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.

Second Quarter Highlights

                                                                             Three Months Ended June 30,
                                                                  2022                                        2021
                                                                   

(in millions of dollars, except per share data)

Net revenues                                                     $2,453                                      $2,550
Base business revenues (a)                                       $2,098                                      $2,039
COVID-19 testing revenues                                         $355                                        $511

DIS revenues                                                     $2,384                                      $2,474
Revenue per requisition change                                   (2.6)%                                      (3.6)%
Requisition volume change                                        (1.4)%                                       45.2%
Organic requisition volume change                                (2.4)%                                       40.1%
DS revenues                                                        $69                                         $76
Net income attributable to Quest Diagnostics                      $234                                        $631
Diluted earnings per share                                        $1.96                                       $4.96
Net cash provided by operating activities                         $402                                        $460



(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 June 30, 2022 compared to the three months ended June 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.

  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 June 30, 2022, we have no material outstanding net accounts receivable
associated with claims for reimbursement under the HRSA COVID-19 Uninsured
Program.

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 six months ended June 30, 2022, we incurred $20 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

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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 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 June 30,                                                  Six Months Ended June 30,
                            2022               2021           $ Change            % Change              2022              2021           $ Change            % Change
                                                                         (dollars in millions, except per share amounts)
Net revenues:
DIS business            $   2,384           $ 2,474          $    (90)                 (3.6) %       $  4,925          $ 5,117          $   (192)                 (3.8) %
DS businesses                  69                76                (7)                 (8.8)              139              153               (14)                 (8.9)
Total net revenues      $   2,453           $ 2,550          $    (97)                 (3.8) %       $  5,064          $ 5,270          $   (206)                 (3.9) %

Operating costs and
expenses and other
operating income:
Cost of services        $   1,611           $ 1,565          $     46                   2.9  %       $  3,257          $ 3,191          $     66                   2.1  %
Selling, general and
administrative                422               429                (7)                 (1.6)              847              836                11                   1.4
Amortization of
intangible assets              27                25                 2                   5.8                54               52                 2                   2.9

Other operating expense
(income), net                   5                (2)                7                       NM              5               (2)                7                       NM
Total operating costs
and expenses, net       $   2,065           $ 2,017          $     48                   2.4  %       $  4,163          $ 4,077          $     86                   2.1  %

Operating income        $     388           $   533          $   (145)                (27.2) %       $    901          $ 1,193          $   (292)                (24.5) %

Other income (expense):
Interest expense, net   $     (36)          $   (38)         $      2                  (5.1) %       $    (73)         $   (76)         $      3                  (3.3) %
Other (expense) income,
net                           (29)              322              (351)                      NM            (53)             326              (379)                      NM
Total non-operating
(expense) income, net   $     (65)          $   284          $   (349)                      NM       $   (126)         $   250          $   (376)                      NM

Income tax expense      $     (77)          $  (177)         $    100                 (56.2) %       $   (187)         $  (330)         $    143                 (43.3) %

Effective income tax
rate                         23.9   %          21.6  %                                                   24.2  %          22.9  %

Equity in earnings of
equity method
investees, net of taxes $       4           $    10          $     (6)                (60.6) %       $     35          $    27          $      8                  29.2  %

Net income attributable
to Quest Diagnostics    $     234           $   631          $   (397)                (62.9) %       $    589          $ 1,100          $   (511)                (46.4) %

Diluted earnings per
common share
attributable to Quest
Diagnostics' common
stockholders            $    1.96           $  4.96          $  (3.00)                (60.5) %       $   4.88          $  8.38          $  (3.50)                (41.8) %

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 June 30,                  Six Months Ended June 30,
                                                        2022                  2021                  2022                  2021
Net revenues:
DIS business                                               97.2  %               97.0  %               97.3  %               97.1  %
DS businesses                                               2.8                   3.0                   2.7                   2.9
Total net revenues                                        100.0  %              100.0  %              100.0  %              100.0  %

Operating costs and expenses and other operating
income:
Cost of services                                           65.7  %               61.4  %               64.3  %               60.6  %
Selling, general and administrative                        17.2                  16.8                  16.7                  15.8
Amortization of intangible assets                           1.0                   1.0                   1.1                   1.0

Other operating expense (income), net                       0.3                  (0.1)                  0.1                     -
Total operating costs and expenses, net                    84.2  %               79.1  %               82.2  %               77.4  %

Operating income                                           15.8  %               20.9  %               17.8  %               22.6  %



  Operating Results

Results for the three months ended June 30, 2022 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.40 as following:

•pre-tax amortization expense of $27 million recorded in amortization of
intangible assets or $0.17 per diluted share;
•pre-tax charges of $21 million ($12 million in other (expense) income, net and
$9 million in equity in earnings of equity method investees, net of taxes), or
$0.13 per diluted share, representing net losses associated with changes in the
carrying value of our strategic investments;
•pre-tax charges of $12 million ($4 million in cost of services and $8 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 $8 million ($2 million in selling, general and
administrative expenses and $6 million in other operating expense (income),
net), or $0.05 per diluted share, primarily representing a loss associated with
the increase in the fair value of the contingent consideration accruals
associated with previous acquisitions, and 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 $4
million, or $0.03 per diluted share, recorded in income tax expense.

Results for the half-year ended June 30, 2022 were impacted by certain items which, on a net basis, reduced diluted earnings per share by $0.70 as following:

•pre-tax amortization expense of $54 million recorded in amortization of
intangible assets or $0.33 per diluted share;
•pre-tax charges of $37 million ($28 million in other (expense) income, net and
$9 million in equity in earnings of equity method investees, net of taxes), or
$0.23 per diluted share, representing net losses associated with changes in the
carrying value of our strategic investments;
•pre-tax charges of $24 million ($7 million in cost of services and $17 million
in selling, general and administrative expenses), or $0.15 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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•pre-tax charges of $10 million ($4 million in selling, general and
administrative expenses and $6 million in other operating expense (income),
net), or $0.06 per diluted share, primarily representing a loss associated with
the increase in the fair value of the contingent consideration accruals
associated with previous acquisitions, and costs associated with donations,
contributions and other financial support through Quest for Health Equity;
partially offset by
•excess tax benefits associated with stock-based compensation arrangements of $9
million, or $0.07 per diluted share, recorded in income tax expense.

  For both the three and six months ended June 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 June 30, 2021 were impacted by certain items which, on a net basis, increased diluted earnings per share by $1.78 as following:

•a pre-tax gain recorded in other (expense) income, net of $314 million, or
$2.04 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, our joint venture partner (see Note 5 to the interim
unaudited consolidated financial statements); and
•excess tax benefits associated with stock-based compensation arrangements of
$5 million, or $0.04 per diluted share, recorded in income tax expense;
partially offset by
•pre-tax amortization expense of $25 million recorded in amortization of
intangible assets or $0.15 per diluted share;
•pre-tax charges of $21 million ($12 million in cost of services and $9 million
in selling, general and administrative expenses), or $0.12 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 $5 million, or $0.03 per diluted share, associated with
donations, contributions and other financial support through Quest for Health
Equity, recorded in selling, general and administrative expenses.

Results for the half-year ended June 30, 2021 were impacted by certain items which, on a net basis, increased diluted earnings per share by $1.42 as following:

•a pre-tax gain recorded in other (expense) income, net of $314 million, or
$1.98 per diluted share, on the sale of our 40% ownership interest in Q2
Solutions; and
•excess tax benefits associated with stock-based compensation arrangements of
$9 million, or $0.07 per diluted share, recorded in income tax expense;
partially offset by
•pre-tax amortization expense of $54 million ($52 million in amortization of
intangible assets and $2 million in equity in earnings of equity method
investees, net of taxes) or $0.31 per diluted share;
•pre-tax charges of $38 million ($19 million in cost of services and $19 million
in selling, general and administrative expenses), or $0.22 per diluted share,
primarily associated with workforce reductions, systems conversions and
integration incurred in connection with further restructuring and integrating
our business;
•pre-tax charges of $8 million, or $0.04 per diluted share representing a
non-cash impairment to the carrying value of an equity method investment,
recorded in equity in earnings of equity method investees, net of taxes;
•pre-tax charges of $5 million, or $0.03 per diluted share, associated with
donations, contributions and other financial support through Quest for Health
Equity, recorded in selling, general and administrative expenses; and
•pre-tax charges of $4 million recorded 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 income

Net income for the three months ended June 30, 2022 decreased by 3.8% compared to the same period of the previous year.

DIS revenue for the three months ended June 30, 2022 decreased by 3.6% compared to the same period of the previous year. For the three months ended June 30, 2022:

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•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 June 30, 2022, recent acquisitions contributed approximately
1.0% to DIS revenues.
•Revenues in the base business (including the impact of recent acquisitions)
increased by 3.3% compared to the prior year period. While our base business has
continued to recover from the impact of the COVID-19 pandemic, we believe that
it was impacted by softer healthcare utilization trends for the three months
ended June 30, 2022 as compared to the three months ended March 31, 2022.
•DIS volume decreased by 1.4% compared to the prior year period driven by a
decrease in COVID-19 testing, partially offset by the impact of recent
acquisitions, which contributed approximately 1.0% to DIS volume, and growth in
the base business.
•Testing volume in the base business (including the impact of recent
acquisitions) was up 1.8% compared to the prior year period due to the impact of
recent acquisitions and the continued recovery from the impact of the COVID-19
pandemic.
•Revenue per requisition decreased by 2.6% compared to prior year period driven
in large part by the decrease in COVID-19 molecular testing, and unit price
pressure of less than 1.0%, partially offset by favorable test mix.

DS revenue for the three months ended June 30, 2022 decreased by 8.8% compared to the same period last year, mainly due to lower revenues associated with our risk assessment services offered to the life insurance industry.

Net income for the six months ended June 30, 2022 decreased by 3.9% compared to the same period of the previous year.

DIS revenue for the half-year ended June 30, 2022 decreased by 3.8% compared to the same period of the previous year. For the six months ended June 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 six months ended June 30, 2022,
recent acquisitions contributed approximately 1.1% to DIS revenues.
•Revenues in the base business (including the impact of recent acquisitions)
increased by 5.1% compared to the prior year period, as our base business
continued to recover from the impact of the COVID-19 pandemic.
•DIS volume was flat compared to the prior year period as growth in the base
business and the impact of recent acquisitions, which contributed approximately
1.1% to DIS volume, were offset by a decrease in COVID-19 testing.
•Testing volume in the base business (including the impact of recent
acquisitions) was up 3.9% compared to the prior year period due to the continued
recovery from the impact of the COVID-19 pandemic.
•Revenue per requisition decreased by 3.9% compared to the prior year period
driven in large part by the decrease in COVID-19 molecular testing and unit
price pressure of less than 1.0%.

  DS revenues for the six months ended June 30, 2022 decreased by 8.9% 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 June 30, 2022, cost of services increased by $46
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 retail channels, and additional costs associated with
our acquisitions. These increases were partially offset by lower supplies
expense associated with reduced COVID-19 testing volumes.

  For the six months ended June 30, 2022, cost of services increased by $66
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 retail channels, and additional costs associated with
our acquisitions. These increases were partially offset by lower supplies
expense associated with reduced COVID-19 testing volumes.


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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 decreased by $7 million for the three months ended June 30, 2022,
compared to the prior year period primarily due to $25 million of lower costs
associated with changes in the value of our deferred compensation obligations,
partially offset by 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 $11 million for the six months ended June 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 $37
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 both the three and six months ended June 30, 2022, amortization expense
increased by $2 million compared to the prior year periods as a result of recent
acquisitions.

Other operating expenses (income), net

Other operating expense (income), net, includes various income and expense items and other expenses related to operating activities.

  For both the three and six months ended June 30, 2022, other operating expense
(income), net primarily represents a loss associated with the increase in the
fair value of the contingent consideration accruals associated with previous
acquisitions.

  Interest Expense, Net

For the periods of three and six months ended June 30, 2022interest expense, net was primarily consistent with the prior year periods.

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 June 30, 2022, other (expense) income, net included
$17 million of losses associated with investments in our deferred compensation
plans and $12 million of losses associated with changes in the carrying value of
our strategic investments.

  For the three months ended June 30, 2021, other (expense) income, net 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 $8 million of gains associated with
investments in our deferred compensation plans.


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  For the six months ended June 30, 2022, other (expense) income, net included
$28 million of losses associated with changes in the carrying value of our
strategic investments and $25 million of losses associated with investments in
our deferred compensation plans.

  For the six months ended June 30, 2021, other (expense) income, net included a
$314 million pre-tax gain on the sale of our 40% ownership interest in Q2
Solutions and $12 million of gains associated with investments in our deferred
compensation plans.

  Income Tax Expense

  Income tax expense for the three months ended June 30, 2022 and 2021 was $77
million and $177 million, respectively. The decrease in income tax expense for
the three months ended June 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 three months ended June 30, 2022 and 2021, the effective income tax
rate was 23.9% and 21.6%, respectively. For the three months ended June 30,
2021, the effective income tax rate benefited from a lower effective income tax
rate, 17.6%, on the gain on the sale of our 40% ownership interest in Q2
Solutions. In addition, the effective income tax rate benefited from $4 million
and $5 million of excess tax benefits associated with stock-based compensation
arrangements for the three months ended June 30, 2022 and 2021, respectively.

  Income tax expense for the six months ended June 30, 2022 and 2021 was $187
million and $330 million, respectively. The decrease in income tax expense for
the six months ended June 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 six months ended June 30, 2022 and 2021, the effective income tax rate
was 24.2% and 22.9%, respectively. For the six months ended June 30, 2021, the
effective income tax rate benefited from a lower effective income tax rate,
17.6%, on the gain on the sale of our 40% ownership interest in Q2 Solutions. In
addition, the effective income tax rate benefited from $9 million of excess tax
benefits associated with stock-based compensation arrangements for both the six
months ended June 30, 2022 and 2021.

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 June 30, 2022 by $6 million compared to the prior year period
primarily due to net losses associated with changes in the carrying value of
strategic investments.

  Equity in earnings of equity method investees, net of taxes increased for the
six months ended June 30, 2022 by $8 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. Lower equity
earnings in the current year period associated with changes in the carrying
value of strategic investments of an equity method investee were 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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