Quest Diagnostics (DGX)

Q2 2011 Earnings Call

July 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

Dane Leone - Macquarie Research

Ricky Goldwasser - Morgan Stanley

Steven Valiquette - UBS Investment Bank

Gary Lieberman - Wells Fargo Securities, LLC

Robert Willoughby

Thomas Gallucci - Lazard Capital Markets LLC

B. Kemp Dolliver - Avondale Partners, LLC

Darren Lehrich - Deutsche Bank AG

Bryan Sekino - Barclays Capital

Anthony Vendetti - Maxim Group LLC

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

Bill Bonello - RBC Capital Markets, LLC

Presentation

Operator

Welcome to the Quest Diagnostics Second 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 may make forward-looking statements. 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, quarterly reports on Form 10-Q and current reports on Form 8-K.

A copy of our earnings press release is available, and a text of our prepared remarks will be available later today in the Investor Relations' Quarterly Updates 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. We grew revenues and adjusted earnings per share in the second quarter despite ongoing market softness. During the quarter, revenues grew 1.5% to $1.9 billion. Adjusted earnings per share increased 5% to $1.12. While clinical testing volumes decreased 0.9%, revenue per acquisition increased 1.6% compared to the prior year. And we generated strong underlying cash flow.

Our growth strategy is to be the leading innovator and provider in the fast-growing esoteric and gene-based testing areas for cancer, cardiovascular disease, infectious disease and neurological disorders. This complements our large routine level through testing services, enabling diagnostics and monitoring of a wide range of chronic diseases.

We continue to focus on growing our genetics, esoteric and anatomic pathology revenues. Demand for our esoteric and gene-based testing continue to grow faster than routine testing, driven significantly by Vitamin D testing, which saw double-digit volume growth in the quarter. However, the rate of growth in Vitamin D testing is moderating. Additionally, ImmunoCAP allergy testing continues to grow.

In Anatomic Pathology, we continue to see pressure on volumes from physician insourcing, particularly in dermatology and hematology oncology. However, we have seen some moderation of this practice in other areas such as GI and GU.

In cancer testing, we continue to promote our colorectal cancer blood test and OVA1 ovarian cancer test and Leumeta blood cancer test. These tests are proprietary to Quest Diagnostics and all showed strong growth.

The acquisitions of Athena and Celera, which closed in the second quarter, will further accelerate our growth in gene-based and esoteric testing. I am pleased these integrations are on track.

We are also taking additional actions to grow our business. We have strengthened our women's health test offering. We introduced SureSwab for gynecological infections and are launching Spinal Muscular Atrophy or SMA testing from Athena more broadly through our broad network. We are seeing early successes.

We also introduced a new prescription drug monitoring service. We are seeing strong growth in this expanding market for pain management. We are helping citizens to ensure that prescribed pain medications are not being abused or diverted.

Turning to sales effectiveness. In some areas, we are pleased with our performance, but we have more work to do. As we have said before, we have completed our sales force expansion, provided them with better tools and enabled them to spend more time with customers.

We continue to work with health plans to move business to us from higher cost providers. Additionally, we have created a new Senior Vice President position to oversee all aspects of our core business with physicians, including sales, marketing, operations and quality. Cathy Doherty, who reports directly to me, has a proven track record over her 21 years of experience with Quest Diagnostics, including successfully leading our hospital services, as well as corporate strategy and business development.

As regards to our costs, we have been looking closely at our cost structure. In the short term, we are aligning our cost with lower volume levels we have seen. Beyond that, we need to become more agile and efficient in our operation. Today, we're announcing a comprehensive initiative to improve profitability in this competitive marketplace, invest for growth and better prepare us for the substantial opportunity in the future. We expect this to reduce our cost structure by $500 million over the next 3 years and help us reach our goal of 20% operating income. I have asked Bob Hagemann to lead this initiative.

Regarding capital deployment, our philosophy comprises the use of cash for growth and strategic advantage, the return of cash to shareholders through share buybacks and dividends. In addition to quarterly dividends, so far this year, we have returned $835 million in cash to shareholders through share buybacks, and we utilized about $1 billion for the acquisition of Athena and Celera.

With regards to acquisitions, in the near-term, our interest is in smaller holding lab acquisitions, which will provide access to more customers and be immediately accretive to earnings.

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