Quest Diagnostics (DGX)

Q3 2011 Earnings Call

October 25, 2011 8:30 am ET


Kathleen Valentine - Director of Investor Relations

Robert A. Hagemann - Chief Financial Officer and Senior Vice President

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


Gary P. Taylor - Citigroup Inc, Research Division

Bill Bonello - RBC Capital Markets, LLC, Research Division

Dane Leone - Macquarie Research

Ralph Giacobbe - Crédit Suisse AG, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Gavin Weiss - JP Morgan Chase & Co, Research Division

Amanda Murphy - William Blair & Company L.L.C., Research Division

Darren Lehrich - Deutsche Bank AG, Research Division

Brendan Strong - Barclays Capital, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Arthur I. Henderson - Jefferies & Company, Inc., Research Division

Unknown Analyst -

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Gary Lieberman - Wells Fargo Securities, LLC, Research Division



Welcome to the Quest Diagnostics Third 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 the text of our prepared remarks will be available later today in the Investor Relations quarterly update section of our website at A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website. Now here is Surya Mohapatra.

Surya N. Mohapatra

Thank you, Kathleen. We have a lot of news to share with you this morning. In a moment, we are going to review our earnings news and discuss our increased dividend and our push to capital deployment. But first, let me tell you about today's succession announcement. As we indicated in our press release earlier today, we have begun a CEO succession process. I joined Quest Diagnostics in 1999 and has seen revenue growth 5x to $7.5 billion. The company has grown from a simple lab to the most advanced genomic and acetylic testing powerhouse for cancer, cardiovascular disease, infectious disease and neurological disorders. With unmatched assets in science and innovation, information technology and access and distribution now in place, the Board and I have agreed, that after all almost 12 years, this is the right time to transition to new leadership.

The Board is engaged in the thought process and will consider both external and internal candidates. Importantly, nothing changes today. I will continue to focus on executing our operating and strategic plan until I turn over leadership to a new CEO. I have agreed to continue to serve as Chairman and CEO for up to 6 months to ensure a smooth transition to my successor. I'll be happy to take any questions you may have at the end of today's call following our prepared remarks.

Turning to our forefronts in the third quarter. Revenues grew 2.2%, adjusted earnings per share increased 4% and we generated strong cash flow. We are beginning to see positive signs in a number of areas, but we have more work to do. The current market environment remains challenging, nevertheless, we are committed to increasing shareholder returns. We have framework that encompasses improving operating performance and a balanced capital deployment philosophy.

Our growth strategy is focused on 3 main elements: driving faster-growing esoteric and gene-based testing for cancer, cardiovascular disease, infectious disease and neurological disorders; enhancing sales effectiveness; and strengthening our relationships with health plans and other payers. Now during the quarter, we continue to see increased demand for our advanced diagnostic services. gene-based and esoteric testing revenues grew 14%, driven by the contribution of neurological testing from Athena and cardiovascular testing from Berkeley Heart, as well as women's health testing specifically, SureSwab. Demand for esoteric and gene-based testing continued to grow faster than routine testing.

We continue to be focused on maintaining and expanding our access to ensure lives. We are working closely with health plans and implores to reduce costly out-of-network leakage by getting involved in benefit plan design and offering employers an extensive set of turnkey tools that channel employees to low-cost testing. In addition, through our QuestNet lab solution, we build and manage lab networks for health plans. As regards to the cost, we have had an ongoing focus on cost structure both to ensure that our costs are aligned with volume in the short term and to make needed changes to make us more competitive and profitable for the future.

Last quarter, we told you about our comprehensive initiative to reduce our cost structure by $500 million over 3 years. We are following a deliberate process to identify opportunities and ensure that we will not do anything to jeopardize patient care, medical quality or growth. You will hear more details from Bob who is leading this strategic initiative.

Now let me share with you our evolving capital deployment philosophy. We are a strong company. We generate significant cash flows. With the key assets and capabilities in place through recent acquisitions to drive long-term growth, we do not see large acquisitions in the next few years. Our focus is on improving our performance and integrating businesses we have acquired. As a result, we plan to return a majority of our future cash to shareholders. This morning, we announced a 70% increase in our dividend to an annualized amount of $0.68 per share. This demonstrates confidence in our continued ability to generate strong cash flows. Starting next year, we are further aligning management's long-term incentives with increasing returns on invested capital. Now, Bob, will provide further analysis, and then we'll take your questions. Bob?

Robert A. Hagemann

Thanks, Surya. Revenues for the quarter were $1.9 billion, 2.2% above the prior year, and adjusted earnings per share was a $1.18 compared to $1.13 in the prior year. Third quarter results include a benefit of $0.05 per share in 2011 and $0.08 per share in the prior year, associated with the favorable resolution of certain tax contingencies. Adjusted earnings per share for the 2011 third quarter exclude $0.10 per share associated with restructuring and integration costs, which are further detailed in Footnote 2 to the earnings release. The acquisitions of Athena and Celera contributed about 3% to revenue growth in the quarter. Our clinical testing revenues, which account for over 90% of our total revenues were about 1% above the prior year and about 1.5% below the prior year before the contributions of Athena and Celera. Volume in the quarter was 1.2% below the prior year and compares to the approximate 1% decrease we saw in the second quarter. The market in terms of estimated position office visits continued to decline in the quarter and were down 6% compared to the prior year. Drugs of Abuse Testing volumes have continued to rebound and grew about 5% in the quarter compared to about 6% last quarter. Revenue per requisition was 2.1% above the prior year with the improvement due to the increased esoteric mix contributed by Athena and Celera. Base revenue per requisition has remained relatively stable sequentially throughout the year. Organic revenue in our non-clinical testing businesses, which include risk assessment, clinical trials testing, products and healthcare IT, grew about 8% for the quarter. Adjusted operating income as a percentage of revenues was 18.3% compared to 18.1% reported in the prior year. Restructuring and integration costs, which are detailed in Footnote 2 to the earnings release reduced the reported operating income percentage by 1.4%. These costs totaled about $27 million in the quarter and compared to our earlier estimate of $20 million. The difference, principally due to additional costs associated with our plans to close our clinical testing operations in the U.K., which had not been contemplated in the year-over-year estimate.

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