FY2017 revenue went
$7.40B- Cost of revenue: $4.72B, 64% of revenue
- SG&A: $1.44B, 19% of revenue
- Net income: $772.0M, 10% of revenue
- Other operating costs: $75.0M, 1.0% of revenue
- Interest, other & tax: $393.0M, 5.3% of revenue
Kept 10% as net income
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2017filed February 23, 2018Financial Statements
FY2017 against FY2016
| Line item | FY2017FY2016 | Change |
|---|---|---|
| Revenue | $7.40B$7.21B | +2.6% |
| Cost of Revenue | $4.72B$4.62B | +2.2% |
| Gross Profit | $2.68B$2.90B | −7.5% |
| SG&A Expenses | $1.44B$1.38B | +4.6% |
| Operating Expenses | $6.24B$5.94B | +5.1% |
| Operating Income | $1.17B$1.28B | −8.8% |
| Interest Expense | $153.00M$144.00M | +6.3% |
| Net Income | $772.00M$645.00M | +19.7% |
| EPS (Basic) | $5.63$4.58 | +22.9% |
| EPS (Diluted) | $5.50$4.51 | +22.0% |
| Shares Outstanding (Basic) | 137.00M140.00M | −2.1% |
| Shares Outstanding (Diluted) | 140.00M142.00M | −1.4% |
05—Questions
Frequently Asked Questions
How much of the 2017 EPS growth came from underlying operations versus one-time tax items?
Most of the 22% diluted EPS increase came from the tax line. The $106 million TCJA benefit and $37 million of excess stock-comp tax benefits together add roughly $1.04 per diluted share. Operating income actually declined 8.8%, so core operating earnings growth was negative on a reported basis, though the prior year included a $118 million pre-tax gain on the Focus sale.
What is the biggest regulatory risk to Quest's revenue over the next few years?
PAMA's revised Medicare Clinical Laboratory Fee Schedule. Management expects CLFS-based revenue to fall about 4% in 2018 and about 10% in each of 2019 and 2020, with further cuts possible after 2020 based on market-rate surveys. The company is also pursuing a legislative fix and supporting an industry lawsuit against CMS.
How is Quest growing beyond routine testing?
Growth is focused on advanced diagnostics (genetic and molecular testing), professional laboratory services for hospitals, consumer-initiated testing, and data and extended care services such as the Wal-Mart joint venture and Quanum health IT. Gene-based and esoteric testing revenue rose to $2.45 billion in 2017 from $2.34 billion in 2016, outpacing routine testing growth.
How well is the company funding its shareholder returns and acquisitions?
Operating cash flow of $1.175 billion covered capital expenditures of $252 million and dividends of $247 million, with the remainder funding acquisitions and buybacks. Debt rose modestly to $3.8 billion to fund late-2017 acquisitions. Management stated it intends to keep an investment-grade rating while returning most free cash flow to investors, and $917 million remained on the repurchase authorization.
06—Continue