Share Repurchase Program20
As of March 31, 2020, $1.2 billion remained available under the Company’s share repurchase authorizations; however the Company has temporarily suspended additional share repurchases under the existing authorization through the end of 2020. The share repurchase authorization has no set expiration or termination date.
Share Repurchases
For the three months ended March 31, 2020, the Company repurchased 0.7 million shares of its common stock for $75 million.
For the three months ended March 31, 2019, the Company repurchased 0.6 million shares of its common stock for $50 million.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Share Repurchase Program
As of September 30, 2020, $1.2 billion remained available under the Company’s share repurchase authorizations; however, in April 2020, the Company temporarily suspended additional share repurchases under the existing authorization. The share repurchase authorization has no set expiration or termination date.
Share Repurchases
For the nine months ended September 30, 2020, the Company repurchased 0.7 million shares of its common stock for $75 million.
For the nine months ended September 30, 2019, the Company repurchased 1.6 million shares of its common stock for $150 million.
Shares Reissued from Treasury Stock
For the threenine months ended March 31,September 30, 2020 and 2019, the Company reissued 1.12.1 million shares and 0.41.8 million shares, respectively, from treasury stock for shares issued under the Employee Stock Purchase Plan and stock option plans. For details regarding the Company's stock ownership and compensation plans, see Note 17 to the audited consolidated financial statements in the Company's 2019 Annual Report on Form 10-K.
Redeemable Noncontrolling Interest
In connection with the sale of an 18.9% noncontrolling interest in a subsidiary to UMass on July 1, 2015, the Company granted UMass the right to require the Company to purchase all of its interest in the subsidiary at fair value commencing July 1, 2020. The subsidiary performs diagnostic information services in a defined territory within the state of Massachusetts. Since the redemption of the noncontrolling interest is outside of the Company's control, it has been presented outside of stockholders' equity at the greater of its carrying amount or its fair value. The Company records changes in the fair value of the noncontrolling interest immediately as they occur. As of March 31,September 30, 2020 and December 31, 2019, the redeemable noncontrolling interest was presented at its fair value. For further information regarding the fair value of the redeemable noncontrolling interest, see Note 6.
11. SUPPLEMENTAL CASH FLOW AND OTHER DATA
Supplemental cash flow and other data for the three and nine months ended September 30, 2020 and 2019 was as follows:
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
11. SUPPLEMENTAL CASH FLOW AND OTHER DATA
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | Nine Months Ended September 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
Depreciation expense | $ | 62 | | | $ | 59 | | | $ | 186 | | | $ | 175 | |
Amortization expense | 27 | | | 23 | | | 77 | | | 72 | |
Depreciation and amortization expense | $ | 89 | | | $ | 82 | | | $ | 263 | | | $ | 247 | |
| | | | | | | |
Interest expense | $ | (42) | | | $ | (45) | | | $ | (126) | | | $ | (136) | |
Interest income | 0 | | | 1 | | | 2 | | | 3 | |
Interest expense, net | $ | (42) | | | $ | (44) | | | $ | (124) | | | $ | (133) | |
| | | | | | | |
Interest paid | $ | 33 | | | $ | 58 | | | $ | 136 | | | $ | 149 | |
Income taxes paid | $ | 148 | | | $ | 65 | | | $ | 168 | | | $ | 148 | |
| | | | | | | |
Accounts payable associated with capital expenditures | $ | 55 | | | $ | 24 | | | $ | 55 | | | $ | 24 | |
| | | | | | | |
Dividends payable | $ | 76 | | | $ | 72 | | | $ | 76 | | | $ | 72 | |
| | | | | | | |
Businesses acquired: | | | | | | | |
Fair value of assets acquired | $ | 126 | | | $ | — | | | $ | 377 | | | $ | 61 | |
Fair value of liabilities assumed | (9) | | | 0 | | | (29) | | | 0 | |
Fair value of net assets acquired | 117 | | | — | | | 348 | | | 61 | |
Merger consideration receivable/payable | 2 | | | 0 | | | 2 | | | (5) | |
Cash paid for business acquisitions | 119 | | | 0 | | | 350 | | | 56 | |
Less: Cash acquired | 18 | | | 0 | | | 21 | | | 0 | |
Business acquisitions, net of cash acquired | $ | 101 | | | $ | — | | | $ | 329 | | | $ | 56 | |
| | | | | | | |
Leases: | | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Leased assets obtained in exchange for new operating lease liabilities | $ | 40 | | | $ | 38 | | | $ | 119 | | | $ | 116 | |
Leased assets obtained in exchange for new finance lease liabilities | $ | 0 | | | $ | 1 | | | $ | 0 | | | $ | 1 | |
Supplemental cash flow
In March 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law. The CARES Act provides numerous tax provisions and other datastimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of social security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain payroll tax credits associated with the retention of employees. The CARES Act also includes a number of benefits that are applicable to the Company and other healthcare providers including, but not limited to, the appropriation of $100 billion to health care providers for related expenses or lost revenues that are attributable to the COVID-19 pandemic.
In April 2020 and August 2020, the Company received approximately $65 million and $73 million, respectively, of funds that were distributed to healthcare providers for related expenses or lost revenues that are attributable to the COVID-19 pandemic under the CARES Act. In October 2020, the Company announced that it plans to return the entire $138 million of funds received.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
The Company accounts for the receipt of the funds under a gain contingency model. Accordingly, such amounts are recognized when the funds are received and the Company has determined that it has satisfied the associated terms and conditions. During the three months ended March 31,June 30, 2020, based on the terms and 2019 was as follows:conditions that were in effect at such time, the Company concluded that it had satisfied such terms and conditions for the $65 million of funds that were received in April 2020 and, therefore, the Company recognized such amount in other operating expense (income), net during the second quarter. During the three months ended September 30, 2020, the Company reversed the $65 million of funds that had previously been recognized in other operating expense (income), net. As of September 30, 2020, no amounts are recorded in the Company's year-to-date consolidated statement of operations and the entire $138 million of funds that the Company intends to return are recorded in accounts payable and accrued expenses on the Company’s consolidated balance sheet. For the nine months ended September 30, 2020, net cash provided by operating activities included the $138 million that the Company received from the funds that were distributed to healthcare providers under the CARES Act.
|
| | | | | | | |
| Three Months Ended March 31, |
| 2020 | | 2019 |
Depreciation expense | $ | 60 |
| | $ | 60 |
|
Amortization expense | 25 |
| | 24 |
|
Depreciation and amortization expense | $ | 85 |
| | $ | 84 |
|
| | | |
Interest expense | $ | (42 | ) | | $ | (45 | ) |
Interest income | 1 |
| | 1 |
|
Interest expense, net | $ | (41 | ) | | $ | (44 | ) |
| | | |
Interest paid | $ | 48 |
| | $ | 28 |
|
Income taxes paid | $ | 18 |
| | $ | 3 |
|
| | | |
Accounts payable associated with capital expenditures | $ | 11 |
| | $ | 13 |
|
Dividends payable | $ | 75 |
| | $ | 72 |
|
| | | |
Businesses acquired: | |
| | |
|
Fair value of assets acquired | $ | 131 |
| | $ | 61 |
|
Fair value of liabilities assumed | (20 | ) | | — |
|
Fair value of net assets acquired | 111 |
| | 61 |
|
Merger consideration paid payable | — |
| | (5 | ) |
Cash paid for business acquisitions | 111 |
| | 56 |
|
Less: Cash acquired | 3 |
| | — |
|
Business acquisitions, net of cash acquired | $ | 108 |
| | $ | 56 |
|
| | | |
Leases: | | | |
Leased assets obtained in exchange for new operating lease liabilities | $ | 32 |
| | $ | 25 |
|
12. COMMITMENTS AND CONTINGENCIES
Letters of Credit
The Company can issue letters of credit totaling $100 million under its secured receivables credit facility and $150 million under its senior unsecured revolving credit facility. For further discussion regarding the Company's secured receivables credit facility and senior unsecured revolving credit facility, see Note 13 to the audited consolidated financial statements in the Company's 2019 Annual Report on Form 10-K and Note 8 to the interim unaudited consolidated financial statements.
In support of its risk management program, to ensure the Company’s performance or payment to third parties, $71 million in letters of credit under the secured receivables credit facility were outstanding as of March 31,September 30, 2020. The letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Contingent Lease Obligations
The Company remains subject to contingent obligations under certain real estate leases, including leases that were entered into by certain predecessor companies of a subsidiary prior to the Company's acquisition of the subsidiary. No liability has been recorded for any of these potential contingent obligations. For further details, see Note 18 to the audited consolidated financial statements in the Company’s 2019 Annual Report on Form 10-K.
Certain Legal Matters
The Company may incur losses associated with these proceedings and investigations, but it is not possible to estimate the amount of loss or range of loss, if any, that might result from adverse judgments, settlements, fines, penalties, or other resolution of these proceedings and investigations based on the stage of these proceedings and investigations, the absence of specific allegations as to alleged damages, the uncertainty as to the certification of a class or classes and the size of any certified class, if applicable, and/or the lack of resolution of significant factual and legal issues. The Company has insurance coverage rights in place (limited in amount; subject to deductible) for certain potential costs and liabilities related to these proceedings and investigations.
401(k) Plan Lawsuit
In June 2020, a putative class action lawsuit, House Johnson v. Quest Diagnostics Incorporated, et. al, was filed in the U.S. District Court for New Jersey against the Company and other defendants with respect to the Company’s 401(k) plan. The complaint alleges, among other things, that the fiduciaries of the 401(k) plan breached their duties by failing to disclose the expenses and risks of plan investment options, allowing unreasonable administration expenses to be charged to plan participants, and selecting and retaining high cost and poor performing investments. In July 2020, a putative class action lawsuit, Rice, et. al v. Quest Diagnostics Incorporated, et. al, was filed in the U.S. District Court for New Jersey. The plaintiffs in the Rice case named the same defendants as those named in the House Johnson case and alleged substantially similar claims to those made in the House Johnson matter. In October 2020, the court consolidated the two lawsuits and plaintiffs filed a consolidated amended complaint. The Company plans to vigorously defend this matter.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
AMCA Data Security Incident.
On June 3, 2019, the Company reported that Retrieval-Masters Creditors Bureau, Inc./American Medical Collection Agency (“AMCA”) had informed the Company and Optum360 LLC that an unauthorized user had access to AMCA’s system between August 1, 2018 and March 30, 2019 (the “AMCA Data Security Incident”). Optum360 provides revenue management services to the Company, and AMCA provided debt collection services to Optum360. AMCA first informed the Company of the AMCA Data Security Incident on May 14, 2019. AMCA’s affected system included financial information (e.g., credit card numbers and bank account information), medical information and other personal information (e.g., social security numbers). Test results were not included. Neither Optum360’s nor the Company’s systems or databases were involved in the incident. AMCA also informed the Company that information pertaining to other laboratories’ customers was also affected. Following announcement of the AMCA Data Security Incident, AMCA sought protection under the U.S. bankruptcy laws.
Following the AMCA Data Security Incident, 39 Numerous putative class action lawsuits were filed against the Company related to the incident; two of those suits subsequently have been dismissed. All but one of the remaining lawsuits are putative class actions in which the plaintiffs purport to represent various classes of consumers. In the pending cases, (most of which also name other defendants), plaintiffs assert a variety of common law and statutory claims in connection with the AMCA Data Security Incident. The U.S. Judicial Panel on Multidistrict Litigation transferred the cases still pending to, and consolidated them for pre-trial proceedings in, the U.S. District Court for New Jersey. OnIn November 15, 2019, the plaintiffs in the multidistrict proceeding filed a consolidated putative class action complaint against the Company and Optum360 that named additional individuals as plaintiffs and that asserted a variety of common law and statutory claims in connection with the AMCA Data Security Incident. OnIn January 22, 2020, the Company moved to dismiss the consolidated complaint.
In addition, certain federal and state governmental authorities are investigating, or otherwise seeking information and/or documents from the Company related to the AMCA Data Security Incident and related matters, including the Office for Civil Rights of the U.S. Department of Health and Human Services, Attorneys General offices from numerous states and the District of Columbia, and certain U.S. senators.
The Company has insurance coverage rights in place for certain potential costs and liabilities related to the AMCA Data Security Incident; this insurance coverage is limited in amount and subject to a deductible. While management believes it is reasonably possible that the Company may incur losses associated with these proceedings and investigations, it is not possible to estimate the amount of loss or range of loss, if any, that might result from adverse judgments, settlements, fines, penalties, or other resolution of these proceedings and investigations based on the stage of these proceedings and investigations, the absence of specific allegations as to alleged damages, the uncertainty as to the certification of a class or classes and the size of any certified class, if applicable, and/or the lack of resolution of significant factual and legal issues.
Other Legal Matters
In the normal course of business, the Company has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with the Company's activities as a provider of diagnostic testing, information and services. These actions could involve claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages, and could have an adverse impact on the Company's client base and reputation.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
The Company is also involved, from time to time, in other reviews, investigations and proceedings by governmental agencies regarding the Company's business which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief.
The federal or state governments may bring claims based on the Company's current practices, which it believes are lawful. In addition, certain federal and state statutes, including the qui tam provisions of the federal False Claims Act, allow private individuals to bring lawsuits against healthcare companies on behalf of government or private payers. The Company is aware of lawsuits, and from time to time has received subpoenas, related to billing practices based on the qui tam provisions of the Civil False Claims Act or other federal and state statutes, regulations or other laws. The Company understands that there may be other pending qui tam claims brought by former employees or other "whistle blowers" as to which the Company cannot determine the extent of any potential liability.
Management cannot predict the outcome of such matters. Although management does not anticipate that the ultimate outcome of such matters will have a material adverse effect on the Company's financial condition, given the high degree of judgment involved in establishing loss estimates related to these types of matters, the outcome of such matters may be material to the Company's consolidated results of operations or cash flows in the period in which the impact of such matters is determined or paid.
These matters are in different stages. Some of these matters are in their early stages. Matters may involve responding to and cooperating with various government investigations and related subpoenas. As of March 31,September 30, 2020, the Company does not believe that material losses related to legal matters are probable.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Reserves for legal matters totaled $1 million as of both March 31,September 30, 2020 and December 31, 2019.
2019, respectively.
Reserves for General and Professional Liability Claims
As a general matter, providers of clinical testing services may be subject to lawsuits alleging negligence or other similar legal claims. These suits could involve claims for substantial damages. Any professional liability litigation could also have an adverse impact on the Company's client base and reputation. The Company maintains various liability insurance coverages for, among other things, claims that could result from providing, or failing to provide, clinical testing services, including inaccurate testing results, and other exposures. The Company's insurance coverage limits its maximum exposure on individual claims; however, the Company is essentially self-insured for a significant portion of these claims. Reserves for such matters, including those associated with both asserted and incurred but not reported claims, are established on an undiscounted basis by considering actuarially determined losses based upon the Company's historical and projected loss experience. Such reserves totaled $135$134 million and $132 million as of March 31,September 30, 2020 and December 31, 2019, respectively. Management believes that established reserves and present insurance coverage are sufficient to cover currently estimated exposures.
13. BUSINESS SEGMENT INFORMATION
The Company's DIS business is the only reportable segment based on the manner in which the Chief Executive Officer, who is the Company's chief operating decision maker ("CODM"), assesses performance and allocates resources across the organization. The DIS business provides diagnostic information services to a broad range of customers, including patients, clinicians, hospitals, IDNs, health plans, employers and ACOs. The Company is the world's leading provider of diagnostic information services, which includes providing 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. The DIS business accounted for greater than 95% of net revenues in 2020 and 2019.
All other operating segments include the Company's DS businesses, which consist of its risk assessment services and healthcare information technology businesses. The Company's DS businesses are the leading provider of risk assessment services for the life insurance industry and offer healthcare organizations and clinicians robust information technology solutions.
As of March 31,September 30, 2020, substantially all of the Company’s services were provided within the United States, and substantially all of the Company’s assets were located within the United States.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
The following table is a summary of segment information for the three and nine months ended March 31,September 30, 2020 and 2019. Segment asset information is not presented since it is not used by the CODM at the operating segment level. Operating earnings (loss) of each segment represents net revenues less directly identifiable expenses to arrive at operating income (loss) for the segment. General corporate activities included in the table below are comprised of general management and administrative corporate expenses, amortization and impairment of intangible assets and other operating income and expenses, net of certain general corporate activity costs that are allocated to the DIS and DS businesses. The accounting policies of the segments are the same as those of the Company as set forth in Note 2 to the audited consolidated financial statements contained in the Company’s 2019 Annual Report on Form 10-K and Note 2 to the interim unaudited consolidated financial statements.
|
| | | | | | | |
| Three Months Ended March 31, |
| 2020 | | 2019 |
Net revenues: | |
| | |
|
DIS business | $ | 1,744 |
| | $ | 1,812 |
|
All other operating segments | 78 |
| | 79 |
|
Total net revenues | $ | 1,822 |
| | $ | 1,891 |
|
| | | |
Operating earnings (loss): | |
| | |
|
DIS business | $ | 205 |
| | $ | 280 |
|
All other operating segments | 9 |
| | 9 |
|
General corporate activities | (39 | ) | | (41 | ) |
Total operating income | 175 |
| | 248 |
|
Non-operating expenses, net | (57 | ) | | (35 | ) |
Income before income taxes and equity in earnings of equity method investees | 118 |
| | 213 |
|
Income tax expense | (26 | ) | | (50 | ) |
Equity in earnings of equity method investees, net of taxes | 14 |
| | 13 |
|
Net income | 106 |
| | 176 |
|
Less: Net income attributable to noncontrolling interests | 7 |
| | 12 |
|
Net income attributable to Quest Diagnostics | $ | 99 |
| | $ | 164 |
|
25
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | Nine Months Ended September 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
Net revenues: | | | | | | | |
DIS business | $ | 2,709 | | | $ | 1,877 | | | $ | 6,217 | | | $ | 5,561 | |
All other operating segments | 77 | | | 79 | | | 218 | | | 239 | |
Total net revenues | $ | 2,786 | | | $ | 1,956 | | | $ | 6,435 | | | $ | 5,800 | |
| | | | | | | |
Operating earnings (loss): | | | | | | | |
DIS business | $ | 840 | | | $ | 345 | | | $ | 1,325 | | | $ | 963 | |
All other operating segments | 16 | | | 10 | | | 29 | | | 31 | |
General corporate activities | (138) | | | (42) | | | (178) | | | (126) | |
Total operating income | 718 | | | 313 | | | 1,176 | | | 868 | |
Non-operating income (expense), net | 35 | | | (43) | | | (50) | | | (120) | |
Income from continuing operations before income taxes and equity in earnings of equity method investees | 753 | | | 270 | | | 1,126 | | | 748 | |
Income tax expense | (177) | | | (62) | | | (269) | | | (175) | |
Equity in earnings of equity method investees, net of taxes | 15 | | | 18 | | | 33 | | | 48 | |
Income from continuing operations | 591 | | | 226 | | | 890 | | | 621 | |
Income from discontinued operations, net of taxes | 0 | | | 0 | | | 0 | | | 20 | |
Net income | 591 | | | 226 | | | 890 | | | 641 | |
Less: Net income attributable to noncontrolling interests | 23 | | | 11 | | | 38 | | | 36 | |
Net income attributable to Quest Diagnostics | $ | 568 | | | $ | 215 | | | $ | 852 | | | $ | 605 | |
14. RELATED PARTIES
The Company's equity method investees primarily consist of its clinical trials central laboratory services joint venture and its diagnostic information services joint ventures, which are accounted for under the equity method of accounting. During both the three months ended March 31,September 30, 2020 and 2019, the Company recognized net revenues of $9$10 million and $8 million, respectively, associated with diagnostic information services provided to its equity method investees. During the nine months ended September 30, 2020 and 2019, the Company recognized net revenues of $25 million and $26 million, respectively, associated with diagnostic information services provided to its equity method investees. As of March 31,both September 30, 2020 and December 31, 2019, there was $5 million and $4 million of accounts receivable from equity method investees related to such services, respectively.services. During both the three months ended March 31,September 30, 2020 and 2019, the Company recognized net revenues of $1 million associated with diagnostic information services provided to a noncontrolling interest partner in a joint venture. During the nine months ended September 30, 2020 and $32019, the Company recognized net revenues of $2 million and $6 million, respectively, associated with diagnostic information services provided to a noncontrolling interest partner in a joint venture. As of December 31, 2019, there was $4 million of receivables from the noncontrolling interest partner included in accounts receivable and other assets related to such services.
During both the three months ended March 31,September 30, 2020 and 2019, the Company recognized income of $4 million associated with the performance of certain corporate services, including transition services, for its equity method investees, classified within selling, general and administrative expenses. During both the nine months ended September 30, 2020 and 2019, the Company recognized income of $12 million associated with the performance of certain corporate services, including transition services, for its equity method investees, classified within selling, general and administrative expenses. As of March 31,September 30, 2020 and December 31, 2019, there was $2 million and $1 million, respectively, of other receivables from equity method investees included in prepaid expenses and other current assets related to these service agreements and other transition related items. In addition, accounts payable and accrued expenses as of March 31,September 30, 2020 and December 31, 2019 included $1 million and $2 million, respectively, due to equity method investees.
During the three months ended March 31, 2020 and 2019, the Company received dividends from its equity method investees of $5 million and $6 million, respectively.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
During the nine months ended September 30, 2020 and 2019, the Company received dividends from its equity method investees of $34 million and $27 million, respectively.
15. REVENUE RECOGNITION AND ALLOWANCE FOR CREDIT LOSSES
DIS
Net revenues in the Company’s DIS business accounted for over 95% of the Company’s total net revenues for the three and nine months ended March 31,September 30, 2020 and 2019 and are primarily comprised of a high volume of relatively low-dollar transactions. The DIS business, which provides clinical testing services and other services, satisfies its performance obligations and recognizes revenues primarily upon completion of the testing process, when results are reported, or when services have been rendered. The Company estimates the amount of consideration it expects to be entitled to receive from customer groups, using the portfolio approach, in exchange for providing services. These estimates include the impact of contractual allowances, including payer denials and price concessions. The portfolios determined using the portfolio approach consist of the following groups of customers: healthcare insurers, government payers (Medicare and Medicaid programs), client payers and patients.
DS
The Company’s DS businesses primarily satisfy their performance obligations and recognize revenues when delivery has occurred or services have been rendered.
The approximate percentage of net revenue by type of customer was as follows:
|
| | | | | | |
| Three Months Ended March 31, | |
| 2020 | | 2019 | |
Healthcare insurers: | | | | |
Fee-for-service | 34 | % | | 33 | % | |
Capitated | 3 |
| | 4 |
| |
Total healthcare insurers | 37 |
| | 37 |
| |
Government payers | 14 |
| | 15 |
| |
Client payers | 33 |
| | 31 |
| |
Patients | 12 |
| | 13 |
| |
Total DIS | 96 |
| | 96 |
| |
DS | 4 |
| | 4 |
| |
Net revenues | 100 | % | | 100 | % | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | Nine Months Ended September 30, | | | | |
| 2020 | | 2019 | | 2020 | | 2019 | | |
Healthcare insurers: | | | | | | | | | |
Fee-for-service | 33 | % | | 32 | % | | 33 | % | | 33 | % | | |
Capitated | 2 | | | 3 | | | 3 | | | 3 | | | |
Total healthcare insurers | 35 | | | 35 | | | 36 | | | 36 | | | |
Government payers | 10 | | | 15 | | | 12 | | | 15 | | | |
Client payers | 40 | | | 33 | | | 37 | | | 32 | | | |
Patients | 12 | | | 13 | | | 12 | | | 13 | | | |
Total DIS | 97 | | | 96 | | | 97 | | | 96 | | | |
DS | 3 | | | 4 | | | 3 | | | 4 | | | |
Net revenues | 100 | % | | 100 | % | | 100 | % | | 100 | % | | |
The approximate percentage of net accounts receivable by type of customer was as follows:
| | | | | | | | | | | |
| September 30, 2020 | | December 31, 2019 |
| | | |
Healthcare Insurers | 30 | % | | 22 | % |
Government Payers | 6 | | | 11 | |
Client Payers | 48 | | | 42 | |
Patients (including coinsurance and deductible responsibilities) | 12 | | | 20 | |
Total DIS | 96 | | | 95 | |
DS | 4 | | | 5 | |
Net accounts receivable | 100 | % | | 100 | % |
|
| | | | | |
| March 31, 2020 | | December 31, 2019 |
| | | |
Healthcare Insurers | 22 | % | | 22 | % |
Government Payers | 10 |
| | 11 |
|
Client Payers | 42 |
| | 42 |
|
Patients (including coinsurance and deductible responsibilities) | 21 |
| | 20 |
|
Total DIS | 95 |
| | 95 |
|
DS | 5 |
| | 5 |
|
Net accounts receivable | 100 | % | | 100 | % |
27
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Allowance for Credit Losses Policy
When estimating its allowance for credit losses, the Company pools its trade receivables based on the following customer types: healthcare insurers, government payers, client payers and patients.
For the healthcare insurers and government payers, collection of the Company’s net revenues is normally a function of providing the complete and correct billing information within the various filing deadlines, and provided that the Company has billed the payers accurately with complete information prior to the established filing deadline, there has historically been little to no collection risk.
Client payers primarily include physicians, hospitals, IDNs, ACOs, employers, other commercial laboratories and institutions for which services are performed on a wholesale basis and are billed based on negotiated fee schedules. Credit risk and ability to pay are more of a consideration for these payers.
With respect to patients, implicit price concessions, which represent differences between amounts billed and the estimated consideration the Company expects to receive from patients, are recognized as a reduction of revenue. Estimates of implicit price concessions consider historical collection experience (including the period the receivables have been outstanding) and other factors including current market conditions.
The Company principally estimates the allowance for credit losses by pool based on historical collection experience, the current credit worthiness of the customers, current economic conditions, expectations of future economic conditions and the period that the receivables have been outstanding. To the extent that any individual payers are identified that have deteriorated in credit quality, the Company removes the customers from their respective pools and establishes allowances based on the individual risk characteristics of such customers.
Although the Company believes that its estimates for contractual allowances and patient price concessions as well as its allowance for credit losses are appropriate, it is possible that the Company will experience an adverse impact on cash collections as a result of the impact of the COVID-19 pandemic.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
16. TAXES ON INCOME
For the three months ended March 31,September 30, 2020 and 2019, the effective income tax rate was 22.0%23.7% and 23.7%22.9%, respectively. The effective income tax rate for the three months ended March 31,September 30, 2020, and 2019 benefited from $8a lower effective income tax rate associated with a $70 million gain recognized as a result of the remeasurement of the Company's previously held equity interest in MACL to fair value (see Note 5); and $3 million respectively, of excess tax benefits associated with stock-based compensation arrangements. ForThe effective income tax rate for the three months ended March 31,September 30, 2019 benefited from a $6 million income tax benefit due to the release of a valuation allowance associated with net operating loss carryforwards; and $3 million of excess tax benefits associated with stock-based compensation arrangements.
For the nine months ended September 30, 2020 and 2019, the effective income tax rate was 23.9% and 23.4%, respectively. The effective income tax rate for the nine months ended September 30, 2020, benefited from a lower effective income tax rate associated with a $70 million gain recognized as a result of the remeasurement of the Company's previously held equity interest in MACL to fair value (see Note 5); and $15 million of excess tax benefits associated with stock-based compensation arrangements. The effective income tax rate for the nine months ended September 30, 2019 benefited from $11 million of excess tax benefits associated with stock-based compensation arrangements; and a $10 million income tax benefit due to the release of valuation allowances associated with net operating loss carryforwards.
The effective income tax rate associated with the $70 million gain recognized as a result of the remeasurement of the Company's previously held equity interest in MACL to fair value was 11.8% due to a permanent difference in the financial reporting and tax basis of goodwill.
For the three and nine months ended September 30, 2020, the Company utilized the most likely estimate of its annual income before taxes to determine the annual effective income tax rate for 2020. As a result of uncertainty associated with the impact of the COVID-19 pandemic, it is possible that the Company will experience variability in the annual projections and, as a result, the annual effective income tax rate. The
17. DISCONTINUED OPERATIONS
During the third quarter of 2006, the Company will updatecompleted the annual effectivewind down of Nichols Institute Diagnostics ("NID"), a test kit manufacturing subsidiary, which was reported as a discontinued operation for the nine months ended September 30, 2019. Discontinued operations, net of taxes, for the nine months ended September 30, 2019 includes discrete tax rate each quarter during 2020 for changesbenefits of $20 million associated with the favorable resolution of certain tax contingencies related to NID. In addition, net cash provided by operating activities in the latest projectionsconsolidated statement of cash flows for the Company.nine months ended September 30, 2019 included a $28 million refund from the taxing authorities related to discontinued operations.
17.18. SUBSEQUENT EVENTS
On April 6, During October 2020, the Company completedamended its acquisition of select assets which constitute substantially all of the operations of Memorial Hermann Diagnostic Laboratories, the outreach laboratory division of Memorial Hermann, in an all cash transaction for $120 million. Based on the preliminary purchase price allocation, the Company expects to recognize approximately $30$600 million of customer-related intangible assets, and approximately $90 million of goodwill. All of the goodwill acquired in connection with the acquisition has been allocated to the Company's DIS business. See Note 5 to the interim unaudited consolidated financial statements for more information about the acquisition.
In April 2020, the Company borrowed $100 million under its secured receivables credit facility and $100 million under its senior unsecured revolving credit facility. See Note 8 for further discussion of such facilities.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
In April 2020, the Company terminated its existing fixed-to-variable interest rate swap agreements. As a result of the termination, the Company received proceeds of $40 million. Such amount will be amortized as a reduction of interest expense over the remaining terms of the hedged debt instruments.
In March 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of social security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain payroll tax credits associated with the retention of employees. The CARES Act also includes a number of benefits that are applicable to the Company and other healthcare providers including, but not limited to, the appropriation of $100 billion to health care providers for related expenses or lost revenues that are attributable to the COVID-19 pandemic. In April 2020, the Company received approximately $65 million from the initial tranche of $30 billion that was distributed to health care providers.
On April 30, 2020, the Company entered into an amendment to its senior unsecured revolving credit facility in order to provideextend the maturity dates for increased flexibilityeach underlying commitment by one year while maintaining the borrowing capacity under the leverage ratio covenant. Pursuantfacility at $600 million. Under the secured receivables credit facility, the Company can borrow against a $250 million loan commitment maturing October 2021 and a $250 million loan commitment maturing October 2022. Additionally, the Company can issue up to $100 million of letters of credit through October 2022. Borrowings under the facility are collateralized by certain domestic receivables. Interest on borrowings under the facility is based on either commercial paper rates for highly-rated issuers or LIBOR, plus a spread of 0.825% to 0.95%.
In October 2020, the Company issued a redemption notice to the amendment, the leverage ratio covenant was increased from the second quarter of 2020 through the second quarter of 2021 as follows:
|
| | |
As of: | | Applicable Covenant: |
June 30, 2020 | | no more than 5 times EBITDA |
September 30, 2020 | | no more than 5.5 times EBITDA |
December 31, 2020 | | no more than 6.5 times EBITDA |
March 31, 2021 | | no more than 6.25 times EBITDA |
June 30, 2021 | | no more than 4.5 times EBITDA |
After the second quarter of 2021, the leverage ratio covenant reverts to no more than 3.5 times EBITDA. During the period that the increased covenant applies, which period may be terminated early by the Company provided that it is in compliance with the historical 3.5 times EBITDA leverage ratio, the amended credit agreement contains certain additional limitations and restrictions including, but not limited to, regarding repurchasesholders of the Company's common stock, the$550 million aggregate principal amount of funds that can be used4.70% senior notes due April 2021, to redeem such notes in November 2020. Upon redemption, the Company will recognize a loss on business acquisitions, the incurrenceextinguishment of secured indebtedness, and, under certain circumstances, the payment of dividends. Interestdebt based on the amended senior unsecured revolving credit facility is subject todifference between the reacquisition price of the debt and the net carrying amount. The Company will pay a pricing schedule that can fluctuate basedredemption premium in accordance with the requirements of such notes using a treasury rate calculated on changes in the Company's credit ratings and current EBITDA leverage ratio.third business day preceding the redemption date.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 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 over 95% of our consolidated net revenues.
We assessesassess 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). Management utilizes requisition data to assist with assessing the growth of the business. Therefore, we believe that the change in the number of requisitions from period to period is useful information for investors as it allows them to assess our growth.
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 utilizes revenue per requisition data in order to assist with assessing various factors impacting the performance of the business, including pricing and trends impacting mix. Therefore, we believe that the change in this metric from period to period is useful information for investors as it allows them to assess such factors, which are relevant to assessing the revenue performance of the business.
Diagnostic Solutions
In our Diagnostic Solutions ("DS") businesses, which represents the balance of our consolidated net revenues, we are the leading provider of risk assessment services for the life insurance industry and we offer healthcare organizations and clinicians robust information technology solutions.
FirstThird Quarter Highlights
•Our total net revenues of $1.82$2.79 billion were down 3.7%up 42.5% from the prior year period.
•In DIS:
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◦ | Revenues of $1.74 billion decreased by 3.8% compared to the prior year period, driven by a decrease in organic volume (volume excluding the impact of acquisitions) and a decline in revenue per requisition, partially offset by the impact of recent acquisitions. |
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◦ | Volume, measured by the number of requisitions, decreased by 2.4% compared to the prior year period, with organic volume down approximately 2.7%, partially offset by volume associated with recent acquisitions of 0.3%. |
| |
◦ | Revenue per requisition decreased by 1.2% compared to the prior year period. |
◦Revenues of $2.71 billion increased by 44.3% compared to the prior year period, driven by demand for COVID-19 molecular and antibody testing, and, to a lesser extent, the impact of recent acquisitions, partially offset by a decline in testing volume in our base business (which excludes COVID-19 molecular and antibody testing).
◦Volume, measured by the number of requisitions, increased by 19.7% compared to the prior year period, with organic growth (which excludes the impact of recent acquisitions) and acquisitions contributing approximately 16.6% and 3.1%, respectively. Organic volume growth was driven by demand for COVID-19 molecular testing, partially offset by declines in testing volumes in the base business. Testing volumes in the base business were negatively impacted by the COVID-19 pandemic and declined by 5% compared to the prior year period.
◦Revenue per requisition increased by 20.9% compared to the prior year period driven, in large part, by COVID-19 molecular testing.
•DS revenues of $78$77 million decreased by 1.9% compared to the prior year period.
Net income•Income from continuing operations attributable to Quest Diagnostics' stockholders was $99$568 million, or $0.73$4.14 per diluted share, in 2020, compared to $164$215 million, or $1.20$1.56 per diluted share, in the prior year period.
•For the threenine months ended March 31,September 30, 2020, net cash provided by operating activities was $247$1,464 million, compared to $275$895 million in the prior year period.
Impact of COVID - 19
As a novel strain of coronavirus (“COVID-19”) continues to spread and severely 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 the amount of COVID-19 testing available to the country and are currently capable of testingperforming more than 50,000200,000 COVID-19 molecular diagnostic tests per day.day to aid in the diagnosis of COVID-19 and approximately 200,000 COVID-19 antibody tests per day to aid in the detection of immune response. We have been effectively managing challenges in the global supply chain; and, at this point, we have sufficient supplies to conduct our business. We have also begun performing a blood-based COVID-19 antibody test. We currently have the capacity to perform approximately 150 thousand antibody tests per day.
We have put preparedness plans in place at our facilities to maintain continuity of operations, while also taking steps to keep colleagues and customers healthy and safe. In line with recommendations to reduce large gatherings and increase social distancing, we have transitioned many of our office-based colleagues toare working in a remote work environment. We are evaluating the best way to bring them back into the office.
During January and February 2020, we experienced growth in DIS revenues and volumes compared to the prior year period. Through February, year-to-date DIS revenues increased 4.2% compared to the prior year period with organic growth and acquisitions contributing approximately 3.7% and 0.5%, respectively. Year-to-date DIS volume through February increased 6.3% compared to the prior year period. Such growth included the benefit of an extra business day in 2020 and the impact of weather in the prior year period, each of which we estimate favorably impacted the comparison by 0.8%. However, in March and April 2020, we experienced and we have continued to experience, a material decline in testing volumes due to the COVID-19 pandemic. During the last two weeks of March, volumes declined in excess of 40% inclusive of COVID-19 testing, across all metro markets. In April, volume declines continued with the declines compared to the prior year period, inclusive of COVID-19 testing, which continued in April with volume declines in the range of 50%50 to 60% compared to the prior year period as government policies were implemented to reduce the transmission of COVID-19. During May and June 2020, we began to experience a recovery in base testing volumes (which excludes COVID-19 molecular and antibody testing), which continued in the third quarter of 2020. Additionally, beginning during the second quarter, we experienced growing demand for COVID-19 testing services and have expanded our capacity in order to satisfy such demand. Volumes in our base business for the second and third quarters of 2020 decreased approximately 34% and 5%, respectively, compared to the prior year periods.
60%. Federal, The decrease in base testing volumes was driven by federal, state and local governmental policies and initiatives designed to reduce the transmission of COVID-19 which have resulted in, among other things, a significant reduction in physician office visits, the cancellation of elective medical procedures, customers closing or severely curtailing their operations (voluntarily or in response to government orders), and the adoption of work-from-home or shelter-in-place policies, all of which have had, and we believe will likely continue to have, an adverse impact on our operating results, financial position and cash flows, and financial condition, including continued declines in base testing volumes. It is also possible that we will experience an adverse impact on cash collections as a result of the impact of the COVID-19 pandemic.
During the second quarter of 2020, the decrease in base testing volumes was partially offset by COVID-19 molecular and antibody testing, including an increase in revenue per requisition driven in large part by COVID-19 molecular testing. During the third quarter of 2020, the decrease in base testing volumes was more than offset by the impact of the COVID-19 testing.
In April 2020 the Centers for Medicare and Medicaid Services ("CMS") announced that it would increase the reimbursement for certain COVID-19 molecular tests making use of high-throughput technologies developed by the private sector that allow for increased testing capacity, faster results, and more effective means of combating the spread of the virus to $100 per test, effective April 14, 2020. In October 2020, CMS announced that, beginning January 1, 2021, Medicare will change the base reimbursement rate for COVID-19 diagnostic tests run on high-throughput technologies to $75 per test with an additional payment of $25 per test if certain additional requirements are met. In conjunction with our trade association, we are currently reviewing how this reimbursement policy will impact laboratories and the patients we serve.
In order to mitigate the impact that the COVID-19 pandemic had on our business, we implemented a series of temporary actions in April 2020 to manage our workforce costs and preserve cash including temporary salary reductions; suspension of certain benefits; reduced hours for employees whose work has significantly declined; and approved furloughs for employees with diminished work requirements who expressed an interest. As our testing volumes started to recover, we recalled the vast majority of employees from furlough and reinstated full working hours for almost all employees who were asked to work reduced hours. By the end of the third quarter of 2020, salaries were restored for all exempt employees that had temporary salary reductions.
We believe COVID-19’s adversethe COVID-19 pandemic’s impact on our consolidated results of operations, financial position and cash flows will be primarily driven by: the severity and duration of the COVID-19 pandemic; the COVID-19 pandemic’s impact on the U.S. healthcare system and the U.S. economy; and the timing, scope and effectiveness of federal, state and local
governmental responses to the COVID-19 pandemic. We may also be impacted by changes in the severity of the COVID-19 pandemic at different times in the various cities and regions where we operate and offer services. Even after the COVID-19 pandemic has moderated and the business and social distancing restrictions have eased, we may continue to experience similar adverse effects to our businesses, consolidated results of operations, financial position and cash flows resulting from a recessionary economic environment that may persist. In the longer term, given the many challenges that hospitals will face, we may have more opportunities to partner with hospitals to help achieve their laboratory strategies, and the COVID-19 pandemic may also be a further catalyst for consolidation in the laboratory testing industry.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
In March 2020, in response to the COVID-19 pandemic, the CARES Act was signed into law. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of Social Security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain payroll tax credits associated with the retention of employees. Beginning in the second quarter of 2020, we started taking advantage of the temporary suspension of payment requirements for the employer portion of Social Security taxes.
The CARES Act also includes a number of benefits that are applicable to us and other healthcare providers including, but not limited to:
•providing coverage for COVID-19 testing at no out of pocketout-of-pocket cost to nearly all patients;
•providing clinical laboratories a one-year reprieve from the reporting requirements under the Protecting Access to Medicare Act ("PAMA") as well as a one-year delay of reimbursement rate reductions for clinical laboratory services provided under Medicare that were scheduled to take place in 2021. Further revisions of the Medicare Clinical Laboratory Fee Schedule for years after 2021 will be based on future surveys of market rates. Reimbursement reduction from 2022-2024 is capped by PAMA at 15% annually;
•appropriating $100 billion to health care providers for related expenses or lost revenues that are attributable to the COVID-19 pandemic. In April 2020 and August 2020, we received approximately $65 million fromand $73 million, respectively, of funds that were distributed to healthcare providers for related expenses or lost revenues that are attributable to the initialCOVID-19 pandemic under the CARES Act. In October 2020, we announced that we plan to return the entire $138 million of funds received. During the three months ended June 30, 2020, we recognized $65 million in other operating expense (income), net related to the first tranche of $30 billionfunds. During the three months ended September 30, 2020, we reversed the $65 million of funds that was distributedhad previously been recognized in other operating expense (income), net. As of September 30, 2020, no amounts are recorded in our year-to-date consolidated statement of operations and the entire $138 million of funds that we intend to health care providers;return are recorded in accounts payable and accrued expenses on our consolidated balance sheet; and
•suspending Medicare sequestration from May 2020 to December 2020. We estimate that theThe suspension of the Medicare sequestration will resulthas resulted in a small benefit to us in the form of higher reimbursement rates for diagnostic testing services performed on behalf of Medicare beneficiaries.
Retirement of Debt
During January 2020, we redeemed in full the outstanding indebtedness under our senior notes due January 2020 and senior notes due March 2020 using proceeds from the issuance, in December 2019, of the 2.95% senior notes due June 2030, along with cash on hand. For the threenine months ended March 31,September 30, 2020, we recorded a loss on retirement of debt, principally comprised of premiums paid, of $1 million in other (expense) income, net.
Senior Notes Offering
During May 2020, we completed a senior notes offering, consisting of $550 million aggregate principal amount of 2.80% senior notes due June 2031 (the “2031 Senior Notes”), which were issued at an original issue discount of $1 million. In October 2020, we issued a redemption notice to the holders of our $550 million aggregate principal amount of 4.70% senior notes due April 2021, to redeem such notes in November 2020. We intend to use the net proceeds from the 2031 Senior Notes, along with cash on hand, to satisfy the redemption.
For further details regarding our debt, see NoteNotes 8 and 18 to the interim unaudited consolidated financial statements.
Acquisition of Blueprint Genetics Oy
On January 21, 2020, we completed the acquisition of Blueprint Genetics Oy ("Blueprint Genetics"), in an all cash transaction for $108 million, net of $3 million cash acquired. Blueprint Genetics is a leading specialty genetic testing company with deep expertise in gene variant interpretation based on next generation sequencing and proprietary bioinformatics. Through the acquisition, we acquired all of Blueprint Genetics' operations. The acquired business is included in our DIS business.
Acquisition of the Outreach Laboratory Services Business of Memorial Hermann Health System
On April 6, 2020, we completed the acquisition of select assets which constitute substantially all of the operations of Memorial Hermann Diagnostic Laboratories, the outreach laboratory division of Memorial Hermann Health System ("Memorial Hermann") in an all cash transaction for $120 million. Memorial Hermann is a not-for-profit health system in Southeast Texas. The acquired business is included in our DIS business.
Acquisition of the Remaining 56% Interest in Mid America Clinical Laboratories, LLC
On August 1, 2020, we completed the acquisition of the remaining 56% interest in Mid America Clinical Laboratories, LLC ("MACL") from our joint venture partners in an all cash transaction for $93 million, net of $18 million cash acquired. MACL is the largest independent clinical laboratory provider in Indiana. Prior to the acquisition, we accounted for our 44% interest in MACL as an equity method investment which was remeasured to its fair value of $87 million on the acquisition date, resulting in a gain of $70 million that was recognized in other income, net in the consolidated statements of operations. As a result of the acquisition, MACL became our wholly owned subsidiary. The acquired business is included in our DIS business.
For further details regarding our acquisitions, see Note 5 to the interim unaudited consolidated financial statements and Note 6 to the audited consolidated financial statements in the Company'sour 2019 Annual Report on Form 10-K.
Acquisition of the Outreach Laboratory Services Business of Memorial Hermann Health System
On January 27, 2020, we entered into a definitive agreement to acquire select assets which constitute substantially all of the operations of Memorial Hermann Diagnostic Laboratories, the outreach laboratory division of Memorial Hermann Health System ("Memorial Hermann"). Memorial Hermann is a not-for-profit health system in Southeast Texas. The acquisition closed on April 6, 2020. See Note 17 to the interim unaudited consolidated financial statements for further details regarding the close of the transaction.
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 save approximately 3% of our costs. We are assessing whether the COVID-19 pandemic will impact our ability to achieve that objective.objective in 2020.
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 identified key themes to change how we operate including reducing denials and patient 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 threenine months ended March 31,September 30, 2020, we incurred $11$34 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 cost savings.
For further details of the Invigorate program and associated costs, see Note 4 to the interim unaudited consolidated financial statements.
Critical Accounting Policies and Estimates
There have been no significant changes to our critical accounting policies from those disclosed in our 2019 Annual Report on Form 10-K except for the adoption of new accounting standards as described in Note 2 to the interim unaudited consolidated financial statements.
Revenues and accounts receivable associated with DIS
The process for estimating revenues and the ultimate collection of receivables associated with our DIS business involves significant assumptions and judgments. We recognize as revenue the amount of consideration to which we expect to be entitled primarily upon completion of the testing process, when results are reported, or when services have been rendered. We estimate the amount of consideration we expect to be entitled to receive from customer groups, using the portfolio approach, in exchange for providing services. These estimates include the impact of contractual allowances, including payer denials, and price concessions. The portfolios determined using the portfolio approach consist of the following customers:
•Healthcare Insurers
•Government Payers (Medicare and Medicaid programs)
•Client Payers
•Patients
We have a standardized approach to estimate the amount of consideration that we expect to be entitled to; this standardized approach considers, among other things, the impact of contractual allowances, including payer denials, and price concessions. Historical collection and payer reimbursement experience (along with the period the receivables have been outstanding), as well as other factors including current market conditions, are integral parts of the estimation process related to revenues and receivables .receivables. Adjustments to our estimated contractual allowances and implicit price concessions are recorded in the current period as changes in estimates. Further adjustments, based on actual receipts, may be recorded upon settlement.
Although we believe that our estimates for contractual allowances and patient price concessions as well as our allowance for credit losses are appropriate, it is possible that we will experience an adverse impact on cash collections as a result of the impact of the COVID-19 pandemic. For further details on revenue and receivables, see Note 15 to the interim unaudited consolidated financial statements.
Accounting for and recoverability of goodwill
We do not amortize goodwill, but evaluate the recoverability and measure the potential impairment of our goodwill annually, or more frequently, in the case of other events that indicate a potential impairment.
Goodwill is evaluated for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The annual impairment test includes an option to perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value; the qualitative analysis may be performed prior to, or as an alternative to, performing a quantitative goodwill impairment test. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, we assess relevant events and circumstances, such as: (a) macroeconomic conditions; (b) industry and market considerations; (c) cost factors; (d) overall financial performance; (e) other relevant entity-specific events; (f) events affecting a reporting unit; and (g) a sustained decrease in share price. If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we are required to perform the quantitative goodwill impairment test. Otherwise, no further analysis is required.
On a quarterly basis, we perform a review of our business to determine if events or changes in circumstances have occurred that indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value. If such events or changes in circumstances were deemed to have occurred, we would perform an impairment test of goodwill and record any noted impairment loss. In conjunction with the preparation of our March 31,September 30, 2020 financial statements, we performed such review and concluded that no impairment test was necessary. However, should the impact of the COVID-19 pandemic be significantly worse than currently expected, it is possible that we could incur impairment charges in the future.
Impact of New Accounting Standards
The adoption of new accounting standards is discussed in Note 2 to the interim unaudited consolidated financial statements.
The impact of recent accounting pronouncements not yet effective on our consolidated financial statements is discussed in Note 2 to the interim unaudited consolidated financial statements.
Results of Operations
The following tables set forth certain results of operations data for the periods presented:
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| Three Months Ended September 30, | | | | | | | | Nine Months Ended September 30, | | | | | | |
| 2020 | | 2019 | | $ Change | | % Change | | 2020 | | 2019 | | $ Change | | % Change |
| (dollars in millions, except per share amounts) | | | | | | | | | | | | | | |
Net revenues: | | | | | | | | | | | | | | | |
DIS business | $ | 2,709 | | | $ | 1,877 | | | $ | 832 | | | 44.3 | % | | $ | 6,217 | | | $ | 5,561 | | | $ | 656 | | | 11.8 | % |
DS businesses | 77 | | | 79 | | | (2) | | | (1.9) | | | 218 | | | 239 | | | (21) | | | (8.6) | |
Total net revenues | $ | 2,786 | | | $ | 1,956 | | | $ | 830 | | | 42.5 | % | | $ | 6,435 | | | $ | 5,800 | | | $ | 635 | | | 11.0 | % |
| | | | | | | | | | | | | | | |
Operating costs and expenses and other operating income: | | | | | | | | | | | | | | | |
Cost of services | $ | 1,580 | | | $ | 1,264 | | | $ | 316 | | | 25.0 | % | | $ | 4,071 | | | $ | 3,773 | | | $ | 298 | | | 7.9 | % |
Selling, general and administrative | 396 | | | 362 | | | 34 | | | 9.5 | | | 1,103 | | | 1,108 | | | (5) | | | (0.4) | |
Amortization of intangible assets | 27 | | | 23 | | | 4 | | | 12.8 | | | 77 | | | 72 | | | 5 | | | 5.9 | |
| | | | | | | | | | | | | | | |
Other operating expense (income), net | 65 | | | (6) | | | 71 | | | NM | | 8 | | | (21) | | | 29 | | | NM |
Total operating costs and expenses, net | $ | 2,068 | | | $ | 1,643 | | | $ | 425 | | | 25.9 | % | | $ | 5,259 | | | $ | 4,932 | | | $ | 327 | | | 6.6 | % |
| | | | | | | | | | | | | | | |
Operating income | $ | 718 | | | $ | 313 | | | $ | 405 | | | 129.5 | % | | $ | 1,176 | | | $ | 868 | | | $ | 308 | | | 35.5 | % |
| | | | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | | | |
Interest expense, net | $ | (42) | | | $ | (44) | | | $ | 2 | | | (3.3) | % | | $ | (124) | | | $ | (133) | | | $ | 9 | | | (6.6) | % |
Other income, net | 77 | | | 1 | | | 76 | | | NM | | 74 | | | 13 | | | 61 | | | NM |
Total non-operating income (expense), net | $ | 35 | | | $ | (43) | | | $ | 78 | | | NM | | $ | (50) | | | $ | (120) | | | $ | 70 | | | NM |
| | | | | | | | | | | | | | | |
Income tax expense | $ | (177) | | | $ | (62) | | | $ | (115) | | | 187.2 | % | | $ | (269) | | | $ | (175) | | | $ | (94) | | | 54.0 | % |
| | | | | | | | | | | | | | | |
Effective income tax rate | 23.7 | % | | 22.9 | % | | | | | | 23.9 | % | | 23.4 | % | | | | |
| | | | | | | | | | | | | | | |
Equity in earnings of equity method investees, net of taxes | $ | 15 | | | $ | 18 | | | $ | (3) | | | (9.1) | % | | $ | 33 | | | $ | 48 | | | $ | (15) | | | (29.9) | % |
| | | | | | | | | | | | | | | |
Amounts attributable to Quest Diagnostics’ common stockholders: | | | | | | | | | | | | | | | |
Income from continuing operations | $ | 568 | | | $ | 215 | | | $ | 353 | | | 164.7 | % | | $ | 852 | | | $ | 585 | | | $ | 267 | | | 45.6 | % |
Income from discontinued operations, net of taxes | $ | — | | | $ | — | | | $ | — | | | NM | | $ | — | | | $ | 20 | | | $ | (20) | | | NM |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Diluted earnings per common share from continuing operations attributable to Quest Diagnostics' common stockholders | $ | 4.14 | | | $ | 1.56 | | | $ | 2.58 | | | 164.6 | % | | $ | 6.25 | | | $ | 4.27 | | | $ | 1.98 | | | 46.0 | % |
| | | | | | | | | | | | | | | |
NM - Not Meaningful | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
|
| | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2020 | | 2019 | | $ Change | | % Change |
| (dollars in millions, except per share amounts) |
Net revenues: | | | | | | | |
DIS business | $ | 1,744 |
| | $ | 1,812 |
| | $ | (68 | ) | | (3.8 | )% |
DS businesses | 78 |
| | 79 |
| | (1 | ) | | (1.9 | ) |
Total net revenues | $ | 1,822 |
| | $ | 1,891 |
| | $ | (69 | ) | | (3.7 | )% |
| | | | | | | |
Operating costs and expenses and other operating income: | |
| | |
| | | | |
Cost of services | $ | 1,270 |
| | $ | 1,244 |
| | $ | 26 |
| | 2.1 | % |
Selling, general and administrative | 347 |
| | 384 |
| | (37 | ) | | (9.6 | ) |
Amortization of intangible assets | 25 |
| | 24 |
| | 1 |
| | 1.1 |
|
Other operating expense (income), net | 5 |
| | (9 | ) | | 14 |
| | NM |
|
Total operating costs and expenses, net | $ | 1,647 |
| | $ | 1,643 |
| | $ | 4 |
| | 0.2 | % |
| | | | | | | |
Operating income | $ | 175 |
| | $ | 248 |
| | $ | (73 | ) | | (29.6 | )% |
| | | | | | | |
Other income (expense): | | | | | | | |
Interest expense, net | $ | (41 | ) | | $ | (44 | ) | | $ | 3 |
| | (6.7 | )% |
Other (expense) income, net | (16 | ) | | 9 |
| | (25 | ) | | NM |
|
Total non-operating expenses, net | $ | (57 | ) | | $ | (35 | ) | | $ | (22 | ) | | 60.9 | % |
| | | | | | | |
Income tax expense | $ | (26 | ) | | $ | (50 | ) | | $ | 24 |
| | (48.6 | )% |
| | | | | | | |
Effective income tax rate | 22.0 | % | | 23.7 | % | | | | |
| | | | | | | |
Equity in earnings of equity method investees, net of taxes | $ | 14 |
| | $ | 13 |
| | $ | 1 |
| | 0.4 | % |
| | | | | | | |
Net income attributable to Quest Diagnostics | $ | 99 |
| | $ | 164 |
| | $ | (65 | ) | | (39.9 | )% |
| | | | | | | |
Diluted earnings per common share attributable to Quest Diagnostics' common stockholders | $ | 0.73 |
| | $ | 1.20 |
| | $ | (0.47 | ) | | (39.6 | )% |
| | | | | | | |
NM - Not Meaningful | | | | | | | |
The following table sets forth certain results of operations data as a percentage of net revenues for the periods presented: |
| | | | | |
| Three Months Ended March 31, |
| 2020 | | 2019 |
Net revenues: | | | |
DIS business | 95.7 | % | | 95.8 | % |
DS businesses | 4.3 |
| | 4.2 |
|
Total net revenues | 100.0 | % | | 100.0 | % |
| | | |
Operating costs and expenses and other operating income: | |
| | |
|
Cost of services | 69.7 | % | | 65.7 | % |
Selling, general and administrative | 19.0 |
| | 20.3 |
|
Amortization of intangible assets | 1.4 |
| | 1.3 |
|
Other operating expense (income), net | 0.3 |
| | (0.5 | ) |
Total operating costs and expenses, net | 90.4 | % | | 86.8 | % |
| | | |
Operating income | 9.6 | % | | 13.2 | % |
Operating Results | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | Nine Months Ended September 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
Net revenues: | | | | | | | |
DIS business | 97.2 | % | | 96.0 | % | | 96.6 | % | | 95.9 | % |
DS businesses | 2.8 | | | 4.0 | | | 3.4 | | | 4.1 | |
Total net revenues | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| | | | | | | |
Operating costs and expenses and other operating income: | | | | | | | |
Cost of services | 56.7 | % | | 64.6 | % | | 63.3 | % | | 65.1 | % |
Selling, general and administrative | 14.2 | | | 18.5 | | | 17.1 | | | 19.1 | |
Amortization of intangible assets | 1.0 | | | 1.2 | | | 1.2 | | | 1.2 | |
| | | | | | | |
Other operating expense (income), net | 2.3 | | | (0.3) | | | 0.1 | | | (0.4) | |
Total operating costs and expenses, net | 74.2 | % | | 84.0 | % | | 81.7 | % | | 85.0 | % |
| | | | | | | |
Operating income | 25.8 | % | | 16.0 | % | | 18.3 | % | | 15.0 | % |
| | | | | | | |
Operating Results
Results for the three months ended March 31,September 30, 2020 were affected by certain items that on a net basis reduced diluted earnings per share by $0.21$0.17 as follows:
•net pre-tax charges of $69 million (charges of $65 million in other operating expense (income), net, $3 million in cost of services and $1 million in equity in earnings of equity method investees, net of taxes), or $0.39 per diluted share, representing the impact of certain items resulting from the COVID-19 pandemic, including the reversal of $65 million of income previously recognized during the second quarter of 2020 attributable to the receipt of funds from the government that were appropriated to healthcare providers under the CARES Act and, to a lesser extent, incremental costs incurred primarily to protect the health and safety of our employees and customers;
•pre-tax amortization expense of $28$30 million ($2527 million in amortization of intangible assets and $3 million in equity in earnings of equity method investees, net of taxes) or $0.15$0.16 per diluted share; and
•pre-tax charges of $18 million ($11 million in cost of services and $7 million in selling, general and administrative expenses), or $0.10 per diluted share, representing costs primarily associated with systems conversions and integration incurred in connection with further restructuring and integrating our business; partially offset by
•a pre-tax gain of $70 million, or $0.46 per diluted share, recognized in other income, net based on the difference between the fair value and the carrying value of an equity interest; and
•excess tax benefits associated with stock-based compensation arrangements of $3 million, or $0.02 per diluted share, recorded in income tax expense.
Results for the nine months ended September 30, 2020 were affected by certain items that on a net basis reduced diluted earnings per share by $0.44 as follows:
•pre-tax amortization expense of $86 million ($77 million in amortization of intangible assets and $9 million in equity in earnings of equity method investees, net of taxes) or $0.47 per diluted share;
•pre-tax charges of $52 million ($38 million of charges in cost of services, $8 million of charges in selling, general and administrative expenses and $8 million of charges in other operating expense (income), net, partially offset by a $2 million gain in equity in earnings of equity method investees, net of taxes), or $0.29 per diluted share, representing the impact of certain items resulting from the COVID-19 pandemic, principally including expense associated with a one-time payment to eligible employees to help offset expenses they incurred as a result of COVID-19, certain asset impairment charges, and incremental costs incurred primarily to protect the health and safety of our employees and customers; and
•pre-tax charges of $43 million ($21 million in cost of services and $22 million in selling, general and administrative expenses), or $0.25 per diluted share, primarily associated with systems conversions and integration incurred in connection with further restructuring and integrating our business; partially offset by
•a pre-tax gain of $70 million, or $0.46 per diluted share, recognized in other income, net based on the difference between the fair value and the carrying value of an equity interest; and
•excess tax benefits associated with stock-based compensation arrangements of $15 million, or $0.11 per diluted share, recorded in income tax expense.
Results for the three months ended September 30, 2019 were affected by certain items that on a net basis reduced diluted earnings per share by $0.20 as follows:
•pre-tax amortization expense of $25 million ($23 million in amortization of intangible assets and $2 million in equity in earnings of equity method investees, net of taxes) or $0.14 per diluted share; and
•pre-tax charges of $16 million ($7 million in cost of services and $9 million in selling, general and administrative expenses), or $0.09 per diluted share, primarily associated with systems conversions and integration incurred in connection with further restructuring and integrating our business; partially offset by
•a net pre-tax chargesgain of $9 million ($1 million in cost of services, $3 million (a $7 million gain in other operating expense (income), net partially offset by a $4 million charge in selling, general and administrative expenses and $5 million in other operating expense (income), net)expenses), or $0.03$0.01 per diluted share, primarily due to a gain associated with certain costs incurred as a resultthe decrease in the fair value of the COVID-19 pandemic and resulting impact on the economy including certain asset impairment charges, and incremental costs incurred primarily to protect the health and safety of our employees and customers and to transition certain employees tocontingent consideration accrual associated with a remote work environment;previous acquisition partially offset by costs incurred related to a data security incident, and
•excess tax benefits associated with stock-based compensation arrangements of $8$3 million, or $0.06$0.02 per diluted share, recorded in income tax expense.
Results for the threenine months ended March 31,September 30, 2019 were affected by certain items that on a net basis reduced diluted earnings per share by $0.20$0.62 as follows:
•pre-tax amortization expense of $29$84 million ($2472 million in amortization of intangible assets and $5$12 million in equity in earnings of equity method investees, net of taxes) or $0.16$0.46 per diluted share; and
•pre-tax charges of $22$64 million ($1129 million in cost of services and $11$35 million in selling, general and administrative expenses), or $0.12$0.35 per diluted share, primarily associated with systems conversions and integration incurred in connection with further restructuring and integrating our business; partially offset by
•a net pre-tax gain of $8$17 million ($1(a $22 million gain in other operating expense (income), net partially offset by a $5 million charge in selling, general and administrative expenses offset by a $9 million gain in other operating (income) expense, net)expenses), or $0.06$0.11 per diluted share, primarily due to a gain associated with an insurance claim for hurricane related losses, and a gain associated with the decrease in the fair value of the contingent consideration accruals associated with previous acquisitions, partially offset by non-cash asset impairment charges;charges, and costs incurred related to a data security incident, and
•excess tax benefits associated with stock-based compensation arrangements of $3$11 million, or $0.02$0.08 per diluted share, recorded in income tax expense.
Net Revenues
Net revenues for the three months ended March 31,September 30, 2020 decreasedincreased by 3.7%42.5% compared to the prior year period.
DIS revenues for the three months ended March 31,September 30, 2020 decreasedincreased by 3.8%44.3% compared to the prior year period driven by demand for COVID-19 molecular and antibody testing, and, to a decrease in organic volume and a decline in revenue per requisition, partially offset bylesser extent, the impact of recent acquisitions. During Januaryacquisitions, partially offset by a decline in testing volume in our base business (which excludes COVID-19 molecular and February 2020, we experiencedantibody testing). For the three months ended September 30, 2020:
•Organic revenue and acquisitions contributed approximately 41.8% and 2.5%, respectively, to DIS revenue growth compared to the prior year period. Through February, year-to-date
•DIS revenuesvolume increased 4.2%by 19.7% with organic volume and acquisitions contributing approximately 16.6% and 3.1%, respectively. Organic volume growth was driven by demand for COVID-19 molecular testing, partially offset by declines in testing volumes in the base business. Testing volumes in the base business were negatively impacted by the COVID-19 pandemic and declined by 5% compared to the prior year period.
•Revenue per requisition increased by 20.9% compared to the prior year period primarily due to favorable mix, driven in large part by COVID-19 molecular testing; partially offset by reimbursement pressure, including unit price reductions associated with organic growthPAMA and acquisitions contributingall other sources, of approximately 3.7% and 0.5%, respectively. Year-to-date DIS volume through February1.7%.
Net revenues for the nine months ended September 30, 2020 increased 6.3%by 11.0% compared to the prior year period. Such
DIS revenues for the nine months ended September 30, 2020 increased by 11.8% compared to the prior year period driven by demand for COVID-19 molecular and antibody testing, and, to a lesser extent, the impact of recent acquisitions, partially offset by a decline in testing volume in our base business. For the nine months ended September 30, 2020:
•Organic revenue and acquisitions contributed approximately 10.5% and 1.3%, respectively, to DIS revenue growth includedcompared to the benefitprior year period.
•DIS volume decreased by 0.1%, with organic volume down approximately 1.4%, partially offset by volume associated with recent acquisitions of 1.3%. Organic volume was negatively impacted by declines in testing volumes in the base business due to the COVID-19 pandemic, partially offset by COVID-19 molecular and antibody testing and, to a lesser extent, the impact of an extra business day in 2020 and the impact of weather in the prior year period, eachboth of which we estimate favorably impacted the comparison by 0.8%approximately 1.0%. However,Testing volumes in Marchthe base business declined approximately 14.4% for the nine months ended September 30, 2020 we experienced, and anticipate that we will continue to experience, a material decline in testing volumes due to the COVID-19 pandemic. During the last two weeks of March, inclusive of COVID-19 testing, volumes declined across all metro markets in excess of 40% compared to the prior year period, as there was a significant reduction in physician office visits, the cancellation of selective medical procedures, customers closing or severely curtailing their operations (voluntarily or in response to government orders), and the adoption of work-from-home or shelter-in-place policies. For the three months ended March 31, 2020:period.
Organic revenue decreased approximately 4.2% compared to the prior year period, which was partially offset by the impact of recent acquisitions which contributed approximately 0.4% to DIS revenue.
DIS volume decreased by 2.4%, with organic volume down approximately 2.7%, partially offset by volume associated with recent acquisitions of 0.3%. Organic volume was negatively impacted by a material decline in testing volumes due to the COVID-19 pandemic. We estimate that testing volumes declined for the three months ended March 31, 2020 by approximately 8.2% compared to the prior year period due to the impact of the COVID-19 pandemic (inclusive of COVID-19 testing).
•Revenue per requisition decreasedincreased by 1.2%12.4% compared to the prior year period primarily due to favorable mix, driven in large part by COVID-19 molecular testing; partially offset by reimbursement pressure, including unit price reductions associated with PAMA and all other sources, of approximately 2.1%; partially offset by favorable mix, driven in part by acquisitions.1.8%.
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,September 30, 2020, cost of services increased by $26$316 million compared to the prior year period. The increase was primarily driven by higher compensationvariable expenses related to increased testing volumes as well as test mix and benefit costs, includinga higher costs as there was one more business daysupply cost associated with COVID-19 testing, and higher performance-based compensation.
For the nine months ended September 30, 2020, cost of services increased by $298 million compared to the prior year period, andperiod. The increase was primarily driven by higher supplies expense, partially duevariable expenses related to test mix.
mix and a higher supply cost associated with COVID-19 testing, higher performance-based compensation, and incremental costs incurred related to the COVID-19 pandemic including expense associated with a one-time payment to eligible employees to help offset expenses they incurred as a result of COVID-19. These increases were partially offset by lower compensation and benefit costs as a result of a series of temporary actions implemented to manage our workforce costs.
Selling, General and Administrative Expenses ("SG&A")
SG&A consist principally of the costs associated with our sales and marketing efforts, billing operations, credit loss expense and general management and administrative support as well as administrative facility costs.
SG&A decreasedincreased by $37$34 million for the three months ended March 31,September 30, 2020, compared to the prior year period, primarily driven by a decreasehigher performance-based compensation costs, and higher costs associated with changes in the value of our deferred compensation obligations, andpartially offset by lower travel related costs.
SG&A decreased by $5 million for the nine months ended September 30, 2020, compared to the prior year period primarily driven by lower compensation and benefit costs as a result of a series of temporary actions implemented to manage our workforce costs, lower travel related costs, lower costs associated with our Invigorate program, and lower costs associated with changes in the value of our deferred compensation obligations, partially offset by higher performance-based compensation costs.
The decreasechange in the value of our deferred compensation obligations is largely offset by gains or losses due to the decreasechanges 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 in our 2019 Annual Report on Form 10-K.
Amortization Expense
AmortizationFor the three and nine months ended September 30, 2020, amortization expense increased by $1$4 million for the three months ended March 31, 2020,and $5 million, respectively, compared to the prior year periodperiods as a result of recent acquisitions.
Other Operating Expense (Income), Net
Other operating expense (income), net includes miscellaneous income and expense items and other charges related to operating activities.
For the three monthsended March 31,September 30, 2020, other operating expense (income), net primarily represents the reversal of $65 million of income that was previously recognized during the three months ended June 30, 2020 relating to the receipt of funds that were appropriated to healthcare providers under the CARES Act (see Note 11 to the interim unaudited consolidated financial statements).
For the nine months certain costs incurred as a resultended September 30, 2020, other operating expense (income), net primarily represents impairment charges due to the impact of the COVID-1COVID-19 pandemic.
9 pandemicFor the three months ended September 30, 2019, other operating expense (income), net primarily represents a gain associated with the decrease in the fair value of a contingent consideration accrual associated with a previous acquisition.
For the nine months ended September 30, 2019, other operating expense (income), net includes a $12 million gain associated with an insurance claim for hurricane related losses and resulting impact ona $12 million gain associated with the economy including certaindecrease in the fair value of the contingent consideration accruals associated with previous acquisitions, partially offset by non-cash asset impairment charges.charges of $2 million.
Interest Expense, Net
Interest expense, net decreased for both the three and nine months ended March 31,September 30, 2020 compared to the prior year period,periods, primarily driven by lower interest rates associated with our variable rate indebtedness, partially offset by higher average outstanding indebtedness.
Other Income, Net
Other (Expense) 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.
Other expense, net for For the three and nine months ended March 31,September 30, 2020, other income, net increased by $25$76 million and $61 million, respectively, compared to the prior year periodperiods. For the three months ended September 30, 2020, the increase was primarily due to lossesa $70 million gain recognized as a result of the remeasurement of our previously held equity interest in MACL to fair value (see Note 5 to the interim unaudited consolidated financial statements) and higher gains associated with investments in our deferred compensation plans.plans compared to the prior year period. For the nine months ended September 30, 2020, the increase was primarily due to a $70 million gain recognized as a result of the remeasurement of our previously held equity interest in MACL to fair value (see Note 5 to the interim unaudited consolidated financial statements), partially offset by lower gains associated with investments in our deferred compensation plans compared to the prior year period.
Income Tax Expense
Income tax expense for the three months ended March 31,September 30, 2020 and 2019 was $26$177 million and $50$62 million, respectively. Income tax expense for the nine months ended September 30, 2020 and 2019 was $269 million and $175 million, respectively. The decreaseincrease in income tax expense for both the three and nine months ended March 31,September 30, 2020 compared to the prior year period was primarily driven by a decreasean increase in income from continuing operations before income taxes and equity in earnings of equity method investees. During
For the three months ended March 31,September 30, 2020 and 2019, wethe effective income tax rate was 23.7% and 22.9%, respectively. The effective income tax rate for the three months ended September 30, 2020, benefited from a lower effective income tax rate associated with a $70 million gain recognized $8 millionas a result of the remeasurement of our previously held equity interest in MACL to fair value; and $3 million respectively,of excess tax benefits associated with stock-based compensation arrangements. The effective income tax rate for the three months ended September 30, 2019 benefited from a $6 million income tax benefit due to the release of a valuation allowance associated with net operating loss carryforwards; and $3 million of excess tax benefits associated with stock-based compensation arrangements.
For the threenine months ended March 31,September 30, 2020 and 2019, the effective income tax rate was 23.9% and 23.4%, respectively. The effective income tax rate for the nine months ended September 30, 2020, benefited from a lower effective income tax rate associated with a $70 million gain recognized as a result of the remeasurement of our previously held equity interest in MACL to fair value; and $15 million of excess tax benefits associated with stock-based compensation arrangements. The effective income tax rate for the nine months ended September 30, 2019 benefited from $11 million of excess tax benefits associated with stock-based compensation arrangements; and a $10 million income tax benefit due to the release of valuation allowances associated with net operating loss carryforwards.
The effective income tax rate associated with the $70 million gain recognized as a result of the remeasurement of our previously held equity interest in MACL to fair value was 11.8% due to a permanent difference in the financial reporting and tax basis of goodwill.
For both the three and nine months ended September 30, 2020, we utilized the most likely estimate of our annual income before taxes to determine the annual effective income tax rate for 2020. As a result of uncertainty associated with the impact of the COVID-19 pandemic, it is possible that we will experience variability in the annual projections and, as a result, the annual effective income tax rate. We will update the annual effective tax rate each quarter during 2020 for changes in the latest projections for the Company.
Equity in Earnings of Equity Method Investees, Net of Taxes
Equity in earnings of equity method investees, net of taxes increaseddecreased for the three and nine months ended March 31,September 30, 2020 by $1$3 million and $15 million, respectively, compared to the prior year periodperiods primarily due to the impact of the COVID-19 pandemic on our equity method investees.
Discontinued Operations
During the third quarter of 2006, we completed the wind down of Nichols Institute Diagnostics ("NID"), a test kit manufacturing subsidiary, which has been classified as discontinued operations for the nine months ended September 30, 2019. Income from discontinued operations, net of taxes, for the nine months ended September 30, 2019 includes discrete tax benefits of $20 million associated with our investment in the Q2 Solutions joint venture.favorable resolution of certain tax contingencies related to NID.
Quantitative and Qualitative Disclosures About Market Risk
We address our exposure to market risks, principally the risk of changes in interest rates, through a controlled program of risk management that includes the use of derivative financial instruments. We do not hold or issue derivative financial instruments for speculative purposes. We seek to mitigate the variability in cash outflows that result from changes in interest rates by maintaining a balanced mix of fixed-rate and variable-rate debt obligations. In order to achieve this objective, we have historically entered into interest rate swaps. Interest rate swaps involve the periodic exchange of payments without the exchange of underlying principal or notional amounts. Net settlements are recognized as an adjustment to interest expense. We believe that our exposures to foreign exchange impacts and changes in commodity prices are not material to our consolidated results of operations or financial position.
As of March 31,September 30, 2020 and December 31, 2019, the fair value of our debt was estimated at approximately $4.3$5.2 billion and $5.1 billion, respectively, principally using quoted prices in active markets and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. As of March 31,September 30, 2020 and December 31, 2019, the estimated fair value exceeded the carrying value of the debt by $219$609 million and $313 million, respectively. A hypothetical 10% increase in interest rates (representing 3217 basis points as of March 31,September 30, 2020 and 28 basis points as of December 31, 2019) would potentially reduce the estimated fair value of our debt by approximately $101$84 million and $100 million as of March 31,September 30, 2020 and December 31, 2019, respectively.
Borrowings under our secured receivables credit facility and our senior unsecured revolving credit facility are subject to variable interest rates. Interest on our secured receivables credit facility is based on either a rate that is intended to approximate commercial paper rates for highly rated issuers, or LIBOR, plus a spread. As of March 31,September 30, 2020,, interest on our senior unsecured revolving credit facility is subject to a pricing schedule that can fluctuate based on changes in our credit ratings.ratings and our leverage ratio. As such, our borrowing cost under this credit arrangement will be subject to both fluctuations in interest rates, our leverage ratio and changes in our credit ratings. As of March 31,September 30, 2020, the borrowing rates under these debt instruments were: for our secured receivables credit facility, commercial paper rates for highly rated issuers, or LIBOR, plus a spread of 0.70% to 0.725%; and for our senior unsecured revolving credit facility, LIBOR plus 1.125%. During October 2020, we amended the secured receivables credit facility and the borrowing rates are now based on commercial paper rates for highly rated issuers, or LIBOR, plus a spread of 0.825% to 0.95%. As of March 31,September 30, 2020, there were no borrowings outstanding under either our $600 million secured receivables credit facility or our $750 million senior unsecured revolving credit facility. The amendment to the secured receivables credit facility did not change the total borrowing capacity under the facility.
In April 2020, we terminated our existing fixed-to-variable interest rate swap agreements. Including the impact of such termination, basedBased on our remaining net exposure to interest rate changes, a hypothetical 10% change to the variable rate component of our variable rate indebtedness would not materially change annual interest expense.
During the first quarter ofMarch 2020, we entered into a forward-starting interest rate swap agreement with a financial institution for a total notional amount of $25 million. Additionally, during May 2020, we entered into interest rate lock agreements with several financial institutions for a total notional amount of $25 million$275 million. The forward-starting interest rate swap agreement and the interest rate lock agreements were entered into in order to hedge a portion of our interest rate exposure associated with variability in future cash flows attributable to changes in interest rates over a ten-year period related to an anticipated issuance of debt. The new debt will replace senior notes that are maturing during 2021. The aggregate fair valueand were accounted for as cash flow hedges. In connection with the issuance of the forward-starting2031 Senior Notes, these agreements were settled
and we received net proceeds of $1 million. The net gain is deferred in stockholders' equity, net of taxes, as a component of accumulated other comprehensive loss, and is being amortized as an adjustment to interest rate swaps was immaterial as of March 31, 2020. A hypothetical 10% change in the forward three-month LIBOR curve (representing an 8 basis points change in the weighted average yield) would also be immaterial.expense, net over a ten-year period.
For further details regarding our outstanding debt, see NoteNotes 8 and 18 to the interim unaudited consolidated financial statements and Note 13 to the audited consolidated financial statements included in our 2019 Annual Report on Form 10-K. For details regarding our financial instruments and hedging activities, see Note 9 to the interim unaudited consolidated financial statements and Note 15 to the audited consolidated financial statements included in our 2019 Annual Report on Form 10-K.
Risk Associated with Investment Portfolio
Our investment portfolio includes equity investments comprised primarily of strategic equity holdings in privately and publicly held companies. These securities are exposed to price fluctuations and are generally concentrated in the life sciences and healthcare industries. Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) with readily determinable fair values are measured at fair value with changes in fair value recognized in net income. Equity investments that do not have readily determinable fair values are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes; we regularly evaluate these equity investments to determine if there are any indicators that the investment is impaired. The carrying value of our equity investments that do not have readily determinable fair values was $25 million as of March 31,September 30, 2020.
We do not hedge our equity price risk. The impact of an adverse movement in equity prices on our holdings in privately held companies cannot be easily quantified, as our ability to realize returns on investments depends on, among other things, the enterprises’ ability to raise additional capital or derive cash inflows from continuing operations or through liquidity events such as initial public offerings, mergers or private sales.
In conjunction with the preparation of our March 31,September 30, 2020 financial statements, we considered whether the carrying values of such investments were impaired and concluded that no such impairment existed. However, should the impact of the COVID-19 pandemic be worse than currently expected, it is possible that we could incur impairment charges in the future.
Liquidity and Capital Resources | | | Three Months Ended March 31, | | Change | | Nine Months Ended September 30, | | | Change |
| 2020 | | 2019 | | | 2020 | | 2019 | | | Change |
| (dollars in millions) | | | | (dollars in millions) | |
Net cash provided by operating activities | $ | 247 |
| | $ | 275 |
| | $ | (28 | ) | Net cash provided by operating activities | $ | 1,464 | | | $ | 895 | | | $ | 569 | |
Net cash used in investing activities | (206 | ) | | (110 | ) | | (96 | ) | Net cash used in investing activities | (604) | | | (311) | | | (293) | |
Net cash (used in) provided by financing activities | (891 | ) | | 164 |
| | (1,055 | ) | |
Net cash used in financing activities | | Net cash used in financing activities | (447) | | | (285) | | | (162) | |
Net change in cash and cash equivalents and restricted cash | $ | (850 | ) | | $ | 329 |
| | $ | (1,179 | ) | Net change in cash and cash equivalents and restricted cash | $ | 413 | | | $ | 299 | | | $ | 114 | |
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly-liquid short-term investments. Cash and cash equivalents as of March 31,September 30, 2020 totaled $342$1,605 million, compared to $1,192 million as of December 31, 2019.
As of March 31,September 30, 2020, approximately 10%2% of our $342$1,605 million of consolidated cash and cash equivalents were held outside of the United States. As a result of changes introduced by the Tax Cuts and Jobs Act, we may repatriate back to the United States the portion of these foreign funds not expected to be used to maintain or expand operations (including through acquisitions) outside of the United States.
Cash Flows from Operating Activities
Net cash provided by operating activities for the threenine months ended March 31,September 30, 2020 and 2019 was $247$1,464 million and $275$895 million, respectively. The $28$569 million decreaseincrease in net cash provided by operating activities for the threenine months ended March 31,September 30, 2020, compared to the prior year period was primarily a result of:
•higher operating income in 2020 as compared to 2019;
•$138 million of proceeds that we received in 2020 from funds that were appropriated to healthcare providers under the CARES Act (during October 2020 we announced our plan to return such funds);
•timing of movements in our working capital accounts including as a result of the temporary suspension of certain payment requirements for the employer portion of Social Security taxes; and
•$40 million of proceeds received in 2020 from the termination of interest rate swaps; partially offset by
•higher performance-based compensation payments in 2020 compared to 2019; and
•a $20$28 million increaserefund received in interest payments duethe prior year period from the taxing authorities associated with the favorable resolution of certain tax contingencies related to timing; partially offset by
timing of movements in our working capital accounts.a discontinued operation.
Days sales outstanding, a measure of billing and collection efficiency, was 5147 days as of March 31,September 30, 2020, 54 days as of December 31, 2019 and 5152 days as of March 31,September 30, 2019. The decrease in DSO is partially due to recent fluctuations in our monthly revenue due to the impact of the COVID-19 pandemic. Although we believe that our current revenue reserves and allowance for credit losses are appropriate, it is possible that we will experience an adverse impact on cash collections as a result of the impact of the COVID-19 pandemic.
Cash Flows from Investing Activities
Net cash used in investing activities for the threenine months ended March 31,September 30, 2020 and 2019 was $206$604 million and $110$311 million, respectively. This $96$293 million increase in cash used in investing activities for the threenine months ended March 31,September 30, 2020, compared to the prior year period was primarily a result of:
•a $52$273 million increase in net cash paid for business acquisitions; and
•a $36$28 million increase in capital expenditures.
Cash Flows from Financing Activities
Net cash used in financing activities for the threenine months ended March 31,September 30, 2020 and 2019 was $891$447 million compared to net cash provided by financing activities for the three months ended March 31, 2019 of $164 million.and $285 million, respectively. This $1,055$162 million increase in cash used in financing activities for the threenine months ended March 31,September 30, 2020, compared to the prior year period was primarily a result of:
•$801253 million of net debt repayments (repayments of debt less proceeds from borrowings) in 2020 compared to $337$36 million of net borrowings (proceeds from borrowing less repayments of debt) in 2019; partially offset by
•a $60$78 million decrease in repurchases of our common stock (see "Share Repurchase Program" for further details); and
•a $46 million increase in proceeds from the exercise of stock options, which was a result of an increase in the volume of stock options exercised and the average exercise price compared to the prior year.
During the threenine months ended March 31,September 30, 2020, we completed the issuance of the 2031 Senior Notes. Additionally, during the nine months ended September 30, 2020, we redeemed in full the outstanding indebtedness under our senior notes due January 2020 and senior notes due March 2020 using proceeds from the issuance, in December 2019, of the 2.95% senior notes due June 2030, along with cash on hand. During the threenine months ended March 31,September 30, 2020, there were no borrowings or repaymentswe borrowed $100 million under our secured receivables credit facility orand $100 million under our senior unsecured revolving credit facility.facility, both of which were repaid prior to September 30, 2020.
During the threenine months ended March 31,September 30, 2019, we completed the issuance of the senior notes due June 2029.2029 and repaid in full our $300 million senior notes due April 1, 2019 at maturity. In addition, there were $640$985 million in cumulative borrowings under the secured receivables credit facility primarily associated with working capital requirements as well as the funding of our 2019 acquisition. During the three months ended March 31, 2019, there were $800acquisition and $1,145 million in repayments under our secured receivables credit facility. During the threenine months ended March 31,September 30, 2019, there were no borrowings under our senior unsecured revolving credit facility.
Dividend Program
During each of the first quarterthree quarters of 2020, our Board of Directors declared a quarterly cash dividend of $0.56 per common share. During each of the four quarters of 2019, our Board of Directors declared a quarterly cash dividend of $0.53 per common share.
Share Repurchase Program
As of March 31,September 30, 2020, $1.2 billion remained available under our share repurchase authorizations; however, in April 2020, we have temporarily suspended additional share repurchases under the existing authorization through the end of 2020.authorization. The share repurchase authorization has no set expiration or termination date.
Share Repurchases
For the threenine months ended March 31,September 30, 2020, we repurchased 0.7 million shares of our common stock for $75 million.
For the threenine months ended March 31,September 30, 2019, we repurchased 0.61.6 million shares of our common stock for $50$150 million.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations as of September 30, 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Payments due by period | | | | | | | | |
Contractual Obligations | | Total | | Remainder of 2020 | | 1-3 years | | 4-5 years | | After 5 years |
| | (dollars in millions) | | | | | | | | |
Outstanding debt | | $ | 4,526 | | | $ | — | | | $ | 551 | | | $ | 300 | | | $ | 3,675 | |
Finance lease obligations | | 31 | | | 1 | | | 5 | | | 4 | | | 21 | |
Interest payments on outstanding debt | | 1,716 | | | 60 | | | 321 | | | 301 | | | 1,034 | |
Operating leases | | 748 | | | 41 | | | 335 | | | 215 | | | 157 | |
Purchase obligations | | 1,677 | | | 86 | | | 625 | | | 494 | | | 472 | |
| | | | | | | | | | |
Total contractual obligations | | $ | 8,698 | | | $ | 188 | | | $ | 1,837 | | | $ | 1,314 | | | $ | 5,359 | |
March 31, 2020:
|
| | | | | | | | | | | | | | | | | | | | |
| | Payments due by period |
Contractual Obligations | | Total | | Remainder of 2020 | | 1-3 years | | 4-5 years | | After 5 years |
| | (dollars in millions) |
Outstanding debt | | $ | 3,976 |
| | $ | — |
| | $ | 550 |
| | $ | 300 |
| | $ | 3,126 |
|
Finance lease obligations | | 32 |
| | 2 |
| | 5 |
| | 3 |
| | 22 |
|
Interest payments on outstanding debt | | 1,650 |
| | 138 |
| | 298 |
| | 277 |
| | 937 |
|
Operating leases | | 747 |
| | 164 |
| | 290 |
| | 172 |
| | 121 |
|
Purchase obligations | | 1,860 |
| | 267 |
| | 624 |
| | 491 |
| | 478 |
|
Merger consideration obligations | | 7 |
| | 7 |
| | — |
| | — |
| | — |
|
Total contractual obligations | | $ | 8,272 |
| | $ | 578 |
| | $ | 1,767 |
| | $ | 1,243 |
| | $ | 4,684 |
|
A description of the terms of our indebtedness and related debt service requirements and future payments of our outstanding debt is contained in Note 8 to the interim unaudited consolidated financial statements and Note 13 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Interest payments on our outstanding debt includesinclude interest associated with finance lease obligations and hashave been calculated after giving effect to our interest rate swap agreements, using the interest rates as of March 31,September 30, 2020 applied to the March 31,September 30, 2020 balances, which are assumed to remain outstanding through their maturity dates.
Operating lease obligations include variable charges (primarily maintenance fees and utilities associated with our real estate leases) in effect as of March 31,September 30, 2020. A discussion and analysis regarding our operating lease obligations is contained in Note 14 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Purchase obligations include our noncancelable commitments to purchase products or services as described in Note 18 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Merger consideration obligations include consideration owed on our business acquisitions. For details regarding our acquisitions, see Note 5 to the interim unaudited consolidated financial statements and Note 6 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
As of March 31,September 30, 2020, our total liabilities associated with unrecognized tax benefits were approximately $88$79 million, which were excluded from the table above. We expect that these liabilities may decrease by less than $10 million within the next twelve months, primarily as a result of payments, settlements, expiration of statutes of limitations and/or the conclusion of tax examinations on certain tax positions. For the remainder, we cannot make reasonably reliable estimates of the timing of the future payments of these liabilities. See Note 8 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K for information regarding our contingent tax liability reserves.
In connection with the sale of an 18.9% noncontrolling interest in a subsidiary to UMass Memorial Medical Center ("UMass"), we granted UMass the right to require us to purchase all of its interest in the subsidiary at fair value commencing July 1, 2020. As of March 31,September 30, 2020, the fair value of the redeemable noncontrolling interest on the interim unaudited consolidated balance sheet was $76$80 million, which was excluded from the table above. Since the redemption of the noncontrolling interest is outside of our control, we cannot make a reasonably reliable estimate of the timing of the future payment, if any, of the redeemable noncontrolling interest. For further details regarding the redeemable noncontrolling interest, see Note 10 to the interim unaudited consolidated financial statements and Note 16 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Equity Method Investees
Our equity method investees primarily consist of our clinical trials central laboratory services joint venture and our diagnostic information services joint ventures,venture, which are accounted for under the equity method of accounting. Our investment in equity method investees is less than 5% of our consolidated total assets. Our proportionate share of income before income taxes associated with our equity method investees is approximately 10%less than 5% of our consolidated income from continuing operations before income taxes and equity in earnings of equity method investees. We partially guarantee a lease obligation of one of our equity method investees, payment under such guarantee is not likely at this time and we have no other material unconditional obligations or guarantees to, or in support of, our equity method investees and their operations.
In conjunction with the preparation of our March 31,September 30, 2020 financial statements, we considered whether the carrying values of our equity method investments were impaired and concluded that no such impairment existed. However, should the impact of the COVID-19 pandemic be worse than currently expected, it is possible that we could incur impairment charges in the future.
For further details regarding related party transactions with our equity method investees, see Note 14 to the interim unaudited consolidated financial statements and Note 20 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Requirements and Capital Resources
During 2020, We estimate that we will makeinvest approximately $400 million during 2020 for capital expenditures, to support and grow our existing operations, principally related to investments in information technology, laboratory equipment and facilities, including our new multi-year laboratory construction in New Jersey, and additional investments in our advanced and consumer growth strategies. The extent
Together with the Quest Diagnostics Foundation, we launched a multi-year initiative to reduce health disparities in underserved communities, including those impacted by the COVID-19 pandemic. As part of such investments is subjectthis initiative, we plan to future consideration in lightdonate testing services and fund a range of initiatives estimated to total more than $100 million aimed at improving access to testing and awareness of the impactvalue of diagnostic insights in managing overall health.
In April 2020 and August 2020, we received approximately $65 million and $73 million, respectively, of funds from the government that were distributed to healthcare providers for related expenses or lost revenues that are attributable to the COVID-19 pandemic.pandemic under the CARES Act. During October 2020, we announced our plan to return the entire $138 million of funds received.
As of March 31,September 30, 2020, we had cash and cash equivalents on hand of $342 million and had $1.3 billion of borrowing capacity available under our existing credit facilities, including $529 million available under our secured receivables credit facility and $750 million available under our senior unsecured revolving credit facility. There were no outstanding borrowings under these credit facilities as of March 31,September 30, 2020. In April 2020, we borrowed $100 million under the secured receivables credit facility and $100 million under the senior unsecured revolving credit facility (see Note 17 to the interim unaudited consolidated financial statements). The secured receivables credit facility includes a $250 million loan commitment which matures in October 2020,2021, and a $250 million loan commitment and a $100 million letter of credit facility which mature in October 2021.2022. The senior unsecured revolving credit facility matures in March 2023. For further details regarding the credit facilities, see Note 13 to the audited consolidated financial statements in our 2019 Annual Report on Form 10-K and NoteNotes 8 and 18 to the interim unaudited consolidated financial statements.
Our secured receivables credit facility is subject to customary affirmative and negative covenants, and certain financial covenants with respect to the receivables that comprise the borrowing base and secure the borrowings under the facility. Our senior unsecured revolving credit facility is also subject to certain financial covenants and limitations on indebtedness. As of March 31, 2020, the senior unsecured revolving credit facility agreement required us to maintain a leverage ratio (as of the last day of each fiscal quarter) of no more than 3.5 times EBITDA, as defined in the agreement. As of March 31,September 30, 2020, we were in compliance with all such applicable financial covenants.
Historically, we have funded seasonal and other working capital requirements, capital expenditures, debt service requirements and other obligations, cash dividends on common shares, share repurchases and additional growth opportunities, including acquisitions, through existing cash and cash equivalents and cash flows from operations, together with our borrowing capacity under our credit facilities. We believe that the COVID-19 pandemic has had and will likelymay continue to have an adverse impact our consolidated results of operations, financial position, and cash flows, including material declines in testing volumes for our base business (which excludes COVID-19 molecular and antibody testing), the extent of which will continue to be primarily driven by: the severity and duration of the COVID-19 pandemic; the COVID-19 pandemic’s impact on the U.S. healthcare system and the U.S. economy; and the timing, scope and effectiveness of federal, state and local governmental responses to the COVID-19 pandemic, including the continuation of social distancing protocols, shelter-in-place protocols, work-from-home mandates and business shutdowns.pandemic. It is also possible that we will experience an adverse impact on cash collections of our accounts receivable as a result of the impact of the COVID-19 pandemic.
We are takingtook certain actions to preserve liquidity, includingliquidity. We temporarily suspendingsuspended share repurchases under our existing share repurchase authorization, and, implementingin April 2020, implemented a series of temporary actions to manage our workforce costscosts.
including: salary reductions; suspension of certain benefits; reduced hours for employees whose work has significantly declined; and approved furloughs for employees with diminished work requirements who expressed an interest. In addition to the $65 million received in April 2020 under the CARES act, we terminated our existing fixed-to-variable interest rate swap agreements, receiving proceeds of $40 million (see Note 17 to the interim unaudited consolidated financial statements).
In addition, we are takingtook certain steps to ensure adequate access to liquidity. OnIn April 30, 2020, we entered into an amendment to our senior unsecured revolving credit facility in order to provide for increased flexibility under the leverage ratio covenant.flexibility. Pursuant to the amendment, the leverage ratio covenant was increased from the second quarter of 2020 through the second quarter of 2021 as follows:
| | | | | | | | |
As of: | | Applicable Covenant: |
| | |
As of: | | Applicable Covenant: |
June 30, 2020 | | no more than 5 times EBITDA |
September 30, 2020 | | no more than 5.5 times EBITDA |
December 31, 2020 | | no more than 6.5 times EBITDA |
March 31, 2021 | | no more than 6.25 times EBITDA |
June 30, 2021 | | no more than 4.5 times EBITDA |
After the second quarter44
Thereafter, the leverage ratio covenant reverts to no more than 3.5 times EBITDA. During the period that the increased covenant applies, which period may be terminated early by us provided that we are in compliance with the historical 3.5 times EBITDA leverage ratio, the amended credit agreement contains certain additional limitations and restrictions including, but not limited to, regarding repurchases of our common stock, the amount of funds that can be used on business acquisitions, the incurrence of secured indebtedness and under certain circumstances, the payment of dividends. Interest on the amended senior unsecured revolving credit facility is subject to a pricing schedule that can fluctuate based on changes in our credit ratings and current EBITDA leverage ratio.
In addition, in May 2020, we completed a senior notes offering, consisting of $550 million aggregate principal amount of 2.80% senior notes due June 2031, which were issued at an original issue discount of $1 million. In October 2020, we issued a redemption notice to the holders of our $550 million aggregate principal amount of 4.70% senior notes due April 2021, to redeem such notes in November 2020. We intend to use the net proceeds from the 2031 Senior Notes, along with cash on hand, to satisfy the redemption.
We believe that our cash and cash equivalents and cash from operations, together with our borrowing capacity under our credit facilities, will provide sufficient financial flexibility to fund seasonal and other working capital requirements, capital expenditures, debt service requirements and other obligations, cash dividends on common shares, and additional growth opportunities for the foreseeable future. However, should it become necessary, we believe that our credit profile should provide us with access to additional financing if such financing becomes necessary, in order to fund normal business operations, make interest payments, fund growth opportunities and satisfy upcoming debt maturities.
Forward-Looking Statements
Some statements and disclosures in this document are forward-looking statements. Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan” or “continue.” These forward-looking statements are based on our current plans and expectations and are subject to a number of risks and uncertainties that could cause our plans and expectations, including actual results, to differ materially from the forward-looking statements. Risks and uncertainties that may affect our future results include, but are not limited to, impacts of the COVID-19 pandemic and measures we have taken in response, adverse results from pending or future government investigations, lawsuits or private actions, the competitive environment, the complexity of billing, reimbursement and revenue recognition for clinical laboratory testing, changes in government regulations, changing relationships with customers, payers, suppliers and strategic partners and other factors discussed in our most recently filed Annual Report on Form 10-K and subsequently filed Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, including those discussed in the “Business,” “Risk Factors,” “Cautionary Factors that May Affect Future Results” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of those reports.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 4. Controls and Procedures
Management, including our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
During the firstthird quarter of 2020, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note 12 to the interim unaudited consolidated financial statements for information regarding the status of legal proceedings involving the Company.
Item 1A. Risk Factors
The COVID-19 pandemic has significantly and adversely affected our consolidated results of operations, financial position and cash flows, and may continue to do so depending on the severity and duration of the COVID-19 pandemic, the pandemic’s impact on the U.S. healthcare system and the timing, scope and effectiveness of federal, state and local governmental responses to the COVID-19 pandemic.
A pandemic caused by a novel strain of coronavirus (“COVID-19”) continues to spread and severely impact the economy of the United States and other countries around the world. Federal, state and local governmental authorities in the United States have implemented numerous policies and initiatives to try and reduce the transmission of COVID-19, such as travel bans and restrictions, quarantines, shelter-in-place orders, and business shutdowns. These policies and initiatives have resulted in, among other things, a significant reduction in physician office visits, the cancelation of elective medical procedures, customers closing or severely curtailing their operations (voluntarily or in response to government orders), and the adoption of work-from-home policies, all of which have had, and we believe will continue to have, an impact on the Company’s consolidated results of operations, financial position and cash flows.
In March 2020, the Company experienced, and anticipates it will continue to experience, a material decline in testing volumes due to the COVID-19 pandemic. For example, in April, volume declines were in the range of 50% to 60% compared to the prior year period. It is possible that the Company will experience an adverse impact on cash collections as a result of the impact of the COVID-19 pandemic. It also is possible that, as a result of the COVID-19 pandemic, we may experience supply chain disruptions, including shortages, delays and price increases in testing equipment and supplies.
The Company believes the COVID-19 pandemic’s adverse impact on its consolidated results Item 1A. of operations, financial position and cash flows will be primarily driven by: the severity and duration of the COVID-19 pandemic; the COVID-19 pandemic’s impact on the U.S. healthcare system and the U.S. economy; and the timing, scope and effectiveness of federal, state and local governmental responses to the COVID-19 pandemic. These primary drivers are beyond the Company’s knowledge and control, and as a result, at this time the Company cannot reasonably estimate the adverse impact the COVID-19 pandemic will have on its businesses, consolidated results of operations, financial position and cash flows, but the adverse impact is likely to be material. Even after the COVID-19 pandemic has moderated and the business and social distancing restrictions have eased, we may continue to experience similar adverse effects to our businesses, consolidated results of operations, financial position and cash flows resulting from a recessionary economic environment that may persist. The impact that the COVID-19 pandemic will have on our businesses, consolidated results of operations, financial position and cash flows could exacerbate the risks identified in “Item 1A. Risk Factors” in our Annual Report on Form 10-K.
Our outstanding debt may impair our financial10-K for the year ended December 31, 2019 and operating flexibility and a failure to satisfy the covenants under any of the agreements governing our outstanding debt could limit the availability of borrowings or result in an event of default under such agreements.
As of March 31, 2020, we had approximately $4 billion of debt outstanding. . Our debt agreements contain various restrictive covenants. These restrictions could limit our ability to use operating cash flow in other areasPart II, Item 1A. of our business because we must useQuarterly Report on Form 10-Q for the quarter ended June 30, 2020 include a portiondiscussion of these funds to make principal and interest payments on our debt. Our ability to comply with the restrictive covenantsrisk factors. There have been no material changes in the debt agreements and other instruments governing our indebtedness, including the leverage ratio covenant will depend upon our future performance and various otherrisk factors including but not limited to the impact on our business, consolidated results of operations, financial condition and cash flows associated with the COVID-19 pandemic, any prolonged recessionary economic environment that may develop and competitive and regulatory factors, many of which are beyond our control. We may not be able to maintain compliance with all of these covenants. In that event, we may not be able to access the borrowing availability under our credit facilities and we may need to seek an amendment to our debt agreements or would need to refinance our indebtedness, as we diddescribed in April 2020, see “Item 2-Management’s Discussion and Analysis Results of Financial Condition and Results of Operations-Liquidity and Capital Resources-Requirements and Capital Resources.” There can be no assurance that we can obtain future amendments or waivers of our debt agreements and instruments, or refinance our debt, and, even if we were able to obtain an amendment in the future, such relief may only last for a limited period. Any noncompliance by us with the covenants under our debt agreements and instruments could result in an event of default under those debt agreements and instruments, whichreports.
may allow the lenders to accelerate payment of the related debt and may result in the acceleration of other debt to which a cross-acceleration or cross-default provision applies. In the event our creditors accelerate the repayment of our indebtedness, we cannot assure you that we would have sufficient assets to make such repayment.
We have obtained ratings on our public debt from Standard and Poor's, Moody's Investor Services and Fitch Ratings. There can be no assurance that any rating so assigned will remain for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if in that rating agency's judgment future circumstances relating to the basis of the rating, such as adverse changes in our Company or our industry, so warrant. If such ratings are lowered, our borrowing costs could increase. Changes in our credit ratings, however, do not require repayment or acceleration of any of our debt.
We or our subsidiaries may incur additional indebtedness in the future. Our ability to make principal and interest payments will depend on our ability to generate cash in the future. If we incur additional debt, a greater portion of our cash flows may be needed to satisfy our debt service obligations and if we do not generate sufficient cash to meet our debt service requirements, we may need to seek additional financing. In that case, it may be more difficult, or we may be unable, to obtain financing on terms that are acceptable to us. As a result, we would be more vulnerable to general adverse economic, industry and capital markets conditions as well as the other risks associated with indebtedness.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The table below sets forth the information with respect to purchases made by or on behalf of the Company of its common stock during the firstthird quarter of 2020.
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
ISSUER PURCHASES OF EQUITY SECURITIES | | | | | | | | | |
Period | | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands) | |
July 1, 2020 – July 31, 2020 | | | | | | | | | |
Share Repurchase Program (A) | | — | | | $ | — | | | — | | | $ | 1,167,138 | | |
Employee Transactions (B) | | — | | | $ | — | | | N/A | | N/A | |
August 1, 2020 – August 31, 2020 | | | | | | | | | |
Share Repurchase Program (A) | | — | | | $ | — | | | — | | | $ | 1,167,138 | | |
Employee Transactions (B) | | 875 | | | $ | 120.58 | | | N/A | | N/A | |
September 1, 2020 – September 30, 2020 | | | | | | | | | |
Share Repurchase Program (A) | | — | | | $ | — | | | — | | | $ | 1,167,138 | | |
Employee Transactions (B) | | — | | | $ | — | | | N/A | | N/A | |
Total | | | | | | | | | |
Share Repurchase Program (A) | | — | | | $ | — | | | — | | | $ | 1,167,138 | | |
Employee Transactions (B) | | 875 | | | $ | 120.58 | | | N/A | | N/A | |
2020.
(A)Since the share repurchase program’s inception in May 2003, our Board of Directors has authorized $9 billion of share repurchases of our common stock through September 30, 2020. The share repurchase authorization has no set expiration or termination date.
|
| | | | | | | | | | | | | | |
ISSUER PURCHASES OF EQUITY SECURITIES |
Period | | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands) |
January 1, 2020 – January 31, 2020 | | |
| | |
| | |
| | |
|
Share Repurchase Program (A) | | — |
| | $ | — |
| | — |
| | $ | 1,242,138 |
|
Employee Transactions (B) | | 1,671 |
| | $ | 106.51 |
| | N/A |
| | N/A |
|
February 1, 2020 – February 29, 2020 | | | | |
| | |
| | |
|
Share Repurchase Program (A) | | 426,818 |
| | $ | 111.63 |
| | 426,818 |
| | $ | 1,194,491 |
|
Employee Transactions (B) | | 68,575 |
| | $ | 112.82 |
| | N/A |
| | N/A |
|
March 1, 2020 – March 31, 2020 | | | | | | |
| | |
|
Share Repurchase Program (A) | | 262,648 |
| | $ | 104.14 |
| | 262,648 |
| | $ | 1,167,138 |
|
Employee Transactions (B) | | 51,663 |
| | $ | 106.58 |
| | N/A |
| | N/A |
|
Total | | |
| | |
| | |
| | |
|
Share Repurchase Program (A) | | 689,466 |
| | $ | 108.78 |
| | 689,466 |
| | $ | 1,167,138 |
|
Employee Transactions (B) | | 121,909 |
| | $ | 110.09 |
| | N/A |
| | N/A |
|
| |
(A) | Since the share repurchase program’s inception in May 2003, our Board of Directors has authorized $9 billion of share repurchases of our common stock through (B)March 31, 2020. The share repurchase authorization has no set expiration or termination date.
|
| |
(B) | Includes: (1) shares delivered or attested to in satisfaction of the exercise price and/or tax withholding obligations by holders of stock options (granted under the Company’s Amended and Restated Employee Long-Term Incentive Plan) who exercised options; and (2) shares withheld (under the terms of grants under the Amended and Restated Employee Long-Term Incentive Plan) who exercised options; and (2) shares withheld (under the terms of grants under the Amended and Restated Employee Long-Term Incentive |
Plan) to offset tax withholding obligations that occur upon the delivery of outstanding common shares underlying restricted stock units and performance share units.
Item 6.Exhibits
Exhibits:
Exhibits:
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| |
10.131.2 | |
| |
32.1 | |
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32.2 | |
| |
10.1 | |
| |
10.2101.INS | |
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31.1 | |
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31.2 | |
| |
32.1 | |
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32.2 | |
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101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document |
| |
101.SCH | Inline XBRL Taxonomy Extension Schema Document - dgx-20200331.xsddgx-20200930.xsd |
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101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document - dgx-20200331_cal.xmldgx-20200930_cal.xml |
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101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document - dgx-20200331_def.xmldgx-20200930_def.xml |
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101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document - dgx-20200331_lab.xmldgx-20200930_lab.xml |
| |
101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document - dgx-20200331_pre.xmldgx-20200930_pre.xml |
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104 | Cover Page Interactive Data File (formatted in Inline XBRL and contained in Exhibit 101) |
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
May 4,October 23, 2020
Quest Diagnostics Incorporated
|
| | | | |
By | /s/ Stephen H. Rusckowski |
| Stephen H. Rusckowski |
| Chairman, Chief Executive Officer |
| and President |
| |
| |
By | /s/ Mark J. Guinan |
| Mark J. Guinan |
| Executive Vice President and |
| Chief Financial Officer |