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 the 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,
accountable care organizations ("ACOs"), and direct contract entities ("DCEs").
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.

First Quarter Highlights

                                                                    Three Months Ended March 31,
                                                                 2022                          2021
                                                            (dollars in

million, except per share data)

Net revenues                                                    $2,611                        $2,720
Base business revenues (a)                                      $2,012                        $1,892
COVID-19 testing revenues                                        $599                          $828

DIS revenues                                                    $2,541                        $2,643
Revenue per requisition change                                  (5.2)%                        20.5%
Requisition volume change                                        1.3%                         25.6%
Organic requisition volume change                                 -%                          21.6%
DS revenues                                                       $70                          $77
Net income attributable to Quest Diagnostics                     $355                          $469
Diluted earnings per share                                       $2.92                        $3.46
Net cash provided by operating activities                        $480                          $731



(a) Excludes COVID-19 testing.

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Contents

The impact that the COVID-19 pandemic has had on our DIS revenue, including request volume and revenue per request, is 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 March 31, 2022 compared to the three months ended March 31, 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.

  In March 2022, the U.S. Health Resources and Services Administration ("HRSA")
informed providers that, after March 22, 2022, it would stop accepting claims
for testing and treatment for uninsured individuals under the HRSA COVID-19
Uninsured Program and that claims submitted prior to that date would be subject
to eligibility and availability of funds. For the three months ended March 31,
2022, revenue for testing of uninsured individuals under the HRSA COVID-19
Uninsured Program represented approximately 12% of our COVID-19 testing revenue.
As of March 31, 2022, less than 5% of our net accounts receivable was associated
with claims for reimbursement for COVID-19 testing of uninsured individuals.
Although we believe that our estimates for contractual allowances and patient
price concessions are appropriate, actual results could differ from those
estimates. For further details on revenue and receivables, see Note 12 to the
interim unaudited consolidated financial statements.

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 more details, see note 4 of the unaudited interim consolidated financial statements.

Invigorating 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.

  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.


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Contents

  For the three months ended March 31, 2022, we incurred $11 million of pre-tax
charges under our Invigorate program primarily consisting of systems conversion
and integration costs, all of which result 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

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 that have not yet become 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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  Table of Contents
Results of Operations

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

                                                             Three Months Ended March 31,
                                                                                  2022                2021           $ Change             % Change
                                                                                          (dollars in millions, except per share amounts)
Net revenues:
DIS business                                                                 $     2,541           $ 2,643          $   (102)                  (3.9) %
DS businesses                                                                         70                77                (7)                  (8.9)
Total net revenues                                                           $     2,611           $ 2,720          $   (109)                  (4.0) %

Operating costs and expenses and other operating
income:
Cost of services                                                             $     1,646           $ 1,626          $     20                    1.3  %
Selling, general and administrative                                                  425               407                18                    4.5
Amortization of intangible assets                                                     27                27                 -                        NM

Total operating costs and expenses, net                                      $     2,098           $ 2,060          $     38                    1.9  %

Operating income                                                             $       513           $   660          $   (147)                 (22.3) %

Other income (expense):
Interest expense, net                                                        $       (37)          $   (38)         $      1                   (1.5) %
Other (expense) income, net                                                          (24)                4               (28)                       NM
Total non-operating expense, net                                             $       (61)          $   (34)         $    (27)                       NM

Income tax expense                                                           $      (110)          $  (153)         $     43                  (28.5) %

Effective income tax rate                                                   

24.4% 24.6%

Equity to results of companies accounted for using the equity method, net of tax

                                                                     $        31           $    17          $     14                   85.9  %

Net income attributable to Quest Diagnostics                                 $       355           $   469          $   (114)                 (24.3) %

Diluted earnings per common share attributable to
Quest Diagnostics' common stockholders                                       $      2.92           $  3.46          $  (0.54)                 (15.6) %

NM - Not Meaningful


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

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  Table of Contents

                                                                          Three Months Ended March
                                                                                    31,
                                                                                         2022                  2021
Net revenues:
DIS business                                                                                97.3  %               97.2  %
DS businesses                                                                                2.7                   2.8
Total net revenues                                                                         100.0  %              100.0  %

Operating expenses and expenses and other operating income: Cost of services

                                                                            63.0  %               59.8  %
Selling, general and administrative                                                         16.3                  14.9
Amortization of intangible assets                                                            1.0                   1.0

Total operating costs and expenses, net                                                     80.3  %               75.7  %

Operating income                                                                            19.7  %               24.3  %



  Operating Results

Results for the three months ended March 31, 2022 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.30 as following:

•pre-tax amortization expense of $27 million or $0.16 per diluted share;
•pre-tax charges of $16 million in other (expense) income, net, or $0.10 per
diluted share, representing net losses associated with changes in the carrying
value of our strategic investments;
•pre-tax charges of $12 million ($3 million in cost of services and $9 million
in selling, general and administrative expenses), or $0.07 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 $2 million in selling, general and administrative, or $0.01
per diluted share, primarily representing 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); partially offset by
•excess tax benefits associated with stock-based compensation arrangements of $5
million, or $0.04 per diluted share, recorded in income tax expense.

For the three months ended March 31, 2022diluted earnings per share benefited from the impact of share buybacks, including under the accelerated share buyback agreements entered into in April 2021 redeem $1.5 billion of our common stock, based on the weighted average number of shares outstanding over the prior year period.

Results for the three months ended March 31, 2021 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.30 as following:

•pre-tax amortization expense of $29 million ($27 million in amortization of
intangible assets and $2 million in equity in earnings of equity method
investees, net of taxes) or $0.16 per diluted share;
•pre-tax charges of $17 million ($7 million in cost of services and $10 million
in selling, general and administrative expenses), or $0.10 per diluted share,
primarily associated with systems conversions and integration incurred in
connection with further restructuring and integrating our business;
•a pre-tax non-cash impairment to the carrying value of an equity method
investment of $8 million, or $0.04 per diluted share, recorded in equity in
earnings of equity method investees, net of taxes; 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 primarily to protect the health and safety
of our employees and customers; partially offset by
•excess tax benefits associated with stock-based compensation arrangements of $4
million, or $0.03 per diluted share, recorded in income tax expense.

Net income

Net income for the three months ended March 31, 2022 decreased by 4.0% compared to the corresponding period of the previous financial year.

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DIS revenue for the three months ended March 31, 2022 decreased by 3.9% compared to the same period of the previous year. For the three months ended March 31, 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 the impact of recent acquisitions. For the
three months ended March 31, 2022, recent acquisitions contributed approximately
1.3% to DIS revenues.
•Revenues in the base business (including the impact of recent acquisitions)
increased by 7.0% compared to the prior year period, as our base business
continued to recover from the impact of the COVID-19 pandemic.
•DIS volume increased by 1.3% compared to the prior year period driven by growth
in the base business, and the impact of recent acquisitions, which contributed
approximately 1.3% to DIS volume, partially offset by a decrease in COVID-19
testing.
•Testing volume in the base business (including the impact of recent
acquisitions) was up 6.2% compared to the prior year period due to the continued
recovery from the impact of the COVID-19 pandemic.
•Revenue per requisition decreased by 5.2% compared to prior year period driven
in large part by the decrease in COVID-19 molecular testing and unit price
pressure of less than 1%.

DS revenue for the three months ended March 31, 2022 decreased by 8.9% compared to the same period last year, mainly due to lower revenues associated with our risk assessment services offered to the life insurance industry.

Cost of services

  Cost of services consists principally of costs for obtaining, transporting and
testing specimens as well as facility costs used for the delivery of our
services. For the three months ended March 31, 2022, cost of services increased
by $20 million compared to the prior year period. The increase was primarily
driven by higher compensation and benefits costs (primarily related to wage
increases), higher collection expense associated with COVID-19 testing volumes
that come in through non-traditional channels, 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.

General and administrative expenses increased by $18 million for the three months ended March 31, 2022compared to the prior year period, primarily due to incremental costs associated with investments in our strategic growth initiatives and higher compensation and benefits costs (including headcount and salary increases) , partially offset by $12 million 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 months ended March 31, 2022amortization expense remained stable compared to the prior year period.

Interest expense, net

Interest expense, net for the three months ended March 31, 2022 was mostly consistent with the prior year period.

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.


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  For the three months ended March 31, 2022, other (expense) income, net
included $16 million of losses associated with changes in the carrying value of
our strategic investments and $8 million of losses associated with investments
in our deferred compensation plans.

For the three months ended March 31, 2021other income (expenses), net included $4 million gains associated with investments in our deferred compensation plans.

income tax expense

  Income tax expense for the three months ended March 31, 2022 and 2021 was $110
million and $153 million, respectively. The decrease in income tax expense for
the three months ended March 31, 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.

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

  Equity in earnings of equity method investees, net of taxes increased for the
three months ended March 31, 2022 by $14 million compared to the prior year
period primarily due to demand for COVID-19 testing services and recovery in the
base business of our diagnostic information services joint venture combined with
lower equity earnings in the prior year period due to a non-cash impairment to
the carrying value of an equity method investment of $8 million, partially
offset by $7 million of lower equity earnings in the current year period as a
result of the April 2021 sale of our 40% ownership interest in Q2 Solutions®.

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