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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended June 30, 2002
Commission file number 1-12215
Quest Diagnostics Incorporated
One Malcolm Avenue
Teterboro, NJ 07608
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of August 2, 2002, there were outstanding 97,424,717 shares of Common Stock,
$.01 par value.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Index to consolidated financial statements filed as part of this report:
Page
Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2002 and 2001 2
Consolidated Balance Sheets as of
June 30, 2002 and December 31, 2001 3
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations"
1
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ------------------------
2002 2001 2002 2001
---------- -------- ---------- ----------
Net revenues ................................... $1,068,810 $931,589 $2,015,572 $1,814,142
---------- -------- ---------- ----------
Costs and expenses:
Cost of services ............................ 630,258 549,391 1,187,996 1,078,456
Selling, general and administrative ......... 276,821 256,474 535,224 509,276
Interest expense, net ....................... 14,916 20,458 27,591 43,158
Amortization of goodwill and other intangible
assets .................................... 2,065 12,139 4,220 23,239
Provision for special charge ................ - 5,997 - 5,997
Minority share of income .................... 3,938 2,851 7,820 3,967
Other, net .................................. (5,660) (1,432) (6,274) (1,134)
---------- -------- ---------- ----------
Total ..................................... 922,338 845,878 1,756,577 1,662,959
---------- -------- ---------- ----------
Income before taxes and extraordinary loss ..... 146,472 85,711 258,995 151,183
Income tax expense ............................. 59,321 38,607 105,155 68,331
---------- -------- ---------- ----------
Income before extraordinary loss ............... 87,151 47,104 153,840 82,852
Extraordinary loss, net of taxes ............... - (21,609) - (21,609)
---------- -------- ---------- ----------
Net income ..................................... $ 87,151 $ 25,495 $ 153,840 $ 61,243
========== ======== ========== ==========
Basic net income per common share:
Income before extraordinary loss ............... $ 0.90 $ 0.51 $ 1.60 $ 0.90
Extraordinary loss, net of taxes ............... - (0.23) - (0.24)
---------- -------- ---------- ----------
Net income ..................................... $ 0.90 $ 0.28 $ 1.60 $ 0.66
========== ======== ========== ==========
Diluted net income per common share:
Income before extraordinary loss ............... $ 0.87 $ 0.48 $ 1.54 $ 0.85
Extraordinary loss, net of taxes .............. - (0.22) - (0.22)
---------- -------- ---------- ----------
Net income .................................... $ 0.87 $ 0.26 $ 1.54 $ 0.63
========== ======== ========== ==========
Weighted average common shares
outstanding - basic ......................... 96,393 92,566 95,907 92,228
Weighted average common shares
outstanding - diluted ....................... 100,297 97,304 99,802 96,962
The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 AND DECEMBER 31, 2001
(in thousands, except per share data)
(unaudited)
June 30, December 31,
2002 2001
----------- -----------
Assets
Current assets:
Cash and cash equivalents ......................................... $ 89,840 $ 122,332
Accounts receivable, net of allowance of $207,392 and $216,203
at June 30, 2002 and December 31, 2001, respectively .............. 597,667 508,340
Inventories ....................................................... 57,930 49,906
Deferred taxes on income .......................................... 146,782 157,649
Prepaid expenses and other current assets ......................... 41,595 38,287
---------- ----------
Total current assets ............................................ 933,814 876,514
Property, plant and equipment, net ................................... 568,994 508,619
Goodwill, net ........................................................ 1,778,297 1,351,123
Intangible assets, net ............................................... 24,184 28,020
Deferred taxes on income ............................................. 46,444 52,678
Other assets ......................................................... 99,752 113,601
---------- ----------
Total assets ......................................................... $3,451,485 $2,930,555
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ............................. $ 644,813 $ 657,219
Short-term borrowings and current portion of long-term debt ....... 301,768 1,404
---------- ----------
Total current liabilities ....................................... 946,581 658,623
Long-term debt ....................................................... 820,819 820,337
Other liabilities .................................................... 114,091 115,608
Commitments and contingencies
Common stockholders' equity:
Common stock, par value $0.01 per share; 300,000 shares authorized;
97,424 and 96,024 shares issued at June 30, 2002 and December 31,
2001, respectively .............................................. 974 960
Additional paid-in capital ........................................ 1,788,479 1,714,676
Accumulated deficit ............................................... (209,086) (362,926)
Unearned compensation ............................................. (8,118) (13,253)
Accumulated other comprehensive loss .............................. (2,255) (3,470)
---------- ----------
Total common stockholders' equity ............................... 1,569,994 1,335,987
---------- ----------
Total liabilities and stockholders' equity ........................... $3,451,485 $2,930,555
========== ==========
The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(in thousands)
(unaudited)
2002 2001
---------- ----------
Cash flows from operating activities:
Net income................................................................... $ 153,840 $ 61,243
Extraordinary loss, net of taxes........................................... - 21,609
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................................. 63,815 70,903
Provision for doubtful accounts........................................... 110,477 110,854
Provision for special charge.............................................. - 5,997
Deferred income tax provision............................................. 17,563 1,247
Minority share of income.................................................. 7,820 3,967
Stock compensation expense................................................ 4,953 11,814
Tax benefits associated with stock-based compensation plans............... 38,189 22,898
Other, net................................................................ (2,056) 2,962
Changes in operating assets and liabilities:
Accounts receivable..................................................... (136,837) (146,154)
Accounts payable and accrued expenses................................... (38,040) (20,253)
Integration, settlement and other special charges....................... (12,668) (33,439)
Other assets and liabilities, net....................................... 10,890 37,987
--------- ---------
Net cash provided by operating activities.................................... 217,946 151,635
--------- ---------
Cash flows from investing activities:
Business acquisitions, net of cash acquired.................................. (333,512) (55,746)
Capital expenditures......................................................... (83,390) (78,432)
Collection of note receivable ............................................... 10,660 2,000
Proceeds from disposition of assets.......................................... 1,043 21,492
Increase in investments and other assets..................................... (2,917) (9,901)
--------- ---------
Net cash used in investing activities........................................ (408,116) (120,587)
--------- ---------
Cash flows from financing activities:
Repayments of long-term debt................................................. (333,265) (734,025)
Proceeds from borrowings..................................................... 475,237 722,333
Costs paid in connection with debt refinancing............................... - (23,684)
Exercise of stock options.................................................... 22,103 10,132
Distributions to minority partners........................................... (6,268) (2,969)
Preferred stock dividends paid............................................... - (147)
Other........................................................................ (129) -
--------- ---------
Net cash provided by (used in) financing activities.......................... 157,678 (28,360)
--------- ---------
Net change in cash and cash equivalents...................................... (32,492) 2,688
Cash and cash equivalents, beginning of year................................. 122,332 171,477
--------- ---------
Cash and cash equivalents, end of period..................................... $ 89,840 $ 174,165
========= =========
Cash paid during the period for:
Interest..................................................................... $ 30,504 $ 50,704
Income taxes................................................................. 38,760 20,442
Businesses acquired:
Fair value of assets acquired.............................................. $ 549,947 $ 55,746
Fair value of liabilities acquired......................................... 204,490 -
The accompanying notes are an integral part of these statements.
4
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, unless otherwise indicated)
(unaudited)
1. BASIS OF PRESENTATION
Background
Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or
the "Company") is the largest clinical laboratory testing business in the United
States. As the nation's leading provider of diagnostic testing and related
services for the healthcare industry, Quest Diagnostics offers a broad range of
clinical laboratory testing services to physicians, hospitals, managed care
organizations, employers, governmental institutions and other independent
clinical laboratories. Quest Diagnostics has the leading market share in
clinical laboratory testing and esoteric testing, including molecular
diagnostics, as well as non-hospital based anatomic pathology services and
testing for drugs of abuse. Through the Company's national network of
laboratories and patient service centers, and its esoteric testing laboratory
and development facilities, Quest Diagnostics offers comprehensive and
innovative diagnostic testing, information and related services used by
physicians and other healthcare customers to diagnose, treat and monitor
diseases and other medical conditions. Quest Diagnostics also offers clinical
testing and services to support clinical trials of new pharmaceuticals
worldwide.
On an annualized basis, Quest Diagnostics processes over 115 million
requisitions through its extensive network of laboratories and patient service
centers in virtually every major metropolitan area throughout the United States.
Basis of Presentation
The interim consolidated financial statements reflect all adjustments
which, in the opinion of management, are necessary for a fair statement of
financial condition and results of operations for the periods presented. Except
as otherwise disclosed, all such adjustments are of a normal recurring nature.
The interim consolidated financial statements have been compiled without audit.
Operating results for the interim periods are not necessarily indicative of the
results that may be expected for the full year. These interim consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements included in the Company's 2001 Annual Report on Form 10-K.
Earnings Per Share
Basic net income per common share is calculated by dividing net income,
less preferred stock dividends (approximately $30 thousand per quarter in 2001),
by the weighted average number of common shares outstanding. Diluted net income
per common share is calculated by dividing net income, less preferred stock
dividends, by the weighted average number of common shares outstanding after
giving effect to all potentially dilutive common shares outstanding during the
period. The if-converted method is used in determining the dilutive effect of
the Company's 1 3/4% contingent convertible debentures in periods when the
holders of such securities are permitted to exercise their conversion rights.
Potentially dilutive common shares include outstanding stock options and
restricted common shares granted under the Company's Employees Equity
Participation Program. These dilutive securities increased the weighted average
number of common shares outstanding by 3.9 million shares and 4.7 million
shares, respectively, for both the three and six months ended June 30, 2002 and
2001. During the fourth quarter of 2001, the Company redeemed all of its then
issued and outstanding shares of preferred stock.
Stock-Based Compensation
Quest Diagnostics has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and follows Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related interpretations to account for its stock-based compensation plans.
Under this approach, the cost of restricted stock awards is expensed over their
vesting period, while the imputed cost of stock option grants and discounts
offered under the Company's Employee Stock Purchase Plan ("ESPP") is disclosed,
based on the vesting provisions of the individual grants, but not charged to
expense. Stock-based compensation expense recorded in accordance with APB 25,
related to restricted stock awards, was $2.5 million and $4.9 million for the
three months ended June 30, 2002 and 2001, respectively, and $5.0 million and
$11.8 million for the six months ended June 30, 2002 and 2001, respectively.
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The following table presents net income and basic and diluted earnings per
common share, had the Company elected to recognize compensation cost based on
the fair value at the grant dates for stock option awards and discounts granted
for stock purchases under the Company's ESPP, consistent with the method
prescribed by SFAS 123:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -----------------------
2002 2001 2002 2001
------- ------- -------- --------
Net income
Net income ..................................... $87,151 $25,495 $153,840 $ 61,243
Impact of recognizing compensation cost pursuant
to provisions of SFAS 123 ................... (9,909) (6,759) (17,953) (10,010)
------- ------- -------- --------
Net income, adjusted for impact of SFAS 123 .... $77,242 $18,736 $135,887 $ 51,233
======= ======= ======== ========
Basic net income per common share
Net income ..................................... $ 0.90 $ 0.28 $ 1.60 $ 0.66
Impact of recognizing compensation cost pursuant
to provisions of SFAS 123 ................... (0.10) (0.08) (0.18) (0.11)
------- ------- -------- --------
Net income, adjusted for impact of SFAS 123 .... $ 0.80 $ 0.20 $ 1.42 $ 0.55
======= ======= ======== ========
Diluted net income per common share
Net income ..................................... $ 0.87 $ 0.26 $ 1.54 $ 0.63
Impact of recognizing compensation cost pursuant
to provisions of SFAS 123 ................... (0.10) (0.07) (0.18) (0.10)
------- ------- -------- --------
Net income, adjusted for impact of SFAS 123 .... $ 0.77 $ 0.19 $ 1.36 $ 0.53
======= ======= ======== ========
The fair value of each option grant was estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -----------------------
2002 2001 2002 2001
------- ------- -------- --------
Dividend yield..................................... 0.0% 0.0% 0.0% 0.0%
Risk-free interest rate............................ 4.3% 5.3% 4.2% 5.2%
Expected volatility................................ 45.2% 47.7% 45.2% 47.7%
Expected holding period, in years.................. 5 5 5 5
New Accounting Standards
In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets"
("SFAS 144"), which supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121").
SFAS 144 further refines SFAS 121's requirement that companies recognize an
impairment loss if the carrying amount of a long-lived asset is not recoverable
based on its undiscounted future cash flows and measure an impairment loss as
the difference between the carrying amount and fair value of the asset. In
addition, SFAS 144 provides guidance on accounting and disclosure issues
surrounding long-lived assets to be disposed of by sale. SFAS 144 also extends
the presentation of discontinued operations to include more disposal
transactions. SFAS 144 is effective for all fiscal quarters of all fiscal years
beginning after December 15, 2001 (January 1, 2002 for the Company). The
Company's adoption of SFAS 144 did not result in any impairment loss being
recorded.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt" ("SFAS 4"), SFAS No. 44, "Accounting for
Intangible Assets of Motor Carriers"
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
("SFAS 44") and SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements" ("SFAS 64") and amends SFAS No. 13, "Accounting for
Leases" ("SFAS 13"). This statement updates, clarifies and simplifies existing
accounting pronouncements. As a result of rescinding SFAS 4 and SFAS 64, the
criteria in APB No. 30, "Reporting the Results of Operations-Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions", will be used to classify gains
and losses from extinguishment of debt. SFAS 44 was no longer necessary because
the transitions under the Motor Carrier Act of 1980 were completed. SFAS 13 was
amended to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions and makes technical corrections to existing pronouncements. The
provisions of SFAS 145 are effective for fiscal years beginning after May 15,
2002, with earlier application encouraged. The Company expects to adopt SFAS 145
effective January 1, 2003 and reflect any necessary reclassifications in its
consolidated statements of operations. The adoption of SFAS 145 will not have a
material impact on the Company's financial position.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses the
recognition, measurement, and reporting of costs associated with exit or
disposal activities, and supercedes Emerging Issues Task Force ("EITF") Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" ("EITF 94-3"). The principal difference between SFAS 146 and
EITF 94-3 relates to the requirements for recognition of a liability for a cost
associated with an exit or disposal activity. SFAS 146 requires that a liability
for a cost associated with an exit or disposal activity, including those related
to employee termination benefits and obligations under operating leases and
other contracts, be recognized when the liability is incurred, and not
necessarily the date of an entity's commitment to an exit plan, as under EITF
94-3. SFAS 146 also establishes that the initial measurement of a liability
recognized under SFAS 146 be based on fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The Company expects to adopt SFAS 146,
effective January 1, 2003. For exit or disposal activities initiated prior to
January 1, 2003, the Company plans to follow the accounting guidance outlined in
EITF 94-3.
2. ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"), which broadens the criteria for recording intangible
assets separate from goodwill. SFAS 142 requires the use of a nonamortization
approach to account for purchased goodwill and certain intangibles. Under a
nonamortization approach, goodwill and certain intangibles are not amortized
into results of operations, but instead are reviewed for impairment and an
impairment charge is recorded in the periods in which the recorded carrying
value of goodwill and certain intangibles is more than its estimated fair value.
The Company adopted SFAS 142 effective January 1, 2002. The provisions of SFAS
142 require that a transitional impairment test be performed as of the beginning
of the year the statement is adopted. The provisions of SFAS 142 also require
that a goodwill impairment test be performed annually or in the case of other
events that indicate a potential impairment. The new criteria for recording
intangible assets separate from goodwill did not require the Company to
reclassify any of its intangible assets. The Company's transitional impairment
test indicated that there was no impairment of goodwill upon adoption of SFAS
142. The annual impairment test of goodwill will be performed at the end of the
Company's fiscal year on December 31st.
Effective January 1, 2002, the Company evaluates the recoverability and
measures the possible impairment of its goodwill under SFAS 142. The impairment
test is a two-step process that begins with the estimation of the fair value of
the reporting unit. The first step screens for potential impairment and the
second step measures the amount of the impairment, if any. Management's estimate
of fair value considers publicly available information regarding the market
capitalization of the Company as well as (i) publicly available information
regarding comparable publicly-traded companies in the clinical laboratory
testing industry, (ii) the financial projections and future prospects of the
Company's business, including its growth opportunities and likely operational
improvements, and (iii) comparable sales prices, if available. As part of the
first step to assess potential impairment, management compares the estimate of
fair value for the Company to the book value of the Company's consolidated net
assets. If the book value of the consolidated net assets is greater than the
estimate of fair value, the Company would then proceed to the second step to
measure the impairment, if any. The second step compares the implied fair value
of goodwill with its carrying value. The implied fair value is determined by
allocating the fair value of the reporting unit to all of the assets and
liabilities of that unit as if the reporting unit had been acquired in a
business combination and the fair value of the reporting unit was the purchase
price paid to acquire the reporting unit. The excess of the fair value of the
reporting unit over the amounts assigned to its assets and
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
liabilities is the implied fair value of goodwill. If the carrying amount of the
reporting unit's goodwill is greater than its implied fair value, an impairment
loss will be recognized in the amount of the excess. Management believes its
estimation methods are reasonable and reflective of common valuation practices.
On a quarterly basis, management performs a review of the Company's
business to determine if events or changes in circumstances have occurred
which could have a material adverse effect on the fair value of the Company and
its goodwill. If such events or changes in circumstances were deemed to have
occurred, the Company would perform an impairment test of goodwill as of the end
of the quarter, consistent with the annual impairment test, and record any noted
impairment loss.
The following table presents net income and basic and diluted earnings per
common share, adjusted to reflect results as if the nonamortization provisions
of SFAS 142 had been in effect for the periods presented:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2002 2001 2002 2001
------- ------- -------- --------
Net income
Reported net income ............................. $87,151 $25,495 $153,840 $ 61,243
Add back: Amortization of goodwill, net of taxes - 9,543 - 18,190
------- ------- -------- --------
Adjusted net income ............................. $87,151 $35,038 $153,840 $ 79,433
======= ======= ======== ========
Income before extraordinary loss, adjusted to
exclude amortization of goodwill, net of taxes $87,151 $56,647 $153,840 $101,042
Basic net income per common share
Reported net income ............................. $ 0.90 $ 0.28 $ 1.60 $ 0.66
Amortization of goodwill ........................ - 0.10 - 0.20
------- ------- -------- --------
Adjusted net income ............................. $ 0.90 $ 0.38 $ 1.60 $ 0.86
======= ======= ======== ========
Income before extraordinary loss, adjusted to
exclude amortization of goodwill, net of taxes $ 0.90 $ 0.61 $ 1.60 $ 1.09
Diluted net income per common share
Reported net income ............................. $ 0.87 $ 0.26 $ 1.54 $ 0.63
Amortization of goodwill ........................ - 0.10 - 0.19
------- ------- -------- --------
Adjusted net income ............................. $ 0.87 $ 0.36 $ 1.54 $ 0.82
======= ======= ======== ========
Income before extraordinary loss, adjusted to
exclude amortization of goodwill, net of taxes $ 0.87 $ 0.58 $ 1.54 $ 1.04
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Other intangible assets consist of the following:
Weighted
Average
Amortization
Period June 30, 2002 December 31, 2001
---------------- ------------------------------------ -----------------------------------
Accumulated Accumulated
Cost Amortization Net Cost Amortization Net
-------- ------------ ------- -------- ------------ -------
Non-compete
agreements.......... 5 years $43,943 $(29,391) $14,552 $43,943 $(26,566) $17,377
Customer lists........ 15 years 41,301 (32,822) 8,479 41,331 (31,787) 9,544
Other................. 12 years 3,267 (2,114) 1,153 3,067 (1,968) 1,099
------- -------- ------- ------- -------- -------
Total.............. 8 years $88,511 $(64,327) $24,184 $88,341 $(60,321) $28,020
======= ======== ======= ======= ======== =======
For the three months ended June 30, 2002 and 2001, amortization expense
related to other intangible assets was $2,065 and $1,989, respectively. For the
six months ended June 30, 2002 and 2001, amortization expense related to other
intangible assets was $4,220 and $3,852, respectively.
The estimated amortization expense related to other intangible assets for
each of the five succeeding fiscal years as of June 30, 2002 is as follows:
Fiscal year ending
December 31,
-------------------
Remainder of 2002 ......... $ 3,725
2003....................... 7,355
2004....................... 5,830
2005....................... 2,503
2006....................... 1,389
2007....................... 639
Thereafter................. 2,743
-------
Total.................... $24,184
=======
3. BUSINESS ACQUISITION
Acquisition of American Medical Laboratories, Incorporated
On April 1, 2002, the Company completed its previously announced
acquisition of all of the outstanding voting stock of American Medical
Laboratories, Incorporated, ("AML") and an affiliated company of AML, LabPortal,
Inc. ("LabPortal"), a provider of electronic connectivity products, in an
all-cash transaction with a combined value of approximately $500 million, which
included the assumption of approximately $160 million in debt.
Through the acquisition of AML, Quest Diagnostics acquired all of AML's
operations, including two full-service laboratories, 51 patient service centers,
and hospital sales, service and logistics capabilities. The all-cash purchase
price of approximately $335 million and related transaction costs, together with
the repayment of approximately $150 million of principal and related accrued
interest, representing substantially all of AML's debt, was financed by Quest
Diagnostics with cash on-hand, $300 million of borrowings under its secured
receivables credit facility and $175 million of borrowings under its unsecured
revolving credit facility. During the second quarter of 2002, Quest Diagnostics
repaid all of the $175 million borrowed under the Company's unsecured revolving
credit facility.
9
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The acquisition of AML was accounted for under the purchase method of
accounting. As such, the cost to acquire AML has been allocated on a preliminary
basis to the assets and liabilities acquired based on estimated fair values as
of the closing date. The consolidated financial statements include the results
of operations of AML subsequent to the closing of the acquisition.
The following table summarizes the Company's preliminary purchase price
allocation related to the acquisition of AML based on the estimated fair value
of the assets acquired and liabilities assumed on the acquisition date. The
purchase price allocation will be finalized after completion of the valuation of
certain assets and liabilities, including costs to integrate AML's operations.
Estimated
Fair Values
as of
April 1, 2002
-------------
Current assets........................................ $ 83,517
Property, plant and equipment......................... 32,207
Goodwill.............................................. 419,871
Other assets.......................................... 3,134
--------
Total assets acquired............................... 538,729
--------
Current portion of long-term debt..................... 11,834
Other current liabilities............................. 43,461
Long-term debt........................................ 139,465
Other liabilities..................................... 2,193
--------
Total liabilities assumed........................... 196,953
--------
Net assets acquired................................. $341,776
========
Based on management's review of the net assets acquired and consultations
with valuation specialists, no intangible assets meeting the criteria under SFAS
No. 141, "Business Combinations", were identified. Of the $420 million allocated
to goodwill, approximately $17 million is expected to be deductible for tax
purposes.
10
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The following unaudited pro forma combined financial information
for the six months ended June 30, 2002 and the three and six months ended
June 30, 2001 assumes that the AML acquisition was effected on January 1, 2001
(in thousands, except per share data):
Three Months
Ended
Six Months Ended June 30, June 30,
2002 2001 2001
---------- ---------- ----------
Net revenues........................................... $2,093,987 $1,958,962 $1,006,049
Income before extraordinary loss....................... 153,437 89,423 49,269
Net income............................................. 153,437 67,815 27,661
Basic earnings per common share:
Income before extraordinary loss....................... $ 1.60 $ 0.97 $ 0.53
Net income............................................. 1.60 0.74 0.30
Weighted average common shares outstanding - basic..... 95,907 92,228 92,566
Diluted earnings per common share:
Income before extraordinary loss....................... $ 1.54 $ 0.92 $ 0.51
Net income............................................. 1.54 0.70 0.28
Weighted average common shares outstanding - diluted... 99,802 96,962 97,304
Proforma results for the six months ended June 30, 2002 exclude $14.5
million of non-recurring merger costs which were incurred and expensed by AML
immediately prior to the closing of the AML acquistion.
The all-cash purchase price for LabPortal of approximately $4 million and
related transaction costs, together with the repayment of all of LabPortal's
outstanding debt of approximately $7 million and related accrued interest, was
financed by Quest Diagnostics with cash on-hand. The acquisition of LabPortal
was accounted for under the purchase method of accounting. As such, the cost to
acquire LabPortal has been allocated on a preliminary basis to the assets and
liabilities acquired based on estimated fair values as of the closing date,
including approximately $7 million of goodwill. The consolidated financial
statements include the results of operations of LabPortal subsequent to the
closing of the acquisition.
4. PROVISION FOR SPECIAL CHARGE
During the second quarter of 2001, the Company recorded a special charge of
$6.0 million in connection with the refinancing of its debt and settlement of
the Company's interest rate swap agreements. Prior to the Company's debt
refinancing in June 2001, the Company's secured credit agreement required the
Company to maintain interest rate swap agreements to mitigate the risk of
changes in interest rates associated with a portion of its variable interest
rate indebtedness. These interest rate swap agreements were considered a hedge
against changes in the amount of future cash flows associated with the interest
payments of the Company's variable rate debt obligations. Accordingly, the
interest rate swap agreements were recorded at their estimated fair value in the
Company's consolidated balance sheet and the related losses on these contracts
were deferred in shareholders' equity as a component of comprehensive income. In
conjunction with the debt refinancing, the interest rate swap agreements were
terminated and the losses which were included in shareholders' equity as a
component of comprehensive income were reflected as a special charge in the
consolidated statement of operations for the three and six months ended June 30,
2001.
5. EXTRAORDINARY LOSS
In conjunction with the Company's debt refinancing in the second quarter of
2001, the Company recorded an extraordinary loss of $36.0 million, ($21.6
million, net of taxes). The loss represented the write-off of deferred financing
costs of $23.2 million, associated with the Company's debt which was refinanced,
and $12.8 million of payments related primarily to the tender premium incurred
in connection with the Company's cash tender offer of the Company's 10 3/4%
Senior Subordinated Notes. See Note 1,"New Accounting Standards", for a
discussion regarding the impact of SFAS 145.
11
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
6. COMMITMENTS AND CONTINGENCIES
The Company has entered into several settlement agreements with various
governmental and private payers during recent years relating to industry-wide
billing and marketing practices that had been substantially discontinued by
early 1993. In addition, the Company is aware of several pending lawsuits filed
under the qui tam provisions of the civil False Claims Act and has received
notices of private claims relating to billing issues similar to those that were
the subject of prior settlements with various governmental payers. Some of the
proceedings against the Company involve claims that are substantial in amount.
Some of the cases involve the operations of SmithKline Beecham Clinical
Laboratories, Inc. ("SBCL") prior to the closing of the SBCL acquisition.
SmithKline Beecham plc ("SmithKline Beecham") has agreed to indemnify Quest
Diagnostics, on an after-tax basis, against monetary payments for governmental
claims or investigations relating to the billing practices of SBCL that had been
settled before or were pending as of the closing date of the SBCL acquisition.
SmithKline Beecham has also agreed to indemnify Quest Diagnostics, on an
after-tax basis, against monetary payments to private payers, relating to or
arising out of the governmental claims. The indemnification with respect to
governmental claims is for 100% of those claims. SmithKline Beecham will
indemnify Quest Diagnostics, in respect of private claims for: 100% of those
claims, up to an aggregate amount of $80 million; 50% of those claims to the
extent the aggregate amount exceeds $80 million but is less than $130 million;
and 100% of such claims to the extent the aggregate amount exceeds $130 million.
The indemnification also covers 80% of out-of-pocket costs and expenses relating
to investigations of the claims indemnified against by SmithKline Beecham.
SmithKline Beecham has also agreed to indemnify the Company with respect to
pending actions relating to a former SBCL employee that at times reused certain
needles when drawing blood from patients. In addition, SmithKline Beecham has
agreed to indemnify the Company against all monetary payments relating to
professional liability claims of SBCL for services provided prior to the closing
of the SBCL acquisition. Amounts due from SmithKline Beecham at June 30, 2002,
related principally to indemnified professional liability claims discussed
above, totaled approximately $11 million. The estimated reserves and related
amounts due from SmithKline Beecham are subject to change as additional
information regarding the outstanding claims is gathered and evaluated.
At June 30, 2002, recorded reserves relating to billing claims
approximated $10 million. Although management believes that established reserves
for both indemnified and non-indemnified claims are sufficient, it is possible
that additional information (such as the indication by the government of
criminal activity, additional tests being questioned or other changes in the
government's or private claimants' theories of wrongdoing) may become available
which may cause the final resolution of these matters to exceed established
reserves by an amount which could be material to the Company's results of
operations and cash flows in the period in which such claims are settled. The
Company does not believe that these issues will have a material adverse effect
on its overall financial condition.
In addition to the billing-related settlement reserves discussed above, the
Company is involved in various legal proceedings arising in the ordinary course
of business. Some of the proceedings against the Company involve claims that are
substantial in amount. Some of these claims involve contracts of SBCL that were
terminated following the Company's acquisition of SBCL. During the second
quarter of 2002, the Company paid approximately $5 million to settle a claim
related to a contract of SBCL that was terminated following the Company's
acquisition of SBCL. The settlement had been fully reserved for. Although
management cannot predict the outcome of such proceedings or any claims made
against the Company, management does not anticipate that the ultimate outcome of
the various proceedings or claims will have a material adverse effect on the
Company's financial position but may be material to the Company's results of
operations and cash flows in the period in which such claims are resolved.
12
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
7. COMMON STOCKHOLDERS' EQUITY
Changes in common stockholders' equity for the six months ended June 30,
2002 were as follows:
Accumulated
Additional Other
Common Paid-In Accumulated Unearned Comprehensive Comprehensive
Stock Capital Deficit Compensation (Loss) Income
---------------------------------------------------------------------------------------
Balance,
December 31, 2001 $960 $1,714,676 $(362,926) $(13,253) $(3,470)
Net income.................... 153,840 $153,840
Other comprehensive income.... 1,215 1,215
--------
Comprehensive income........ $155,055
========
Issuance of common stock under
benefit plans (214 common
shares)..................... 2 13,523
Exercise of options (1,186
common shares).............. 12 22,091
Tax benefits associated with
stock-based compensation
plans....................... 38,189
Amortization of unearned
compensation................ 5,135
- ----------------------------------------------------------------------------------------------------
Balance,
June 30, 2002 $974 $1,788,479 $(209,086) $ (8,118) $(2,255)
================================================================
13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Changes in common stockholders' equity for the six months ended June 30,
2001 were as follows:
Accumulated
Additional Other
Common Paid-In Accumulated Unearned Comprehensive Comprehensive
Stock Capital Deficit Compensation (Loss) Income
---------------------------------------------------------------------------------------
Balance,
December 31, 2000 $465 $1,591,976 $(525,111) $(31,077) $(5,458)
Net income.................... 61,243 $61,243
Other comprehensive income.... 1,859 1,859
-------
Comprehensive income........ $63,102
=======
Two-for-one stock split (47,149
common shares).............. 472 (472)
Preferred dividends declared (59)
Issuance of common stock under
benefit plans (193 common
shares)..................... 2 24,764 (4,053)
Exercise of options (606 common
shares)..................... 6 10,126
Shares to cover employee
payroll tax withholdings on
exercised options (2 common
shares)..................... (189)
Tax benefits associated with
stock-based compensation
plans....................... 22,898
Amortization of unearned
compensation................ 12,481
- -----------------------------------------------------------------------------------------------------
Balance,
June 30, 2001 $945 $1,649,103 $(463,927) $(22,649) $(3,599)
==== ========== ========== ========= ========
During the six months ended June 30, 2001, two thousand common shares were
surrendered to cover employee payroll tax withholdings related to the exercise
of stock options. For reporting purposes, these shares were accounted for as
treasury purchases which were immediately retired.
For the six months ended June 30, 2001, other comprehensive income included
the cumulative effect of the change in accounting for derivative financial
instruments upon adoption of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended, which reduced comprehensive
income by approximately $1 million. In addition, in conjunction with the
Company's debt refinancing, the interest rate swap agreements were terminated
and the losses which were included in shareholders' equity as a component of
comprehensive income were reflected as a special charge in the consolidated
statements of operations for the three and six months ended June 30, 2001 (See
Note 4).
8. PENDING ACQUISITION
Acquisition of Unilab Corporation
On April 2, 2002, the Company entered into a definitive agreement with
Unilab Corporation ("Unilab"), which provides that Quest Diagnostics will
acquire all of the outstanding shares of Unilab common stock and assume Unilab's
existing debt of approximately $200 million. In exchange for their Unilab
shares, Unilab stockholders may elect to receive $26.50 in cash, 0.3256 shares
of Quest Diagnostics common stock or a combination of cash and stock. The
aggregate amount of cash available to Unilab stockholders will be limited to 30%
of the total consideration available for the Unilab shares. Unilab has
approximately 37.4 million shares of common stock outstanding on a fully diluted
basis. If Unilab stockholders elect to receive 30% of the consideration in cash
and if all options are exercised, Quest Diagnostics
14
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
would issue approximately 8.5 million shares and pay $297 million in cash to the
stockholders of Unilab. If Unilab stockholders elect to receive 100% of the
consideration in Quest Diagnostics common stock and all Unilab options were
exercised, Quest Diagnostics would issue approximately 12.2 million common
shares to the stockholders of Unilab. The transaction, which has been approved
by the Boards of Directors of both companies, is subject to the satisfaction of
customary conditions, including the tender of a majority of Unilab's common
stock on a fully diluted basis, and regulatory review.
During the second quarter of 2002, the Company and Unilab received a
request for additional information (commonly referred to as a "second request")
from the Federal Trade Commission ("FTC") under the Hart-Scott-Rodino Antitrust
Improvements Act (the "HSR Act") in connection with the Company's pending
acquisition of Unilab. Subject to completion of the HSR process and satisfaction
of the other conditions to the cash election exchange offer and the agreement
and plan of merger, the Company hopes to close the transaction in the third
quarter of 2002. The Company and Unilab are continuing their discussions with
the FTC regarding the proposed transaction and the process is taking longer
than anticipated. The Company continues to believe that the transaction is
not anti-competitive.
As part of the acquisition, Quest Diagnostics would acquire all of Unilab's
operations, including its primary testing facilities in Los Angeles, San Jose
and Sacramento, California, its more than 400 regional service and testing
facilities located throughout California and its operations in Arizona. The
Company expects to finance the cash portion of the purchase price and any
retirements of Unilab's existing debt with the proceeds from a new $450 million
five-year amortizing term loan commitment, which is available for the
acquisition of Unilab, available borrowings under its unsecured revolving credit
facility and cash on hand. The term loan, which is contingent upon the
completion of the Unilab transaction, will carry interest at LIBOR plus 1.3125%
and require principal repayments of the initial amount borrowed equal to 15%,
20%, 20%, 20% and 25% in years one through five, respectively. Since the
transaction has yet to close, a preliminary purchase price allocation is not
practical at this time.
9. SUMMARIZED FINANCIAL INFORMATION
The Company's 6 3/4% senior notes due 2006, 7 1/2% senior notes due 2011
and 1 3/4% contingent convertible debentures are guaranteed by each of the
Company's wholly owned subsidiaries that operate clinical laboratories in the
United States (the "Subsidiary Guarantors"). With the exception of Quest
Diagnostics Receivables Incorporated (see paragraph below), the non-guarantor
subsidiaries are primarily foreign and less than wholly owned subsidiaries.
In conjunction with the Company's receivables financing in 2000, the
Company formed a new wholly owned non-guarantor subsidiary, Quest Diagnostics
Receivables Incorporated ("QDRI"). The Company and the Subsidiary Guarantors,
with the exception of AML, transfer all private domestic receivables
(principally excluding receivables due from Medicare, Medicaid and other federal
programs and receivables due from customers of its joint ventures) to QDRI. QDRI
utilizes the transferred receivables to collateralize the Company's secured
receivables credit facility. The Company and the Subsidiary Guarantors provide
collection services to QDRI. QDRI uses cash collections principally to purchase
new receivables from the Company and the Subsidiary Guarantors.
The following condensed consolidating financial data illustrates the
composition of the combined guarantors. Investments in subsidiaries are
accounted for by the parent using the equity method for purposes of the
supplemental consolidating presentation. Earnings (losses) of subsidiaries are
therefore reflected in the parent's investment accounts and earnings. The
principal elimination entries relate to investments in subsidiaries and
intercompany balances and transactions. On April 1, 2002, Quest Diagnostics
acquired AML (see Note 3) which has been included in the accompanying condensed
consolidating financial data, subsequent to the closing of the acquisition, as a
Subsidiary Guarantor.
15
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Net revenues................................ $ 363,269 $1,545,617 $254,858 $(148,172) $2,015,572
Costs and expenses:
Cost of services.......................... 244,113 867,811 76,072 - 1,187,996
Selling, general and administrative....... 84,571 327,658 130,633 (7,638) 535,224
Interest, net............................. 40,409 122,626 5,090 (140,534) 27,591
Amortization of intangible assets......... 996 3,224 - - 4,220
Royalty (income) expense.................. (124,157) 124,157 - - -
Other, net................................ 1,687 (693) 552 - 1,546
--------- ----------- -------- --------- ----------
Total.................................... 247,619 1,444,783 212,347 (148,172) 1,756,577
--------- ----------- -------- --------- ----------
Income before taxes and extraordinary loss.. 115,650 100,834 42,511 - 258,995
Income tax expense.......................... 45,094 40,511 19,550 - 105,155
--------- ----------- -------- --------- ----------
Income before equity earnings............... 70,556 60,323 22,961 - 153,840
Equity earnings from subsidiaries........... 83,284 - - (83,284) -
--------- ----------- -------- --------- ----------
Net income.................................. $ 153,840 $ 60,323 $ 22,961 $ (83,284) $ 153,840
========= =========== ======== ========= ==========
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Net revenues................................ $ 301,626 $1,437,653 $217,717 $(142,854) $1,814,142
Costs and expenses:
Cost of services.......................... 219,952 808,689 49,815 - 1,078,456
Selling, general and administrative....... 78,758 312,868 125,014 (7,364) 509,276
Interest, net............................. 33,461 131,882 13,305 (135,490) 43,158
Amortization of goodwill and other
intangible assets....................... 2,324 20,616 299 - 23,239
Provision for special charge.............. 5,997 - - - 5,997
Royalty (income) expense.................. (122,054) 122,054 - - -
Other, net................................ 685 (877) 3,025 - 2,833
--------- ---------- -------- --------- ----------
Total.................................... 219,123 1,395,232 191,458 (142,854) 1,662,959
--------- ---------- -------- --------- ----------
Income before taxes and extraordinary loss.. 82,503 42,421 26,259 - 151,183
Income tax expense.......................... 36,922 20,517 10,892 - 68,331
--------- ---------- -------- --------- ----------
Income before equity earnings and
extraordinary loss.......................... 45,581 21,904 15,367 - 82,852
Equity earnings from subsidiaries........... 19,542 - - (19,542) -
--------- ---------- -------- --------- ----------
Income before extraordinary loss............ 65,123 21,904 15,367 (19,542) 82,852
Extraordinary loss, net of taxes............ (3,880) (15,567) (2,162) - (21,609)
--------- ---------- -------- --------- ----------
Net income.................................. $ 61,243 $ 6,337 $ 13,205 $ (19,542) $ 61,243
========= ========== ======== ========= ==========
16
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
June 30, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents................... $ - $ 82,958 $ 6,882 $ - $ 89,840
Accounts receivable, net.................... 15,072 106,775 475,820 - 597,667
Other current assets........................ 85,893 64,511 95,903 - 246,307
----------- ---------- ---------- ----------- ----------
Total current assets..................... 100,965 254,244 578,605 - 933,814
Property, plant and equipment, net.......... 200,684 342,595 25,715 - 568,994
Intangible assets, net ..................... 153,765 1,605,326 43,390 - 1,802,481
Intercompany receivable (payable)........... 13,791 181,441 (195,232) - -
Investment in subsidiaries.................. 1,709,595 - - (1,709,595) -
Other assets................................ 67,095 39,454 39,647 - 146,196
----------- ---------- ---------- ----------- ----------
Total assets............................. $ 2,245,895 $2,423,060 $ 492,125 $(1,709,595) $3,451,485
=========== ========== ========== =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses....... $ 318,592 $ 292,008 $ 34,213 $ - $ 644,813
Short-term borrowings and current portion of
long-term debt............................ - 1,425 300,343 - 301,768
----------- ---------- ---------- ----------- ----------
Total current liabilities................ 318,592 293,433 334,556 - 946,581
Long-term debt.............................. 313,930 503,729 3,160 - 820,819
Other liabilities........................... 43,379 54,494 16,218 - 114,091
Common stockholders' equity................. 1,569,994 1,571,404 138,191 (1,709,595) 1,569,994
----------- ---------- ---------- ----------- ----------
Total liabilities and stockholders' equity $ 2,245,895 $2,423,060 $ 492,125 $(1,709,595) $3,451,485
=========== ========== ========== =========== ==========
Condensed Consolidating Balance Sheet
December 31, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents................... $ - $ 110,571 $ 11,761 $ - $ 122,332
Accounts receivable, net.................... 9,083 52,232 447,025 - 508,340
Other current assets........................ 93,144 52,755 99,943 - 245,842
----------- ---------- ---------- ----------- ----------
Total current assets..................... 102,227 215,558 558,729 - 876,514
Property, plant and equipment, net.......... 170,494 320,244 17,881 - 508,619
Intangible assets, net ..................... 154,809 1,188,031 36,303 - 1,379,143
Intercompany receivable (payable)........... 425,735 92,378 (518,113) - -
Investment in subsidiaries.................. 1,096,647 - - (1,096,647) -
Other assets................................ 75,633 54,998 35,648 - 166,279
----------- ---------- ---------- ----------- ----------
Total assets............................. $ 2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555
=========== ========== ========== =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses....... $ 334,666 $ 290,039 $ 32,514 $ - $ 657,219
Short-term borrowings and current portion of
long-term debt............................ 21 1,040 343 - 1,404
----------- ---------- ---------- ----------- ----------
Total current liabilities................ 334,687 291,079 32,857 - 658,623
Long-term debt.............................. 310,690 502,519 7,128 - 820,337
Other liabilities........................... 44,181 57,469 13,958 - 115,608
Common stockholders' equity................. 1,335,987 1,020,142 76,505 (1,096,647) 1,335,987
----------- ---------- ---------- ----------- ----------
Total liabilities and stockholders' equity $ 2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555
=========== ========== ========== =========== ==========
17
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income.................................. $ 153,840 $ 60,323 $ 22,961 $ (83,284) $ 153,840
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization............. 22,605 37,647 3,563 - 63,815
Provision for doubtful accounts........... 2,460 15,679 92,338 - 110,477
Other, net................................ (29,804) (2,787) 15,776 83,284 66,469
Changes in operating assets and liabilities 31,859 (89,358) (119,156) - (176,655)
----------- ---------- ---------- ---------- ---------
Net cash provided by operating activities... 180,960 21,504 15,482 - 217,946
Net cash used in investing activities....... (205,897) (54,056) (1,930) (146,233) (408,116)
Net cash provided by (used in) financing
activities................................ 24,937 4,939 (18,431) 146,233 157,678
----------- ---------- ---------- ---------- ---------
Net change in cash and cash equivalents..... - (27,613) (4,879) - (32,492)
Cash and cash equivalents, beginning of year - 110,571 11,761 - 122,332
----------- ---------- ---------- ---------- ---------
Cash and cash equivalents, end of period.... $ - $ 82,958 $ 6,882 $ - $ 89,840
=========== ========== ========== ========== =========
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income.................................. $ 61,243 $ 6,337 $ 13,205 $ (19,542) $ 61,243
Extraordinary loss, net of taxes 3,880 15,567 2,162 - 21,609
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization............. 19,443 49,106 2,354 - 70,903
Provision for doubtful accounts........... 715 10,047 100,092 - 110,854
Provision for special charge.............. 5,997 - - - 5,997
Other, net................................ 27,480 30,349 (34,483) 19,542 42,888
Changes in operating assets and liabilities (101,123) (4,194) (56,542) - (161,859)
----------- ---------- ---------- ---------- ---------
Net cash provided by operating activities... 17,635 107,212 26,788 - 151,635
Net cash used in investing activities....... (23,888) (91,941) (194) (4,564) (120,587)
Net cash provided by (used in) financing
activities................................ 6,253 (14,318) (24,859) 4,564 (28,360)
----------- ---------- ---------- ---------- ---------
Net change in cash and cash equivalents..... - 953 1,735 - 2,688
Cash and cash equivalents, beginning of year - 163,863 7,614 - 171,477
----------- ---------- ---------- ---------- ---------
Cash and cash equivalents, end of period.... $ - $ 164,816 $ 9,349 $ - $ 174,165
=========== ========== ========== ========== =========
18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions and select accounting policies that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
While many operational aspects of our business are subject to complex
federal, state and local regulations, the accounting for our business is
generally straight-forward with net revenues primarily recognized upon
completion of the testing process. Our revenues are primarily comprised of a
high volume of relatively low dollar transactions, and about half of all our
costs and expenses consist of employee compensation and benefits. Due to the
nature of our business, several of our accounting policies involve significant
estimates and judgments. These accounting policies have been described in our
2001 Annual Report on Form 10-K, with the following accounting policy adopted
effective January 1, 2002:
Accounting for and recoverability of goodwill
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"). The impact of adopting SFAS 142 is
summarized in Note 2 to the interim consolidated financial statements.
Effective January 1, 2002, we evaluate the recoverability and measure the
possible impairment of our goodwill under SFAS 142. The impairment test is a
two-step process that begins with the estimation of the fair value of the
reporting unit. The first step screens for potential impairment and the second
step measures the amount of the impairment, if any. Our estimate of fair value
considers publicly available information regarding the market capitalization of
our Company, as well as (i) publicly available information regarding comparable
publicly-traded companies in the clinical laboratory testing industry, (ii) the
financial projections and future prospects of our business, including its growth
opportunities and likely operational improvements, and (iii) comparable sales
prices, if available. As part of the first step to assess potential impairment,
we compare our estimate of fair value for the Company to the book value of our
consolidated net assets. If the book value of our consolidated net assets is
greater than our estimate of fair value, we would then proceed to the second
step to measure the impairment, if any. The second step compares the implied
fair value of goodwill with its carrying value. The implied fair value is
determined by allocating the fair value of the reporting unit to all of the
assets and liabilities of that unit as if the reporting unit had been acquired
in a business combination and the fair value of the reporting unit was the
purchase price paid to acquire the reporting unit. The excess of the fair value
of the reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. If the carrying amount of the reporting unit
goodwill is greater than its implied fair value, an impairment loss will be
recognized in the amount of the excess. We believe our estimation methods are
reasonable and reflective of common valuation practices.
On a quarterly basis, we perform a review of our business to determine if
events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the Company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would perform an
impairment test of goodwill as of the end of the quarter, consistent with the
annual impairment test, and record any noted impairment loss.
Integration of Acquired Businesses
American Medical Laboratories, Incorporated
On April 1, 2002, we completed our previously announced acquisition of all
of the outstanding voting stock of American Medical Laboratories, Incorporated,
("AML"). See Note 3 to the interim consolidated financial statements for a full
discussion of this transaction.
We estimate that we will incur between $10 million and $15 million of costs
to integrate Quest Diagnostics and AML. The majority of these costs are expected
to require cash outlays and are expected to primarily relate to severance and
other integration-related costs during 2002 and 2003, including the elimination
of excess capacity and workforce reductions. Of the total costs indicated above,
estimated costs related to actions that impact the employees and operations of
AML, which will be accounted for as a cost of the AML acquisition and included
in goodwill, are expected to total between $7 million and $10 million. Of the
total costs indicated above, estimated costs related to actions that impact
Quest Diagnostics' employees
19
and operations, which will be accounted for as a charge to earnings in the
period that the integration plans are approved and communicated, are expected to
total between $3 million and $5 million. We expect to finalize and record these
costs during the third quarter of 2002. We expect that the AML integration will
result in approximately $15 million of annual synergies and that we will achieve
this annual rate of synergies by the end of 2003.
Unilab Corporation
On April 2, 2002, we entered into a definitive agreement with Unilab
Corporation ("Unilab") which provides that we will acquire all of the
outstanding shares of Unilab common stock. See Note 8 to the interim
consolidated financial statements for a full discussion of this transaction.
We estimate that we will incur up to $20 million of costs to integrate
Quest Diagnostics and Unilab. A significant portion of these costs is expected
to require cash outlays and are expected to primarily relate to severance and
other integration-related costs during 2002 and 2003, including the elimination
of excess capacity and workforce reductions. These estimates are preliminary and
will be subject to revisions as integration plans are developed and finalized.
To the extent that the costs relate to actions that impact the employees and
operations of Unilab, such costs will be accounted for as a cost of the Unilab
acquisition and included in goodwill. To the extent that the costs relate to
actions that impact Quest Diagnostics' employees and operations, such costs will
be accounted for as a charge to earnings in the period that the integration
plans are approved and communicated. We expect to finalize and record these
costs during the fourth quarter of 2002.
Results of Operations
Three and Six Months Ended June 30, 2002 Compared with Three and Six Months
Ended June 30, 2001
Reported net income for the three months ended June 30, 2002 increased to
$87 million from $25 million for the three months ended June 30, 2001. For the
six months ended June 30, 2002, reported net income increased to $154 million
from $61 million for the prior year period. Assuming the nonamortization
provisions of SFAS 142 had been in effect in 2001, net income for the three and
six months ended June 30, 2001 would have been $35 million and $79 million,
respectively. In addition, results for the three and six months ended June 30,
2001 included an extraordinary loss of $36 million ($22 million, net of tax) and
a special charge of $6.0 million ($3.6 million, net of tax), both of which were
incurred in conjunction with our debt refinancing in the second quarter of 2001.
After considering the impact of SFAS 142 and excluding the extraordinary loss
and special charge in 2001, income for the three months ended June 30, 2002
increased by $27 million, compared to the prior year period, an increase of 45%.
After considering the impact of SFAS 142 and excluding the extraordinary loss
and special charge in 2001, income for the six months ended June 30, 2002
increased by $49 million, compared to the prior year period, an increase of 47%.
These increases in earnings were primarily attributable to revenue growth,
driven by improvements in average revenue per requisition and clinical testing
volume, improved efficiencies generated from our Six Sigma and Standardization
initiatives, and a reduction in net interest expense, partially offset by
increases in employee compensation and supply costs, depreciation expense and
investments in our information technology strategy and strategic growth
opportunities.
Net Revenues
Net revenues for the three and six months ended June 30, 2002 grew by 14.7%
and 11.1%, respectively, compared to the prior year period. The acquisition of
AML, which was completed on April 1, 2002, contributed approximately 60% and 40%
to the increase in net revenues for the three and six months ended June 30,
2002. For the three and six months ended June 30, 2002, clinical testing volume,
measured by the number of requisitions, increased 12% and 7.3%, respectively,
compared to the prior year period. Assuming AML had been part of Quest
Diagnostics in 2001, clinical testing volume would have increased 3.7% and 3.5%,
respectively, on a pro forma basis, for the three and six months ended June 30,
2002, compared to the prior year period. Average revenue per requisition
increased 2.4% and 3.2%, respectively, for the three and six months ended June
30, 2002. Our drugs-of-abuse testing business continued to negatively impact
total company volume comparisons, reducing volume growth by approximately 1% for
the three and six months ended June 30, 2002. The improvement in average revenue
per requisition was primarily attributable to a continuing shift in test mix to
higher value testing, contributing more than half of the improvement in average
revenue per requisition, and a shift in payer mix to higher priced
fee-for-service reimbursement.
20
Operating Costs and Expenses
Total operating costs for the three and six months ended June 30, 2002
increased $101 million and $135 million, respectively, from the year earlier
period primarily due to increases in our clinical testing volume, largely as a
result of the AML acquisition, employee compensation and supply costs and
depreciation expense; partially offset by a reduction in bad debt expense. While
our cost structure has been favorably impacted by the synergies realized as a
result of the integration of SmithKline Beecham Clinical Laboratories, Inc.
("SBCL") and the improved efficiencies generated from our Six Sigma and
Standardization initiatives, we continue to make investments to enhance our
infrastructure to pursue our overall business strategy. These investments
include those related to:
o Skills training for all employees, which together with our competitive
pay and benefits, helps to increase employee satisfaction and
performance, which we believe will result in better service to our
customers;
o Our information technology strategy, which is designed to result in
better service to our customers; and
o Our strategic growth opportunities.
Cost of services, which includes the costs of obtaining, transporting and
testing specimens was 59.0% of net revenues for the three months ended June 30,
2002 and remained unchanged from the prior year period. For the six months ended
June 30, 2002, costs of services, as a percentage of net revenues, decreased to
58.9% from 59.4% a year ago. The positive net impact of increased average
revenue per requisition and our Six Sigma and Standardization efforts on
reducing cost of services as a percentage of net revenues was offset by the
addition of AML's cost structure as of April 1, 2002.
Selling, general and administrative expenses, which includes the costs of
the sales force, billing operations, bad debt expense and general management and
administrative support, decreased during the three months ended June 30, 2002 as
a percentage of net revenues to 25.9% from 27.5% in the prior year period. For
the six months ended June 30, 2002, selling, general and administrative expenses
decreased as a percentage of net revenues to 26.6% from 28.1% in the prior year
period. These decreases were primarily due to improvements in average revenue
per requisition, efficiencies from our Six Sigma and Standardization efforts, in
particular bad debt expense, and the addition of AML's cost structure as of
April 1, 2002. During the second quarter of 2002, bad debt expense was reduced
to 5.2% of net revenues, compared to 6.0% of net revenues a year ago. For the
six months ended June 30, 2002, bad debt expense was 5.5% of net revenues,
compared to 6.1% of net revenues in the prior year. The improvements in bad debt
expense were principally attributable to the continued progress that we have
made in our overall collection experience through process improvements, driven
by our Six Sigma and Standardization initiatives, primarily related to the
collection of diagnosis, patient and insurance information necessary to
effectively bill for services performed. Based on prior experience, as well as
the continued sharing of internal best practices in the billing functions, we
believe that additional opportunities exist to further improve our overall
collection experience.
Interest, Net
Net interest expense for the three and six months ended June 30, 2002
decreased from the prior year periods by $5.5 million and $15.6 million,
respectively. These reductions were primarily due to the favorable impact of our
debt refinancings in 2001 and a favorable interest rate environment.
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets for the three and six
months ended June 30, 2002 decreased from the prior year period by $10.1 million
and $19.0 million, respectively, principally as the result of adopting SFAS 142,
effective January 1, 2002. See Note 2 to the interim consolidated financial
statements for further details regarding the impact of SFAS 142.
Provision for Special Charge
During the second quarter of 2001, we recorded a special charge of $6.0
million in connection with the refinancing of our debt and settlement of our
interest rate swap agreements. Prior to our debt refinancing in June 2001, our
secured credit agreement required us to maintain interest rate swap agreements
to mitigate the risk of changes in interest rates associated with a portion of
our variable interest rate indebtedness. These interest rate swap agreements
were considered a hedge against changes in the amount of future cash flows
associated with the interest payments of our variable rate debt
21
obligations. Accordingly, the interest rate swap agreements were recorded at
their estimated fair value in our consolidated balance sheet and the related
losses on these contracts were deferred in shareholders' equity as a component
of comprehensive income. In conjunction with the debt refinancing, the interest
rate swap agreements were terminated and the losses which were reflected in
shareholders' equity as a component of comprehensive income were reflected as a
special charge in the consolidated statement of operations for the three and six
months ended June 30, 2001.
Minority Share of Income
Minority share of income for the three and six months ended June 30, 2002
increased from the prior year level, primarily due to the improved performance
of our consolidated joint ventures.
Other, Net
Other, net, which represents income for each of the periods presented,
increased $4.2 million and $5.1 million, for the three and six months ended June
30, 2002, respectively. The increases are primarily due to improved operating
performance at our unconsolidated joint ventures, which resulted in an increase
in equity earnings of $2.5 million and $3.9 million for the three and six months
ended June 30, 2002. The second quarter of 2001 reflects the net impact of
writing-off $7.0 million of impaired assets, partially offset by a $6.3
million gain on the sale of an investment. The remainder of the increases for
both periods is primarily due to miscellaneous real estate and investment gains
and losses in both 2002 and 2001.
Income Taxes
During 2001, our effective tax rate was significantly impacted by goodwill
amortization, the majority of which was not deductible for tax purposes, and had
the effect of increasing the overall tax rate. The reduction in the effective
tax rate for the three and six months ended June 30, 2002 was primarily due to
the reduction in amortization of goodwill (as a result of adopting SFAS 142,
effective January 1, 2002) the majority of which was not deductible for tax
purposes.
Extraordinary Loss
In conjunction with our debt refinancing in the second quarter of 2001, we
recorded an extraordinary loss of $36 million, ($22 million, net of taxes). The
loss represented the write-off of deferred financing costs of $23 million,
associated with our debt which was refinanced, and $12.8 million of payments
related primarily to the tender premium incurred in connection with our cash
tender offer of our 10 3/4% senior subordinated notes due 2006 (the
"Subordinated Notes").
EBITDA
EBITDA represents income before net interest expense, income taxes,
depreciation and amortization, and special items in 2001. The specials items
represented the extraordinary loss and the special charge associated with our
debt refinancing in the second quarter of 2001. EBITDA is presented and
discussed because management believes it is a useful adjunct to net income and
other measurements under accounting principles generally accepted in the United
States since it is a meaningful measure of a company's performance and ability
to meet its future debt service requirements, fund capital expenditures and meet
working capital requirements. EBITDA is not a measure of financial performance
under accounting principles generally accepted in the United States and should
not be considered as an alternative to (i) net income (or any other measure of
performance under accounting principles generally accepted in the United States)
as a measure of performance or (ii) cash flows from operating, investing or
financing activities as an indicator of cash flows or as a measure of liquidity.
EBITDA for the three months ended June 30, 2002 improved to $195 million,
or 18.2% of net revenues, from $149 million, or 16.0% of net revenues, in 2001.
For the six months ended June 30, 2002, EBITDA improved to $350 million, or
17.4% of net revenues, from $271 million, or 15.0% of net revenues, in 2001. The
increases in EBITDA were primarily due to revenue growth, driven by improvements
in average revenue per requisition and clinical testing volume and improved
efficiencies generated from our Six Sigma and Standardization initiatives,
partially offset by increases in employee compensation and supply costs, and
investments in our information technology strategy and strategic growth
opportunities. The improvements in EBITDA as a percentage of net revenues were
also driven by these same factors and were partially offset by the acquisition
of AML, which had EBITDA percentages lower than those of Quest Diagnostics.
22
Impact of Contingent Convertible Debentures on Earnings per Common Share
On November 26, 2001, we completed our $250 million offering of 1 3/4%
contingent convertible debentures due 2021 (the "Debentures"). Each one thousand
dollar principal amount of Debentures is convertible into 11.429 shares of our
common stock, which represents an initial conversion price of $87.50 per share.
Holders may surrender the Debentures for conversion into shares of our common
stock under any of the following circumstances: (i) if the sales price of our
common stock is above 120% of the conversion price (or $105 per share) for
specified periods; (ii) if we call the Debentures or (iii) if specified
corporate transactions have occurred. See Note 12 to the Consolidated Financial
Statements contained in our 2001 Annual Report on Form 10-K for a further
discussion of the Debentures.
The if-converted method is used in determining the dilutive effect of the
Debentures in periods when the holders of such securities are permitted to
exercise their conversion rights. As of and for the three and six months ended
June 30, 2002, the holders of our Debentures did not have the ability to
exercise their conversion rights. Had the requirements to allow the holders to
exercise their conversion rights been met and the Debentures remained
outstanding for the entire period, diluted net income per common share would
have been reduced by approximately 2% during the quarter and six months ended
June 30, 2002.
Quantitative and Qualitative Disclosures About Market Risk
We address our exposure to market risks, principally the market risk of
changes in interest rates, through a controlled program of risk management that
may include the use of derivative financial instruments. We do not hold or issue
derivative financial instruments for trading purposes. We do not believe that
our foreign exchange exposure is material to our financial position or results
of operations taken as a whole. See Note 2 to the Consolidated Financial
Statements contained in our 2001 Annual Report on Form 10-K for additional
discussion of our financial instruments and hedging activities.
At June 30, 2002 and December 31, 2001, the fair value of our debt was
estimated at approximately $1.2 billion and $857 million, respectively, using
quoted market prices and yields for the same or similar types of borrowings,
taking into account the underlying terms of the debt instruments. At June 30,
2002 and December 31, 2001, the estimated fair value exceeded the carrying value
of the debt by approximately $70 million and $35 million, respectively. An
assumed 10% increase in interest rates (representing approximately 50 basis
points) would potentially reduce the estimated fair value of our debt by
approximately $23 million and $26 million at June 30, 2002 and December 31,
2001, respectively.
Our Debentures have a contingent interest component that will require us to
pay contingent interest based on certain thresholds, as outlined in the
Indenture. The contingent interest component which is more fully described in
Note 12 to the Consolidated Financial Statements contained in our 2001 Annual
Report on Form 10-K, is considered to be a derivative instrument subject to SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities", as
amended. As such, the derivative was recorded at its fair value in the
consolidated balance sheet and was not material at June 30, 2002 and
December 31, 2001.
Borrowings under our unsecured revolving credit facility under our Credit
Agreement and our secured receivables credit facility are subject to variable
interest rates. Interest rates on our unsecured revolving credit facility are
also subject to a pricing schedule that fluctuates over an approximate range of
50 basis points, based on changes in our credit rating. As such, our borrowing
cost under these credit facilities will be subject to both fluctuations in
interest rates and changes in our credit rating. As of June 30, 2002, our
borrowing rate for LIBOR-based loans was LIBOR plus 1.3125%. At June 30, 2002
and December 31, 2001, we had approximately $307 million and $7 million,
respectively, of variable interest rate debt outstanding, which included $300
million outstanding under our secured receivables credit facility at
June 30, 2002.
Based on our net exposure to interest rate changes, an assumed 10% change
in interest rates on our variable rate indebtedness (representing approximately
20 basis points) would impact net interest expense by approximately $0.6 million
on an annual basis, assuming no changes to the debt outstanding at June
30, 2002.
23
Liquidity and Capital Resources
Cash and Cash Equivalents
Cash and cash equivalents at June 30, 2002 totaled $90 million, a decrease
of $32 million from December 31, 2001. Cash flows from operating activities in
2002 provided cash of $218 million, which along with cash flows from financing
activities of $158 million, were used to fund investing activities, which
required cash of $408 million. Cash and cash equivalents at June 30, 2001
totaled $174 million, an increase of $2.7 million from December 31, 2000. Cash
flows from operating activities in 2001 provided cash of $152 million, which was
used to fund investing and financing activities, which required cash of $149
million.
Cash From Operating Activities
Net cash from operating activities for 2002 was $66 million higher than the
2001 level. This increase was primarily due to improved operating performance.
Days sales outstanding, a measure of billing and collection efficiency, was 52
days at both June 30, 2002 and March 31, 2002, compared to 54 days at December
31, 2001.
Cash From Investing Activities
Net cash used in investing activities in 2002 was $408 million, consisting
primarily of acquisition and related costs of $334 million, primarily to acquire
the outstanding voting stock of AML, and capital expenditures of $83 million.
Net cash used in investing activities in 2001 was $121 million, consisting
primarily of capital expenditures of $78 million, acquisition and related costs
of $56 million, including $47 million to acquire the assets of Clinical
Laboratories of Colorado, Inc., and $21 million in proceeds from the disposition
of assets, principally related to the sale of an investment in the second
quarter of 2001.
Cash From Financing Activities
Net cash provided by financing activities in 2002 was $158 million,
consisting primarily of the net cash activity associated with our acquisition of
AML and proceeds from the exercise of stock options. AML's all-cash purchase
price of approximately $335 million and related transaction costs, together with
the repayment of approximately $150 million of acquired AML debt and accrued
interest was financed by us with cash on-hand and $300 million of borrowings
under our existing secured receivables credit facility and $175 million of
borrowings under our existing unsecured revolving credit facility. During the
second quarter of 2002, we repaid all of the $175 million borrowed under our
unsecured revolving credit facility.
Net cash used in financing activities for 2001 was $28 million, consisting
primarily of the net cash activity associated with our debt refinancing in the
second quarter of 2001, partially offset by proceeds from the exercise of stock
options. During the second quarter of 2001, we refinanced the majority of our
long-term debt. The gross proceeds of $722 million from our senior notes
offering and the new term loan under our unsecured credit agreement, together
with cash on-hand, was used to repay the entire outstanding principal under our
then existing secured credit agreement and to consummate the cash tender offer
and consent solicitation for our Subordinated Notes. Of the $734 million in debt
repayments for the six months ended June 30, 2001, $584 million related to the
repayment of the entire outstanding principal under our then existing secured
credit agreement and $147 million represented the aggregate principal amount of
outstanding Subordinated Notes which were tendered. During the remainder of
2001, we redeemed all of the remaining $3 million of our outstanding
Subordinated Notes. During 2001, we incurred approximately $30 million of costs
associated with the debt refinancing. Of that amount, $24 million was included
in financing activities and principally represented $11 million of costs
associated with placing the new debt, and a $13 million tender premium incurred
in conjunction with our cash tender offer of the Subordinated Notes, which was
included in the extraordinary loss recorded in the second quarter of 2001. The
remaining $6 million was reflected in cash from operations and represented the
cost to settle the interest rate swap agreements on the debt which was
refinanced.
Dividend Policy
We have never declared or paid cash dividends on our common stock and do
not anticipate paying dividends on our common stock in the foreseeable future.
We currently intend to retain all available funds and any future earnings to
retire debt and fund the growth of our business.
24
Contractual Obligations and Commitments
A full description of the terms of our indebtedness, related debt service
requirements and our future payments under certain of our contractual
obligations is contained in Note 12 to the Consolidated Financial Statements in
our 2001 Annual Report on Form 10-K. A full discussion and analysis regarding
our minimum rental commitments under noncancelable operating leases,
noncancelable commitments to purchase products or services, and reserves with
respect to insurance claims is contained in Note 17 to the Consolidated
Financial Statements in our 2001 Annual Report on Form 10-K. See Note 6 to the
interim consolidated financial statements for information regarding the status
of billing-related claims. See Note 3 to the interim consolidated financial
statements for a full discussion and analysis regarding our acquisition of AML.
As more fully described in Note 12 to the Consolidated Financial Statements
in our 2001 Annual Report on Form 10-K, the borrowings outstanding under our
secured receivables credit facility are classified as a current liability.
However, it is our current intention to roll-over this facility annually, as we
have done since 2001. If we are not able to roll-over all or a part of this
facility, we will need to refinance the secured receivables credit facility with
cash on-hand, our unsecured revolving credit facility or a new financing
agreement.
Our Credit Agreement relating to our unsecured revolving credit facility
contains various covenants and conditions, including the maintenance of certain
financial ratios, that could impact our ability to, among other things, incur
additional indebtedness, repurchase shares of our outstanding common stock, make
additional investments and consummate acquisitions. We do not expect these
covenants to adversely impact our ability to execute our growth strategy or
conduct normal business operations.
On April 2, 2002, we entered into a definitive agreement with Unilab
to acquire all of the outstanding shares of Unilab common stock and assume
Unilab's debt of approximately $200 million. See Note 8 to the interim
consolidated financial statements for a full discussion and analysis regarding
the transaction.
Unconsolidated Joint Ventures
At June 30, 2002 and December 31, 2001, we had investments in
unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and
Dayton, Ohio. At June 30, 2002, as a result of the AML acquisition, we also
had an investment in an unconsolidated joint venture in Chesapeake, Virginia.
Our investments in unconsolidated joint ventures are accounted for under the
equity method of accounting. We believe that our transactions with our joint
ventures are conducted at arm's length, reflecting current market conditions and
pricing. Total annual net revenues of our unconsolidated joint ventures, on a
combined basis, are less than 6% of our consolidated net revenues. As of
June 30, 2002 and December 31, 2001, total assets associated with our
unconsolidated joint ventures are less than 3% of our consolidated total assets.
We have no material obligations or guarantees to, or in support of, our
unconsolidated joint ventures and their operations.
Requirements and Capital Resources
We estimate that we will invest approximately $160 million to $170 million
during 2002 for capital expenditures, principally related to investments in
information technology, equipment, and facility upgrades and expansions. Other
than the reduction for outstanding letters of credit under our unsecured
revolving credit facility, which approximated $33 million at July 25, 2002, all
of our $325 million unsecured revolving credit facility remains available to us
for future borrowing.
We believe that cash from operations and our borrowing capacity under our
revolving credit facilities, together with the indemnification by SmithKline
Beecham plc against monetary fines, penalties or losses from outstanding
government and other related claims, will provide sufficient financial
flexibility to meet seasonal working capital requirements and to fund capital
expenditures, debt service requirements and additional growth opportunities for
the foreseeable future. Improvements in our industry and in particular our
financial performance have resulted in improvements to our credit ratings from
both Standard & Poor's and Moody's Investor Services. Our investment grade
credit ratings have had a favorable impact on our cost of and access to capital.
We believe that our improved financial performance should provide us with access
to additional financing, if necessary, to fund growth opportunities which cannot
be funded from existing sources.
As discussed above in "Contractual Obligations and Commitments", on April
2, 2002, we entered into a definitive agreement with Unilab to acquire all of
the outstanding shares of Unilab common stock and assume Unilab's debt of
approximately $200 million. We have obtained a commitment, which is contingent
upon the completion of the Unilab acquisition, for a $450 million five-year
amortizing term loan to be used to finance the transaction. See Note 8 to the
interim consolidated financial statements for a full discussion and analysis
regarding the transaction.
25
Impact of New Accounting Standards
In August 2001, the FASB issued SFAS No. 144 "Accounting for Impairment or
Disposal of Long-Lived Assets". In April 2002, the FASB issued SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections". In July 2002, the FASB issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities".
The impact of the above referenced accounting standards is discussed in
Note 1 to the interim consolidated financial statements.
Forward Looking Statements
Some statements and disclosures in this document are forward-looking
statements. Forward-looking statements include all statements that do not relate
solely to historical or current facts and can be identified by the use of words
such as "may", "believe", "will", "expect", "project", "estimate", "anticipate",
"plan" or "continue". These forward-looking statements are based on our current
plans and expectations and are subject to a number of risks and uncertainties
that could significantly cause our plans and expectations, including actual
results, to differ materially from the forward-looking statements. The Private
Securities Litigation Reform Act of 1995 provides a "safe harbor" for
forward-looking statements to encourage companies to provide prospective
information about their companies without fear of litigation.
We would like to take advantage of the "safe harbor" provisions of the
Litigation Reform Act in connection with the forward-looking statements included
in this document. The risks and other factors that could cause our actual
financial results to differ materially from those projected, forecasted or
estimated by us in forward-looking statements are detailed in our 2001 Annual
Report on Form 10-K.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note 6 to the interim consolidated financial statements for information
regarding the status of government investigations and private claims, including
those related to SBCL.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of stockholders of the Company was held on May 7,
2002. At the meeting the matters described below were approved by the
stockholders.
(b-c) The following nominees for the office of director were elected for
terms expiring at the 2005 annual meeting of stockholders, with the following
number of votes for and withheld:
For Withheld
William F. Buehler 89,212,102 576,729
Van C. Campbell 88,573,611 1,215,220
Rosanne Haggerty 89,189,648 599,183
Dan C. Stanzione 88,715,994 1,072,837
The following persons continue as directors:
Kenneth D. Brody
Mary A. Cirillo
Kenneth W. Freeman
William R. Grant
Gail R. Wilensky
John B. Ziegler
The appointment of PricewaterhouseCoopers LLP as independent accountants to
audit the financial statements of the Company and its subsidiaries for the
fiscal year ending December 31, 2002, was approved, with the following number of
votes for, against, and abstained:
For: 86,776,549 Against: 2,893,155 Abstained: 119,127
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
2.1 Agreement and Plan of Merger, dated as of April 2, 2002,
among the Company, Quest Diagnostics Newco Incorporated and
Unilab Corporation (incorporated by reference to Exhibit 2.1
to the current report on Form 8-K (Date of Report: April 2,
2002)).
2.2 Amendment to the Agreement and Plan of Merger, dated as of
May 13, 2002 among the Company, Quest Diagnostics Newco
Incorporated and Unilab Corporation (incorporated by
reference to Annex to the prospectus forming a part of the
Company's registration statement on Form S-4 (No.
333-88330)).
2.3 Amendment No. 2 to the Agreement and Plan of Merger, dated
as of June 20, 2002 among the Company, Quest Diagnostics
Newco Incorporated and Unilab Corporation (incorporated by
reference to Annex to the prospectus forming a part of the
Company's registration statement on Form S-4 (No.
333-88330)).
27
10.1 Term Loan Credit Agreement dated as of June 21, 2002 among
Quest Diagnostics Incorporated, certain subsidiary
guarantors of the Company, the lenders party thereto, and
Bank of America, N.A., as Administrative Agent (incorporated
by reference to Exhibit 99.12 of the Company's Registration
Statement on Form S-4 (No. 333-88330)).
10.2 Amendment No. 3 to the Amended and Restated Credit and
Security Agreement dated as of July 24, 2002 among Quest
Diagnostics Receivables Inc., as Borrower, the Company, as
Initial Servicer, each of the lenders party thereto and
Wachovia Bank, National Association, as Administrative
Agent.
10.3 The Quest Diagnostics Incorporated 1996
Employee Equity Participation Program, as amended.
10.4 The Quest Diagnostics Incorporated 1999
Employee Equity Participation Program, as amended.
(b) Reports on Form 8-K:
On April 12, 2002, the Company filed a current report on Form 8-K
(Date of Report: April 1, 2002) reporting under Item 5 on the
acquisition of American Medical Laboratories, Incorporated and the
guarantee of certain indebtedness of the Company by certain of the
Company's subsidiaries.
On April 2, 2002, the Company filed a current report on Form 8-K (Date
of Report: April 2, 2002) reporting under Item 5 on the execution of a
definitive agreement and plan of merger with Unilab Corporation and
the execution of a stockholders agreement with certain stockholders of
Unilab Corporation.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
August 12, 2002
Quest Diagnostics Incorporated
By /s/ Kenneth W. Freeman
----------------------------
Kenneth W. Freeman Chairman of the Board and
Chief Executive Officer
By /s/Robert A. Hagemann
----------------------------
Robert A. Hagemann Vice President and
Chief Financial Officer
29