Quest Diagnostics (DGX) reported an EPS of $1.13 during the third quarter of fiscal 2010, surpassing the year-ago quarter’s $1.02. However, excluding an 8-cent benefit associated with a favorable tax resolution, the EPS came in at $1.05, ahead of the Zacks Consensus Estimate of $1.00.

Revenues for the quarter declined 1.7% year over year to $1.9 billion, driven by continued softness in physician office visits, and meeting the Zacks Consensus Estimate. However, EPS improved over the year-ago period due to the 6.9% reduction in the number of outstanding shares and an 18% reduction in income tax expense to $102.9 million.

Clinical testing revenues, which account for most of Quest’s sales, declined 1.7% compared to the prior year. While clinical testing volume (measured by the number of requisitions) during the quarter declined 0.3%, revenues per requisition were lower by 1.3% compared to the year-ago period and remained unchanged sequentially.

Operating margin for the reported quarter declined to 18.1% on an operating income of $337 million compared to 18.4% in the year-ago period on an operating income of $348 million. Although operating costs came down by 1.4%, a 1.7% reduction in revenues brought down the operating margin.

Quest exited the quarter with $369.3 million in cash and cash equivalents, down from $534.3 million at the end of December 2009. Based on a strong cash balance, the company plans to reward its shareholders in the form of share buybacks and suitable acquisitions.

During the quarter, Quest repurchased $324 million of its common shares and made capital expenditures of $47 million. The company announced another $250 million buyback program after exhausting its previous authorization of $750 million granted in January 2010.

Outlook

Quest revised its outlook for 2010. The company increased the lower end of its previous EPS (from continuing operations) guidance by 5 cents to $3.95-$4.00. However, revenues are expected to decline by 1.5% compared to the earlier projection of 1% decline.

We believe that the company is primarily banking on share repurchases to improve its bottom line. Quest expects operating margin to be around 17.5% -18% and $1.1 billion in cash from operations. In addition, the company’s earlier expectation of $200 million in capital expenditures remained unchanged.

Recommendation

Quest is confident about its long-term potential. The company continues to remain focused on gene-based and esoteric testing along with increasing sales effectiveness and improvement in operational efficiency. However, the macro environment continues to be a major concern and is negatively impacting testing volume. We believe in the near term, volume and pricing outlook will continue to remain under pressure unless the economic scenario improves.

We currently have an Underperform recommendation on Quest.

 
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