September 30, 2005, other operating expense, net includes a $6.2 million charge primarily related to forgiveness of amounts owed by patients and physicians, and related property damage as a result of hurricanes in the Gulf Coast. For the nine months ended September 30, 2004, other operating expense, net includes a $10.3 million charge associated with the acceleration of certain pension obligations in connection with the succession of the Company’s prior CEO.
Operating income for the three months ended September 30, 2005 was $243.2 million, or 17.7% of net revenues, compared to $232 million, or 18.0% of net revenues, in the prior year period. For the nine months ended September 30, 2005, operating income was $734.3 million, or 18.0% of net revenues, compared to $671 million or 17.4% of net revenues, in the prior year period. The increases in operating income for the three and nine month periods ended September 30, 2005 were principally driven by revenue growth. The decrease in operating income as a percentage for the three month period is primarily attributable to the performance at NID, which reduced operating income by $10 million compared to the prior year, and the $6.2 million charge recorded during the third quarter of 2005 related to the hurricanes. These items reduced operating income as a percentage of revenue compared to the prior year by 1.2% during the third quarter of 2005. Also, impacting the comparisons for the nine month period is a $10.3 million charge in the second quarter of 2004 related to the acceleration of certain pension obligations associated with the succession of the Company’s prior CEO, which reduced operating income, as a percentage of net revenues, by 0.3%, for the nine months ended September 30, 2004.
Interest expense, net for the three and nine months ended September 30, 2005 decreased from the prior year periods primarily due to the redemption of our contingent convertible debentures in January 2005, as well as the 2004 refinancing of certain of our debt. Interest expense, net for the nine months ended September 30, 2004, included a $2.9 million charge representing the write-off of deferred financing costs associated with our 2004 refinancing. See Note 10 to the Consolidated Financial Statements contained in our 2004 Annual Report on Form 10-K for a further discussion of the redemption and the debt refinancing.
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. For the three and nine months ended September 30, 2005, other income (expense), net includes a $7.1 million charge associated with the write-down of an investment.
Due to a required change in accounting effective December 31, 2004, we included the dilutive effect of our 1¾% contingent convertible debentures, or the Debentures, in our dilutive earnings per common share calculations using the if-converted method, regardless of whether or not the holders of these securities were permitted to exercise their conversion rights, and retroactively restated previously reported diluted earnings per common share. References to previously reported diluted weighted average common shares outstanding, including diluted earnings per common share calculations and related disclosures, have been restated to give effect to the required change in accounting for all periods presented. This change reduced previously reported diluted earnings per common share by approximately 2% for the three and nine months ended September 30, 2004. The Debentures were redeemed, principally through a conversion into common shares, as of January 18, 2005. See Note 10 to the Consolidated Financial Statements contained in our 2004 Annual Report on Form 10-K and Note 3 to the interim consolidated financial statements for a further discussion of the Debentures.
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. In October 2005 we entered into interest rate lock agreements with two financial institutions for a total notional amount of $300 million to lock the U.S. treasury bond rate component of a portion of our offering of debt securities later that same month. 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 2004 Annual Report on Form 10-K for additional discussion of our financial instruments and hedging activities. See Note 8 to the interim consolidated financial statements for information regarding our treasury lock agreements entered into during October 2005.
At September 30, 2005 and December 31, 2004, the fair value of our debt was estimated at approximately $0.9 billion and $1.2 billion, 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 September 30, 2005 and December 31, 2004, the estimated fair value exceeded the carrying value of the debt by approximately $39 million and $84 million, respectively. An assumed 10% increase in interest rates (representing approximately 46 and 45 basis points at September 30, 2005 and December 31, 2004, respectively) would reduce the estimated fair value of our debt by approximately $8 million and $17 million at September 30, 2005 and December 31, 2004, respectively.
Borrowings under our senior unsecured revolving credit facility, our secured receivables credit facility and our term loan due December 2008 are subject to variable interest rates. Interest on the secured receivables credit facility is based on rates that are intended to approximate commercial paper rates for highly rated issuers. Interest rates on our senior unsecured revolving credit facility and term loan due December 2008 are subject to a pricing schedule that can fluctuate based on changes in our credit ratings. As such, our borrowing cost under these credit arrangements will be subject to both fluctuations in interest rates and changes in our credit ratings. As of September 30, 2005, our borrowing rates for our LIBOR-based loans ranged from LIBOR plus 0.55% to LIBOR plus 0.625%. At September 30, 2005, there was $230 million of borrowings outstanding under our $300 million secured receivables credit facility, $75 million outstanding under our term loan due December 2008 and no borrowings outstanding under our $500 million senior unsecured revolving credit facility. Based on our net exposure to interest rate changes, an assumed 10% change in interest rates on our variable rate indebtedness (representing approximately 37 basis points) would impact annual net interest expense by approximately $1.1 million, assuming no changes to the debt outstanding at September 30, 2005. See Note 3 to the interim consolidated financial statements for details regarding our debt outstanding.
Liquidity and Capital Resources
Cash and Cash Equivalents
Cash and cash equivalents at September 30, 2005 totaled $210 million, compared to $73 million at December 31, 2004. Cash flows from operating activities in 2005 were $548 million, which were used to fund investing and financing activities, which required cash of $239 million and $172 million, respectively. Cash and cash equivalents at September 30, 2004 totaled $201 million, compared to $155 million at December 31, 2003. Cash flows from operating activities in 2004 provided cash of $535 million, which were used to fund investing and financing activities of $130 million and $359 million, respectively.
Cash Flows From Operating Activities
Net cash provided by operating activities for the nine months ended September 30, 2005 was $548 million compared to $535 million in the prior year period. This increase was primarily due to improved operating performance and a smaller increase in net accounts receivable compared to the prior year, partially offset by the timing and net amount of various payments for taxes and other liabilities. Days sales outstanding, a measure of billing and collection efficiency, was 45 days at September 30, 2005, compared to 47 days at December 31, 2004.
Cash Flows From Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2005 was $239 million, consisting primarily of capital expenditures of $178 million, investments in companies which develop diagnostic tests of $38 million, and an acquisition of a small regional laboratory for $19 million.
Net cash used in investing activities for the nine months ended September 30, 2004 was $130 million, consisting primarily of capital expenditures.
Contributing the majority of the increase in capital expenditures is the construction of a new laboratory facility in California, into which we plan to consolidate certain of our operations in the Los Angeles area.
Cash Flows From Financing Activities
Net cash used in financing activities for the nine months ended September 30, 2005 was $172 million, and includes purchases of treasury stock totaling $190 million and dividend payments of $51 million, partially offset by $85 million received from the exercise of stock options. In addition, we repaid the remaining $100 million of principal
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outstanding under our senior unsecured revolving credit facility with $100 million of borrowings under our secured receivables credit facility, which carries a slightly lower borrowing cost. The $190 million in treasury stock purchases represents 3.8 million shares of our common stock purchased at an average price of $50.52 per share.
Net cash used in financing activities for the nine months ended September 30, 2004 was $359 million, and includes purchases of treasury stock totaling $381 million and $46 million in dividend payments, partially offset by $83 million received from the exercise of stock options. In addition, we repaid the remaining $305 million of principal outstanding under our term loan due June 2007 with $100 million of borrowings under our senior unsecured revolving credit facility, $130 million of borrowings under our secured receivables credit facility and $75 million of borrowings under our term loan due December 2008. The $381 million in treasury stock purchases represents 9.1 million shares of our common stock purchased at an average price of $41.92 per share, including 2.4 million shares purchased from GlaxoSmithKline in the second quarter of 2004.
Stock Split
On June 20, 2005, the Company effected a two-for-one stock split through the issuance of a stock dividend of one new share of common stock for each share of common stock held by stockholders of record on June 6, 2005. References to previously reported number of common shares and per common share amounts including earnings per common share calculations and related disclosures, have been restated to give retroactive effect to the stock split for all periods presented.
Dividend Policy
During each of the quarters of 2005 and 2004, our Board of Directors has declared a quarterly cash dividend of $0.09 and $0.075 per common share, respectively. 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
For the three months ended September 30, 2005, we repurchased 2 million shares of our common stock at an average price of $50.41 per share for $98 million. For the nine months ended September 30, 2005, we repurchased 3.8 million shares of our common stock at an average price of $50.52 for $190 million. Through September 30, 2005, we have repurchased 28.4 million shares of our common stock at an average price of $41.63 for approximately $1.2 billion under our share repurchase program. At September 30, 2005, our remaining authorizations for share repurchases totaled $322 million.
Contractual Obligations and Commitments
See Note 8 to the interim consolidated financial statements for information regarding our treasury lock agreements and our $900 million private placement of senior notes commenced in October 2005. A description of the terms of our other indebtedness, related debt service requirements and our future payments under certain of our contractual obligations is contained in Note 10 to the Consolidated Financial Statements in our 2004 Annual Report on Form 10-K. A discussion and analysis regarding our minimum rental commitments under noncancelable operating leases and noncancelable commitments to purchase products or services at December 31, 2004 is contained in Note 14 to the Consolidated Financial Statements in our 2004 Annual Report on Form 10-K. See Note 4 to the interim consolidated financial statements for information regarding the status of our remaining contractual obligations and commitments as of September 30, 2005. See Note 3 to the interim consolidated financial statements for information regarding the components of our outstanding indebtedness as of September 30, 2005.
Our credit agreements relating to our senior unsecured revolving credit facility and our term loan due December 2008 contain various covenants and conditions, including the maintenance of certain financial ratios, that could impact our ability to, among other things, incur additional indebtedness. 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
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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 $235 million during 2005 for capital expenditures to support and expand our existing operations, principally related to investments in information technology, equipment, and facility upgrades.
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 strong 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 Standards
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 123, revised 2004, “Share-Based Payment” and in May 2005, issued SFAS No. 154, “Accounting Changes and Error Corrections”. The impact of these 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 (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 2004 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 third quarter of 2005, 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. |
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PART II - OTHER INFORMATION
See Note 4 to the interim consolidated financial statements for information regarding the status of legal proceedings involving the Company.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
ISSUER PURCHASES OF EQUITY SECURITIES
Period | | | (a) Total
Number of
Shares
Purchased | | | (b) Average Price
Paid per Share | | | (c) Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs | | |
(d) Approximate Dollar Value
of Shares that May Yet Be
Purchased Under the Plans or
Programs
(in thousands) | |
July 1, 2005 –
July 31, 2005 | | | – | | | | $ | – | | | | | – | | | | | $420,198 | |
August 1, 2005 –
August 31, 2005 | | | 838,900 | | | | $ | 49.99 | | | | | 838,900 | | | | | $378,257 | |
September 1, 2005 –
September 30, 2005 | | | 1,114,500 | | | | $ | 50.73 | | | | | 1,114,500 | | | | | $321,719 | |
Total | | | 1,953,400 | | | | $ | 50.41 | | | | | 1,953,400 | | | | | $321,719 | |
In 2003, our Board of Directors authorized a share repurchase program, which permitted us to purchase up to $600 million of our common stock. In July 2004, our Board of Directors authorized us to purchase up to an additional $300 million of our common stock. Under a separate authorization from our Board of Directors, in December 2004 we repurchased 5.4 million shares of our common stock for approximately $254 million from GlaxoSmithKline plc. In January 2005, our Board of Directors expanded the share repurchase authorization by an additional $350 million.
Exhibits:
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. §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. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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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.
October 28, 2005
Quest Diagnostics Incorporated
By |
/s/ Surya N. Mohapatra
| | |
|
| Surya N. Mohapatra, Ph.D.
Chairman, President and
Chief Executive Officer | | | |
By | /s/ Robert A. Hagemann | | |
|
| Robert A. Hagemann
Senior Vice President and
Chief Financial Officer | | | |
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