Quest Diagnostics Reports Third Quarter 2017 Financial Results, Updates 2017 Financial Guidance and Reaffirms Long Term Outlook

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

Change

2017

2016

Change

(dollars in millions, except per share data)

Reported:

Net revenues (a) (c)

$

1,931

$

1,885

2.4

%

$

5,773

$

5,654

2.1

%

Diagnostic Information Services revenues

$

1,850

$

1,800

2.8

%

$

5,517

$

5,365

2.8

%

Revenue per requisition

1.2

%

0.5

%

Requisition volume

1.6

%

2.3

%

Operating income (b) (c)

$

298

$

322

(7.4)

%

$

896

$

1,001

(10.5)

%

Operating income as a percentage of net
 revenues (c)

15.5

%

17.1

%

(160) bps

15.5

%

17.7

%

(220) bps

Net income attributable to Quest
 Diagnostics (c) (d)

$

161

$

192

(16.0)

%

$

518

$

490

5.8

%

Diluted EPS (c) (d)

$

1.15

$

1.34

(14.2)

%

$

3.68

$

3.42

7.6

%

Cash provided by operations (e)

$

362

$

301

20.5

%

$

852

$

765

11.5

%

Capital expenditures

$

63

$

61

2.5

%

$

170

$

165

2.7

%

Adjusted:

Revenues on an equivalent basis

$

1,931

$

1,885

2.4

%

$

5,773

$

5,628

2.6

%

Operating income (f)

$

325

$

320

1.6

%

$

965

$

925

4.3

%

Operating income as a percentage of net
 revenues

16.8

%

17.0

%

(20) bps

16.7

%

16.4

%

30 bps

Net income attributable to Quest
 Diagnostics (d)

$

181

$

182

(0.7)

%

$

560

$

509

10.1

%

Diluted EPS excluding amortization (d)

$

1.39

$

1.37

1.5

%

$

4.27

$

3.84

11.2

%

(a)

For the nine months ended September 30, 2016, net revenues include $26 million related to the Focus Diagnostics products business, which was sold on May 13, 2016. 

(b)

For the three months ended September 30, 2016, reported operating income includes a gain on escrow recovery associated with an acquisition.  For the nine months ended September 30, 2016, reported operating income includes a gain on escrow recovery associated with an acquisition and $129 million related to the Focus Diagnostics products business and the gain from sale on May 13, 2016.

(c)

For further details impacting the year-over-year comparisons related to net revenues, operating income, operating income as a percentage of net revenues, net income attributable to Quest Diagnostics, and diluted EPS, see note 2 of the financial tables attached below.

(d)

Excess tax benefit associated with stock-based compensation arrangements impacted income tax expense and diluted EPS as follows:

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions, except per share data)

Income tax benefit

$

7

$

3

$

36

$

7

Diluted EPS

$

0.04

$

0.02

$

0.25

$

0.05

(e) 

For details impacting the year-over-year comparisons related to cash provided by operations, see note 4 of the financial tables attached below.

(f) 

For the nine months ended September 30, 2016, adjusted operating income includes $12 million related to the Focus Diagnostics products business.

Current Outlook

Previous Outlook

Low

High

Low

High

Revenues

Approximately $7.71 billion

$7.69 billion

$7.74 billion

Revenue increase on a reported basis

Approximately 2.6%

2.3%

3.1%

Revenue increase on an equivalent basis (g)

Approximately 3.0%

2.6%

3.4%

Reported diluted EPS

$4.87

$4.92

$4.90

$5.00

Adjusted diluted EPS excluding amortization

$5.62

$5.67

$5.62

5.72

Cash provided by operations

Approximately $1.2 billion

Approximately $1.2 billion

Capital expenditures

$250 million

$300 million

$250 million

$300 million

(g)  

Reported revenues for full year 2016 were $7.52 billion.  Revenues on an equivalent basis for full year 2016 were $7.49 billion which represents the company's reported revenues, excluding all Focus Diagnostics products revenue.    

Quest Diagnostics Incorporated and Subsidiaries

Consolidated Statements of Operations

For the Three and Nine Months Ended September 30, 2017 and 2016

(in millions, except per share data)

(unaudited)

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

Net revenues

$

1,931

$

1,885

$

5,773

$

5,654

Operating costs and expenses and other operating income:

Cost of services

1,190

1,157

3,525

3,456

Selling, general and administrative

423

409

1,297

1,281

Amortization of intangible assets

19

18

54

54

Gain on disposition of business

—

—

—

(118)

Other operating expense (income), net

1

(21)

1

(20)

Total operating costs and expenses, net

1,633

1,563

4,877

4,653

Operating income

298

322

896

1,001

Other income (expense):

Interest expense, net

(38)

(37)

(112)

(107)

Other (expense) income, net

(2)

4

12

(50)

Total non-operating expenses, net

(40)

(33)

(100)

(157)

Income before income taxes and equity in earnings of equity method
  investees

258

289

796

844

Income tax expense

(92)

(95)

(264)

(345)

Equity in earnings of equity method investees, net of taxes

9

11

25

30

Net income

175

205

557

529

Less: Net income attributable to noncontrolling interests

14

13

39

39

Net income attributable to Quest Diagnostics

$

161

$

192

$

518

$

490

Earnings per share attributable to Quest Diagnostics' common 
     stockholders:

Basic

$

1.18

$

1.37

$

3.77

$

3.46

Diluted

$

1.15

$

1.34

$

3.68

$

3.42

Weighted average common shares outstanding:

Basic

137

139

137

141

Diluted

140

142

140

143

Quest Diagnostics Incorporated and Subsidiaries

Consolidated Balance Sheets

September 30, 2017 and December 31, 2016

(in millions, except per share data)

(unaudited)

September 30,
 2017

December 31,
 2016

Assets

Current assets:

Cash and cash equivalents

$

350

$

359

Accounts receivable, net

960

926

Inventories

100

82

Prepaid expenses and other current assets

134

164

Total current assets

1,544

1,531

Property, plant and equipment, net

1,097

1,029

Goodwill

6,164

6,000

Intangible assets, net

1,029

949

Investment in equity method investees

459

443

Other assets

146

148

Total assets

$

10,439

$

10,100

Liabilities and Stockholders' Equity

Current liabilities:

Accounts payable and accrued expenses

$

1,047

$

975

Current portion of long-term debt

5

6

Total current liabilities

1,052

981

Long-term debt

3,759

3,728

Other liabilities

722

654

Redeemable noncontrolling interest

78

77

Stockholders' equity:

Quest Diagnostics stockholders' equity:

Common stock, par value $0.01 per share; 600 shares authorized as of both September 30, 2017 
     and December 31, 2016; 216 shares issued as of both September 30, 2017 and December 31, 
     2016

2

2

Additional paid-in capital

2,585

2,545

Retained earnings

6,946

6,613

Accumulated other comprehensive loss

(48)

(72)

Treasury stock, at cost; 80 shares and 79 shares as of September 30, 2017 and December 31, 
     2016, respectively

(4,691)

(4,460)

Total Quest Diagnostics stockholders' equity

4,794

4,628

Noncontrolling interests

34

32

Total stockholders' equity

4,828

4,660

Total liabilities and stockholders' equity

$

10,439

$

10,100

Quest Diagnostics Incorporated and Subsidiaries

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2017 and 2016

(in millions)

(unaudited)

Nine Months Ended
September 30,

2017

2016

Cash flows from operating activities:

Net income

$

557

$

529

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

197

186

Provision for doubtful accounts

241

242

Deferred income tax provision

90

19

Stock-based compensation expense

54

52

Gain on disposition of business

—

(118)

Other, net

(5)

(15)

Changes in operating assets and liabilities:

Accounts receivable

(265)

(316)

Accounts payable and accrued expenses

(3)

43

Income taxes payable

—

74

Termination of interest rate swap agreements

—

54

Other assets and liabilities, net

(14)

15

Net cash provided by operating activities

852

765

Cash flows from investing activities:

Business acquisitions, net of cash acquired

(299)

(139)

Proceeds from disposition of business

1

270

Escrow proceeds associated with disposition of business

25

—

Capital expenditures

(170)

(165)

Decrease (increase) in investments and other assets

4

(11)

Net cash used in investing activities

(439)

(45)

Cash flows from financing activities:

Proceeds from borrowings

—

1,869

Repayments of debt

(5)

(1,722)

Purchases of treasury stock

(350)

(440)

Exercise of stock options

125

63

Employee payroll tax withholdings on stock issued under stock-based compensation plans

(23)

(10)

Dividends paid

(186)

(168)

Distributions to noncontrolling interests

(38)

(31)

Other financing activities, net

55

(8)

Net cash used in financing activities

(422)

(447)

Net change in cash and cash equivalents

(9)

273

Cash and cash equivalents, beginning of period

359

133

Cash and cash equivalents, end of period

$

350

$

406

Cash paid during the period for:

Interest

$

104

$

116

Income taxes

$

177

$

262

1)  The computation of basic and diluted earnings per common share is as follows:

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(in millions, except per share data)

Amounts attributable to Quest Diagnostics' common stockholders:

Net income attributable to Quest Diagnostics

$

161

$

192

$

518

$

490

Less: earnings allocated to participating securities

1

2

2

3

Earnings available to Quest Diagnostics' common stockholders - basic and
  diluted

$

160

$

190

$

516

$

487

Weighted average common shares outstanding - basic

137

139

137

141

Effect of dilutive securities:

Stock options and performance share units

3

3

3

2

Weighted average common shares outstanding - diluted

140

142

140

143

Earnings per share attributable to Quest Diagnostics' common
  stockholders:

Basic

$

1.18

$

1.37

$

3.77

$

3.46

Diluted

$

1.15

$

1.34

$

3.68

$

3.42

2)  The following tables reconcile reported GAAP results to non-GAAP adjusted results:

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions, except per share data)

Adjusted operating income:

Operating income

$

298

$

322

$

896

$

1,001

Gain on disposition of business (a)

—

—

—

(118)

Restructuring and integration charges (b)

23

18

63

55

Other (c)

4

(20)

6

(13)

Adjusted operating income

$

325

$

320

$

965

$

925

Adjusted operating income as a percentage of
net revenues:

Operating income as a percentage of net revenues

15.5

%

17.1

%

15.5

%

17.7

%

Gain on disposition of business (a)

—

—

—

(2.1)

Restructuring and integration charges (b)

1.2

1.0

1.1

1.0

Other (c)

0.1

(1.1)

0.1

(0.2)

Adjusted operating income as a percentage of net revenues

16.8

%

17.0

%

16.7

%

16.4

%

Adjusted net income:

Net income attributable to Quest Diagnostics

$

161

$

192

$

518

$

490

Gain on disposition of business (a)

—

—

—

(118)

Retirement of debt and related refinancing charges (d)

—

—

—

48

Restructuring and integration charges (b)

23

18

64

58

Other (c)

9

(20)

4

(6)

Income tax (benefit) expense associated with the special
items above (e)

(12)

(8)

(26)

37

Adjusted net income

$

181

$

182

$

560

$

509

Adjusted diluted EPS excluding amortization expense:

Diluted earnings per common share

$

1.15

$

1.34

$

3.68

$

3.42

Gain on disposition of business (a) (e)

—

—

—

(0.24)

Retirement of debt and related refinancing charges (d) (e)

—

—

—

0.21

Restructuring and integration charges (b) (e)

0.10

0.08

0.28

0.25

Other (c) (e)

0.04

(0.15)

0.02

(0.09)

Amortization expense (f)

0.10

0.10

0.29

0.29

Adjusted diluted EPS excluding amortization expense

$

1.39

$

1.37

$

4.27

$

3.84

Revenue on an equivalent basis:

Net revenues

$

1,931

$

1,885

$

5,773

$

5,654

Excluded revenue (g)

—

—

—

(26)

Revenue on an equivalent basis

$

1,931

$

1,885

$

5,773

$

5,628

(a) 

For the nine months ended September 30, 2016, represents the pre-tax gain on the sale of our Focus Diagnostics products business to DiaSorin S.p.A.

(b) 

For the three and nine months ended September 30, 2017 and 2016, represents costs primarily associated with systems conversions and integration incurred in connection with further restructuring and integrating our business.  The following table summarizes the pre-tax impact of restructuring and integration charges on the company's consolidated statements of operations:     

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions)

Cost of services

$

12

$

8

$

31

$

25

Selling, general and administrative

11

10

32

30

Operating income

$

23

$

18

$

63

$

55

Equity in earnings of equity method investees, net of taxes

$

—

$

—

$

1

$

3

(c) 

For the three months ended September 30, 2017, primarily represents non-cash asset impairment charges and incremental costs incurred as a result of the hurricanes.  For the nine months ended September 30, 2017, primarily represents non-cash asset impairment charges, incremental costs incurred as a result of hurricanes and costs incurred related to certain legal matters, partially offset by gain on the sale of an interest in an equity method investee.  For the three months ended September 30, 2016, primarily represents a gain on escrow recovery associated with an acquisition.  For the nine months ended September 30, 2016, primarily represents a gain on escrow recovery associated with an acquisition, partially offset by costs associated with winding down subsidiaries, non-cash asset impairment charges and costs incurred related to certain legal matters.  The following table summarizes the pre-tax impact of these other items on the company's consolidated statements of operations:   

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions)

Cost of services

$

3

$

—

$

3

$

—

Selling, general and administrative

1

—

3

6

Other operating expense (income), net

—

(20)

—

(19)

Operating income

$

4

$

(20)

$

6

$

(13)

Other (expense) income, net

$

5

$

—

$

(2)

$

7

(d)  

For the nine months ended September 30, 2016, represents charges associated with the March 2016 cash tender offer where the company purchased $200 million of its 6.95% Senior Notes due July 2037 and 5.75% Senior Notes due January 2040.  The pre-tax charges associated with the retirement of debt and related refinancing charges are recorded in other (expense) income, net on the company's consolidated statements of operations.    

(e)  

For gain on disposition of business, income tax expense resulted in a combined tax rate of 71.4%, which was significantly in excess of the statutory rate primarily due to a lower tax basis in the assets sold, specifically the goodwill associated with the disposition.  For the retirement of debt and related refinancing charges, restructuring and integration charges and other items, income tax impacts, where recorded, were calculated using combined tax rates of 38.7% and 38.9% for 2017 and 2016, respectively.  The following table summarizes the income tax (benefit) expense associated with the special items: 

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions)

Gain on disposition of business

$

—

$

—

$

—

$

84

Retirement of debt and related refinancing charges

—

—

—

(18)

Restructuring and integration charges

(9)

(8)

(25)

(23)

Other

(3)

—

(1)

(6)

$

(12)

$

(8)

$

(26)

$

37

(f) 

Represents the impact of amortization expense on diluted earnings per common share, net of the income tax benefit.  The income tax benefit was primarily calculated using combined tax rates of 38.7% and 38.9% for 2017 and 2016, respectively.  The pre-tax amortization expense that is excluded from the calculation of adjusted diluted EPS excluding amortization expense is recorded in the company's statements of operations as follows:

Three Months Ended
September 30,

Nine Months Ended
September 30,

2017

2016

2017

2016

(dollars in millions)

Amortization of intangible assets

$

19

$

18

$

54

$

54

Equity in earnings of equity method investees, net of taxes

4

4

12

12

$

23

$

22

$

66

$

66

(g) 

For the nine months ended September 30, 2016, excluded revenue represents reported revenues from the Focus Diagnostics products business, which was sold on May 13, 2016.

3)

For the three months ended September 30, 2017, the company repurchased 0.6 million shares of its common stock for $65 million.  For the nine months ended September 30, 2017, the company repurchased 3.6 million shares of its common stock for $365 million, which includes an accrual of $15 million recorded in accounts payable and accrued expenses in the consolidated balance sheet for share repurchases not settled.  At September 30, 2017, $1.0 billion remained available under the company's share repurchase authorizations.                                                 

4)

For the nine months ended September 30, 2016, net cash provided by operations included a $68 million tax payment related to the sale of our Focus Diagnostics products business, and $47 million of pre-tax cash charges related to the retirement of debt in connection with the March 2016 cash tender offer, partially offset by $54 million of proceeds from the termination of interest swap agreements.  For the nine months ended September 30, 2017, net cash provided by operations benefited from a decrease in 2017 tax payments associated with the realization of a deferred tax benefit and improved operating performance.

5)

The outlook for adjusted diluted EPS excluding amortization expense represents management's estimates for the full year 2017 before the impact of special items and amortization expense.  Further impacts to earnings related to special items may be incurred throughout the remainder of the year.  The following table reconciles our 2017 outlook for adjusted diluted EPS excluding amortization expense to the corresponding amounts determined under GAAP:

Low

High

Adjusted diluted EPS excluding amortization expense:

Diluted earnings per common share

$

4.87

$

4.92

Restructuring and integration charges (a)

0.34

0.34

Amortization expense (b)

0.39

0.39

Other

0.02

0.02

Adjusted diluted EPS excluding amortization expense

$

5.62

$

5.67

(a)  

Represents estimated full year pre-tax charges of $80 million primarily associated with systems conversions and integration costs incurred in connection with further restructuring and integrating our business.  Income tax benefits were calculated using a combined tax rate of 38.7%.

(b)  

Represents the full year impact of amortization expense on the calculation of adjusted diluted EPS excluding amortization expense.  Amortization expense used in the calculation is as follows (dollars in millions):

Amortization of intangible assets

$

73

Amortization expense included in equity in earnings of equity
  method investees

16

Total pre-tax amortization expense

$

89

Total amortization expense, net of an estimated tax benefit

$

55

6)

The outlook for 3.0% revenue growth on an equivalent basis in 2017 represents management's estimates for 2017 versus reported 2016 revenues adjusted to exclude the 2016 revenues from the Focus Diagnostics products business.  The company completed its exit from the products business as a result of the sale of Focus Diagnostics products on May 13, 2016.  Consequently, our 2017 revenues will not include revenues associated with that business.  The following tables reconcile our 2016 net revenues determined under GAAP with equivalent revenue for 2016 and provide our 2017 revenue outlook:

Three Months Ended

Year Ended

March 31,
 2016

June 30,
 2016

September 30,
 2016

December 31,
 2016

December 31,
 2016

(dollars in millions)

2016 Revenue on an equivalent basis:

Net revenues

$

1,863

$

1,906

$

1,885

$

1,861

$

7,515

Excluded revenue (a)

(18)

(8)

—

—

(26)

2016 Revenue on an equivalent basis

$

1,845

$

1,898

$

1,885

$

1,861

$

7,489

2017 Revenue outlook:

2016 Revenue on an equivalent basis

$

7,489

2017 Equivalent revenue growth

3.0

%

2017 Revenue outlook

$

7,710

(a)  

The 2016 excluded revenue is comprised of all of Focus Diagnostics products revenues reported in 2016.