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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 March 31, 2004
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 [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_]
As of April 23, 2004, there were outstanding 103,467,426 shares of the
registrant's common stock, $.01 par value.
PART I - FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Index to consolidated financial statements filed as part of this report:
Consolidated Statements of Operations for the
Three Months Ended March 31, 2004 and 2003 2
Consolidated Balance Sheets as of
March 31, 2004 and December 31, 2003 3
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2004 and 2003 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 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" 22
Item 4. Controls and Procedures
Controls and Procedures 22
1
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(in thousands, except per share data)
(unaudited)
Three Months Ended
March 31,
-----------------------
2004 2003
---------- ----------
Net revenues ........................................... $1,255,742 $1,092,797
---------- ----------
Operating costs and expenses:
Cost of services ....................................... 737,281 648,097
Selling, general and administrative .................... 307,545 279,199
Amortization of intangible assets ...................... 2,064 2,023
Other operating (income) expense, net .................. (27) 223
---------- ----------
Total operating costs and expenses .................. 1,046,863 929,542
---------- ----------
Operating income ....................................... 208,879 163,255
Other income (expense):
Interest expense, net .................................. (14,644) (13,909)
Minority share of income ............................... (4,454) (3,803)
Equity earnings in unconsolidated joint ventures ....... 4,557 4,056
Other income (expense), net ............................ 1,199 (805)
---------- ----------
Total non-operating expenses, net ................... (13,342) (14,461)
---------- ----------
Income before taxes .................................... 195,537 148,794
Income tax expense ..................................... 79,388 60,758
---------- ----------
Net income ............................................. $ 116,149 $ 88,036
========== ==========
Basic earnings per common share:
Net income ............................................. $ 1.13 $ 0.88
Weighted average common shares outstanding - basic ..... 103,142 100,037
Diluted earnings per common share:
Net income ............................................. $ 1.10 $ 0.86
Weighted average common shares outstanding - diluted ... 105,742 102,455
The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2004 AND DECEMBER 31, 2003
(in thousands, except per share data)
(unaudited)
March 31, December 31,
2004 2003
---------- ------------
Assets
Current assets:
Cash and cash equivalents................................................ $ 190,075 $ 154,958
Accounts receivable, net of allowance of $207,210 and $211,739 at
March 31, 2004 and December 31, 2003, respectively.................... 650,511 609,187
Inventories.............................................................. 72,625 72,484
Deferred income taxes.................................................... 98,114 108,975
Prepaid expenses and other current assets................................ 62,296 50,182
---------- ----------
Total current assets.................................................. 1,073,621 995,786
Property, plant and equipment, net....................................... 609,765 607,305
Goodwill, net............................................................ 2,517,338 2,518,875
Intangible assets, net................................................... 15,013 16,978
Deferred income taxes.................................................... 50,829 49,635
Other assets............................................................. 113,491 112,839
---------- ----------
Total assets............................................................. $4,380,057 $4,301,418
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses.................................... $ 617,399 $ 649,850
Short-term borrowings and current portion of long-term debt.............. 44,597 73,950
---------- ----------
Total current liabilities............................................. 661,996 723,800
Long-term debt........................................................... 1,057,749 1,028,707
Other liabilities........................................................ 155,857 154,217
Commitments and contingencies
Common stockholders' equity:
Common stock, par value $0.01 per share; 300,000 shares authorized;
106,819 and 106,804 shares issued at March 31, 2004 and December
31, 2003, respectively................................................ 1,068 1,068
Additional paid-in capital............................................... 2,252,801 2,267,014
Retained earnings ...................................................... 481,151 380,559
Unearned compensation.................................................... (1,798) (2,346)
Accumulated other comprehensive income................................... 3,549 5,947
Treasury stock, at cost; 3,453 and 3,990 shares at March 31, 2004 and
December 31, 2003, respectively....................................... (232,316) (257,548)
---------- ----------
Total common stockholders' equity..................................... 2,504,455 2,394,694
---------- ----------
Total liabilities and stockholders' equity............................... $4,380,057 $4,301,418
========== ==========
The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(in thousands)
(unaudited)
2004 2003
-------- ---------
Cash flows from operating activities:
Net income.............................................................. $116,149 $ 88,036
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization........................................... 41,070 36,701
Provision for doubtful accounts......................................... 56,626 54,629
Deferred income tax provision........................................... 11,419 10,046
Minority share of income................................................ 4,454 3,803
Stock compensation expense.............................................. 548 1,536
Tax benefits associated with stock-based compensation plans............. 24,447 5,637
Other, net.............................................................. (1,080) (1,027)
Changes in operating assets and liabilities:
Accounts receivable.................................................. (97,950) (84,316)
Accounts payable and accrued expenses................................ (63,895) (96,236)
Integration, settlement and other special charges.................... (13,975) (4,898)
Income taxes payable................................................. 41,544 40,038
Other assets and liabilities, net.................................... (8,666) 4,352
-------- ---------
Net cash provided by operating activities............................... 110,691 58,301
-------- ---------
Cash flows from investing activities:
Business acquisitions, net of cash acquired............................. -- (236,396)
Capital expenditures.................................................... (45,137) (37,481)
Increase in investments and other assets................................ (3,614) (2,628)
Proceeds from disposition of assets..................................... 3,293 9
-------- ---------
Net cash used in investing activities................................... (45,458) (276,496)
-------- ---------
Cash flows from financing activities:
Proceeds from borrowings................................................ 75,000 450,000
Repayments of debt...................................................... (75,359) (268,987)
Purchases of treasury stock............................................. (44,871) --
Exercise of stock options............................................... 34,483 2,799
Dividends paid.......................................................... (15,429) --
Distributions to minority partners...................................... (3,940) (3,002)
Financing costs paid.................................................... -- (4,224)
Other .................................................................. -- 429
-------- ---------
Net cash (used in) provided by financing activities..................... (30,116) 177,015
-------- ---------
Net change in cash and cash equivalents................................. 35,117 (41,180)
Cash and cash equivalents, beginning of period.......................... 154,958 96,777
-------- ---------
Cash and cash equivalents, end of period................................ $190,075 $ 55,597
======== =========
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 commercial
clinical laboratories. Quest Diagnostics is the leading provider of esoteric
testing, including gene-based testing, and testing for drugs of abuse. The
Company is also a leading provider of anatomic pathology services and testing to
support clinical trials of new pharmaceuticals worldwide. 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.
On an annualized basis, Quest Diagnostics processes over 130 million
requisitions for testing 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 2003 Annual Report on Form 10-K.
Certain amounts reported in the Company's consolidated statements of operations
for the three months ended March 31, 2003 have been reclassified to conform to
the 2004 presentation, which reports operating income on the face of the
consolidated statements of operations.
Earnings Per Share
Basic earnings per common share is calculated by dividing net income by the
weighted average common shares outstanding. Diluted earnings per common share is
calculated by dividing net income by the weighted average 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 Employee Equity
Participation Program. These dilutive securities increased the weighted average
common shares outstanding by 2.6 million shares and 2.4 million shares for the
three months ended March 31, 2004 and 2003, respectively.
Stock-Based Compensation
The Company has chosen to adopt the disclosure only provisions of Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
Statement No. 123" ("SFAS 148"), and continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), and related interpretations. 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 $0.5 million and $1.5 million for the three months ended March
31, 2004 and 2003, respectively.
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
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
granted for stock purchases under the Company's ESPP, consistent with the method
prescribed by SFAS 123, as amended by SFAS 148:
Three Months Ended
March 31,
-------------------
2004 2003
-------- --------
Net income:
Net income, as reported ..................... $116,149 $ 88,036
Add: Stock-based compensation under APB 25... 548 1,536
Deduct: Total stock-based compensation
expense determined under fair value
method for all awards, net of related tax
effects .................................. (10,962) (14,805)
-------- --------
Pro forma net income ........................ $105,735 $ 74,767
======== ========
Earnings per common share:
Basic - as reported ......................... $ 1.13 $ 0.88
-------- --------
Basic - pro forma ........................... $ 1.03 $ 0.75
-------- --------
Diluted - as reported ....................... $ 1.10 $ 0.86
-------- --------
Diluted - pro forma ......................... $ 1.01 $ 0.74
-------- --------
The fair value of each option grant was estimated on the date of grant
currently calculated using the Black-Scholes option-pricing model with the
following weighted average assumptions:
Three Months Ended
March 31,
------------------
2004 2003
-------- -------
Dividend yield.............................. 0.7% 0.0%
Risk-free interest rate..................... 3.0% 2.9%
Expected volatility......................... 47.3% 48.1%
Expected holding period, in years........... 5 5
New Accounting Standard
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised in December 2003 ("FIN 46"). FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. Historically, entities generally were not consolidated unless
the entity was controlled through voting interests. FIN 46 also requires
disclosures about variable interest entities that a company is not required to
consolidate but in which it has a significant variable interest. The adoption
of FIN 46 did not have an impact on the Company's consolidated financial
statements.
2. BUSINESS ACQUISITION
On February 28, 2003, the Company completed the acquisition of Unilab
Corporation ("Unilab"), the leading commercial clinical laboratory in
California. In connection with the acquisition of Unilab, the Company entered
into an agreement to sell to Laboratory Corporation of America Holdings, Inc.,
certain assets in northern California (the "Divestiture"). During the fourth
quarter of 2003, the Company finalized its plan related to the integration of
Unilab into the Company's laboratory network. As part of the plan, and following
the Divestiture, the Company closed its previously owned clinical laboratory in
the San Francisco Bay area and completed the integration of remaining customers
in the northern California area to Unilab's laboratories in San Jose and
Sacramento. The Company currently operates two laboratories in the Los Angeles
metropolitan area. The Company plans to open a new regional laboratory in the
Los Angeles metropolitan area
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
and then integrate its business in the Los Angeles metropolitan area into the
new facility. As of March 31, 2004 and December 31, 2003, accruals related to
the Unilab integration plan totaled approximately $6 million and $7 million,
respectively. While the majority of the accrued costs at March 31, 2004 are
expected to be paid during the remainder of 2004, there are certain severance
costs that have payment terms extending into 2005.
The following unaudited pro forma combined financial information for the
three months ended March 31, 2003, assumes that the acquisition of Unilab and
the related Divestiture were completed on January 1, 2003 (in thousands, except
per share data):
Three Months Ended
March 31, 2003
------------------
Pro forma
------------------
Net revenues .............................................. $1,163,023
Net income ................................................ 96,715
Basic earnings per common share:
Net income ................................................ $ 0.92
Weighted average common shares outstanding - basic ........ 104,583
Diluted earnings per common share:
Net income ................................................ $ 0.90
Weighted average common shares outstanding - diluted ...... 107,036
The unaudited pro forma combined financial information presented above
reflects certain reclassifications to the historical financial statements of
Unilab to conform the acquired company's accounting policies and classification
of certain costs and expenses to that of Quest Diagnostics. These adjustments
had no impact on pro forma net income. Pro forma results for the three months
ended March 31, 2003 exclude $14.5 million of direct transaction costs, which
were incurred and expensed by Unilab immediately prior to the closing of the
Unilab acquisition.
3. GOODWILL AND INTANGIBLE ASSETS
Goodwill at March 31, 2004 and December 31, 2003 consisted of the
following:
March 31, December 31,
2004 2003
---------- ------------
Goodwill ........................................... $2,705,391 $2,706,928
Less: accumulated amortization ..................... (188,053) (188,053)
---------- ----------
Goodwill, net ...................................... $2,517,338 $2,518,875
========== ==========
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The changes in the gross carrying amount of goodwill for the period ended
March 31, 2004 and for the year ended December 31, 2003 are as follows:
March 31, December 31,
2004 2003
---------- ------------
Balance at beginning of period...................... $2,706,928 $1,976,903
Goodwill acquired during the period................. -- 730,025
Other............................................... (1,537) --
---------- ----------
Balance at end of period............................ $2,705,391 $2,706,928
========== ==========
Intangible assets at March 31, 2004 and December 31, 2003 consisted of the
following:
Weighted March 31, 2004 December 31, 2003
Average -------------------------------- --------------------------------
Amortization Accumulated Accumulated
Period Cost Amortization Net Cost Amortization Net
------------ ------- ------------ ------- ------- ------------ -------
Non-compete agreements.... 5 years $44,942 $(39,381) $ 5,561 $44,942 $(37,947) $ 6,995
Customer lists............ 15 years 42,225 (36,023) 6,202 42,225 (35,568) 6,657
Other..................... 10 years 5,895 (2,645) 3,250 5,895 (2,569) 3,326
------- -------- ------- ------ -------- -------
Total.................. 10 years $93,062 $(78,049) $15,013 $93,062 $(76,084) $16,978
======= ======== ======= ======= ======== =======
Amortization expense related to intangible assets was $2,064 and $2,023 for
the three months ended March 31, 2004 and 2003, respectively.
The estimated amortization expense related to intangible assets for each of
the five succeeding fiscal years and thereafter as of March 31, 2004 is as
follows:
Fiscal Year Ending
December 31,
- ----------------------
Remainder of 2004......... $ 4,404
2005...................... 3,168
2006...................... 1,891
2007...................... 1,057
2008...................... 867
2009...................... 769
Thereafter................ 2,857
-------
Total.................. $15,013
=======
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
4. DEBT
Term Loan due December 2008
On December 19, 2003, the Company entered into a new $75 million amortizing
term loan facility (the "term loan due December 2008"), which was funded on
January 12, 2004 and the proceeds of which were used to repay $75 million of
outstanding principal under the Company's term loan due June 2007. Interest is
based on LIBOR plus an applicable margin that can fluctuate over a range of up
to 119 basis points, based on changes in the Company's public debt rating. As of
March 31, 2004, the Company's borrowing rate for LIBOR-based loans was LIBOR
plus 0.55%. The term loan due December 2008 requires principal repayments of the
initial amount borrowed equal to 20% on each of the third and fourth anniversary
dates of the funding and the remainder of the outstanding balance on December
31, 2008. The term loan due December 2008 is guaranteed by the Company's wholly
owned subsidiaries that operate clinical laboratories in the United States
(the "Subsidiary Guarantors").
2004 Debt Refinancings
On April 20, 2004, the Company entered into a new $500 million senior
unsecured revolving credit facility to replace its existing $325 million
unsecured revolving credit facility. Under the new $500 million senior unsecured
revolving credit facility (the "Credit Facility"), which matures in April 2009,
interest is based on certain published rates plus an applicable margin that will
vary over an approximate range of 90 basis points based on changes in the
Company's credit ratings. At the option of the Company, it may elect to enter
into LIBOR-based interest rate contracts for periods up to 180 days. Interest on
any outstanding amounts not covered under the LIBOR-based interest rate
contracts is based on an alternate base rate, which is calculated by reference
to the prime rate or federal funds rate. As of April 30, 2004, the Company's
borrowing rate for LIBOR-based loans was LIBOR plus 0.625%. The Credit Facility
is guaranteed by the Subsidiary Guarantors. The Credit Facility contains various
covenants, including the maintenance of certain financial ratios, which could
impact the Company's ability to, among other things, incur additional
indebtedness.
In addition, on April 20, 2004, the Company entered into a new $300 million
receivables securitization facility to replace its existing $250 million
receivables securitization facility which matured in April 2004. The new $300
million receivables securitization facility (the "secured receivables credit
facility") matures in April 2007. Interest on the $300 million secured
receivables credit facility is based on rates that are intended to approximate
commercial paper rates for highly rated issuers. The secured receivables credit
facility is supported by one-year back-up facilities provided by two banks on a
committed basis. Borrowings outstanding under the secured receivables credit
facility, if any, are classified as a current liability on our consolidated
balance sheet since the lenders fund the borrowings through the issuance of
commercial paper which matures at various dates within one year from the date of
issuance and the term of the one-year back-up facilities described above.
On April 30, 2004, the Company repaid the remaining $230 million of
principal outstanding under its term loan due June 2007 with $100 million of
borrowings under its new $500 million unsecured revolving credit facility and
$130 million of borrowings under its new $300 million secured receivables credit
facility.
In conjunction with the debt refinancings outlined above, the Company is
expected to record a charge to earnings of approximately $3 million in the
second quarter of 2004, representing the write-off of deferred financing costs
associated with the Company's debt and credit facilities which were refinanced.
9
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
5. COMMITMENTS AND CONTINGENCIES
The Company has standby letters of credit issued under its $68 million
letter of credit lines to ensure its performance or payment to third parties,
which amounted to $61 million at March 31, 2004. The letters of credit, which
are renewed annually, primarily represent collateral for current and future
automobile liability and workers' compensation loss payments.
The Company has entered into several settlement agreements with various
government and private payers during recent years relating to industry-wide
billing and marketing practices that had been substantially discontinued by the
mid-1990s. The Company is aware of certain pending lawsuits filed under the qui
tam provisions of the civil False Claims Act. Some of the proceedings against
the Company involve claims that are substantial in amount.
Although management believes that established reserves for billing-related
claims are sufficient, including qui tam cases of which management is aware, 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 position. However, the Company
understands that there may be pending qui tam claims brought by former employees
or other "whistle blowers" as to which it has not been provided with a copy of
the complaint and accordingly cannot determine the extent of any potential
liability.
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. 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 proceedings or claims are resolved.
As a general matter, providers of clinical laboratory testing services may
be subject to lawsuits alleging negligence or other similar legal claims. These
suits could involve claims for substantial damages. Any professional liability
litigation could also have an adverse impact on the Company's client base and
reputation. The Company maintains various liability insurance programs for
claims that could result from providing or failing to provide clinical
laboratory testing services, including inaccurate testing results and other
exposures. The Company's insurance coverage limits its maximum exposure on
individual claims; however, the Company is essentially self-insured for a
significant portion of these claims. The basis for claims reserves incorporates
actuarially determined losses based upon the Company's historical and projected
loss experience. Management believes that present insurance coverage and
reserves are sufficient to cover currently estimated exposures. Although
management cannot predict the outcome of any claims made against the Company,
management does not anticipate that the ultimate outcome of any such 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.
10
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
6. STOCKHOLDERS' EQUITY
Changes in stockholders' equity for the three months ended March 31, 2004
were as follows:
Accumulated
Shares of Other
Common Additional Compre- Treasury Compre-
Stock Common Paid-In Retained Unearned hensive Stock, hensive
Outstanding Stock Capital Earnings Compensation Income at Cost Income
----------- ------ ---------- -------- ------------ ----------- --------- --------
Balance,
December 31, 2003.......... 102,814 $1,068 $2,267,014 $380,559 $(2,346) $ 5,947 $(257,548)
Net income.................... 116,149 $116,149
Other comprehensive
loss....................... (2,398) (2,398)
--------
Comprehensive income....... $113,751
========
Dividend declared ............ (15,557)
Issuance of common stock
under benefit plans........ 49 1 3,065
Exercise of stock options..... 1,124 (35,620) 70,103
Shares to cover employee
payroll tax withholdings
on stock issued under
benefit plans.............. (74) (1) (6,105)
Tax benefits associated
with stock-based
compensation plans ........ 24,447
Amortization of unearned
compensation............... 548
Purchases of treasury stock... (547) (44,871)
------- ------ ---------- -------- ------- ------ ---------
Balance,
March 31, 2004............. 103,366 $1,068 $2,252,801 $481,151 $(1,798) $3,549 $(232,316)
======= ====== ========== ======== ======= ====== =========
In 2003, the Company's Board of Directors authorized a share repurchase
program, which permits the Company to purchase up to $600 million of its common
stock. For the quarter ended March 31, 2004, the Company repurchased 0.5 million
shares of its common stock at an average price of $81.97 per share for a total
of $45 million. Since the inception of the share repurchase program, the Company
has repurchased approximately 4.5 million shares of its common stock at an
average price of $66.64 per share for a total of $303 million. For the quarter
ended March 31, 2004, the Company reissued 1.0 million of these shares held in
treasury in connection with employee benefit plans. At March 31, 2004, $297
million of the share repurchase authorization remains available.
During the first quarter of 2004, the Company's Board of Directors declared
a quarterly cash dividend of $0.15 per common share payable on April 21, 2004 to
shareholders of record on April 7, 2004.
11
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Changes in stockholders' equity for the three months ended March 31, 2003
were as follows:
Accumulated
Shares of Retained Other
Common Additional Earnings Compre- Compre-
Stock Common Paid-In (Accumulated Unearned hensive hensive
Outstanding Stock Capital Deficit) Compensation Income (Loss) Income
----------- ------ ---------- ------------ ------------ ------------- -------
Balance,
December 31, 2002.......... 97,963 $ 980 $1,817,511 $(40,772) $(3,332) $(5,524)
Net income.................... 88,036 $88,036
Other comprehensive income.... 744 744
-------
Comprehensive income....... $88,780
=======
Shares issued to acquire
Unilab..................... 7,055 71 372,393
Fair value of Unilab
converted options.......... 8,452
Issuance of common stock
under benefit plans........ 205 2 8,095 (5,041)
Exercise of stock options..... 197 2 2,797
Shares to cover employee
payroll tax withholdings
on stock issued under
benefit plans.............. (163) (2) (8,661)
Tax benefits associated with
stock-based compensation
plans...................... 5,637
Amortization of unearned
compensation............... 1,687
------- ------ ---------- -------- ------- -------
Balance,
March 31, 2003............. 105,257 $1,053 $2,206,224 $ 47,264 $(6,686) $(4,780)
======= ====== ========== ======== ======= =======
7. SUPPLEMENTAL CASH FLOW & OTHER DATA
Three Months Ended
March 31,
-------- --------
2004 2003
-------- --------
Depreciation expense........................................ $ 39,006 $ 34,678
Interest expense............................................ (15,050) (14,185)
Interest income............................................. 406 276
-------- --------
Interest expense, net....................................... (14,644) (13,909)
Interest paid............................................... 21,903 27,111
Income taxes paid........................................... 3,571 7,198
Businesses acquired:
Fair value of assets acquired............................... $ -- $972,764
Fair value of liabilities assumed........................... -- 275,349
Non-cash financing activities:
Fair value of common stock issued to acquire Unilab......... $ -- $372,464
Fair value of converted options issued in conjunction with
the Unilab acquisition................................... -- 8,452
12
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
8. 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 due 2021 are guaranteed by 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 receivables securitization, the Company formed a
new wholly owned non-guarantor subsidiary, Quest Diagnostics Receivables
Incorporated ("QDRI"). Through March 31, 2004, the Company and the Subsidiary
Guarantors, with the exception of American Medical Laboratories, Incorporated
("AML") and Unilab, 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. In
conjunction with the Company's new $300 million secured receivables credit
facility in April 2004, effective in the second quarter of 2004, the Company and
the Subsidiary Guarantors, including AML and Unilab, will transfer all private
domestic receivables 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 February 28, 2003, Quest Diagnostics
acquired Unilab, which has been included in the accompanying condensed
consolidating financial data, subsequent to the closing of the acquisition, as a
Subsidiary Guarantor.
13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2004
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
-------- ---------- ------------- ------------ ------------
Net revenues................................. $200,225 $992,321 $121,658 $(58,462) $1,255,742
Operating costs and expenses:
Cost of services ......................... 120,820 573,835 42,626 -- 737,281
Selling, general and administrative ...... 27,916 225,625 58,335 (4,331) 307,545
Amortization of intangible assets ........ 523 1,532 9 -- 2,064
Royalty (income) expense ................. (80,999) 80,999 -- -- --
Other operating (income) expense, net .... (736) 19 690 -- (27)
-------- -------- -------- -------- ----------
Total operating costs and expenses .... 67,524 882,010 101,660 (4,331) 1,046,863
-------- -------- -------- -------- ----------
Operating income ............................ 132,701 110,311 19,998 (54,131) 208,879
Non-operating expenses, net ................. (14,696) (51,719) (1,058) 54,131 (13,342)
-------- -------- -------- -------- ----------
Income before taxes ......................... 118,005 58,592 18,940 -- 195,537
Income tax expense .......................... 49,705 23,437 6,246 -- 79,388
-------- -------- -------- -------- ----------
Income before equity earnings ............... 68,300 35,155 12,694 -- 116,149
Equity earnings from subsidiaries ........... 47,849 -- -- (47,849) --
-------- -------- -------- -------- ----------
Net income .................................. $116,149 $ 35,155 $ 12,694 $(47,849) $ 116,149
======== ======== ======== ======== ==========
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2003
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
-------- ---------- ------------- ------------ ------------
Net revenues ................................ $191,631 $849,370 $112,980 $(61,184) $1,092,797
Operating costs and expenses:
Cost of services ......................... 115,506 495,786 36,805 -- 648,097
Selling, general and administrative ...... 19,227 207,039 56,757 (3,824) 279,199
Amortization of intangible assets ........ 289 1,734 -- -- 2,023
Royalty (income) expense ................. (69,304) 69,304 -- -- --
Other operating (income) expense, net .... -- (3) 226 -- 223
-------- -------- -------- -------- ----------
Total operating costs and expenses .... 65,718 773,860 93,788 (3,824) 929,542
-------- -------- -------- -------- ----------
Operating income ............................ 125,913 75,510 19,192 (57,360) 163,255
Non-operating expenses, net ................. (17,300) (53,104) (1,417) 57,360 (14,461)
-------- -------- -------- -------- ----------
Income before taxes ......................... 108,613 22,406 17,775 -- 148,794
Income tax expense .......................... 44,191 8,963 7,604 -- 60,758
-------- -------- -------- -------- ----------
Income before equity earnings ............... 64,422 13,443 10,171 -- 88,036
Equity earnings from subsidiaries ........... 23,614 -- -- (23,614) --
-------- -------- -------- -------- ----------
Net income .................................. $ 88,036 $ 13,443 $ 10,171 $(23,614) $ 88,036
======== ======== ======== ======== ==========
14
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
March 31, 2004
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
---------- ---------- ------------- ------------ ------------
Assets
Current assets:
Cash and cash equivalents ................... $ 177,215 $ 1,195 $ 11,665 $ -- $ 190,075
Accounts receivable, net .................... 20,420 85,378 544,713 -- 650,511
Other current assets ........................ 39,058 101,404 92,573 -- 233,035
---------- ---------- --------- ----------- ----------
Total current assets ..................... 236,693 187,977 648,951 -- 1,073,621
Property, plant and equipment, net .......... 222,626 358,808 28,331 -- 609,765
Goodwill and intangible assets, net ......... 157,954 2,328,995 45,402 -- 2,532,351
Intercompany receivable (payable) ........... 602,976 (72,147) (530,829) -- --
Investment in subsidiaries .................. 1,970,807 -- -- (1,970,807) --
Other assets ................................ 51,770 71,425 41,125 -- 164,320
---------- ---------- --------- ----------- ----------
Total assets ............................. $3,242,826 $2,875,058 $ 232,980 $(1,970,807) $4,380,057
========== ========== ========= =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ....... $ 373,073 $ 214,820 $ 29,506 $ -- $ 617,399
Current portion of long-term debt ........... -- 44,597 -- -- 44,597
---------- ---------- --------- ----------- ----------
Total current liabilities ................ 373,073 259,417 29,506 -- 661,996
Long-term debt .............................. 315,916 739,877 1,956 -- 1,057,749
Other liabilities ........................... 49,382 83,687 22,788 -- 155,857
Common stockholders' equity ................. 2,504,455 1,792,077 178,730 (1,970,807) 2,504,455
---------- ---------- --------- ----------- ----------
Total liabilities and stockholders' equity $3,242,826 $2,875,058 $ 232,980 $(1,970,807) $4,380,057
========== ========== ========= =========== ==========
Condensed Consolidating Balance Sheet
December 31, 2003
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
---------- ---------- ------------- ------------ ------------
Assets
Current assets:
Cash and cash equivalents ................... $ 141,588 $ 1,991 $ 11,379 $ -- $ 154,958
Accounts receivable, net .................... 17,919 164,247 427,021 -- 609,187
Other current assets ........................ 36,576 114,758 80,307 -- 231,641
---------- ---------- --------- ----------- ----------
Total current assets ..................... 196,083 280,996 518,707 -- 995,786
Property, plant and equipment, net .......... 228,109 350,196 29,000 -- 607,305
Goodwill and intangible assets, net ......... 158,295 2,332,147 45,411 -- 2,535,853
Intercompany receivable (payable) ........... 510,958 (106,078) (404,880) -- --
Investment in subsidiaries .................. 1,929,235 -- -- (1,929,235) --
Other assets ................................ 73,398 50,053 39,023 -- 162,474
---------- ---------- --------- ----------- ----------
Total assets ............................. $3,096,078 $2,907,314 $ 227,261 $(1,929,235) $4,301,418
========== ========== ========= =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ....... $ 337,635 $ 281,753 $ 30,462 $ -- $ 649,850
Current portion of long-term debt ........... -- 73,950 -- -- 73,950
---------- ---------- --------- ----------- ----------
Total current liabilities ................ 337,635 355,703 30,462 -- 723,800
Long-term debt .............................. 315,844 710,908 1,955 -- 1,028,707
Other liabilities ........................... 47,905 83,781 22,531 -- 154,217
Common stockholders' equity ................. 2,394,694 1,756,922 172,313 (1,929,235) 2,394,694
---------- ---------- --------- ----------- ----------
Total liabilities and stockholders' equity $3,096,078 $2,907,314 $ 227,261 $(1,929,235) $4,301,418
========== ========== ========= =========== ==========
15
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2004
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Cash flows from operating activities:
Net income ............................................ $116,149 $ 35,155 $ 12,694 $(47,849) $ 116,149
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................... 13,803 24,848 2,419 -- 41,070
Provision for doubtful accounts .................... 1,148 15,510 39,968 -- 56,626
Other, net ......................................... 9,342 (7,805) (9,598) 47,849 39,788
Changes in operating assets and liabilities ........ (68,855) 59,399 (133,486) -- (142,942)
-------- --------- --------- -------- ---------
Net cash provided by (used in) operating activities ... 71,587 127,107 (88,003) -- 110,691
Net cash used in investing activities ................. (10,169) (23,914) (1,983) (9,392) (45,458)
Net cash (used in) provided by financing activities ... (25,791) (103,989) 90,272 9,392 (30,116)
-------- --------- --------- -------- ---------
Net change in cash and cash equivalents ............... 35,627 (796) 286 -- 35,117
Cash and cash equivalents, beginning of period ........ 141,588 1,991 11,379 -- 154,958
-------- --------- --------- -------- ---------
Cash and cash equivalents, end of period .............. $177,215 $ 1,195 $ 11,665 $ -- $ 190,075
======== ========= ========= ======== =========
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2003
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Cash flows from operating activities:
Net income ............................................ $ 88,036 $ 13,443 $ 10,171 $ (23,614) $ 88,036
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................... 13,417 21,306 1,978 -- 36,701
Provision for doubtful accounts .................... 1,757 11,184 41,688 -- 54,629
Other, net ......................................... (7,421) (5,913) 9,715 23,614 19,995
Changes in operating assets and liabilities ........ 7,536 (85,134) (63,462) -- (141,060)
--------- -------- -------- --------- ---------
Net cash provided by (used in) operating activities ... 103,325 (45,114) 90 -- 58,301
Net cash used in investing activities ................. (546,659) (20,633) (4,334) 295,130 (276,496)
Net cash provided by financing activities ............. 407,287 63,211 1,647 (295,130) 177,015
--------- -------- -------- --------- ---------
Net change in cash and cash equivalents ............... (36,047) (2,536) (2,597) -- (41,180)
Cash and cash equivalents, beginning of period ........ 79,015 7,377 10,385 -- 96,777
--------- -------- -------- --------- ---------
Cash and cash equivalents, end of period .............. $ 42,968 $ 4,841 $ 7,788 $ -- $ 55,597
========= ======== ======== ========= =========
16
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, as well as 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 it is generally
straightforward 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 one-half of total operating 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 2003 Annual
Report on Form 10-K.
Integration of Unilab Corporation
On February 28, 2003, we completed the acquisition of Unilab Corporation,
or Unilab, the leading commercial clinical laboratory in California. In
connection with the acquisition of Unilab, we entered into an agreement to sell
to Laboratory Corporation of America Holdings, Inc., certain assets in northern
California, or the Divestiture. During the fourth quarter of 2003, we finalized
our plan related to the integration of Unilab into our laboratory network. As
part of the plan, and following the Divestiture, we closed our previously owned
clinical laboratory in the San Francisco Bay area and completed the integration
of remaining customers in the northern California area to Unilab's laboratories
in San Jose and Sacramento. We currently operate two laboratories in the Los
Angeles metropolitan area. We plan to open a new regional laboratory in the Los
Angeles metropolitan area and then integrate our business in the Los Angeles
metropolitan area into the new facility.
As of March 31, 2004 and December 31, 2003, accruals related to the Unilab
integration plan totaled approximately $6 million and $7 million, respectively.
While the majority of the accrued costs at March 31, 2004 are expected to be
paid during the remainder of 2004, there are certain severance costs that have
payment terms extending into 2005.
Results of Operations
Three Months Ended March 31, 2004 Compared with Three Months Ended March
31, 2003
Net income for the three months ended March 31, 2004 increased to $116
million from $88 million for the prior year period. This increase in earnings
was primarily attributable to revenue growth and improved efficiencies generated
from our Six Sigma and standardization initiatives.
Net Revenues
Net revenues for the three months ended March 31, 2004 grew by 14.9% over
the prior year level and include three months of results of Unilab, which was
acquired on February 28, 2003, compared to one month of Unilab results in the
prior year. Pro forma revenue growth, assuming that the Unilab acquisition and
the related Divestiture had been completed on January 1, 2003, was 8.0% for the
three months ended March 31, 2004.
For the three months ended March 31, 2004, clinical testing volume,
measured by the number of requisitions, increased 11.1% compared to the prior
year period. On a pro forma basis, assuming that the Unilab acquisition and the
Divestiture had been completed on January 1, 2003, testing volume increased
2.9%. Approximately 2% of the improved volume is due to an extra day in the
current quarter caused by Leap Year and less severe weather than the year
before.
For the three months ended March 31, 2004, average revenue per requisition
improved 3.1%, or 4.4% on a pro forma basis, assuming that the Unilab
acquisition and the Divestiture had been completed on January 1, 2003. The
improvement in average revenue per requisition was primarily attributable to a
continuing shift in test mix to higher value testing, including gene-based and
esoteric testing. The inclusion of Unilab's results subsequent to February 28,
2003 served to reduce average revenue per requisition, reflecting Unilab's lower
revenue per requisition.
17
Drugs of abuse testing, which is among our lowest priced services and
accounts for approximately 6% of our volume and 3% of our consolidated net
revenues, showed modest growth during the quarter, the first reported growth in
several years.
Our businesses, other than clinical laboratory testing, which represent
approximately 4% of our consolidated net revenues, grew over 20% during the
three months ended March 31, 2004 and contributed approximately one-half of a
percent to reported revenue growth.
Operating Costs and Expenses
Total operating costs and expenses for the three months ended March 31,
2004 increased $117 million from the prior year period primarily due to
increases in our clinical testing volume (largely as a result of the Unilab
acquisition). The increased costs were primarily in the areas of employee
compensation and benefits and testing supplies. While our cost structure has
been favorably impacted by 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.
Cost of services, which includes the costs of obtaining, transporting and
testing specimens, was 58.7% of net revenues for the three months ended March
31, 2004, compared to 59.3% in the prior year period. This improvement was
primarily the result of the increase in average revenue per requisition and
efficiency gains resulting from our Six Sigma and standardization initiatives.
This improvement was partially offset by initial installation costs of deploying
our Internet-based orders and results systems in physicians' offices and our
patient service centers. The increase in the number of orders and test results
reported via our Internet-based systems is improving the initial collection of
billing information which is reducing the cost of billing and bad debt expense,
both of which are components of selling, general and administrative expenses. At
March 31, 2004, approximately 30% of our orders and approximately 40% of our
test results were being transmitted via the Internet. Additionally, we believe
that the number of physicians who no longer draw blood in their office continues
to increase, which is resulting in an increase in the number of blood draws in
our patient service centers or by our phlebotomists placed in physicians'
offices. This shift has increased our operating costs associated with our blood
draws, but is reducing costs in accessioning and other parts of our operations
due to improved billing information and a reduction in the number of inadequate
patient samples obtained by our trained phlebotomists compared to samples
collected by physician employed phlebotomists.
Selling, general and administrative expenses, which include the costs of
the sales force, billing operations, bad debt expense and general management and
administrative support, decreased during the three months ended March 31, 2004,
as a percentage of net revenues, to 24.5% from 25.5% in the prior year period.
This improvement was primarily due to efficiencies from our Six Sigma and
standardization initiatives and the improvement in average revenue per
requisition. During the first quarter of 2004, bad debt expense improved to 4.5%
of net revenues, compared to 5.0% in the prior year period. The reduction in bad
debt expense as a percentage of net revenues occurred despite the addition of
Unilab, which has higher levels of bad debt than the rest of Quest Diagnostics.
This improvement primarily relates to the collection of diagnosis, patient and
insurance information necessary to more effectively bill for services performed.
We believe that our Six Sigma and standardization initiatives and the increased
use of electronic ordering by our customers will provide additional
opportunities to further improve our overall collection experience and cost
structure.
Operating Income
Operating income for the three months ended March 31, 2004 improved to $209
million, or 16.6% of net revenues, from $163 million, or 14.9% of net revenues,
in the prior year period. The increase in operating income was driven by revenue
growth and continuing efficiencies generated from our Six Sigma and
standardization efforts, which have reduced both the cost of services and
selling, general and administrative expenses as a percentage of net revenues.
Other Income (Expense)
Other income (expense), net represents miscellaneous income and expense
items related to non-operating activities such as gains and losses associated
with investments and other non-operating assets.
18
Impact of Contingent Convertible Debentures on Diluted Earnings per Common Share
The if-converted method is used in determining the dilutive effect of our 1
3/4% contingent convertible debentures due 2021 (the "Debentures") in periods
when the holders of such securities are permitted to exercise their conversion
rights. As of and for the three months ended March 31, 2004, the holders of the
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 earnings
per common share would have been reduced by approximately 2% during the three
months ended March 31, 2004. See Note 11 to the Consolidated Financial
Statements contained in our 2003 Annual Report on Form 10-K for a further
discussion of the Debentures.
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. See Note 2 to the Consolidated Financial Statements contained in
our 2003 Annual Report on Form 10-K for additional discussion of our financial
instruments and hedging activities.
At both March 31, 2004 and December 31, 2003, the fair value of our debt
was estimated at approximately $1.2 billion, 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 March 31, 2004 and December 31,
2003, the estimated fair value exceeded the carrying value of the debt by
approximately $100 million and $86 million, respectively. An assumed 10%
increase in interest rates (representing approximately 50 basis points at both
March 31, 2004 and December 31, 2003) would potentially reduce the estimated
fair value of our debt by approximately $23 million and $17 million at March 31,
2004 and December 31, 2003, respectively.
The Debentures have a contingent interest component that will require us to
pay contingent interest based on certain thresholds, as outlined in the
indenture governing the Debentures. The contingent interest component, which is
more fully described in Note 11 to the Consolidated Financial Statements
contained in our 2003 Annual Report on Form 10-K, is considered to be a
derivative instrument subject to Statement of Financial Accounting Standards 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 March 31, 2004 and December 31, 2003.
Borrowings under our $325 million unsecured revolving credit facility, our
term loan facilities and our $250 million secured receivables credit facility
are subject to variable interest rates. Interest rates on our $325 million
unsecured revolving credit facility and term loans are subject to a pricing
schedule that can fluctuate based on changes in our credit rating. As such, our
borrowing cost under these credit arrangements will be subject to both
fluctuations in interest rates and changes in our credit rating. As of March 31,
2004, our borrowing rate for LIBOR-based loans was principally LIBOR plus
1.1875%. At March 31, 2004, there was $230 million outstanding under our term
loan due June 2007, $75 million outstanding under our term loan due December
2008, and there were no borrowings outstanding under our $325 million unsecured
revolving credit facility or our $250 million secured receivables credit
facility. See Note 4 to the interim consolidated financial statements for
details regarding the 2004 debt refinancings.
Based on our net exposure to interest rate changes, an assumed 10% change
in interest rates on our variable rate indebtedness (representing approximately
11 basis points) would impact annual net interest expense by approximately $0.3
million, assuming no changes to the debt outstanding at March 31, 2004.
Liquidity and Capital Resources
Cash and Cash Equivalents
Cash and cash equivalents at March 31, 2004 totaled $190 million, compared
to $155 million at December 31, 2003. Cash flows from operating activities in
2004 provided cash of $111 million, which together with cash on-hand were used
to fund investing and financing activities, which required cash of $45 million
and $30 million, respectively. Cash and cash equivalents at March 31, 2003
totaled $56 million, compared to $97 million at December 31, 2002. Cash flows
from operating activities in the first quarter of 2003 were $58 million, which
along with cash flows from financing activities of $177 million and cash
on-hand, were used to fund investing activities, which required cash of $276
million.
19
Cash Flows From Operating Activities
Net cash provided by operating activities for the three months ended March
31, 2004 was $111 million compared to $58 million in the prior year period. This
increase was primarily due to improved operating performance and increased tax
benefits associated with stock-based compensation plans, partially offset by an
increase in accounts receivable associated with growth in net revenues. Days
sales outstanding, a measure of billing and collection efficiency, improved to
45 days at March 31, 2004 from 48 days at December 31, 2003.
Cash Flows From Investing Activities
Net cash used in investing activities for the three months ended March 31,
2004 was $45 million, consisting primarily of capital expenditures of $45
million.
Net cash used in investing activities was $276 million for the first
quarter of 2003, consisting primarily of acquisition and related transaction
costs of $236 million to acquire the outstanding capital stock of Unilab, and
capital expenditures of $37 million. The acquisition and related transaction
costs included the cash portion of the Unilab purchase price of $297 million and
approximately $11 million of transaction costs paid in the first quarter of
2003, partially offset by $72 million of cash acquired from Unilab.
Cash Flows From Financing Activities
Net cash used in financing activities in the three months ended March 31,
2004 was $30 million, consisting primarily of purchases of treasury stock
totaling $45 million and a $15 million dividend payment, partially offset by $34
million received from the exercise of stock options. In addition, $75 million of
borrowings under our term loan due December 2008 were used to repay $75 million
under our term loan due June 2007. The $45 million in treasury stock purchases
represents 547 thousand shares of our common stock repurchased at an average
price of $81.97 per share.
Net cash provided by financing activities in 2003 was $177 million,
consisting primarily of $450 million of borrowings under our term loan due June
2007, partially offset by debt repayments totaling $269 million. Borrowings
under our term loan due June 2007 were used to finance the cash portion of the
purchase price and related transaction costs associated with the acquisition of
Unilab, and to repay $220 million of debt, representing substantially all of
Unilab's then existing outstanding debt, and related accrued interest. Of the
$220 million, $124 million represents payments related to our cash tender offer
on March 7, 2003, for all of the outstanding $100.8 million principal amount of
Unilab's 12 3/4% Senior Subordinated Notes due 2009 and $23 million of related
tender premium and associated tender offer costs. The remaining debt repayments
in the first quarter of 2003 consisted primarily of a $42 million repayment
under our term loan due June 2007 and a $6 million capital lease repayment.
Dividend Policy
On October 21, 2003, our Board of Directors declared the payment of a
quarterly cash dividend of $0.15 per common share. The quarterly dividend was
paid on January 23, 2004 to shareholders of record on January 8, 2004 and
totaled $15.4 million. During the first quarter of 2004, our Board of Directors
declared a quarterly cash dividend of $0.15 per common share payable on April
21, 2004 to shareholders of record on April 7, 2004. The quarterly dividend was
paid on April 21, 2004 and totaled approximately $15.5 million. We expect to
fund future dividend payments with cash flows from operations, and do not expect
the dividend to have a material impact on our ability to finance future growth.
Share Repurchase Plan
In 2003, our Board of Directors authorized a share repurchase program,
which permits us to purchase up to $600 million of our common stock. During the
three months ended March 31, 2004, we repurchased 547 thousand shares of our
common stock at an average price of $81.97 per share for a total of $45 million.
Since the inception of the share repurchase program, we have repurchased
approximately 4.5 million shares of our common stock at an average price of
$66.64 per share for a total of $303 million. During the first quarter of 2004,
we reissued 1.0 million of these shares held in treasury in connection with
employee benefit plans. At March 31, 2004, $297 million of the share repurchase
authorization remains available. We expect to fund the share repurchase program
with cash flows from operations and do not expect the share repurchase program
to have a material impact on our ability to finance future growth.
20
Contractual Obligations and Commitments
A 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 11 to the Consolidated Financial Statements in
our 2003 Annual Report on Form 10-K. A discussion of our debt refinancings in
April 2004 is contained in Note 4 to the interim consolidated financial
statements. A discussion and analysis regarding our minimum rental commitments
under noncancelable operating leases and noncancelable commitments to purchase
products or services at December 31, 2003 is contained in Note 15 to the
Consolidated Financial Statements in our 2003 Annual Report on Form 10-K. See
Note 5 to the interim consolidated financial statements for information
regarding the status of our remaining contractual obligations and commitments.
Our credit agreements relating to our unsecured revolving credit facility
and our term loan facilities contain 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.
Unconsolidated Joint Ventures
We have investments in unconsolidated joint ventures in Phoenix, Arizona;
Indianapolis, Indiana; and Dayton, Ohio, which 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 net revenues of our unconsolidated joint ventures, on a combined
basis, are less than 6% of our consolidated net revenues. Total assets
associated with our unconsolidated joint ventures are less than 3% of our
consolidated total assets. We have no material unconditional 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 $180 million to $190 million
during 2004 for capital expenditures to support and expand our existing
operations, principally related to investments in information technology,
equipment, and facility upgrades.
In April 2004, we entered into a new $500 million senior unsecured
revolving credit facility to replace our existing $325 million unsecured
revolving credit facility. In addition, we entered into a new $300 million
secured receivables credit facility to replace our existing $250 million secured
receivables credit facility, which matured in April 2004. On April 30, 2004, we
repaid the remaining $230 million of principal outstanding under our term loan
due June 2007 with $100 million of borrowings under our new $500 million senior
unsecured revolving credit facility and $130 million of borrowings under our new
$300 million secured receivables credit facility. The refinancings were done to
take advantage of the improved lending environment and our improved credit
profile. See Note 4 to the interim consolidated financial statements for further
details regarding the refinancings. As of April 30, 2004, $400 million of our
new $500 million senior unsecured revolving credit facility and $170 million of
our new $300 million secured receivables credit facility remained available to
us for future borrowing.
We believe that cash from operations and our borrowing capacity under our
credit facilities will provide sufficient financial flexibility to meet seasonal
working capital requirements and to fund capital expenditures, debt service
requirements, cash dividends on common shares, share repurchases and additional
growth opportunities for the foreseeable future. Our investment grade credit
ratings have had a favorable impact on our cost of and access to capital, and we
believe that our improved financial performance should provide us with access to
additional financing, if necessary, to fund growth opportunities that cannot be
funded from existing sources.
Impact of New Accounting Standard
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised in December 2003. The impact of this
accounting standard is discussed in Note 1 to the interim consolidated financial
statements.
21
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 (the "Litigation Reform Act") 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 may include, but are not limited
to, unanticipated expenditures, changing relationships with customers, payers,
suppliers and strategic partners, competitive environment, changes in government
regulations, conditions of the economy and other factors described in our 2003
Annual Report on Form 10-K and subsequent filings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Item 4. Controls and Procedures
(a) Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended) as of the end of the period
covered by this report. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures are adequate and effective.
(b) During the quarterly period covered by this report, there were no changes
in our internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note 5 to the interim consolidated financial statements for information
regarding the status of government investigations and private claims.
Item 2. Changes in Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
- -----------------------------------------------------------------------------------------------------------------
(d) Approximate Dollar Value of
(a) Total (c) Total Number of Shares Shares that May Yet Be
Number of Purchased as Part of Purchased Under the Plans or
Shares (b) Average Price Publicly Announced Plans Programs
Period Purchased Paid per Share or Programs (in thousands)
- -----------------------------------------------------------------------------------------------------------------
January 1, 2004 -
January 31, 2004 -- -- -- $342,452
- -----------------------------------------------------------------------------------------------------------------
February 1, 2004 -
February 29, 2004 -- -- -- $342,452
- -----------------------------------------------------------------------------------------------------------------
March 1, 2004 -
March 31, 2004 547,400 $81.97 547,400 $297,580
- -----------------------------------------------------------------------------------------------------------------
Total 547,400 $81.97 547,400 $297,580
- -----------------------------------------------------------------------------------------------------------------
In 2003, our Board of Directors authorized a share repurchase program,
which permits us to purchase up to $600 million of our common stock.
23
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Fifth Supplemental Indenture dated as of April 16, 2004, among
Unilab Acquisition Corporation (d/b/a FNA Clinics of America),
Quest Diagnostics Incorporated, The Bank Of New York, and the
Subsidiary Guarantors
10.2 Third Amended and Restated Credit and Security Agreement dated
as of April 20, 2004 among Quest Diagnostics Receivables Inc.,
as Borrower, Quest Diagnostics Incorporated, as Servicer, each
of the lenders party thereto and Wachovia Bank, National
Association, as Administrative Agent
10.3 Second Amended and Restated Receivables Sale Agreement dated as
of April 20, 2004 among Quest Diagnostics Incorporated and each
of its direct or indirect wholly owned subsidiaries who is or
hereafter becomes a seller hereunder, as the Sellers, and Quest
Diagnostics Receivables Inc., as the Buyer
10.4 Amended and Restated Credit Agreement dated as of April 20,
2004 among Quest Diagnostics Incorporated, the Subsidiary
Guarantors and the Banks
10.5 Form of Supplemental Deferred Compensation Plan
10.6 Letter Agreement dated April 21, 2004 between the Company and
Kenneth W. Freeman (filed as an Exhibit to the Company's
current report on Form 8-K (Date of Report: April 22, 2004) and
incorporated herein by reference)
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Report on Form 8-K filed during the first quarter of 2004:
On January 27, 2004, the Company furnished a current report on Form 8-K
reporting its press release of January 27, 2004 announcing, among other
things, its results for the quarter and year ended December 31, 2003.
24
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.
April 30, 2004
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
Senior Vice President and
Chief Financial Officer
25
STATEMENT OF DIFFERENCES
The section symbol shall be expressed as............................'SS'
The greater-than-or-equal-to sign shall be expressed as................. >=