filings.toolsCover and table of contents
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Cover and table of contents
| UNITED STATES | ||
| SECURITIES AND EXCHANGE COMMISSION | ||
| WASHINGTON, DC 20549 | ||
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2021
Or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-12215
Quest Diagnostics Incorporated
| Delaware | 16-1387862 | ||||||||||||||||
| (State of Incorporation) | (I.R.S. Employer Identification Number) | ||||||||||||||||
| 500 Plaza Drive | |||||||||||||||||
| Secaucus, | NJ | 07094 | |||||||||||||||
| (973) | 520-2700 |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common Stock, $0.01 Par Value | DGX | New York Stock Exchange |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||
| Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 15, 2021, there were outstanding 122,674,771 shares of the registrant’s common stock, $.01 par value.
PART I - FINANCIAL INFORMATION
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
(unaudited)
(in millions, except per share data)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Net revenues | $ | 2,774 | $ | 2,786 | $ | 8,044 | $ | 6,435 | |||||||||||||||
| Operating costs and expenses and other operating income: | |||||||||||||||||||||||
| Cost of services | 1,670 | 1,580 | 4,861 | 4,071 | |||||||||||||||||||
| Selling, general and administrative | 427 | 396 | 1,263 | 1,103 | |||||||||||||||||||
| Amortization of intangible assets | 25 | 27 | 77 | 77 | |||||||||||||||||||
| Other operating expense (income), net | — | 65 | (2) | 8 | |||||||||||||||||||
| Total operating costs and expenses, net | 2,122 | 2,068 | 6,199 | 5,259 | |||||||||||||||||||
| Operating income | 652 | 718 | 1,845 | 1,176 | |||||||||||||||||||
| Other income (expense): | |||||||||||||||||||||||
| Interest expense, net | (38) | (42) | (114) | (124) | |||||||||||||||||||
| Other income, net | 40 | 77 | 366 | 74 | |||||||||||||||||||
| Total non-operating income (expense), net | 2 | 35 | 252 | (50) | |||||||||||||||||||
| Income before income taxes and equity in earnings of equity method investees | 654 | 753 | 2,097 | 1,126 | |||||||||||||||||||
| Income tax expense | (153) | (177) | (483) | (269) | |||||||||||||||||||
| Equity in earnings of equity method investees, net of taxes | 26 | 15 | 53 | 33 | |||||||||||||||||||
| Net income | 527 | 591 | 1,667 | 890 | |||||||||||||||||||
| Less: Net income attributable to noncontrolling interests | 22 | 23 | 62 | 38 | |||||||||||||||||||
| Net income attributable to Quest Diagnostics | $ | 505 | $ | 568 | $ | 1,605 | $ | 852 | |||||||||||||||
| Earnings per share attributable to Quest Diagnostics’ common stockholders: | |||||||||||||||||||||||
| Basic | $ | 4.11 | $ | 4.20 | $ | 12.63 | $ | 6.33 | |||||||||||||||
| Diluted | $ | 4.02 | $ | 4.14 | $ | 12.41 | $ | 6.25 | |||||||||||||||
| Weighted average common shares outstanding: | |||||||||||||||||||||||
| Basic | 123 | 135 | 127 | 134 | |||||||||||||||||||
| Diluted | 125 | 137 | 129 | 136 | |||||||||||||||||||
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
(unaudited)
(in millions)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Net income | $ | 527 | $ | 591 | $ | 1,667 | $ | 890 | |||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Foreign currency translation adjustment | (4) | 10 | 14 | (6) | |||||||||||||||||||
| Net change in available-for-sale debt securities, net of taxes | — | — | (7) | — | |||||||||||||||||||
| Net deferred gain on cash flow hedges, net of taxes | 1 | 3 | 1 | 3 | |||||||||||||||||||
| Other comprehensive (loss) income | (3) | 13 | 8 | (3) | |||||||||||||||||||
| Comprehensive income | 524 | 604 | 1,675 | 887 | |||||||||||||||||||
| Less: Comprehensive income attributable to noncontrolling interests | 22 | 23 | 62 | 38 | |||||||||||||||||||
| Comprehensive income attributable to Quest Diagnostics | $ | 502 | $ | 581 | $ | 1,613 | $ | 849 |
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2021 AND DECEMBER 31, 2020
(unaudited)
(in millions, except per share data)
| September 30, 2021 | December 31, 2020 | ||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 987 | $ | 1,158 | |||||||
| Accounts receivable, net of allowance for credit losses of $29 and $28 as of September 30, 2021 and December 31, 2020, respectively | 1,473 | 1,520 | |||||||||
| Inventories | 205 | 223 | |||||||||
| Prepaid expenses and other current assets | 189 | 157 | |||||||||
| Total current assets | 2,854 | 3,058 | |||||||||
| Property, plant and equipment, net | 1,634 | 1,627 | |||||||||
| Operating lease right-of-use assets | 596 | 604 | |||||||||
| Goodwill | 7,057 | 6,873 | |||||||||
| Intangible assets, net | 1,152 | 1,167 | |||||||||
| Investments in equity method investees | 124 | 521 | |||||||||
| Other assets | 155 | 176 | |||||||||
| Total assets | $ | 13,572 | $ | 14,026 | |||||||
| Liabilities and Stockholders’ Equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable and accrued expenses | $ | 1,610 | $ | 1,633 | |||||||
| Current portion of long-term debt | 1 | 2 | |||||||||
| Current portion of long-term operating lease liabilities | 148 | 141 | |||||||||
| Total current liabilities | 1,759 | 1,776 | |||||||||
| Long-term debt | 4,006 | 4,013 | |||||||||
| Long-term operating lease liabilities | 495 | 499 | |||||||||
| Other liabilities | 801 | 847 | |||||||||
| Commitments and contingencies | |||||||||||
| Redeemable noncontrolling interest | 79 | 82 | |||||||||
| Stockholders’ equity: | |||||||||||
| Quest Diagnostics stockholders’ equity: | |||||||||||
| Common stock, par value $0.01 per share; 600 shares authorized as of both September 30, 2021 and December 31, 2020; 162 and 217 shares issued as of September 30, 2021 and December 31, 2020, respectively | 2 | 2 | |||||||||
| Additional paid-in capital | 1,936 | 2,841 | |||||||||
| Retained earnings | 7,333 | 9,303 | |||||||||
| Accumulated other comprehensive loss | (13) | (21) | |||||||||
| Treasury stock, at cost; 39 and 84 shares as of September 30, 2021 and December 31, 2020, respectively | (2,866) | (5,366) | |||||||||
| Total Quest Diagnostics stockholders’ equity | 6,392 | 6,759 | |||||||||
| Noncontrolling interests | 40 | 50 | |||||||||
| Total stockholders’ equity | 6,432 | 6,809 | |||||||||
| Total liabilities and stockholders’ equity | $ | 13,572 | $ | 14,026 |
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
(unaudited)
(in millions)
| Nine Months Ended September 30, | |||||||||||
| 2021 | 2020 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 1,667 | $ | 890 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | 302 | 263 | |||||||||
| Provision for credit losses | 3 | 18 | |||||||||
| Deferred income tax (benefit) provision | (87) | 12 | |||||||||
| Stock-based compensation expense | 60 | 63 | |||||||||
| Gain on disposition of joint venture | (314) | — | |||||||||
| Other, net | (48) | (60) | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Accounts receivable | 45 | (355) | |||||||||
| Accounts payable and accrued expenses | 36 | 514 | |||||||||
| Income taxes payable | 49 | 95 | |||||||||
| Termination of interest rate swap agreements | — | 40 | |||||||||
| Other assets and liabilities, net | 39 | (16) | |||||||||
| Net cash provided by operating activities | 1,752 | 1,464 | |||||||||
| Cash flows from investing activities: | |||||||||||
| Business acquisitions, net of cash acquired | (251) | (329) | |||||||||
| Capital expenditures | (259) | (256) | |||||||||
| Proceeds from disposition of joint venture | 755 | — | |||||||||
| Decrease (increase) in investments and other assets | 3 | (19) | |||||||||
| Net cash provided by (used in) investing activities | 248 | (604) | |||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from borrowings | — | 749 | |||||||||
| Repayments of debt | (2) | (1,002) | |||||||||
| Purchases of treasury stock | (1,910) | (75) | |||||||||
| Exercise of stock options | 108 | 144 | |||||||||
| Employee payroll tax withholdings on stock issued under stock-based compensation plans | (22) | (13) | |||||||||
| Dividends paid | (232) | (222) | |||||||||
| Distributions to noncontrolling interest partners | (75) | (34) | |||||||||
| Other financing activities, net | (38) | 6 | |||||||||
| Net cash used in financing activities | (2,171) | (447) | |||||||||
| Net change in cash and cash equivalents and restricted cash | (171) | 413 | |||||||||
| Cash and cash equivalents and restricted cash, beginning of period | 1,158 | 1,192 | |||||||||
| Cash and cash equivalents and restricted cash, end of period | $ | 987 | $ | 1,605 | |||||||
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
(unaudited)
(in millions)
| For the Three Months Ended September 30, 2021 | Quest Diagnostics Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares of Common Stock Outstanding | Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Compre- hensive Loss | Treasury Stock, at Cost | Non- controlling Interests | Total Stock- holders’ Equity | Redeemable Non-controlling Interest | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, June 30, 2021 | 122 | $ | 2 | $ | 2,555 | $ | 10,246 | $ | (10) | $ | (6,894) | $ | 41 | $ | 5,940 | $ | 78 | |||||||||||||||||||||||||||||||||||||||
| Net income | 505 | 19 | 524 | 3 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of taxes | (3) | (3) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividends declared | (76) | (76) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interest partners | (20) | (20) | (2) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under benefit plans | 2 | 4 | 6 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | 21 | 21 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 1 | 7 | 33 | 40 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Retirement of treasury stock | (649) | (3,342) | 3,991 | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2021 | 123 | $ | 2 | $ | 1,936 | $ | 7,333 | $ | (13) | $ | (2,866) | $ | 40 | $ | 6,432 | $ | 79 | |||||||||||||||||||||||||||||||||||||||
| For the Nine Months Ended September 30, 2021 | Quest Diagnostics Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares of Common Stock Outstanding | Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Compre- hensive Loss | Treasury Stock, at Cost | Non- controlling Interests | Total Stock- holders’ Equity | Redeemable Non-controlling Interest | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2020 | 133 | $ | 2 | $ | 2,841 | $ | 9,303 | $ | (21) | $ | (5,366) | $ | 50 | $ | 6,809 | 76 | $ | 82 | ||||||||||||||||||||||||||||||||||||||
| Net income | 1,605 | 53 | 1,658 | 9 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of taxes | 8 | 8 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividends declared | (233) | (233) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interest partners | (63) | (63) | (12) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under benefit plans | (25) | 42 | 17 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | 60 | 60 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 2 | 19 | 89 | 108 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares to cover employee payroll tax withholdings on stock issued under stock-based compensation plans | (10) | (12) | (22) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Purchases of treasury stock | (12) | (300) | (1,610) | (1,910) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Retirement of treasury stock | (649) | (3,342) | 3,991 | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2021 | 123 | $ | 2 | $ | 1,936 | $ | 7,333 | $ | (13) | $ | (2,866) | $ | 40 | $ | 6,432 | $ | 79 |
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
(unaudited)
(in millions)
| For the Three Months Ended September 30, 2020 | Quest Diagnostics Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares of Common Stock Outstanding | Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Compre- hensive Loss | Treasury Stock, at Cost | Non- controlling Interests | Total Stock- holders’ Equity | Redeemable Non-controlling Interest | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, June 30, 2020 | 134 | $ | 2 | $ | 2,764 | $ | 8,307 | $ | (55) | $ | (5,187) | $ | 50 | $ | 5,881 | $ | 77 | |||||||||||||||||||||||||||||||||||||||
| Net income | 568 | 18 | 586 | 5 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of taxes | 13 | 13 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividends declared | (75) | (75) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interest partners | (22) | (22) | (2) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under benefit plans | 1 | 1 | 3 | 4 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | 32 | 32 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 4 | 23 | 27 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2020 | 135 | $ | 2 | $ | 2,801 | $ | 8,800 | $ | (42) | $ | (5,161) | $ | 46 | $ | 6,446 | $ | 80 | |||||||||||||||||||||||||||||||||||||||
| For the Nine Months Ended September 30, 2020 | Quest Diagnostics Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares of Common Stock Outstanding | Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Compre- hensive Loss | Treasury Stock, at Cost | Non- controlling Interests | Total Stock- holders’ Equity | Redeemable Non-controlling Interest | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2019 | 133 | $ | 2 | $ | 2,722 | $ | 8,174 | $ | (39) | $ | (5,218) | $ | 46 | $ | 5,687 | $ | 76 | |||||||||||||||||||||||||||||||||||||||
| Net income | 852 | 31 | 883 | 7 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of taxes | (3) | (3) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividends declared | (226) | (226) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interest partners | (31) | (31) | (3) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under benefit plans | 1 | 7 | 10 | 17 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | 63 | 63 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 2 | 22 | 122 | 144 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares to cover employee payroll tax withholdings on stock issued under stock-based compensation plans | (13) | (13) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Purchases of treasury stock | (1) | (75) | (75) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2020 | 135 | $ | 2 | $ | 2,801 | $ | 8,800 | $ | (42) | $ | (5,161) | $ | 46 | $ | 6,446 | $ | 80 |
The accompanying notes are an integral part of these statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(in millions, unless otherwise indicated)
1. DESCRIPTION OF BUSINESS
Background
Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or the "Company") empower people to take action to improve health outcomes. The Company uses its 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. The Company's diagnostic information services business ("DIS") provides information and insights based on an industry-leading menu of routine, non-routine and advanced clinical testing and anatomic pathology testing, and other diagnostic information services. The Company provides services to a broad range of customers, including patients, clinicians, hospitals, independent delivery networks ("IDNs"), health plans, employers, accountable care organizations ("ACOs"), and direct contract entities ("DCEs"). The Company offers the broadest access in the United States to diagnostic information services through its nationwide network of laboratories, patient service centers and phlebotomists in physician offices and the Company's connectivity resources, including call centers and mobile paramedics, nurses and other health and wellness professionals. The Company is the world's leading provider of diagnostic information services. The Company provides interpretive consultation with one of the largest medical and scientific staffs in the industry. The Company's Diagnostic Solutions businesses ("DS") are the leading provider of risk assessment services for the life insurance industry and offer healthcare organizations and clinicians robust information technology solutions.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The interim unaudited consolidated financial statements reflect all adjustments which in the opinion of management are necessary for a fair statement of results of operations, comprehensive income, financial condition, cash flows and stockholders' equity for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. These interim unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s 2020 Annual Report on Form 10-K. The year-end balance sheet data was derived from the audited consolidated financial statements as of December 31, 2020 but does not include all the disclosures required by accounting principles generally accepted in the United States (“GAAP”).
The accounting policies of the Company are the same as those set forth in Note 2 to the audited consolidated financial statements contained in the Company’s 2020 Annual Report on Form 10-K.
A novel strain of coronavirus (“COVID-19”) continues to impact the economy of the United States and other countries around the world. The Company's testing volume and revenues have been materially impacted by the COVID-19 pandemic, including periods of decline in testing volume in the Company's base business (which excludes COVID-19 testing) compared to historical 2019 levels and periods of significant demand for COVID-19 testing. As a result, operating results for the three and nine months ended September 30, 2021 may not be indicative of the results that may be expected for the full year.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings Per Share
The Company's unvested restricted stock units that contain non-forfeitable rights to dividends are participating securities and, therefore, are included in the earnings allocation in computing earnings per share using the two-class method. Basic earnings per common share is calculated by dividing net income attributable to Quest Diagnostics, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding. Diluted earnings per
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
common share is calculated by dividing net income attributable to Quest Diagnostics, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the dilutive effect of outstanding stock options and performance share units granted under the Company's Amended and Restated Employee Long-Term Incentive Plan and its Amended and Restated Non-Employee Director Long-Term Incentive Plan, as well as the dilutive effect of accelerated share repurchase agreements ("ASRs"). Earnings allocable to participating securities include the portion of dividends declared as well as the portion of undistributed earnings during the period allocable to participating securities.
New Accounting Standards to be Adopted
In March 2020, the Financial Accounting Standards Board issued a new accounting standard which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform due to the risk of cessation of the London Interbank Offered Rate ("LIBOR"). The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The pronouncement is effective immediately and can be applied through December 31, 2022. The adoption of this standard is not expected to have a material impact on the Company’s consolidated results of operations, financial position or cash flows.
3. EARNINGS PER SHARE
The computation of basic and diluted earnings per common share was as follows (in millions, except per share data):
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Amounts attributable to Quest Diagnostics’ common stockholders: | |||||||||||||||||||||||
| Net income attributable to Quest Diagnostics | $ | 505 | $ | 568 | $ | 1,605 | $ | 852 | |||||||||||||||
| Less: Earnings allocated to participating securities | 2 | 2 | 6 | 3 | |||||||||||||||||||
| Earnings available to Quest Diagnostics’ common stockholders – basic and diluted | $ | 503 | $ | 566 | $ | 1,599 | $ | 849 | |||||||||||||||
| Weighted average common shares outstanding – basic | 123 | 135 | 127 | 134 | |||||||||||||||||||
| Effect of dilutive securities: | |||||||||||||||||||||||
| Stock options and performance share units | 2 | 2 | 2 | 2 | |||||||||||||||||||
| Weighted average common shares outstanding – diluted | 125 | 137 | 129 | 136 | |||||||||||||||||||
| Earnings per share attributable to Quest Diagnostics’ common stockholders: | |||||||||||||||||||||||
| Basic | $ | 4.11 | $ | 4.20 | $ | 12.63 | $ | 6.33 | |||||||||||||||
| Diluted | $ | 4.02 | $ | 4.14 | $ | 12.41 | $ | 6.25 | |||||||||||||||
The following securities were not included in the calculation of diluted earnings per share due to their antidilutive effect:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Stock options and performance share units | — | 1 | — | 1 |
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
In April 2021, the Company entered into ASRs with several financial institutions to repurchase $1.5 billion of the Company's common stock as part of the Company's share repurchase program. See Note 9 for further details. The sum of basic and diluted earnings per share attributable to Quest Diagnostics' common stockholders for the first three quarters of 2021 did not equal the total for the nine months ended September 30, 2021 due to both quarterly fluctuations in the Company's earnings and in the weighted average common shares outstanding throughout the period as a result of the impact of the ASRs.
4. BUSINESS ACQUISITIONS
On June 1, 2021, the Company completed the acquisition of the outreach laboratory services business of Mercy Health, which serves providers and patients in Arkansas, Kansas, Missouri and Oklahoma, in an all-cash transaction for $225 million. Based on the preliminary purchase price allocation, which may be revised as additional information becomes available during the measurement period, the assets acquired primarily consist of $54 million of customer-related intangible assets and $171 million of tax-deductible goodwill. The intangible assets are being amortized over a useful life of 15 years.
The acquisition was accounted for under the acquisition method of accounting. As such, the assets acquired and liabilities assumed were recorded based on their estimated fair values as of the closing date. Supplemental pro forma combined financial information has not been presented as the impact of the acquisition is not material to the Company's consolidated financial statements. The goodwill recorded primarily includes the expected synergies resulting from combining the operations of the acquired entity with those of the Company and the value associated with an assembled workforce and other intangible assets that do not qualify for separate recognition. All of the goodwill acquired in connection with the acquisition has been allocated to the Company's DIS business. For further details regarding business segment information, see Note 12.
For details regarding the Company's 2020 acquisitions, see Note 6 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
5. DISPOSITION
On April 1, 2021, the Company sold its 40% ownership interest in Q2 Solutions® ("Q2 Solutions"), its clinical trials central laboratory services joint venture, to IQVIA Holdings, Inc. ("IQVIA"), its joint venture partner, for $760 million in an all-cash transaction. The sales price is subject to customary post-closing adjustments. Prior to the transaction, the Company accounted for its minority interest as an equity method investment. As a result of the transaction, during the nine months ended September 30, 2021, the Company recorded a $314 million pre-tax gain in other income, net in the consolidated statement of operations based on the difference between the net sales proceeds and the carrying value of the investment, including $20 million of cumulative translation losses which were previously recorded in accumulated other comprehensive loss. During the nine months ended September 30, 2021, the Company also recorded $55 million of income tax expense related to the gain, consisting of $127 million of current income tax expense, partially offset by $72 million of deferred income tax benefit.
Under a multi-year agreement, the Company will remain the strategic preferred laboratory provider for Q2 Solutions' clients, providing a range of lab testing capabilities to augment Q2 Solutions' core offerings and extend its industry leading suite of services.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
6. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table provides a summary of the recognized assets and liabilities that are measured at fair value on a recurring basis:
| Basis of Fair Value Measurements | |||||||||||||||||||||||
| Quoted Prices in Active Markets for Identical Assets/Liabilities | Significant Other Observable Inputs | Significant Unobservable Inputs | |||||||||||||||||||||
| September 30, 2021 | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Deferred compensation trading securities | $ | 75 | $ | 75 | $ | — | $ | — | |||||||||||||||
| Cash surrender value of life insurance policies | 54 | — | 54 | — | |||||||||||||||||||
| Equity investments | 49 | 49 | — | — | |||||||||||||||||||
| Available-for-sale debt securities | 1 | — | — | 1 | |||||||||||||||||||
| Total | $ | 179 | $ | 124 | $ | 54 | $ | 1 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Deferred compensation liabilities | $ | 139 | $ | — | $ | 139 | $ | — | |||||||||||||||
| Redeemable noncontrolling interest | $ | 79 | $ | — | $ | — | $ | 79 |
| Basis of Fair Value Measurements | |||||||||||||||||||||||
| December 31, 2020 | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Deferred compensation trading securities | $ | 67 | $ | 67 | $ | — | $ | — | |||||||||||||||
| Cash surrender value of life insurance policies | 50 | — | 50 | — | |||||||||||||||||||
| Available-for-sale debt securities | 12 | — | — | 12 | |||||||||||||||||||
| Total | $ | 129 | $ | 67 | $ | 50 | $ | 12 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Deferred compensation liabilities | $ | 126 | $ | — | $ | 126 | $ | — | |||||||||||||||
| Redeemable noncontrolling interest | $ | 82 | $ | — | $ | — | $ | 82 |
A detailed description regarding the Company's fair value measurements is contained in Note 7 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
The Company offers certain employees the opportunity to participate in a non-qualified supplemental deferred compensation plan. A participant's deferrals, together with Company matching credits, are invested in a variety of participant-directed investment options that are classified as trading securities. These trading securities are classified within Level 1 of the fair value hierarchy because the changes in the fair value of these securities are measured using quoted prices in active markets based on the market price per unit multiplied by the number of units held, exclusive of any transaction costs. A corresponding adjustment for changes in fair value of the trading securities is also reflected in the changes in fair value of the deferred compensation obligation. The deferred compensation liabilities are classified within Level 2 of the fair value hierarchy because their inputs are derived principally from observable market data by correlation to the trading securities.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
The Company offers certain employees the opportunity to participate in a non-qualified deferred compensation program. A participant's deferrals, together with Company matching credits, are “invested” at the direction of the employee in a hypothetical portfolio of investments which are tracked by an administrator. The Company purchases life insurance policies, with the Company named as beneficiary of the policies, for the purpose of funding the program's liability. Changes in the cash surrender value of the life insurance policies are based upon earnings and changes in the value of the underlying investments. Changes in the fair value of the deferred compensation obligation are derived using quoted prices in active markets based on the market price per unit multiplied by the number of units. The cash surrender value and the deferred compensation obligation are classified within Level 2 of the fair value hierarchy because their inputs are derived principally from observable market data by correlation to the hypothetical investments. Deferrals under the plan currently may only be made by participants who made deferrals under the plan in 2017.
The Company's investment portfolio primarily includes equity investments comprised mostly of strategic holdings in companies 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 in prepaid expenses and other current assets in the Company's consolidated balance sheet. Equity investments that do not have readily determinable fair values (which consist of investments in preferred and common shares of private companies) are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes. During the three months ended September 30, 2021, certain of the Company's equity investments became publicly-traded and, based on the readily determinable fair values, the Company recognized gains of $42 million in other income, net in the Company's consolidated statement of operations. Such equity investments are now classified within Level 1 of the fair value hierarchy because the changes in the fair values of the securities are measured using quoted prices in active markets based on the market price per share multiplied by the number of shares held, exclusive of any transaction costs.
The Company's available-for-sale debt securities are measured at fair value based on estimated future cash flows. These fair value measurements are classified within Level 3 of the fair value hierarchy as the fair value is based on significant inputs that are not observable, including cash flow projections.
In connection with the sale of an 18.9% noncontrolling interest in a subsidiary to UMass Memorial Medical Center ("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. As of September 30, 2021, the redeemable noncontrolling interest was presented at its fair value. The fair value measurement of the redeemable noncontrolling interest is classified within Level 3 of the fair value hierarchy because the fair value is based on a discounted cash flow analysis that takes into account, among other items, the joint venture's expected future cash flows, long term growth rates, and a discount rate commensurate with economic risk.
During the nine months ended September 30, 2021, the Company recorded an $8 million impairment charge, which is included in equity in earnings of equity method investees, net of taxes, in order to adjust to fair value an investment that is accounted for under the equity method of accounting. Following the impairment charge, the carrying value of the investment is not material. The fair value measurement was classified within Level 3 of the fair value hierarchy as it was based on significant inputs that are not observable, including cash flow projections.
The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approximate fair value based on the short maturities of these instruments. As of September 30, 2021 and December 31, 2020, the fair value of the Company’s debt was estimated at $4.5 billion and $4.6 billion, respectively. Principally all of the Company's debt is classified within Level 1 of the fair value hierarchy because the fair value of the debt is estimated based on rates currently offered to the Company with identical terms and maturities, using quoted active market prices and yields, taking into account the underlying terms of the debt instruments.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
7. GOODWILL AND INTANGIBLE ASSETS
The changes in goodwill for the nine months ended September 30, 2021 and for the year ended December 31, 2020 were as follows:
| September 30, 2021 | December 31, 2020 | ||||||||||
| Balance, beginning of period | $ | 6,873 | $ | 6,619 | |||||||
| Goodwill acquired during the period | 188 | 247 | |||||||||
| Adjustments to goodwill | (4) | 7 | |||||||||
| Balance, end of period | $ | 7,057 | $ | 6,873 |
Principally all of the Company’s goodwill as of September 30, 2021 and December 31, 2020 was associated with its DIS business.
For the nine months ended September 30, 2021, goodwill acquired was principally associated with the acquisition of the outreach laboratory services businesses of Mercy Health and adjustments to goodwill primarily related to foreign currency translation. For the year ended December 31, 2020, goodwill acquired was principally associated with the acquisitions of Blueprint Genetics Oy; Memorial Hermann Diagnostic Laboratories, the outreach laboratory division of Memorial Hermann Health System; and the remaining 56% interest in Mid America Clinical Laboratories, LLC (see Note 6 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K). For the year ended December 31, 2020, adjustments to goodwill primarily related to foreign currency translation.
Intangible assets as of September 30, 2021 and December 31, 2020 consisted of the following:
| Weighted Average Amortization Period (in years) | September 30, 2021 | December 31, 2020 | |||||||||||||||||||||||||||||||||||||||
| Cost | Accumulated Amortization | Net | Cost | Accumulated Amortization | Net | ||||||||||||||||||||||||||||||||||||
| Amortizing intangible assets: | |||||||||||||||||||||||||||||||||||||||||
| Customer-related | 17 | $ | 1,541 | $ | (704) | $ | 837 | $ | 1,479 | $ | (638) | $ | 841 | ||||||||||||||||||||||||||||
| Non-compete agreements | 9 | 3 | (2) | 1 | 3 | (2) | 1 | ||||||||||||||||||||||||||||||||||
| Technology | 14 | 142 | (72) | 70 | 141 | (65) | 76 | ||||||||||||||||||||||||||||||||||
| Other | 5 | 108 | (100) | 8 | 108 | (95) | 13 | ||||||||||||||||||||||||||||||||||
| Total | 17 | 1,794 | (878) | 916 | 1,731 | (800) | 931 | ||||||||||||||||||||||||||||||||||
| Intangible assets not subject to amortization: | |||||||||||||||||||||||||||||||||||||||||
| Trade names | 235 | — | 235 | 235 | — | 235 | |||||||||||||||||||||||||||||||||||
| Other | 1 | — | 1 | 1 | — | 1 | |||||||||||||||||||||||||||||||||||
| Total intangible assets | $ | 2,030 | $ | (878) | $ | 1,152 | $ | 1,967 | $ | (800) | $ | 1,167 |
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of September 30, 2021 is as follows:
| Year Ending December 31, | |||||
| Remainder of 2021 | $ | 26 | |||
| 2022 | 102 | ||||
| 2023 | 100 | ||||
| 2024 | 97 | ||||
| 2025 | 96 | ||||
| 2026 | 90 | ||||
| Thereafter | 405 | ||||
| Total | $ | 916 |
8. FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments to manage its exposure to market risks for changes in interest rates and, from time to time, foreign currencies. This strategy includes the use of interest rate swap agreements, forward-starting interest rate swap agreements, interest rate lock agreements and foreign currency forward contracts to manage its exposure to movements in interest and currency rates. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. These policies prohibit holding or issuing derivative financial instruments for speculative purposes. The Company does not enter into derivative financial instruments that contain credit-risk-related contingent features or requirements to post collateral.
Interest Rate Risk
The Company is exposed to interest rate risk on its cash and cash equivalents and its debt obligations. Interest income earned on cash and cash equivalents may fluctuate as interest rates change; however, due to their relatively short maturities, the Company does not hedge these assets or their investment cash flows and the impact of interest rate risk is not material. The Company's debt obligations consist of fixed-rate and variable-rate debt instruments. The Company's primary objective is to achieve the lowest overall cost of funding while managing the variability in cash outflows within an acceptable range. In order to achieve this objective, the Company has historically entered into interest rate swap agreements.
Interest rate swaps involve the periodic exchange of payments without the exchange of underlying principal or notional amounts. Net settlements between the counterparties are recognized as an adjustment to interest expense, net.
Interest Rate Derivatives – Cash Flow Hedges
From time to time, the Company has entered into various interest rate lock agreements and forward-starting interest rate swap agreements to hedge part of the Company's interest rate exposure associated with the variability in future cash flows attributable to changes in interest rates.
Interest Rate Derivatives – Fair Value Hedges
Historically, the Company has entered into various fixed-to-variable interest rate swap agreements in order to convert a portion of the Company's long-term debt into variable interest rate debt. All such fixed-to-variable interest rate swap agreements have been terminated and proceeds from the terminations have been reflected as basis adjustments to the hedged debt instruments and are being amortized as a reduction of interest expense, net over the remaining terms of such debt instruments.
As of September 30, 2021 and December 31, 2020, the following amounts were recorded on the consolidated balance sheets related to cumulative basis adjustments for fair value hedges included in the carrying amount of long-term debt:
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
| Hedge Accounting Basis Adjustment (a) | |||||||||||||||||||||||||||||
| Balance Sheet Classification | September 30, 2021 | December 31, 2020 | |||||||||||||||||||||||||||
| Long-term debt | $ | 41 | $ | 51 |
(a) As of both September 30, 2021 and December 31, 2020, the entire balance is associated with remaining unamortized hedging adjustments on discontinued relationships.
The following table presents the effect of fair value hedge accounting on the consolidated statements of operations for the three and nine months ended September 30, 2021 and 2020:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||||||||
| Other income, net | Other income, net | Other income, net | Other income, net | ||||||||||||||||||||||||||
| Total for line item in which the effects of fair value hedges are recorded | $ | 40 | $ | 77 | $ | 366 | $ | 74 | |||||||||||||||||||||
| Gain (loss) on fair value hedging relationships: | |||||||||||||||||||||||||||||
| Hedged items (Long-term debt) | $ | — | $ | — | $ | — | $ | (68) | |||||||||||||||||||||
| Derivatives designated as hedging instruments | $ | — | $ | — | $ | — | $ | 68 |
A detailed description regarding the Company's use of derivative financial instruments is contained in Note 15 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
9. STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST
Stockholders' Equity
Changes in Accumulated Other Comprehensive Loss by Component
Comprehensive income (loss) includes:
-
Foreign currency translation adjustments;
-
Net deferred gains (losses) on cash flow hedges, which represent deferred gains (losses), net of tax, on interest rate-related derivative financial instruments designated as cash flow hedges, net of amounts reclassified to interest expense (see Note 8); and
-
Net changes in available-for-sale debt securities, which represent unrealized holding gains (losses), net of tax on available-for-sale debt securities.
For the three and nine months ended September 30, 2021 and 2020, the tax effects related to the deferred gains (losses) on cash flow hedges and net changes in available-for-sale debt securities were not material. Foreign currency translation adjustments related to indefinite investments in non-U.S. subsidiaries are not adjusted for income taxes.
On April 1, 2021, the Company sold its 40% ownership interest in Q2 Solutions, its clinical trials central laboratory services joint venture, to IQVIA, its joint venture partner. As a result of the transaction, during the nine months ended September 30, 2021, $20 million of cumulative translation losses were reclassified from accumulated other comprehensive loss to other income, net. See Note 5 for further details.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Dividend Program
During each of the first three quarters of 2021, the Company's Board of Directors declared a quarterly cash dividend of $0.62 per common share. During each of the four quarters of 2020, the Company's Board of Directors declared a quarterly cash dividend of $0.56 per common share.
Share Repurchase Program
In each of February 2021 and March 2021, the Company's Board of Directors increased the size of its share repurchase program by $1 billion. As of September 30, 2021, $1.3 billion remained available under the Company’s share repurchase authorization. The share repurchase authorization has no set expiration or termination date.
Share Repurchases
For the nine months ended September 30, 2021, the Company repurchased 12.5 million shares of its common stock for a value of $1.6 billion, including 9.1 million shares repurchased under ASRs.
The repurchases under the ASRs were initiated in April 2021 with the Company's entry into ASRs with several financial institutions to repurchase $1.5 billion of the Company's common stock as part of the Company's share repurchase program. Each of the ASRs was structured to permit the Company to purchase shares immediately with the final purchase price of those shares determined by the volume-weighted average price of the Company's common stock during the repurchase period, less a fixed discount and was accounted for as two transactions: (1) a treasury stock repurchase and (2) a forward contract. For the nine months ended September 30, 2021, the Company paid $1.5 billion to the financial institutions and received 9.1 million shares of its common stock, at an initial price of $132.27 per share for a value of $1.2 billion, which represents 80% of the total value of shares to be repurchased under the ASRs. The ASR contracts will settle the remaining shares, based on the volume-weighted average price of the Company's common stock during the repurchase period, less a fixed discount, upon the completion of the ASRs during the fourth quarter of 2021. The Company recorded the transactions as an increase to treasury stock of $1.2 billion and it recorded the remaining $300 million as a decrease to additional paid-in capital in the Company’s consolidated balance sheet. The $300 million recorded in additional paid-in capital will be included in treasury stock upon completion of the ASRs.
For the nine months ended September 30, 2020, the Company repurchased 0.7 million shares of its common stock for $75 million.
Shares Reissued from Treasury Stock
The Company's practice has been to issue shares related to its Employee Stock Purchase Plan ("ESPP") and its stock-based compensation program from shares of its common stock held in treasury or by issuing new shares of its common stock. In January 2021, the Company began to issue shares related to its ESPP and stock-based compensation program solely from common stock held in treasury. For the nine months ended September 30, 2021 and 2020, the Company reissued 1.7 million shares and 2.1 million shares, respectively from treasury stock. For details regarding the Company's stock ownership and compensation plans, see Note 17 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
Treasury Stock Retirement
During the three months ended September 30, 2021, the Company retired 55 million shares of treasury stock. In accordance with the Company's policy, the amount paid to repurchase the shares in excess of par value was allocated between retained earnings and additional paid-in capital based on a pro-rata allocation of additional paid-in capital at the time of the share retirement.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
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. As of September 30, 2021 and December 31, 2020, 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.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
10. SUPPLEMENTAL CASH FLOW AND OTHER DATA
Supplemental cash flow and other data for the three and nine months ended September 30, 2021 and 2020 was as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Depreciation expense | $ | 76 | $ | 62 | $ | 225 | $ | 186 | |||||||||||||||
| Amortization expense | 25 | 27 | 77 | 77 | |||||||||||||||||||
| Depreciation and amortization expense | $ | 101 | $ | 89 | $ | 302 | $ | 263 | |||||||||||||||
| Interest expense | $ | (38) | $ | (42) | $ | (114) | $ | (126) | |||||||||||||||
| Interest income | — | — | — | 2 | |||||||||||||||||||
| Interest expense, net | $ | (38) | $ | (42) | $ | (114) | $ | (124) | |||||||||||||||
| Interest paid | $ | 33 | $ | 33 | $ | 111 | $ | 136 | |||||||||||||||
| Income taxes paid | $ | 187 | $ | 148 | $ | 522 | $ | 168 | |||||||||||||||
| Accounts payable associated with capital expenditures | $ | 24 | $ | 55 | $ | 24 | $ | 55 | |||||||||||||||
| Dividends payable | $ | 77 | $ | 76 | $ | 77 | $ | 76 | |||||||||||||||
| Businesses acquired: | |||||||||||||||||||||||
| Fair value of assets acquired | $ | 20 | $ | 126 | $ | 254 | $ | 377 | |||||||||||||||
| Fair value of liabilities assumed | — | (9) | (3) | (29) | |||||||||||||||||||
| Fair value of net assets acquired | 20 | 117 | 251 | 348 | |||||||||||||||||||
| Merger consideration receivable/payable | — | 2 | — | 2 | |||||||||||||||||||
| Cash paid for business acquisitions | 20 | 119 | 251 | 350 | |||||||||||||||||||
| Less: Cash acquired | — | 18 | — | 21 | |||||||||||||||||||
| Business acquisitions, net of cash acquired | $ | 20 | $ | 101 | $ | 251 | $ | 329 | |||||||||||||||
| Leases: | |||||||||||||||||||||||
| Leased assets obtained in exchange for new operating lease liabilities | $ | 46 | $ | 40 | $ | 115 | $ | 119 | |||||||||||||||
In March 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law. 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. The Company accounted for the receipt of the funds under a gain contingency model. Accordingly, the amounts were recognized when the funds were received and the Company determined that it satisfied the associated terms and conditions. During the three months ended June 30, 2020, based on the terms and 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 of 2020. During the three months ended September 30, 2020, the Company reversed the $65 million of funds that had previously been recognized and, during the three months ended December 31, 2020, the Company returned the entire $138 million of funds.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
11. COMMITMENTS AND CONTINGENCIES
Letters of Credit
The Company can issue letters of credit totaling $100 million under its $600 million secured receivables credit facility and $150 million under its $750 million senior unsecured revolving credit facility. See Note 13 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
In support of its risk management program, $70 million in letters of credit under the secured receivables credit facility were outstanding as of September 30, 2021, providing collateral for current and future automobile liability and workers’ compensation loss payments.
Contingent Lease Obligations
The Company remains subject to contingent obligations under certain real estate leases for which no liability has been recorded. For further details, see Note 18 to the audited consolidated financial statements in the Company’s 2020 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 2020, two putative class action lawsuits were 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 October 2020, the court consolidated the two lawsuits under the caption In re: Quest Diagnostics ERISA Litigation and plaintiffs filed a consolidated amended complaint. In May 2021, the court denied the Company's motion to dismiss the complaint.
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. The bankruptcy proceeding has been dismissed.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
Numerous putative class action lawsuits were filed against the Company related to 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. In November 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. In January 2020, the Company moved to dismiss the consolidated complaint; the motion to dismiss is pending.
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.
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.
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 or other practices based on the 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 September 30, 2021, the Company does not believe that material losses related to legal matters are probable.
Reserves for legal matters totaled $6 million and $1 million as of September 30, 2021 and December 31, 2020, respectively.
Reserves for General and Professional Liability Claims
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
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 $153 million and $138 million as of September 30, 2021 and December 31, 2020, respectively. Management believes that established reserves and present insurance coverage are sufficient to cover currently estimated exposures.
12. 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, ACOs and DCEs. The Company is the world's leading provider of diagnostic information services, which includes providing information and insights based on an industry-leading menu of routine, non-routine and advanced clinical testing and anatomic pathology testing, and other diagnostic information services. The DIS business accounted for greater than 95% of net revenues in 2021 and 2020.
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 September 30, 2021, 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.
The following table is a summary of segment information for the three and nine months ended September 30, 2021 and 2020. 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 2020 Annual Report on Form 10-K and Note 2 to the interim unaudited consolidated financial statements.
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, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Net revenues: | |||||||||||||||||||||||
| DIS business | $ | 2,703 | $ | 2,709 | $ | 7,820 | $ | 6,217 | |||||||||||||||
| All other operating segments | 71 | 77 | 224 | 218 | |||||||||||||||||||
| Total net revenues | $ | 2,774 | $ | 2,786 | $ | 8,044 | $ | 6,435 | |||||||||||||||
| Operating earnings (loss): | |||||||||||||||||||||||
| DIS business | $ | 713 | $ | 840 | $ | 2,026 | $ | 1,325 | |||||||||||||||
| All other operating segments | 8 | 16 | 26 | 29 | |||||||||||||||||||
| General corporate activities | (69) | (138) | (207) | (178) | |||||||||||||||||||
| Total operating income | 652 | 718 | 1,845 | 1,176 | |||||||||||||||||||
| Non-operating income (expense), net | 2 | 35 | 252 | (50) | |||||||||||||||||||
| Income before income taxes and equity in earnings of equity method investees | 654 | 753 | 2,097 | 1,126 | |||||||||||||||||||
| Income tax expense | (153) | (177) | (483) | (269) | |||||||||||||||||||
| Equity in earnings of equity method investees, net of taxes | 26 | 15 | 53 | 33 | |||||||||||||||||||
| Net income | 527 | 591 | 1,667 | 890 | |||||||||||||||||||
| Less: Net income attributable to noncontrolling interests | 22 | 23 | 62 | 38 | |||||||||||||||||||
| Net income attributable to Quest Diagnostics | $ | 505 | $ | 568 | $ | 1,605 | $ | 852 |
Net revenues by major service were as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Routine clinical testing services | $ | 1,210 | $ | 1,055 | $ | 3,392 | $ | 2,812 | |||||||||||||||
| COVID-19 testing services | 709 | 965 | 2,048 | 1,571 | |||||||||||||||||||
| Gene-based and esoteric (including advanced diagnostics) testing services | 646 | 556 | 1,972 | 1,491 | |||||||||||||||||||
| Anatomic pathology testing services | 138 | 133 | 408 | 343 | |||||||||||||||||||
| All other | 71 | 77 | 224 | 218 | |||||||||||||||||||
| Total net revenues | $ | 2,774 | $ | 2,786 | $ | 8,044 | $ | 6,435 |
13. REVENUE RECOGNITION
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 September 30, 2021 and 2020 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 in exchange for providing services using the portfolio approach. These estimates include the impact of contractual allowances (including payer denials), and patient 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.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
For further details regarding revenue recognition in the Company's DIS business, see Note 3 to the audited consolidated financial statements in the Company's 2020 Annual Report on Form 10-K.
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 September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||||||||
| Healthcare insurers: | |||||||||||||||||||||||||||||
| Fee-for-service | 41 | % | 33 | % | 39 | % | 33 | % | |||||||||||||||||||||
| Capitated | 2 | 2 | 3 | 3 | |||||||||||||||||||||||||
| Total healthcare insurers | 43 | 35 | 42 | 36 | |||||||||||||||||||||||||
| Government payers | 10 | 10 | 10 | 12 | |||||||||||||||||||||||||
| Client payers | 31 | 40 | 33 | 37 | |||||||||||||||||||||||||
| Patients | 13 | 12 | 12 | 12 | |||||||||||||||||||||||||
| Total DIS | 97 | 97 | 97 | 97 | |||||||||||||||||||||||||
| DS | 3 | 3 | 3 | 3 | |||||||||||||||||||||||||
| Net revenues | 100 | % | 100 | % | 100 | % | 100 | % |
The approximate percentage of net accounts receivable by type of customer was as follows:
| September 30, 2021 | December 31, 2020 | ||||||||||
| Healthcare Insurers | 35 | % | 34 | % | |||||||
| Government Payers | 6 | 6 | |||||||||
| Client Payers | 36 | 46 | |||||||||
| Patients (including coinsurance and deductible responsibilities) | 20 | 11 | |||||||||
| Total DIS | 97 | 97 | |||||||||
| DS | 3 | 3 | |||||||||
| Net accounts receivable | 100 | % | 100 | % |
14. TAXES ON INCOME
For the three months ended September 30, 2021 and 2020, the effective income tax rate was 23.4% and 23.7%, respectively. The effective income tax rate for the three months ended September 30, 2021, benefited from a $6 million income tax benefit associated with changes in reserves for uncertain tax positions, and $6 million of excess tax benefits associated with stock-based compensation. The effective income tax rate for the three months ended September 30, 2020, benefited from a lower effective income tax rate, 11.8%, associated with a $70 million gain recognized as a result of the remeasurement of the Company's previously held equity interest in Mid America Clinical Laboratories, LLC ("MACL") to fair value, and $3 million of excess tax benefits associated with stock-based compensation.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, unless otherwise indicated)
For the nine months ended September 30, 2021 and 2020, the effective income tax rate was 23.1% and 23.9%, respectively. For the nine months ended September 30, 2021, the effective income tax rate benefited from a lower effective income tax rate, 17.6%, on the gain on the sale of the Company's 40% ownership interest in Q2 Solutions (see Note 5). For the nine months ended September 30, 2020, the effective income tax rate benefited from a lower effective income tax rate, 11.8%, 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. In addition, the effective income tax rate benefited from $15 million of excess tax benefits associated with stock-based compensation arrangements for both the nine months ended September 30, 2021 and 2020.
15. SUBSEQUENT EVENT
During October 2021, the Company amended its $600 million secured receivables credit facility in order to extend the maturity dates for each underlying commitment by one year while maintaining the aggregate borrowing capacity under the secured receivables credit facility at $600 million. Under the secured receivables credit facility, the Company can borrow against a $250 million loan commitment maturing October 2022 and a $250 million loan commitment maturing October 2023. Additionally, the Company can issue up to $100 million of letters of credit through October 2023. Borrowings under the secured receivables credit facility are collateralized by certain domestic receivables. Interest on borrowings under the secured receivables credit facility are based on either commercial paper rates for highly-rated issuers or LIBOR, plus a spread of 0.725% to 0.80%.
Next: Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations