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Leading diagnostic testing company, Quest Diagnostics (DGX - Analyst Report) reported earnings per share ("EPS") from continuing operations of 72 cents in the first quarter of 2013, down considerably from 97 cents in the year-ago period. However, after taking into account certain charges related to restructuring and integration (17 cents), adjusted EPS from continuing operations were 89 cents. Adjusted EPS was down 15.3% year over year, missing the Zacks Consensus Estimate of $1.04 as well. The year-ago quarter had incurred a cost of 8 cents per share, related to restructuring and integration as well as CEO succession costs.

Revenues from continuing operations for the first quarter were down 6.4% year over year to $1.79 billion, marginally missing the Zacks Consensus Estimate of $1.87 billion. We believe that the overall soft industry trends leading to low volume growth was a dampener for the company. In the reported quarter, volume (measured by the number of requisitions) declined 3.4% year over year.

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 first-quarter and fiscal 2013 results on Apr19, 2013. Revenue per requisition was down 3.4% primarily due to reduced reimbursement.

Notably, as a part of its strategy to align assets in the core diagnostics information service business, Quest Diagnostics completed the divesture of its HemoCue diagnostics products business earlier this month. The company announced that Radiometer Medical ApS purchased this business for $300 million plus customary adjustments for cash balances. Last December, Quest Diagnostics also sold its OralDNA Labs salivary-diagnostics business to Access Genetics. The company believes that these divestitures will allow it to refocus its resources toward core diagnostic information services.

In addition, in a separate press release today, the company declared that it has entered into a definitive agreement to acquire lab-related clinical outreach service operations of Dignity Health in Calif. and Nev. The company believes that this acquisition, which is expected to close in Jun 2013, is consistent with its goal of contributing 1%-2% revenue growth a year through accretive acquisitions. Although financial terms of the deal were not disclosed, Quest Diagnostics believes the transaction to be neutral to its 2013 adjusted EPS and slight accretive to that of 2014.

Coming back to the quarter’s earnings, among operating costs, cost of services during the reported quarter stood at $1.09 billion, down 1.5% year over year. Selling, general and administrative (SG&A) expenses dropped 7.3% to $448 million. Other operating income was $0.6 million, compared to expense of $0.4 million in the year-ago quarter. However, adjusted operating margin in the quarter contracted 280 basis points (bps) to 13.79% on adjusted operating income of $246.3 million.

Quest Diagnostics exited the first quarter with $133.6 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 $47.2 million compared with $161.3 million in year-ago quarter. The company is focused on enhancing shareholders’ value and improving returns on capital. During the reported quarter, Quest Diagnostics repurchased shares worth $62 million and reduced outstanding debt by $207 million.

Outlook

Quest Diagnostics provided an updated fiscal 2013 outlook. The company expects to report flat year-over-year revenues in fiscal 2013 compared with the earlier projected band of nil to 1%. The current Zacks Consensus Estimate of $7.39 billion remains almost in line with the guided range. EPS is still expected to remain in the range of $4.35−$4.55. The Zacks Consensus Estimate of $4.46 falls within the range. Moreover, the company reiterated its expectation of $250 million of capital expenditure and $1.0 billion as cash provided by operations.

Recommendation

We remain cautious about the company as it is continuously witnessing challenges with testing volume. Concerns also linger about the soft industry trends due to a decline in physician office visits, flat pricing and low organic revenue. Moreover, a disappointing fiscal 2013 revenue guidance reflected the fact that the industry trend will not improve in the near future, 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 new CEO, Steve Rusckowski. We also expect this to run successfully adding synergies to its ongoing $500 million restructuring initiative, associated with its Invigorate program. The stock retains a Zacks Rank #3 (Hold).

Other Stocks to Consider

While we prefer to remain on the sidelines on Quest Diagnostics, other medical device stocks worth a look are Cyberonics Inc. (CYBX - Analyst Report) and Cepheid (CPHD - Analyst Report). Both the stocks carry a Zacks Rank #1 (Strong Buy).

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