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Quest Diagnostics’ (DGX - Analyst Report) second quarter of 2013 adjusted earnings per share (EPS) of $1.06 lagged the Zacks Consensus Estimate by 3 cents and the year-ago earnings by 5.2%.The adjusted EPS in the reported quarter excludes certain one-time charges related to restructuring and integration (7 cents). Reported EPS was $1.09, down 9.2% year over year. The year-ago quarter had incurred a cost of 6 cents per share related to restructuring and integration as well as CEO succession.

Revenues from continuing operations for the second quarter of 2013 were down 3.3% year over year to $1.81 billion, marginally missing the Zacks Consensus Estimate of $1.83 billion. Volume (measured by the number of requisitions) inched up 0.1% year over year.

Revenue per requisition was down 3.7% primarily due to reduced reimbursement (3.2% of the reduction). Moreover, the business mix impact of Quest Diagnostics’ recent toxicology acquisition contributed to the rest of the decline in revenue per requisition.

We believe that the overall soft industry trends leading to low volume growth were a dampener for the company. In addition, lower healthcare utilization and reimbursement cut acted as other major dampeners. We expect this challenging scenario to adversely affect Quest Diagnostics’ peer Laboratory Corporation of America Holdings (LH - Analyst Report)) as well, which is scheduled to release its second quarter of 2013 results on Jul 18, 2013.

Among operating costs, cost of services during the reported quarter stood at $1.09 billion, down 0.74% year over year. Selling, general and administrative (SG&A) expenses dropped 1.3% to $418.5 million. Other operating income was $5 million, compared to expense of $0.2 million in the year-ago quarter. However, adjusted operating margin in the quarter contracted 176 basis points (bps) to 16.9% on adjusted operating income of $308.5 million.

Quest Diagnostics exited the second quarter of 2013 with $148.3 million in cash and cash equivalents, down from $295.6 million at the end of fiscal 2012. Cash provided by operating activities for the quarter was $208 million compared with $251 million in the year-ago quarter. The company is focused on enhancing shareholder value and improving return on capital. During the reported quarter, Quest Diagnostics repurchased shares worth $405 million.

Recent Activities

As a part of its strategy to align assets in the core diagnostics information service business, Quest Diagnostics announced that it has sold the rights to royalties from commercialization of the drug candidate ibrutinib to Royalty Pharma for $485 million in cash.

Further, in June, the company completed the acquisition of lab-related clinical outreach service operations of Calif.-based Dignity Health and Concentra's toxicology business. Quest Diagnostics believes that these acquisitions remain consistent with its strategy of delivering 1%–2% growth from acquisitions. The acquisitions are also a part of the company’s recently initiated five-pronged strategy, which includes disciplined capital deployment.

In April, the company completed the divesture of HemoCue diagnostics products business. In December, Quest Diagnostics divested its OralDNA Labs salivary-diagnostics business in order to refocus its resources to core diagnostic information services.

In addition, the company’s acquisition of UMass Medical Lab in Jan 2013 is in sync with its goal to create a planned 'lab of the future.' According to the company, this will help it increase long-term growth opportunities in the rapidly growing esoteric markets.

Outlook

Quest Diagnostics provided an updated fiscal 2013 outlook. Currently, revenues are expected to be down 1%–2% from the prior-year quarter as compared to the earlier projection of flat year-over-year revenues.

The current Zacks Consensus Estimate of $7.28 billion remains above the guided range. EPS is expected to remain in the range of $4.35−$4.50 (earlier band was $4.35−$4.55). The Zacks Consensus Estimate of $4.35 matches the lower end of the range. However, the company did not alter its estimate for capital expenditure ($250 million) and cash provided by operations ($1.0 billion).

Recommendation

We remain cautious about Quest Diagnostics as it is continuously witnessing challenges with testing volume and reimbursement cut. Concerns also linger about the soft industry trends due to a decline in physician office visits, flat pricing and low organic revenues. Moreover, a disappointing fiscal 2013 revenue guidance reflects no improvement in the industry trend going forward, which adds to our concerns.

However, we are optimistic regarding the company’s strategy to refocus on Diagnostic Information Services along with the organizational structure developed by the company’s CEO, Steve Rusckowski. We also expect this add synergies to its ongoing $500 million restructuring initiative associated with its Invigorate program. The stock retains a Zacks Rank #4 (Sell).

Other Stocks to Consider

Some better performing medical stocks include China Cord Blood Corporation (CO - Snapshot Report) and ResMed Inc. (RMD - Analyst Report). Both the stocks carry a Zacks Rank #1 (Strong Buy).

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