Quest Diagnostics (DGX)

Q1 2011 Earnings Call

April 20, 2011 8:30 am ET

Executives

Kathleen Valentine - Director of Investor Relations

Robert Hagemann - Chief Financial Officer and Senior Vice President

Surya Mohapatra - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Ralph Giacobbe - Crédit Suisse AG

William Quirk - Piper Jaffray Companies

Shelley Gnall-Sazenski

Ricky Goldwasser - Morgan Stanley

Steven Valiquette - UBS Investment Bank

Gary Lieberman - Wells Fargo Securities, LLC

Kemp Dolliver - Avondale Partners, LLC

Robert Willoughby

Thomas Gallucci - Lazard Capital Markets LLC

Darren Lehrich - Deutsche Bank AG

Alexander Draper - Raymond James & Associates, Inc.

Brendan Strong - Barclays Capital

Gary Taylor - Citigroup Inc

Anthony Vendetti - Maxim Group LLC

Unknown Analyst -

Amanda Murphy - William Blair & Company L.L.C.

Bill Bonello - RBC Capital Markets, LLC

Presentation

Operator

Welcome to the Quest Diagnostics First Quarter Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question-and-answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Quest Diagnostics is strictly prohibited. Now I'd like to introduce Kathleen Valentine, Director of Investor Relations for Quest Diagnostics. Go ahead, please.

Kathleen Valentine

Thank you, and good morning. I am here with Surya Mohapatra, our Chairman and Chief Executive Officer; and Bob Hagemann, our Chief Financial Officer.

During this call, we make forward-looking statements with respect to both Quest Diagnostics and Celera Corporation. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in Quest Diagnostics 2010 annual report on Form 10-K and current reports on Form 8-K.

In connection with Quest Diagnostics' tender offer for the common stock of Celera Corporation, Quest Diagnostics and its subsidiary have filed with the SEC a tender offer statement, on a scheduled TO, including the offer to purchase and related documents. Celera has filed with the SEC a tender offer solicitation recommendation statement on a scheduled 14b-9.

You are strongly advised to read these documents carefully because they will contain important information. Those materials and all other documents filed by Quest Diagnostics and Celera with the SEC will be available at no charge on the SEC's website at www.sec.gov.

A copy of our earnings press release is available and a text of our prepared remarks will be available in the Investor Relations Quarterly Update section of our website at www.questdiagnostics.com. A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website. Now, here is Surya Mohapatra.

Surya Mohapatra

Thank you, Kathleen. This was an important quarter for Quest Diagnostics. We completed our acquisition of Athena Diagnostics and established a leading position in the neurology diagnostics market. We also announced our proposed acquisition of Celera to further strengthen our leadership position in cardiovascular testing, as well as molecular diagnostics products and discovery. These transactions position us well for the future.

In this quarter, we returned $835 million to shareholders through share buybacks, immediately enhancing shareholder value. Our testing volume continued to improve, and we increased revenues.

Our earnings were down, and we took actions to reduce our cost structure accordingly. During the first quarter, revenues grew 1% to $1.8 billion on 2% volume growth. Adjusted earnings per share were $1, and cash flow was $161 million. I will update you on our progress after Bob discusses the financial results. Bob?

Robert Hagemann

Thanks, Surya. Revenues for the quarter were $1.8 billion, about 1% above the prior year, and adjusted earnings per share was $1, compared to $0.99 in the prior year. Adjusted 2011 earnings per share exclude $0.14 per share associated with the following items: $0.05 charge for workforce reductions; $0.02 for costs associated with the Athena and Celera transactions; $0.07 impact of severe winter storms.

Our Clinical Testing revenues, which account for over 90% of our total revenues, were slightly above the prior-year level by 0.3%. Volume in the quarter was 2% above the prior year and reflects the continued and steady improvement we have seen over the last several quarters.

There are 2 important dynamics to understand relative to our volumes. First, the number of business days in the quarter. Due to the number of business days in the quarter, we estimate the year-over-year comparisons benefited by approximately 1%. Secondly, while we experienced severe weather last year in the first quarter, which reduced volumes by an estimated 1.1%, this year's storms had an even greater impact affecting volumes by an estimated 1.4%. As such, weather unfavorably impacted the year-over-year comparisons by 0.3%. After considering these 2 items, the underlying volume grew an estimated 1.3% versus the prior year and reflects continued improvement. Drugs of Abuse Testing volumes have continued to rebound and grew about 11% in the quarter and contributed modestly to the improved volume trend.

Revenue from acquisition was 1.7% below the prior year and a little over 1% below last year's fourth quarter. While year-over-year revenue for acquisition continues to benefit from an increased mix in gene-based and esoteric testing and increases in the number of test order per acquisition, this benefit continues to be offset by some business and payer mix changes, the latest Medicare fee decrease of 1.75%, which went into effect January 1 and the pricing changes in connection with several large contract extensions executed in the first half of last year.

The business and payer mix changes, which continues to pressure revenue per acquisition include a further rebound in lower-priced Drugs of Abuse Testing and weakness in our higher-priced Anatomic Pathology Testing.

Revenue in our Nonclinical Testing businesses, which include Risk Assessment, Clinical Trials Testing, Point-of-Care testing and Healthcare IT grew 7% for the quarter versus the prior year. Adjusted operating income as a percentage of revenues was 16.3%, compared to 18.1% in the prior year.

The special items, as detailed in footnote 2 to the earnings release, reduced the operating income percentage by 1.6% in each year. Adjusted operating income in the first quarter, which was below the prior-year level is consistent with what we expected in our full year estimate, which contemplates improvement in the latter part of the year.

In the quarter, we took further actions to reduce our cost structure resulting in a charge for workforce deductions. The benefit of these actions will show up in future quarters. As previously shared with you, we've also made recent investments in sales and service, which are temporarily pressuring margins, but which we expect over the longer term will result in accelerated revenue growth and a return to margin expansion.

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