QUEST DIAGNOSTICS INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

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Our company

Diagnostic Information Services

  Quest Diagnostics empowers people to take action to improve health outcomes.
We use our extensive database of clinical lab results to derive diagnostic
insights that reveal new avenues to identify and treat disease, inspire healthy
behaviors and improve healthcare management. Our diagnostic information services
business ("DIS") provides information and insights based on an industry-leading
menu of routine, non-routine and advanced clinical testing and anatomic
pathology testing, and other diagnostic information services. We provide
services to a broad range of customers, including patients, clinicians,
hospitals, independent delivery networks ("IDNs"), health plans, employers and
accountable care organizations ("ACOs"). We offer the broadest access in the
United States to diagnostic information services through our nationwide network
of laboratories, patient service centers and phlebotomists in physician offices
and our connectivity resources, including call centers and mobile paramedics,
nurses and other health and wellness professionals. We are the world's leading
provider of diagnostic information services. We provide interpretive
consultation with one of the largest medical and scientific staffs in the
industry. Our DIS business makes up greater than 95% of our consolidated net
revenues.

  We assess our revenue performance for the DIS business based upon, among other
factors, volume (measured by test requisitions) and revenue per requisition.
Each requisition accompanies patient specimens, indicating the test(s) to be
performed and the party to be billed for the test(s). Revenue per requisition is
impacted by various factors, including, among other items, the impact of fee
schedule changes (i.e., unit price), test mix, payer mix, and the number of
tests per requisition. Management uses number of requisitions and revenue per
requisition data to assist with assessing the growth and performance of the
business, including understanding trends affecting number of requisitions,
pricing and test mix. Therefore, we believe that information related to changes
in these metrics from period to period are useful information for investors as
it allows them to assess the performance of the business.

Diagnostic Solutions

  In our Diagnostic Solutions ("DS") businesses, which represent the balance of
our consolidated net revenues, we offer a variety of solutions for life insurers
and healthcare organizations and clinicians. We are the leading provider of risk
assessment services for the life insurance industry. In addition, we offer
healthcare organizations and clinicians robust information technology solutions.

Third Quarter Highlights

                                                                         

Three months completed September 30,

                                                                   2022                                          2021
                                                                    

(in millions of dollars, except per share data)

Net revenues                                                      $2,486                                        $2,774
Base business revenues (a)                                        $2,170                                        $2,065
COVID-19 testing revenues                                          $316                                          $709

DIS revenues                                                      $2,419                                        $2,703
Revenue per requisition change                                    (5.1)%                                        (5.4)%
Requisition volume change                                         (6.2)%                                         5.3%
Organic requisition volume change                                 (6.4)%                                         3.2%
DS revenues                                                         $67                                          $71
Net income attributable to Quest Diagnostics                       $256                                          $505
Diluted earnings per share                                         $2.17                                        $4.02
Net cash provided by operating activities                          $502                                          $561



(a) Excludes COVID-19 testing.

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The impacts that the COVID-19 pandemic has had on our DIS revenues, including request volume and revenue per request are discussed in more detail below under “Impact of COVID-19” and “Results of Operations”.

For a more in-depth discussion of year-over-year changes for the three months ended September 30, 2022 compared to the three months ended September 30, 2021see “Results of operations” below.

Impact of COVID-19

  As a novel strain of coronavirus (COVID-19) continues to impact the economy of
the United States and other countries around the world, we are committed to
being a part of the coordinated public and private sector response to this
unprecedented challenge. We have made substantial investments to expand and
maintain the amount of COVID-19 testing available to the country. We have been
effectively managing challenges in the global supply chain; and, at this point,
we have sufficient supplies to conduct our business.

  Due to the COVID-19 pandemic, we have experienced significant volatility,
including periods of material decline compared to prior year periods in testing
volume in our base business (which excludes COVID-19 testing) and periods of
significant demand for COVID-19 testing services, with demand generally
fluctuating in line with changes in the prevalence of the virus and related
variants. Additionally, compared to historical levels, our revenue per
requisition has been positively impacted by COVID-19 molecular testing.

The acquisition of Health Pack, LLC (“Health Pack“)

  On February 1, 2022, we completed the acquisition of Pack Health, a patient
engagement company that helps individuals adopt healthier behaviors to improve
outcomes, in an all cash transaction for $123 million, net of $4 million cash
acquired, which consisted of cash consideration of $105 million and contingent
consideration initially estimated at $18 million. The contingent consideration
arrangement is dependent upon the achievement of certain revenue benchmarks. The
acquired business is included in our DIS business.

For further details, see Notes 4 and 6 to the unaudited interim consolidated financial statements.

Invigorate Program

  We are engaged in a multi-year program called Invigorate, which is designed to
reduce our cost structure and improve our performance. We currently aim annually
to achieve savings and productivity improvements of approximately 3% of our
costs, which we believe will help offset pressures from the current inflationary
environment.

  Invigorate has consisted of several flagship programs, with structured plans
in each, to drive savings and improve performance across the customer value
chain. These flagship programs include: organization excellence; information
technology excellence; procurement excellence; field and customer service
excellence; lab excellence; and revenue services excellence. In addition to
these programs, we have identified key themes to change how we operate including
reducing denials and patient price concessions; further digitizing our business;
standardization and automation; and optimization initiatives in our lab network
and patient service center network. We believe that our efforts to standardize
our information technology systems, equipment and data also foster our efforts
to strengthen our foundation for growth and support the value creation
initiatives of our clinical franchises by enhancing our operational flexibility,
empowering and enhancing the customer experience, facilitating the delivery of
actionable insights and bolstering our large data platform.

  For the nine months ended September 30, 2022, we incurred $32 million of
pre-tax charges under our Invigorate program primarily consisting of systems
conversion and integration costs, all of which resulted in cash expenditures.
Additional restructuring charges may be incurred in future periods as we
identify additional opportunities to achieve further savings and productivity
improvements.

Critical Accounting Policies

There have been no material changes to our critical accounting policies from those disclosed in our 2021 Annual Report on Form 10-K.

Impact of new accounting standards

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The adoption of new accounting standards, if any, is discussed in Note 2 to the unaudited interim consolidated financial statements.

The impact of recent accounting pronouncements not yet effective on our consolidated financial statements, if any, are also discussed in Note 2 to the unaudited interim consolidated financial statements.

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Operating results

  The following tables set forth certain results of operations data for the
periods presented:

                                           Three Months Ended September 30,                                               Nine Months Ended September 30,
                             2022               2021           $ Change            % Change                2022               2021           $ Change            % Change
                                                                           (dollars in millions, except per share amounts)
Net revenues:
DIS business            $    2,419           $ 2,703          $   (284)                (10.5) %       $    7,344           $ 7,820          $   (476)                 (6.1) %
DS businesses                   67                71                (4)                 (5.9)                206               224               (18)                 (7.9)
Total net revenues      $    2,486           $ 2,774          $   (288)                (10.4) %       $    7,550           $ 8,044          $   (494)                 (6.1) %

Operating costs and
expenses and other
operating income:
Cost of services        $    1,618           $ 1,670          $    (52)                 (3.1) %       $    4,875           $ 4,861          $     14                   0.3  %
Selling, general and
administrative                 464               427                37                   8.5               1,311             1,263                48                   3.8
Amortization of
intangible assets               27                25                 2                   4.3                  81                77                 4                   3.4

Other operating income,
net                            (15)                -               (15)                      NM              (10)               (2)               (8)                      NM
Total operating costs
and expenses, net       $    2,094           $ 2,122          $    (28)                 (1.4) %       $    6,257           $ 6,199          $     58                   0.9  %

Operating income        $      392           $   652          $   (260)                (39.7) %       $    1,293           $ 1,845          $   (552)                (29.9) %

Other income (expense):
Interest expense, net   $      (33)          $   (38)         $      5                 (12.5) %       $     (106)          $  (114)         $      8                  (6.3) %
Other (expense) income,
net                             (8)               40               (48)                      NM              (61)              366              (427)                      NM
Total non-operating
(expense) income, net   $      (41)          $     2          $    (43)                      NM       $     (167)          $   252          $   (419)                      NM

Income tax expense      $      (81)          $  (153)         $     72                 (47.3) %       $     (268)          $  (483)         $    215                 (44.6) %

Effective income tax
rate                          23.0   %          23.4  %                                                     23.8   %          23.1  %

Equity in earnings of
equity method
investees, net of taxes $        6           $    26          $    (20)                (80.2) %       $       41           $    53          $    (12)                (24.5) %

Net income attributable
to Quest Diagnostics    $      256           $   505          $   (249)                (49.3) %       $      845           $ 1,605          $   (760)                (47.4) %

Diluted earnings per
common share
attributable to Quest
Diagnostics' common
stockholders            $     2.17           $  4.02          $  (1.85)                (46.0) %       $     7.05           $ 12.41          $  (5.36)                (43.2) %

NM - Not Meaningful





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The following table shows certain data on operating results as a percentage of net revenues for the periods presented:

                                                      Three Months Ended September 30,             Nine Months Ended September 30,
                                                         2022                  2021                   2022                  2021
Net revenues:
DIS business                                                97.3  %               97.4  %                97.3  %               97.2  %
DS businesses                                                2.7                   2.6                    2.7                   2.8
Total net revenues                                         100.0  %              100.0  %               100.0  %              100.0  %

Operating costs and expenses and other operating
income:
Cost of services                                            65.1  %               60.2  %                64.6  %               60.4  %
Selling, general and administrative                         18.7                  15.4                   17.4                  15.7
Amortization of intangible assets                            1.1                   0.9                    1.1                   1.0

Other operating income, net                                 (0.7)                    -                   (0.2)                    -
Total operating costs and expenses, net                     84.2  %               76.5  %                82.9  %               77.1  %

Operating income                                            15.8  %               23.5  %                17.1  %               22.9  %



  Operating Results

Results for the three months ended September 30, 2022 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.19 as follows:

•pre-tax amortization expense of $27 million recorded in amortization of
intangible assets or $0.17 per diluted share;
•pre-tax charges of $13 million ($6 million in cost of services and $7 million
in selling, general and administrative expenses), or $0.08 per diluted share,
primarily associated with workforce reductions, systems conversions and
integration incurred in connection with further restructuring and integrating
our business; and
•pre-tax charges of $2 million in other (expense) income, net or $0.01 per
diluted share, representing net losses associated with changes in the carrying
value of our strategic investments; partially offset by
•a net pre-tax gain of $9 million ($2 million of charges in cost of services,
and $5 million of charges in selling, general and administrative expenses offset
by $16 million of gains in other operating income, net), or $0.06 per diluted
share, primarily representing a $10 million gain from a payroll tax credit under
the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") associated
with the retention of employees and a $7 million gain associated with the
decrease in the fair value of the contingent consideration accrual associated
with previous acquisitions, partially offset by $5 million of costs associated
with donations, contributions and other financial support through Quest for
Health Equity (our initiative with the Quest Diagnostics Foundation to reduce
health disparities in underserved communities); and
•excess tax benefits associated with stock-based compensation arrangements of $1
million, or $0.01 per diluted share, recorded in income tax expense.

Results for the nine months ended September 30, 2022 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.89 as following:

•pre-tax amortization expense of $81 million recorded in amortization of
intangible assets or $0.50 per diluted share;
•pre-tax charges of $39 million ($30 million in other (expense) income, net and
$9 million in equity in earnings of equity method investees, net of taxes), or
$0.24 per diluted share, representing net losses associated with changes in the
carrying value of our strategic investments;
•pre-tax charges of $37 million ($13 million in cost of services and $24 million
in selling, general and administrative expenses), or $0.23 per diluted share,
primarily associated with workforce reductions, systems conversions and
integration incurred in connection with further restructuring and integrating
our business; and

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•net pre-tax charges of $1 million ($2 million of charges in cost of services,
and $9 million of charges in selling, general and administrative expenses
largely offset by $10 million of gains in other operating income, net), or $0.00
per diluted share, primarily representing $9 million of costs associated with
donations, contributions and other financial support through Quest for Health
Equity offset by a $10 million gain from a payroll tax credit under the CARES
Act associated with the retention of employees; partially offset by
•excess tax benefits associated with stock-based compensation arrangements of
$10 million, or $0.08 per diluted share, recorded in income tax expense.

  For the three and nine months ended September 30, 2022, diluted earnings per
share benefited from the impact of share repurchases, including under
accelerated share repurchase agreements ("ASRs") entered into in April 2021 to
repurchase $1.5 billion of our common stock, on our weighted average shares
outstanding as compared to the prior year periods.

Results for the three months ended September 30, 2021 were impacted by certain items which, on a net basis, increased diluted earnings per share by $0.06 as following:

•a net pre-tax gain of $45 million (a $42 million gain recorded in other
(expense) income, net and a $3 million gain recorded in equity in earnings of
equity method investees, net of taxes), or $0.26 per diluted share, primarily
due to gains associated with changes in the carrying value of our strategic
investments; and
•excess tax benefits associated with stock-based compensation arrangements of $6
million, or $0.04 per diluted share, recorded in income tax expense; partially
offset by
•pre-tax amortization expense of $25 million, or $0.15 per diluted share;
•pre-tax charges of $13 million ($7 million in cost of services and $6 million
in selling, general and administrative expenses), or $0.08 per diluted share,
primarily associated with systems conversions and integration incurred in
connection with further restructuring and integrating our business; and
•pre-tax charges of $4 million in selling, general and administrative expenses,
or $0.01 per diluted share, primarily due to costs associated with donations,
contributions and other financial support through Quest for Health Equity.

Results for the nine months ended September 30, 2021 were impacted by certain items which, on a net basis, increased diluted earnings per share by $1.50 as following:

•a pre-tax gain recorded in other (expense) income, net of $314 million, or
$2.00 per diluted share, on the sale of our 40% ownership interest in Q2
Solutions® ("Q2 Solutions"), our clinical trials central laboratory services
joint venture, to IQVIA Holdings, Inc. ("IQVIA"), our joint venture partner (see
Note 5 to the interim unaudited consolidated financial statements);
•a net pre-tax gain of $37 million (a $42 million gain recorded in other
(expense) income, net, partially offset by $5 million of net charges recorded in
equity in earnings of equity method investees), or $0.22 per diluted share,
primarily due to gains associated with changes in the carrying value of our
strategic investments, partially offset by a non-cash impairment charge to the
carrying value of an equity method investment; and
•excess tax benefits associated with stock-based compensation arrangements of
$15 million, or $0.11 per diluted share, recorded in income tax expense;
partially offset by
•pre-tax amortization expense of $79 million ($77 million in amortization of
intangible assets and $2 million in equity in earnings of equity method
investees, net of taxes) or $0.46 per diluted share;
•pre-tax charges of $51 million ($26 million in cost of services and $25 million
in selling, general and administrative expenses), or $0.30 per diluted share,
primarily associated with systems conversions and integration incurred in
connection with further restructuring and integrating our business;
•pre-tax charges of $9 million in selling, general and administrative expenses,
or $0.04 per diluted share, primarily due to costs associated with donations,
contributions and other financial support through Quest for Health Equity; and
•pre-tax charges of $4 million in cost of services, or $0.03 per diluted share,
representing the impact of certain items resulting from the COVID-19 pandemic
including incremental costs incurred to protect the health and safety of our
employees and customers.

  Net Revenues

Net income for the three months ended September 30, 2022 decreased by 10.4% compared to the same period of the previous year.

DIS revenue for the three months ended September 30, 2022 decreased by 10.5% compared to the same period of the previous year.

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For the three months ended September 30, 2022:

•The decrease in revenue compared to the prior year period was driven by a
decrease in COVID-19 testing, partially offset by growth in the base business
(which excludes COVID-19 testing) and, to a lesser extent, the impact of recent
acquisitions. For the three months ended September 30, 2022, recent acquisitions
contributed approximately 0.5% to DIS revenues.
•DIS volume decreased by 6.2% compared to the prior year period driven by a
decrease in COVID-19 testing, partially offset by growth in the base business
and the impact of recent acquisitions, which contributed approximately 0.2% to
DIS volume.
•Revenue per requisition decreased by 5.1% compared to prior year period driven
in large part by the decrease in COVID-19 molecular testing, and unit price
pressure of approximately 0.5%, partially offset by favorable test mix.
•Revenues in the base business (including the impact of recent acquisitions)
increased by 5.4% compared to the prior year period.
•Testing volume in the base business (including the impact of recent
acquisitions) was up 1.6% compared to the prior year period.
•Revenue per requisition in the base business increased by 3.3% compared to the
prior year period primarily due to favorable test mix.

  DS revenues for the three months ended September 30, 2022 decreased by 5.9%
compared to the prior year period primarily due to lower revenues associated
with our risk assessment services offered to the life insurance industry.

Net income for the nine months ended September 30, 2022 decreased by 6.1% compared to the same period of the previous year.

DIS revenue for the nine months ended September 30, 2022 decreased by 6.1% compared to the same period of the previous year.

For the nine months ended September 30, 2022:

•The decrease in revenue compared to the prior year period was driven by a
decrease in COVID-19 testing, partially offset by growth in the base business
and the impact of recent acquisitions. For the nine months ended September 30,
2022, recent acquisitions contributed approximately 0.9% to DIS revenues.
•DIS volume decreased by 2.2% compared to the prior year period driven by a
decrease in COVID-19 testing, partially offset by growth in the base business
and the impact of recent acquisitions, which contributed approximately 0.8% to
DIS volume.
•Revenue per requisition decreased by 4.3% compared to the prior year period
driven in large part by the decrease in COVID-19 molecular testing and unit
price pressure of approximately 0.5%, partially offset by favorable test mix.
•Revenues in the base business (including the impact of recent acquisitions)
increased by 5.2% compared to the prior year period.
•Testing volume in the base business (including the impact of recent
acquisitions) was up 3.1% compared to the prior year period.
•Revenue per requisition in the base business increased by 1.7% compared to the
prior year period primarily due to favorable test mix.

  DS revenues for the nine months ended September 30, 2022 decreased by 7.9%
compared to the prior year period primarily due to lower revenues associated
with our risk assessment services offered to the life insurance industry.

Cost of services

The cost of services primarily includes the costs of obtaining, transporting and analyzing samples as well as the costs of facilities used in the provision of our services.

  For the three months ended September 30, 2022, cost of services decreased by
$52 million compared to the prior year period. The decrease was primarily driven
by lower expense associated with reduced COVID-19 testing volumes, and $20
million of expense in the prior year period associated with a payment to
eligible employees to help offset expenses they incurred as a result of
COVID-19. These decreases were partially offset by higher compensation and
benefits costs (primarily related to wage increases).


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  For the nine months ended September 30, 2022, cost of services increased by
$14 million compared to the prior year period. The increase was primarily driven
by higher compensation and benefits costs (primarily related to wage increases),
and additional costs associated with our acquisitions. These increases were
partially offset by lower supplies expense associated with reduced COVID-19
testing volumes.

Selling, general and administrative (“SG&A”) expenses

General and administrative expenses primarily include costs associated with our sales and marketing efforts, billing transactions, credit losses and general management and administrative support and administrative facility costs.

  SG&A increased by $37 million for the three months ended September 30, 2022,
compared to the prior year period primarily due to additional costs associated
with investments in our strategic growth initiatives and higher compensation and
benefits costs (including headcount and wage increases).

  SG&A increased by $48 million for the nine months ended September 30, 2022,
compared to the prior year period, primarily driven by additional costs
associated with investments in our strategic growth initiatives and higher
compensation and benefits costs (including headcount and wage increases),
partially offset by $42 million of lower costs associated with changes in the
value of our deferred compensation obligations.

  The changes in the value of our deferred compensation obligations is largely
offset by changes in the value of the associated investments, which are recorded
in other (expense) income, net. For further details regarding our deferred
compensation plans, see Note 17 to the audited consolidated financial statements
included in our 2021 Annual Report on Form 10-K.

Depreciation expense

  For the three and nine months ended September 30, 2022, amortization expense
increased by $2 million and $4 million, respectively, compared to the prior year
periods as a result of recent acquisitions.

Other operating income, net

Other operating income, net, includes miscellaneous income and expenses and other expenses related to operating activities.

  For both the three and nine months ended September 30, 2022, other operating
income, net includes a $10 million gain from a payroll tax credit under the
CARES Act associated with the retention of employees. The three months ended
September 30, 2022 also includes a gain associated with the decrease in the fair
value of the contingent consideration accrual associated with previous
acquisitions.

Interest expense, net

  For the three and nine months ended September 30, 2022, interest expense, net
decreased by $5 million and $8 million, respectively, compared to the prior year
periods due to increased interest income resulting from the impact of rising
interest rates on our cash and cash equivalents.

Other (expenses) income, net

  Other (expense) income, net represents miscellaneous income and expense items
related to non-operating activities, such as gains and losses associated with
investments and other non-operating assets.

For the three months ended September 30, 2022other income (expenses), net included $6 million losses associated with investments in our deferred compensation plans.

  For the three months ended September 30, 2021, other (expense) income, net
included $42 million of gains associated with changes in the carrying value of
our strategic investments.


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For the nine months ended September 30, 2022other income (expenses), net included $31 million losses associated with investments in our deferred compensation plans and $30 million losses associated with changes in the carrying value of our strategic investments.

  For the nine months ended September 30, 2021, other (expense) income, net
primarily included a $314 million pre-tax gain on the sale of our 40% ownership
interest in Q2 Solutions, our clinical trials central laboratory services joint
venture, to IQVIA, our joint venture partner (see Note 5 to the interim
unaudited consolidated financial statements) and $42 million of gains associated
with changes in the carrying value of our strategic investments.

income tax expense

  Income tax expense for the three months ended September 30, 2022 and 2021 was
$81 million and $153 million, respectively. The decrease in income tax expense
for the three months ended September 30, 2022 compared to the prior year period
was primarily driven by a decrease in income before income taxes and equity in
earnings of equity method investees.

  Income tax expense for the nine months ended September 30, 2022 and 2021 was
$268 million and $483 million, respectively. The decrease in income tax expense
for the nine months ended September 30, 2022 compared to the prior year period
was primarily driven by a decrease in income before income taxes and equity in
earnings of equity method investees.

  For the nine months ended September 30, 2022 and 2021, the effective income
tax rate was 23.8% and 23.1%, respectively. For the nine months ended
September 30, 2021, the effective income tax rate benefited from a lower
effective income tax rate, 17.6%, on the gain on the sale of the Company's 40%
ownership interest in Q2 Solutions. In addition, the effective income tax rate
benefited from $10 million and $15 million of excess tax benefits associated
with stock-based compensation arrangements for the nine months ended
September 30, 2022 and 2021, respectively.

Equity in earnings of companies accounted for using the equity method, net of tax

  Equity in earnings of equity method investees, net of taxes decreased for the
three months ended September 30, 2022 by $20 million compared to the prior year
period primarily due to lower demand for COVID-19 testing services at our
diagnostic information services joint venture.

  Equity in earnings of equity method investees, net of taxes decreased for the
nine months ended September 30, 2022 by $12 million compared to the prior year
period primarily due to $14 million of lower equity earnings in the current year
period associated with changes in the carrying value of strategic investments of
an equity method investee and lower demand for COVID-19 testing services at our
diagnostic information services joint venture, partially offset by a non-cash
impairment to the carrying value of an equity method investment of $8 million in
the prior year period.

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