01—Abstract
Summary
Summary of the 10-K filed February 21, 2019. Cited figures are marked; the original filing is the authoritative source.
Quest Diagnostics (DGX) closed 2018 with net revenues of $7.53 billiona, up 1.7% year over year, but operating income fell 5.5% to $1.10 billion and diluted EPS declined 3.8% to $5.29 from $5.50.
The decline reflects $122 millionb of pre-tax restructuring and integration charges under the Invigorate cost program, a higher effective cost base from acquisitions, and pricing pressure. Organic DIS revenue actually declined 1.3%, with acquisitions (including Oxford Immunotec's U.S. lab business, ReproSource, MedXM and Cape Cod Healthcare's outreach business) supplying the growth. Revenue per requisition fell 1.2% on PAMA-driven Medicare rate cuts, higher denials and patient concessions, while volume rose 2.5%.
Management's strategic message is a shift toward faster growth: the company now targets a compound annual revenue growth rate above 2%, up from 1-2%, built on partnerships with health plans (a long-term UnitedHealthcare agreement and new in-network status with Horizon BCBS New Jersey and BCBS Georgia, adding roughly 43 million insured lives effective January 1, 2019), IDN reference testing, consumer-initiated testing, and advanced diagnostics. Capital returns remain a priority: the quarterly dividend was raised 6% to $0.53c, and about $2.8 billion has been returned via buybacks since 2013, though 2018 repurchases ($322 million) were lower than in 2017. Free cash flow was about $817 million (operating cash flow of $1.2 billion less $383 million of capex), and total debt rose to $3.9 billion.
The key risks for investors are regulatory and reimbursement. Medicare CLFS rates were cut in 2018 and are scheduled to fall roughly another 10%d in each of 2019 and 2020, with the company expecting 2019 reimbursement pressure above 2.5%. Other concerns include potential FDA regulation of laboratory-developed tests, payer consolidation, hospital insourcing, cyber risk following a 2016 data breach, and False Claims Act exposure.
02—Key points
Key Highlights
- Net revenues rose 1.7% to $7.53 billion, but organic DIS revenue declined 1.3%; growth came from acquisitions contributing about 3.2 points.
- Operating income fell 5.5% to $1.10 billion, and operating margin compressed to 14.6% from 15.7%, partly due to $122 million of restructuring and integration charges.
- Diluted EPS was $5.29, down 3.8% from $5.50; 2018 items reduced EPS by a net $0.45.
- Revenue per requisition fell 1.2% from PAMA reimbursement cuts, denials and higher patient concessions, while requisition volume rose 2.5%.
- Strategy was upgraded to a compound annual revenue growth target above 2%, supported by new health plan contracts adding about 43 million insured lives effective January 1, 2019.
- Operating cash flow was $1.2 billion and capex was $383 million; the quarterly dividend was raised 6% to $0.53, and total debt was $3.9 billion.
- Medicare Clinical Laboratory Fee Schedule cuts of roughly 10% per year in 2019 and 2020 are the principal reimbursement risk.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2018, Quest Diagnostics Inc kept $0.10.
- Revenue$7.53B100.0%
- Cost of revenue−$4.93B65.4%
- Gross profit$2.60B34.6%
- Operating costs−$1.50B20.0%
- Operating income$1.10B14.6%
- Interest, other & tax−$365.0M4.8%
- Net income$736.0M9.8%
Where FY2018 revenue went
$7.53B- Cost of revenue: $4.93B, 65% of revenue
- SG&A: $1.42B, 19% of revenue
- Net income: $736.0M, 9.8% of revenue
- Other operating costs: $80.0M, 1.1% of revenue
- Interest, other & tax: $365.0M, 4.8% of revenue
Kept 9.8% as net income
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2018filed February 21, 2019Financial Statements
FY2018 against FY2017
| Line item | FY2018FY2017 | Change |
|---|---|---|
| Revenue | $7.53B$7.40B | +1.7% |
| Cost of Revenue | $4.93B$4.72B | +4.4% |
| Gross Profit | $2.60B$2.68B | −2.9% |
| SG&A Expenses | $1.42B$1.44B | −1.3% |
| Operating Expenses | $6.43B$6.24B | +3.1% |
| Operating Income | $1.10B$1.17B | −5.5% |
| Interest Expense | $169.00M$153.00M | +10.5% |
| Net Income | $736.00M$772.00M | −4.7% |
| EPS (Basic) | $5.39$5.63 | −4.3% |
| EPS (Diluted) | $5.29$5.50 | −3.8% |
| Shares Outstanding (Basic) | 136.00M137.00M | −0.7% |
| Shares Outstanding (Diluted) | 139.00M140.00M | −0.7% |
05—Questions
Frequently Asked Questions
Why did Quest's operating income and EPS decline in 2018 despite revenue growth?
Operating income fell 5.5% to $1.10 billion while revenue grew 1.7%. Drivers included $122 million of pre-tax restructuring and integration charges, higher cost of services tied to acquisitions and reinvestment, and pricing pressure that reduced revenue per requisition by 1.2%. Diluted EPS fell 3.8% to $5.29, though 2017 had benefited from a $106 million tax reform benefit.
How much of Quest's 2018 growth was organic?
Very little. DIS revenue grew 1.9%, but acquisitions contributed 3.2 points, so organic revenue declined 1.3%. Volume growth of 2.5% was roughly 2 points from acquisitions and 0.5 points organic.
What is the biggest regulatory threat to Quest's earnings?
PAMA-driven Medicare reimbursement cuts. Clinical lab fee schedule rates were reduced in 2018 and are scheduled to fall about 10% in each of 2019 and 2020, with further cuts of up to 15% annually possible from 2021 to 2023. Management expects 2019 reimbursement pressure to exceed 2.5% of revenue. Potential FDA regulation of laboratory-developed tests is a further risk.
How is Quest returning capital to shareholders?
The company paid $266 million in dividends in 2018 and raised the quarterly dividend 6% to $0.53. It repurchased $322 million of stock in 2018, down from $465 million in 2017, and about $592 million remained under its authorization at year-end. Management expects to return a majority of free cash flow to shareholders.
What growth opportunities does management highlight for 2019 and beyond?
Management highlights new health plan partnerships, including UnitedHealthcare and Horizon BCBS New Jersey, which expand insured-life access to about 90% of U.S. insured lives. Other opportunities include hospital reference and outreach testing through Professional Laboratory Services, consumer-initiated testing (QuestDirect), advanced diagnostics and population health services. Acquisitions such as Oxford Immunotec's U.S. lab business and ReproSource are expected to add growth.
06—Continue