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Quest Diagnostic Misses on Q1 Earnings, Ups Guidance

Zacks Equity Research

Quest Diagnostics’ (DGX) first-quarter 2014 adjusted earnings per share (EPS) from continuing operations of 84 cents missed both the Zacks Consensus Estimate and the year-ago number by 5.6%.

Adjusted EPS in the reported quarter excludes restructuring and integration charge costs associated with recent acquisitions and the company's ongoing efforts to drive operational excellence. Reported EPS in the first quarter was 71 cents, also a penny short of the year-ago reported earnings.

Revenues from continuing operations for the first quarter of 2014 were down 2.3% year over year to $1.75 billion, in line with the Zacks Consensus Estimate. Volume (measured by the number of requisitions) edged up 0.7% year over year as recent acquisitions by the company added 3.5% to the volume.

Revenues per requisition dropped 2.8%, primarily due to reduced reimbursement and the business mix impact of Quest Diagnostics’ year-ago toxicology acquisition.

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 cuts acted as other major deterrents. We expect this challenging scenario to adversely affect Quest Diagnostics’ peer Laboratory Corporation of America Holdings (LH) as well, which is scheduled to release its first-quarter 2014 results on Apr 25.

Among operating costs, cost of services during the reported quarter stood at $1.1 billion, up 0.82% year over year. Selling, general and administrative (SG&A) expenses fell 7.4% to $415 million.

The company did not incur any operating expenses in the ‘Other’ category as against $1 million incurred in the year-ago quarter. Accordingly, adjusted operating margin in the quarter contracted 59 basis points (bps) to 13.2% on adjusted operating income of $230 million.

Quest Diagnostics exited the quarter with $144 million in cash and cash equivalents, down from $187 million at the end of 2013. Cash provided by operating activities for the year was $84 million compared with $47 million a year ago.


Quest Diagnostics increased its 2014 guidance. The company currently expectsrevenues to increase in the range of 2% to 4%. Earlier the company had estimated 2014 revenues to remain 2% below the 2013 level. The current Zacks Consensus Estimate is pegged at $7.30.

In addition, the company’s 2014 adjusted EPS is expected to remain in the range of$3.95 to $4.15 as against the earlier provided range of $3.90−$4.10. The Zacks Consensus Estimate of $4.04 remains within the range.

Cash provided by operations outlook remains at $900 million, and the estimate for capital expenditure is reiterated at $300 million.

Our Take

Quest Diagnostics has been focusing on high-potential areas such as gene-based esoteric testing for cancer, cardiovascular disease, infectious disease and neurological disorders. The company has experienced increasing demand for gene-based and esoteric tests compared to routine tests on account of increased esoteric mix contributed by Athena and Celera.

As part of this strategy, in Jan 2014, Quest Diagnostics announced a multi-year deal with Life Technologies.  Per the deal, Quest Diagnostics can use Life Technologies’ Ion Torrent, a next-generation sequencing (NGS) platform for the development of molecular tests.

Quest Diagnostics has also signed a similar agreement with Illumina Inc. (ILMN) whereby it will be allowed to use the latter’s MiSeq sequencing and genotyping technology platform and related reagents for molecular laboratory-developed tests. These deals are consistent with the company’s aim of becoming a global leader in diagnostic and healthcare services. Quest Diagnostics has been working on strengthening its suite of diagnostic tests for quite some time now.

However, we remain cautious about Quest Diagnostics’ fate going forward as it is continuously witnessing challenges with regard to testing volume and reimbursement cuts. 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 2014 guidance reflects no improvement in the industry trend going forward, which adds to our concerns.

The stock retains a Zacks Rank #2 (Buy). Another player in the broader medical sector is St. Jude Medical Inc. (STJ) carrying a similar Zacks Rank #2.

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