UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Commission file number 001-12215
Quest Diagnostics Incorporated
1290 Wall Street West
Lyndhurst, NJ 07071
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
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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
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes No X
As of October 26, 2005 there were 202,086,845 outstanding shares of the registrant’s common stock, $.01 par value.
PART I - FINANCIAL INFORMATION
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Item 1. |
| Financial Statements |
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| Index to consolidated financial statements filed as part of this report: |
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| 2 | |
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| Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 | 3 |
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| Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004 | 4 |
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| 5 | |
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Item 2. |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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| Management’s Discussion and Analysis of Financial Condition and Results of Operations | 20 |
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Item 3. |
| Quantitative and Qualitative Disclosures About Market Risk |
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| See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” | 25 |
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Item 4. |
| Controls and Procedures |
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| 25 |
1
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(in thousands, except per share data)
(unaudited)
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| Three Months Ended |
| Nine Months Ended |
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| 2005 |
| 2004 |
| 2005 |
| 2004 |
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Net revenues |
| $ | 1,371,821 |
| $ | 1,289,897 |
| $ | 4,068,835 |
| $ | 3,843,313 |
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Operating costs and expenses: |
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Cost of services |
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| 807,020 |
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| 748,424 |
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| 2,385,780 |
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| 2,233,282 |
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Selling, general and administrative |
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| 313,426 |
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| 308,248 |
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| 937,448 |
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| 923,195 |
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Amortization of intangible assets |
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| 912 |
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| 1,664 |
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| 2,776 |
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| 5,786 |
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Other operating (income) expense, net |
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| 7,267 |
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| (142 | ) |
| 8,569 |
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| 10,449 |
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Total operating costs and expenses |
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| 1,128,625 |
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| 1,058,194 |
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| 3,334,573 |
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| 3,172,712 |
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Operating income |
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| 243,196 |
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| 231,703 |
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| 734,262 |
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| 670,601 |
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Other income (expense): |
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Interest expense, net |
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| (11,840 | ) |
| (13,630 | ) |
| (37,263 | ) |
| (44,620 | ) |
Minority share of income |
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| (4,833 | ) |
| (4,893 | ) |
| (14,918 | ) |
| (14,366 | ) |
Equity earnings in unconsolidated joint ventures |
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| 5,852 |
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| 5,548 |
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| 19,506 |
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| 15,502 |
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Other income (expense), net |
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| (6,336 | ) |
| 3 |
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| (6,125 | ) |
| (21 | ) |
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Total non-operating expenses, net |
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| (17,157 | ) |
| (12,972 | ) |
| (38,800 | ) |
| (43,505 | ) |
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Income before taxes |
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| 226,039 |
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| 218,731 |
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| 695,462 |
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| 627,096 |
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Income tax expense |
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| 90,791 |
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| 88,587 |
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| 279,514 |
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| 253,974 |
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Net income |
| $ | 135,248 |
| $ | 130,144 |
| $ | 415,948 |
| $ | 373,122 |
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Earnings per common share: |
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Basic |
| $ | 0.67 |
| $ | 0.64 |
| $ | 2.06 |
| $ | 1.82 |
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Diluted |
| $ | 0.66 |
| $ | 0.62 |
| $ | 2.02 |
| $ | 1.75 |
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Weighted average common shares outstanding: |
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Basic |
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| 202,681 |
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| 202,489 |
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| 202,332 |
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| 204,930 |
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Diluted |
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| 206,126 |
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| 212,258 |
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| 206,214 |
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| 215,312 |
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Dividends per common share |
| $ | 0.09 |
| $ | 0.075 |
| $ | 0.27 |
| $ | 0.225 |
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The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
SEPTEMBER 30, 2005 AND DECEMBER 31, 2004
(in thousands, except per share data)
(unaudited)
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| September 30, |
| December 31, |
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Assets |
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Current assets: |
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Cash and cash equivalents |
| $ | 210,089 |
| $ | 73,302 |
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Accounts receivable, net of allowance for doubtful accounts of $205,832 and $202,857 at September 30, 2005 and December 31, 2004, respectively |
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| 693,792 |
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| 649,281 |
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Inventories |
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| 78,173 |
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| 75,327 |
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Deferred income taxes |
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| 101,458 |
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| 83,030 |
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Prepaid expenses and other current assets |
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| 67,830 |
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| 50,140 |
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Total current assets |
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| 1,151,342 |
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| 931,080 |
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Property, plant and equipment, net |
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| 670,862 |
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| 619,485 |
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Goodwill, net |
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| 2,524,596 |
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| 2,506,950 |
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Intangible assets, net |
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| 9,824 |
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| 11,462 |
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Deferred income taxes |
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| 30,583 |
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| 29,374 |
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Other assets |
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| 147,527 |
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| 105,437 |
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Total assets |
| $ | 4,534,734 |
| $ | 4,203,788 |
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Liabilities and Stockholders’ Equity |
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Current liabilities: |
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Accounts payable and accrued expenses |
| $ | 686,607 |
| $ | 668,987 |
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Short-term borrowings and current portion of long-term debt |
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| 504,900 |
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| 374,801 |
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Total current liabilities |
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| 1,191,507 |
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| 1,043,788 |
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Long-term debt |
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| 349,399 |
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| 724,021 |
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Other liabilities |
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| 166,087 |
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| 147,328 |
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Commitments and contingencies |
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Stockholders’ equity: |
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Common stock, par value $0.01 per share; 300,000 shares authorized; 213,646 and 213,567 shares issued at September 30, 2005 and December 31, 2004, respectively |
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| 2,136 |
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| 1,068 |
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Additional paid-in capital |
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| 2,180,056 |
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| 2,195,346 |
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Retained earnings |
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| 1,180,047 |
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| 818,734 |
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Unearned compensation |
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| (2,538 | ) |
| (11 | ) |
Accumulated other comprehensive (loss) income |
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| (4,241 | ) |
| 3,866 |
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Treasury stock, at cost; 11,845 and 17,347 shares at September 30, 2005 and December 31, 2004, respectively |
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| (527,719 | ) |
| (730,352 | ) |
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Total stockholders’ equity |
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| 2,827,741 |
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| 2,288,651 |
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Total liabilities and stockholders’ equity |
| $ | 4,534,734 |
| $ | 4,203,788 |
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The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(in thousands)
(unaudited)
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| Nine Months Ended September 30, |
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| 2005 |
| 2004 |
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Cash flows from operating activities: |
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Net income |
| $ | 415,948 |
| $ | 373,122 |
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Adjustments to reconcile net income to net cash provided by operating |
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Depreciation and amortization |
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| 128,986 |
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| 126,455 |
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Provision for doubtful accounts |
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| 177,954 |
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| 172,027 |
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Deferred income tax provision (benefit) |
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| (10,930 | ) |
| 31,391 |
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Minority share of income |
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| 14,918 |
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| 14,366 |
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Stock compensation expense |
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| 1,407 |
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| 1,179 |
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Tax benefits associated with stock-based compensation plans |
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| 28,396 |
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| 54,156 |
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Other, net |
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| 8,472 |
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| 2,526 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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| (222,465 | ) |
| (248,885 | ) |
Accounts payable and accrued expenses |
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| (6,109 | ) |
| (10,251 | ) |
Integration, settlement and other special charges |
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| (1,604 | ) |
| (17,426 | ) |
Income taxes payable |
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| 30,276 |
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| 27,161 |
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Other assets and liabilities, net |
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| (17,075 | ) |
| 9,386 |
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Net cash provided by operating activities |
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| 548,174 |
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| 535,207 |
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Cash flows from investing activities: |
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Capital expenditures |
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| (178,332 | ) |
| (134,146 | ) |
Business acquisition, net of cash acquired |
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| (19,323 | ) |
| – |
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Transaction costs |
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| (1,264 | ) |
| – |
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Increase in investments and other assets |
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| (40,138 | ) |
| (3,177 | ) |
Proceeds from disposition of assets |
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| 74 |
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| 7,551 |
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Net cash used in investing activities |
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| (238,983 | ) |
| (129,772 | ) |
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Cash flows from financing activities: |
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Proceeds from borrowings |
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| 99,999 |
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| 304,921 |
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Repayments of debt |
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| (100,507 | ) |
| (305,908 | ) |
Purchases of treasury stock |
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| (190,467 | ) |
| (381,145 | ) |
Exercise of stock options |
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| 84,845 |
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| 83,085 |
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Dividends paid |
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| (51,492 | ) |
| (46,214 | ) |
Distributions to minority partners |
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| (14,782 | ) |
| (11,982 | ) |
Financing costs paid |
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| – |
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| (2,114 | ) |
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Net cash used in financing activities |
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| (172,404 | ) |
| (359,357 | ) |
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Net change in cash and cash equivalents |
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| 136,787 |
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| 46,078 |
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Cash and cash equivalents, beginning of period |
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| 73,302 |
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| 154,958 |
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Cash and cash equivalents, end of period |
| $ | 210,089 |
| $ | 201,036 |
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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 services for the healthcare industry, Quest Diagnostics offers a broad range of clinical laboratory testing services to patients, physicians, hospitals, healthcare insurers, 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 laboratories and development facilities, Quest Diagnostics offers comprehensive and innovative diagnostic testing, information and services used by physicians and other healthcare professionals to make decisions to improve health.
On an annual basis, Quest Diagnostics processes approximately 140 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 2004 Annual Report on Form 10-K.
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, adjusted for the after-tax impact of the interest expense associated with the Company’s 1¾% contingent convertible debentures due 2021 (the “Debentures”), by the weighted average common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the dilutive effect of the Debentures, and outstanding stock options and restricted common shares granted under the Company’s Employee Equity Participation Program.
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 the number of common shares and per common share amounts in the accompanying consolidated balance sheets and consolidated statements of operations, including earnings per common share calculations and related disclosures, have been restated to give retroactive effect to the stock split for all periods presented.
In September 2004, the Emerging Issues Task Force reached a final consensus on Issue 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share”, (“Issue 04-8”), effective December 31, 2004. Pursuant to Issue 04-8, the Company included the dilutive effect of its Debentures in its 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. The Debentures were called for redemption by the Company in December 2004, and redeemed as of January 18, 2005. See Note 3 for a further discussion of the Debentures. References to previously reported diluted weighted average common shares outstanding and diluted earnings per common share amounts in the accompanying consolidated statements of operations and related disclosures, have been restated to give retroactive effect of the required change in accounting for all periods presented.
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The computation of basic and diluted earnings per common share (using the if-converted method) was as follows (in thousands, except per share data):
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| Three Months Ended |
| Nine Months Ended |
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| 2005 |
| 2004 |
| 2005 |
| 2004 |
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Net income available to common stockholders – basic |
| $ | 135,248 |
| $ | 130,144 |
| $ | 415,948 |
| $ | 373,122 |
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Add: Interest expense associated with the Debentures, net of related tax effects |
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| – |
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| 832 |
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| 82 |
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| 2,494 |
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Net income available to common stockholders – diluted |
| $ | 135,248 |
| $ | 130,976 |
| $ | 416,030 |
| $ | 375,616 |
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Weighted average common shares outstanding – basic |
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| 202,681 |
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| 202,489 |
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| 202,332 |
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| 204,930 |
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Effect of dilutive securities: |
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Stock options and restricted common stock |
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| 3,445 |
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| 4,055 |
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| 3,678 |
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| 4,668 |
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Debentures |
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| – |
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| 5,714 |
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| 204 |
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| 5,714 |
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Weighted average common shares outstanding – diluted |
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| 206,126 |
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| 212,258 |
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| 206,214 |
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| 215,312 |
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Basic earnings per common share |
| $ | 0.67 |
| $ | 0.64 |
| $ | 2.06 |
| $ | 1.82 |
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Diluted earnings per common share |
| $ | 0.66 |
| $ | 0.62 |
| $ | 2.02 |
| $ | 1.75 |
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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 $0.6 million and $0.2 million for the three months ended September 30, 2005 and 2004, respectively, and $1.4 million and $1.2 million for the nine months ended September 30, 2005 and 2004, 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 granted for stock purchases under the Company’s ESPP, consistent with the method prescribed by SFAS 123, as amended by SFAS 148 (in thousands, except per share data):
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
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| Three Months Ended |
| Nine Months Ended |
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| 2005 |
| 2004 |
| 2005 |
| 2004 |
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Net income: |
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Net income, as reported |
| $ | 135,248 |
| $ | 130,144 |
| $ | 415,948 |
| $ | 373,122 |
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Add: Stock-based compensation under APB 25 |
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| 617 |
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| 214 |
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| 1,407 |
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| 1,179 |
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Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects |
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| (8,282 | ) |
| (11,770 | ) |
| (27,471 | ) |
| (33,531 | ) |
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Pro forma net income |
| $ | 127,583 |
| $ | 118,588 |
| $ | 389,884 |
| $ | 340,770 |
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Earnings per common share: |
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Basic – as reported |
| $ | 0.67 |
| $ | 0.64 |
| $ | 2.06 |
| $ | 1.82 |
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|
|
| ||||||||
Basic – pro forma |
| $ | 0.63 |
| $ | 0.59 |
| $ | 1.93 |
| $ | 1.66 |
|
|
|
|
|
|
| ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted – as reported |
| $ | 0.66 |
| $ | 0.62 |
| $ | 2.02 |
| $ | 1.75 |
|
|
|
|
|
|
| ||||||||
Diluted – pro forma |
| $ | 0.62 |
| $ | 0.56 |
| $ | 1.88 |
| $ | 1.59 |
|
|
|
|
|
|
|
The fair value of each stock option award granted prior to January 1, 2005 was estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of each stock option award granted subsequent to January 1, 2005 was estimated on the date of grant using a lattice-based option-valuation model. Management believes a lattice-based option-valuation model provides a more accurate measure of fair value. The expected volatility in connection with the Black-Scholes option-pricing model was based on the historical volatility of the Company’s stock, while the expected volatility under the lattice-based option-valuation model was based on the current and the historical implied volatilities from traded options of the Company’s stock. The weighted average assumptions used in valuing options granted in the periods presented are noted in the following table:
|
| Three Months Ended
| Nine Months Ended
| ||||||||||
|
|
|
| ||||||||||
|
| 2005
| 2004
| 2005
| 2004
| ||||||||
|
|
|
|
| |||||||||
Dividend yield |
| 0.7 | % | 0.7 | % | 0.7 | % | 0.7 | % | ||||
Risk-free interest rate |
| 3.9 | % | 3.7 | % | 4.0 | % | 3.1 | % | ||||
Expected volatility |
| 22.4 | % | 46.6 | % | 23.2 | % | 47.2 | % | ||||
Expected holding period, in years |
| 5 |
| 5 |
| 6 |
| 5 |
|
New Accounting Standards
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, revised 2004, “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires that companies recognize compensation cost relating to share-based payment transactions based on the fair value of the equity or liability instruments issued. SFAS 123R is effective for annual periods beginning after June 15, 2005. The Company expects to adopt SFAS 123R effective January 1, 2006 using the modified prospective approach. Under this approach, awards that are granted, modified or settled after January 1, 2006 will be measured and accounted for in accordance with SFAS 123R. Unvested awards that were granted prior to January 1, 2006 will continue to be accounted for in accordance with SFAS 123, except that compensation costs will be recognized in the Company’s results of operations over their remaining vesting period. The Company has not completely finalized what changes will be made to its equity compensation plans in light of the accounting change, and therefore is not yet in a position to quantify its impact.
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces APB No. 20 “Accounting Changes”, and SFAS No. 3 “Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for the Company beginning January 1, 2006.
2. | GOODWILL AND INTANGIBLE ASSETS |
Goodwill at September 30, 2005 and December 31, 2004 consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
|
|
| ||||
|
|
|
|
|
|
|
|
Goodwill |
| $ | 2,712,649 |
| $ | 2,695,003 |
|
Less: accumulated amortization |
|
| (188,053 | ) |
| (188,053 | ) |
|
|
|
| ||||
Goodwill, net |
| $ | 2,524,596 |
| $ | 2,506,950 |
|
|
|
|
|
The changes in the gross carrying amount of goodwill for the nine-month period ended September 30, 2005 and for the year ended December 31, 2004 are as follows:
|
| September 30, |
| December 31, |
| ||
|
|
|
| ||||
|
|
|
|
|
|
|
|
Balance at beginning of period |
| $ | 2,695,003 |
| $ | 2,706,928 |
|
Goodwill acquired during the period |
|
| 17,646 |
|
| – |
|
Other |
|
| – |
|
| (11,925 | ) |
|
|
|
| ||||
Balance at end of period |
| $ | 2,712,649 |
| $ | 2,695,003 |
|
|
|
|
|
During the nine months ended September 30, 2005, the Company completed an acquisition of a small regional laboratory for $19 million in cash.
For the year ended December 31, 2004, the reduction in goodwill was primarily related to an increase in pre-acquisition tax net operating losses and credit carryforwards associated with businesses acquired.
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Intangible assets at September 30, 2005 and December 31, 2004 consisted of the following:
|
|
|
| September 30, 2005 |
| December 31, 2004 |
| ||||||||||||||
|
|
|
|
|
| ||||||||||||||||
|
| Weighted |
| Cost |
| Accumulated |
| Net |
| Cost |
| Accumulated |
| Net |
| ||||||
|
|
|
|
|
|
|
|
| |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-compete agreements |
| 5 years |
| $ | 45,707 |
| $ | (43,765 | ) | $ | 1,942 |
| $ | 44,942 |
| $ | (42,348 | ) | $ | 2,594 |
|
Customer lists |
| 15 years |
|
| 42,422 |
|
| (37,986 | ) |
| 4,436 |
|
| 42,225 |
|
| (37,197 | ) |
| 5,028 |
|
Other |
| 7 years |
|
| 7,026 |
|
| (3,580 | ) |
| 3,446 |
|
| 6,850 |
|
| (3,010 | ) |
| 3,840 |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Total |
| 10 years |
| $ | 95,155 |
| $ | (85,331 | ) | $ | 9,824 |
| $ | 94,017 |
| $ | (82,555 | ) | $ | 11,462 |
|
|
|
|
|
|
|
|
|
|
|
Amortization expense related to intangible assets was $912 and $1,664 for the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, amortization expense related to intangible assets was $2,776 and $5,786, respectively.
The estimated amortization expense related to intangible assets for each of the five succeeding fiscal years and thereafter as of September 30, 2005 is as follows:
Fiscal Year Ending |
|
|
| ||
|
|
| |||
|
|
|
|
| |
Remainder of 2005 |
| $ | 828 |
| |
2006 |
|
| 2,603 |
| |
2007 |
|
| 1,213 |
| |
2008 |
|
| 1,019 |
| |
2009 |
|
| 920 |
| |
2010 |
|
| 672 |
| |
Thereafter |
|
| 2,569 |
| |
|
|
| |||
Total |
| $ | 9,824 |
| |
|
|
|
3. | DEBT |
Short-term borrowings and current portion of long-term debt at September 30, 2005 and December 31, 2004 consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
|
|
| ||||
Borrowings under $300 million Secured Receivables Credit Facility |
| $ | 229,920 |
| $ | 129,921 |
|
Debentures called for redemption in December 2004 |
|
| – |
|
| 244,660 |
|
6¾% senior notes due July 2006 |
|
| 274,766 |
|
| – |
|
Current portion of long-term debt |
|
| 214 |
|
| 220 |
|
|
|
|
| ||||
Total short-term borrowings and current portion of long-term debt |
| $ | 504,900 |
| $ | 374,801 |
|
|
|
|
|
9
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Long-term debt at September 30, 2005 and December 31, 2004 consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
|
|
| ||||
Term loan due December 2008 |
| $ | 75,000 |
| $ | 75,000 |
|
Borrowings under $500 million Credit Facility |
|
| – |
|
| 100,000 |
|
6¾% senior notes due July 2006 |
|
| – |
|
| 274,531 |
|
7½% senior notes due July 2011 |
|
| 274,364 |
|
| 274,281 |
|
Other |
|
| 249 |
|
| 429 |
|
|
|
|
| ||||
Total |
|
| 349,613 |
|
| 724,241 |
|
Less: current portion |
|
| 214 |
|
| 220 |
|
|
|
|
| ||||
Total long-term debt |
| $ | 349,399 |
| $ | 724,021 |
|
|
|
|
|
In December 2004, the Company called for redemption all of its outstanding Debentures. Under the terms of the Debentures, the holders of the Debentures had an option to submit their Debentures for redemption at par plus accrued and unpaid interest or convert their Debentures into shares of the Company’s common stock at a conversion price of $43.75 per share. Through December 31, 2004, $3.2 million of principal of the Debentures were converted into less than 0.1 million shares of the Company’s common stock. The outstanding principal of the Debentures at December 31, 2004 was classified as a current liability within short-term borrowings and current portion of long-term debt on the Company’s consolidated balance sheet. As of January 18, 2005, the redemption was completed and $0.4 million of principal was redeemed for cash and $249.6 million of principal was converted into approximately 5.7 million shares of the Company’s common stock.
On January 31, 2005, the Company repaid $100 million of principal outstanding under its $500 million senior unsecured revolving credit facility (the “Credit Facility”) with $100 million of borrowings under its $300 million receivables securitization facility (the “Secured Receivables Credit Facility”).
4. | COMMITMENTS AND CONTINGENCIES |
The Company has standby letters of credit issued under its $75 million letter of credit lines to ensure its performance or payment to third parties, which amounted to $72 million at September 30, 2005. 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 related to billing practices filed under the qui tam provisions of the civil False Claims Act, and other federal and state statutes. In addition, 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.
During the second quarter of 2005, the Company received a subpoena from the United States Attorney’s office for the District of New Jersey. The subpoena seeks the production of business and financial records regarding capitation and risk sharing arrangements with government and private payers for the years 1993 through 1999. During the third quarter of 2005, the Company received a subpoena from the U.S. Department of Health and Human Services, Office of the Inspector General. The subpoena seeks the production of various business records including records regarding our relationship with health maintenance organizations, independent physician associations, group purchasing organizations, and preferred provider organizations from 1995 to the present. The Company is cooperating with the United States Attorney’s Office and the Office of the Inspector General.
During the fourth quarter of 2004, the Company and its test kit manufacturing subsidiary, NID, each received a subpoena from the United States Attorney’s office for the Eastern District of New York. The Company and NID have been cooperating with the United States Attorney’s Office. In connection with such cooperation, we have been producing various business records, including documents related to testing and test kits manufactured by NID. In the second and third quarters of 2005, the U.S. Food and Drug Administration (“FDA”) conducted an inspection of NID and issued a Form 483 listing the observations made by the FDA during the course of the inspection. NID has filed its initial response to the Form 483 and is in the process of preparing a supplemental response. Noncompliance with FDA regulatory requirements or failure to take adequate and timely corrective action on the part of NID, could lead to regulatory or enforcement action by the FDA against
10
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
NID, including, but not limited to, a warning letter, injunction, suspension of production and/or distribution, seizure or recall of products, fines or penalties, denial of pre-market clearance for new or changed products, recommendation against award of government contracts, and criminal prosecution. NID is cooperating with the FDA.
Management has established reserves in accordance with generally accepted accounting principles for the matters discussed above. Although management cannot predict the outcome of such matters, management does not anticipate that the ultimate outcome of such matters will have a material adverse effect on the Company’s financial position but may be material to the Company’s results of operations or cash flows in the period in which the impact of such matters is determined or paid. However, the Company understands that there may be pending qui tam claims brought by former employees or other “whistle blowers”, or other pending claims as to which the Company has not been provided with a copy of the complaint and accordingly cannot determine the extent of any potential liability.
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 coverage 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 considers 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 or cash flows in the period in which the impact of such claims is determined or paid.
11
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
5. | STOCKHOLDERS’ EQUITY |
Changes in stockholders’ equity for the nine months ended September 30, 2005 were as follows:
|
| Shares of |
| Common |
| Additional |
| Retained |
| Unearned |
| Accumulated |
| Treasury |
|
| Compre- |
| |||||||
Balance, December 31, 2004 |
| 196,220 |
| $ | 1,068 |
| $ | 2,195,346 |
| $ | 818,734 |
| $ | (11 | ) | $ | 3,866 |
| $ | (730,352 | ) |
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
| 415,948 |
|
|
|
|
|
|
|
|
|
|
| $ | 415,948 |
|
Other comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (8,107 | ) |
|
|
|
|
| (8,107 | ) |
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| $ | 407,841 |
|
Adjustment for 2-for-1 stock split |
|
|
|
| 1,068 |
|
| (1,068 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends declared |
|
|
|
|
|
|
|
|
|
| (54,635 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock under benefit plans |
| 374 |
|
|
|
|
| 3,386 |
|
|
|
|
| (3,934 | ) |
|
|
|
| 12,612 |
|
|
|
|
|
Exercise of stock options |
| 3,345 |
|
|
|
|
| (58,507 | ) |
|
|
|
|
|
|
|
|
|
| 143,352 |
|
|
|
|
|
Shares to cover employee payroll tax withholdings on stock issued under benefit plans |
|
|
|
|
|
|
| (7 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of contingent convertible debentures |
| 5,632 |
|
|
|
|
| 12,510 |
|
|
|
|
|
|
|
|
|
|
| 237,136 |
|
|
|
|
|
Tax benefits associated with stock-based compensation plans |
|
|
|
|
|
|
| 28,396 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of unearned compensation |
|
|
|
|
|
|
|
|
|
|
|
|
| 1,407 |
|
|
|
|
|
|
|
|
|
|
|
Purchases of treasury stock |
| (3,770 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (190,467 | ) |
|
|
|
|
Balance, September 30, 2005 |
| 201,801 |
| $ | 2,136 |
| $ | 2,180,056 |
| $ | 1,180,047 |
| $ | (2,538 | ) | $ | (4,241 | ) | $ | (527,719 | ) |
|
|
|
|
For the three months ended September 30, 2005, the Company repurchased 2.0 million shares of its common stock at an average price of $50.41 per share for $98 million. For the nine months ended September 30, 2005, the Company repurchased 3.8 million shares of its common stock at an average price of $50.52 per share for $190 million. For the three and nine months ended September 30, 2005, the Company reissued 0.9 million and 3.7 million shares, respectively, for employee benefit plans. For the nine months ended September 30, 2005, the Company has reissued 5.6 million shares in connection with the conversion of its Debentures. Since the inception of the share repurchase program in May 2003 through September 30, 2005, the Company has repurchased 28.4 million shares of its common stock at an average price of $41.63 for approximately $1.2 billion. At September 30, 2005, $322 million of the share repurchase authorizations remained available.
During each of the quarters of 2005 and 2004, the Company’s Board of Directors has declared a quarterly cash dividend of $0.09 and $0.075 per common share, respectively.
12
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Changes in stockholders’ equity for the nine months ended September 30, 2004 were as follows:
|
| Shares of |
| Common |
| Additional |
| Retained |
| Unearned |
| Accumulated |
| Treasury |
|
| Compre- |
| |||||||
Balance, December 31, 2003 |
| 205,627 |
| $ | 1,068 |
| $ | 2,267,014 |
| $ | 380,559 |
| $ | (2,346 | ) | $ | 5,947 |
| $ | (257,548 | ) |
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
| 373,122 |
|
|
|
|
|
|
|
|
|
|
| $ | 373,122 |
|
Other comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (5,757 | ) |
|
|
|
|
| (5,757 | ) |
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| $ | 367,365 |
|
Dividends declared |
|
|
|
|
|
|
|
|
|
| (45,997 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock under benefit plans |
|
|
|
| 1 |
|
| 1,524 |
|
|
|
|
| 962 |
|
|
|
|
| 8,126 |
|
|
|
|
|
Exercise of stock options |
| 5,403 |
|
|
|
|
| (102,170 | ) |
|
|
|
|
|
|
|
|
|
| 185,255 |
|
|
|
|
|
Shares to cover employee payroll tax withholdings on stock issued under benefit plans |
| (152 | ) |
| (1 | ) |
| (6,265 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax benefits associated with stock-based compensation plans |
|
|
|
|
|
|
| 54,156 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of unearned compensation |
|
|
|
|
|
|
|
|
|
|
|
|
| 1,179 |
|
|
|
|
|
|
|
|
|
|
|
Purchases of treasury stock |
| (9,092 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (381,145 | ) |
|
|
|
|
Balance, September 30, 2004 |
| 202,074 |
| $ | 1,068 |
| $ | 2,214,259 |
| $ | 707,684 |
| $ | (205 | ) | $ | 190 |
| $ | (445,312 | ) |
|
|
|
|
For the three months ended September 30, 2004, the Company purchased 2.7 million shares of its common stock at an average price of $40.82 per share for $110 million and reissued 1.3 million shares in connection with employee benefit plans. For the nine months ended September 30, 2004, the Company purchased 9.1 million shares of its common stock at an average price of $41.92 per share for $381 million and reissued 5.6 million shares in connection with employee benefit plans.
6. | SUPPLEMENTAL CASH FLOW & OTHER DATA |
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| 2005 |
| 2004 |
| 2005 |
| 2004 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense |
| $ | 42,543 |
| $ | 40,874 |
| $ | 126,210 |
| $ | 120,669 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
| (13,232 | ) |
| (14,067 | ) |
| (39,608 | ) |
| (45,885 | ) |
Interest income |
|
| 1,392 |
|
| 437 |
|
| 2,345 |
|
| 1,265 |
|
Interest expense, net |
|
| (11,840 | ) |
| (13,630 | ) |
| (37,263 | ) |
| (44,620 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid |
|
| 22,914 |
|
| 21,505 |
|
| 47,889 |
|
| 47,420 |
|
Income taxes paid |
|
| 82,969 |
|
| 30,952 |
|
| 231,946 |
|
| 143,343 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of Debentures |
| $ | – |
| $ | – |
| $ | 244,338 |
| $ | – |
|
13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
7. | PENDING ACQUISITION |
Acquisition of LabOne, Inc.
On August 8, 2005, the Company signed a definitive agreement to acquire LabOne, Inc. (“LabOne”). LabOne provides health screening and risk assessment services to life insurance companies, as well as clinical diagnostic testing services to healthcare providers and drugs-of-abuse testing to employers. LabOne, which is headquartered in Lenexa, Kansas, reported revenues of $468 million for the year ended December 31, 2004, and has 3,100 employees. LabOne operates major laboratories in Lenexa, Kansas, and Cincinnati, Ohio, as well as a state-of-the-art call center in Lee’s Summit, Missouri, and provides paramedical examination services throughout the United States and Canada.
Under the terms of the agreement, which was unanimously approved by both companies’ Boards of Directors, Quest Diagnostics will acquire all outstanding common shares of LabOne for $43.90 per share in an all-cash transaction valued at $934 million, after the assumed settlement of LabOne’s convertible debt for $132 million. The total cash required to complete the transaction is approximately $980 million, which includes the $934 million payment for the common shares and settlement of the convertible debt, as well as transaction costs, and the repayment of substantially all of LabOne’s other debt. The transaction, which is expected to be completed during the first week of November 2005, is subject to the satisfaction of customary conditions. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, expired on October 13, 2005. On October 27, 2005, the shareholders of LabOne approved the agreement and plan of merger.
The Company expects to finance the acquisition and repayment of substantially all of LabOne’s existing debt through a combination of the net proceeds of a private placement of senior notes, cash on hand, and if necessary, borrowings under its existing credit facilities.
The acquisition will be accounted for under the purchase method of accounting.
8. | SUBSEQUENT EVENTS |
Treasury Lock Agreements
In October 2005, the Company entered into interest rate lock agreements with two financial institutions for a total notional amount of $300 million to lock the U.S. treasury rate component of the Company’s anticipated offering of at least $300 million of debt securities in the fourth quarter of 2005 (the “Treasury Lock Agreements”). The Treasury Lock Agreements, which had an original maturity date of November 9, 2005, were entered into to hedge part of the Company’s interest rate exposure associated with the minimum amount of debt securities to be issued in the fourth quarter of 2005. In connection with the Company’s private placement of senior notes on October 25, 2005 (which is discussed below), the Treasury Lock Agreements were settled and the Company received $2.5 million, representing the gain on the settlement of the Treasury Lock Agreements. These gains will be deferred in stockholders’ equity (as a component of comprehensive income) and will be amortized as an adjustment to interest expense over the term of the senior notes due 2015.
Private Placement of Senior Notes
On October 25, 2005, the Company commenced a $900 million private placement of senior notes (the “Senior Notes”) pursuant to rule 144A under the Securities Act. The Company expects the transaction to be completed by October 31, 2005. The Senior Notes were priced in two tranches: (a) $400 million aggregate principal amount of 5.125% senior notes due November 1, 2010 (“Senior Notes due 2010”); and (b) $500 million aggregate principal amount of 5.45% senior notes due November 1, 2015 (“Senior Notes due 2015”). The Senior Notes will require semiannual interest payments. The Senior Notes will be unsecured obligations of the Company and will rank equally with the Company’s other unsecured senior obligations. The Senior Notes will be guaranteed by the Company’s wholly owned subsidiaries that operate clinical laboratories in the United States (the “Subsidiary Guarantors”). The Company expects to use the net proceeds from the Senior Notes, together with cash on hand and, if necessary, borrowings under its existing credit facilities, to pay the cash purchase price and transaction costs of the LabOne acquisition and to repay substantially all of the debt of LabOne. Under a registration rights agreement to be executed in connection with the offering and sale of the Senior Notes and
14
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
related guarantees, the Company has agreed to file a registration statement intended to enable the holders of the Senior Notes to exchange the notes and guarantees for publicly registered notes and guarantees.
9. | SUMMARIZED FINANCIAL INFORMATION |
The Company’s 6¾% senior notes due 2006, 7½% senior notes due 2011 and the Debentures are guaranteed by the Subsidiary Guarantors. With the exception of Quest Diagnostics Receivables Incorporated (see paragraph below), the non-guarantor subsidiaries are primarily foreign subsidiaries and less than wholly owned subsidiaries. In January 2005, the Company completed its redemption of all of its outstanding Debentures (see Note 3 for further details).
In conjunction with the Company’s Secured Receivables Credit Facility, the Company maintains a 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 Corporation (“Unilab”), transferred 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. Effective with the second quarter of 2004, the Company and Subsidiary Guarantors, including AML and Unilab, 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.
15
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 September 30, 2005
|
| Parent |
| Subsidiary |
| Non- |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
| $ | 225,287 |
| $ | 1,083,255 |
| $ | 139,534 |
| $ | (76,255 | ) | $ | 1,371,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services |
|
| 121,551 |
|
| 639,025 |
|
| 46,444 |
|
| – |
|
| 807,020 |
|
Selling, general and administrative |
|
| 27,679 |
|
| 223,512 |
|
| 67,494 |
|
| (5,259 | ) |
| 313,426 |
|
Amortization of intangible assets |
|
| 421 |
|
| 491 |
|
| – |
|
| – |
|
| 912 |
|
Royalty (income) expense |
|
| (89,462 | ) |
| 89,462 |
|
| – |
|
| – |
|
| – |
|
Other operating expense (income), net |
|
| 7,200 |
|
| (1 | ) |
| 68 |
|
| – |
|
| 7,267 |
|
|
|
|
|
|
|
| ||||||||||
Total operating costs and expenses |
|
| 67,389 |
|
| 952,489 |
|
| 114,006 |
|
| (5,259 | ) |
| 1,128,625 |
|
|
|
|
|
|
|
| ||||||||||
Operating income |
|
| 157,898 |
|
| 130,766 |
|
| 25,528 |
|
| (70,996 | ) |
| 243,196 |
|
Non-operating expenses, net |
|
| (22,451 | ) |
| (64,775 | ) |
| (927 | ) |
| 70,996 |
|
| (17,157 | ) |
|
|
|
|
|
|
| ||||||||||
Income before taxes |
|
| 135,447 |
|
| 65,991 |
|
| 24,601 |
|
| – |
|
| 226,039 |
|
Income tax expense |
|
| 52,543 |
|
| 26,397 |
|
| 11,851 |
|
| – |
|
| 90,791 |
|
|
|
|
|
|
|
| ||||||||||
Income before equity earnings |
|
| 82,904 |
|
| 39,594 |
|
| 12,750 |
|
| – |
|
| 135,248 |
|
Equity earnings from subsidiaries |
|
| 52,344 |
|
| – |
|
| – |
|
| (52,344 | ) |
| – |
|
|
|
|
|
|
|
| ||||||||||
Net income |
| $ | 135,248 |
| $ | 39,594 |
| $ | 12,750 |
| $ | (52,344 | ) | $ | 135,248 |
|
|
|
|
|
|
|
|
Condensed Consolidating Statement of Operations
Three Months Ended September 30, 2004
|
| Parent |
| Subsidiary |
| Non– |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
| $ | 208,270 |
| $ | 1,016,843 |
| $ | 131,491 |
| $ | (66,707 | ) | $ | 1,289,897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services |
|
| 111,829 |
|
| 592,352 |
|
| 44,243 |
|
| – |
|
| 748,424 |
|
Selling, general and administrative |
|
| 22,871 |
|
| 221,531 |
|
| 68,788 |
|
| (4,942 | ) |
| 308,248 |
|
Amortization of intangible assets |
|
| 381 |
|
| 1,274 |
|
| 9 |
|
| – |
|
| 1,664 |
|
Royalty (income) expense |
|
| (83,418 | ) |
| 83,418 |
|
| – |
|
| – |
|
| – |
|
Other operating expense (income), net |
|
| (3 | ) |
| (3 | ) |
| (136 | ) |
| – |
|
| (142 | ) |
|
|
|
|
|
|
| ||||||||||
Total operating costs and expenses |
|
| 51,660 |
|
| 898,572 |
|
| 112,904 |
|
| (4,942 | ) |
| 1,058,194 |
|
|
|
|
|
|
|
| ||||||||||
Operating income |
|
| 156,610 |
|
| 118,271 |
|
| 18,587 |
|
| (61,765 | ) |
| 231,703 |
|
Non–operating expenses, net |
|
| (18,611 | ) |
| (55,217 | ) |
| (909 | ) |
| 61,765 |
|
| (12,972 | ) |
|
|
|
|
|
|
| ||||||||||
Income before taxes |
|
| 137,999 |
|
| 63,054 |
|
| 17,678 |
|
| – |
|
| 218,731 |
|
Income tax expense |
|
| 56,127 |
|
| 25,221 |
|
| 7,239 |
|
| – |
|
| 88,587 |
|
|
|
|
|
|
|
| ||||||||||
Income before equity earnings |
|
| 81,872 |
|
| 37,833 |
|
| 10,439 |
|
| – |
|
| 130,144 |
|
Equity earnings from subsidiaries |
|
| 48,272 |
|
| – |
|
| – |
|
| (48,272 | ) |
| – |
|
|
|
|
|
|
|
| ||||||||||
Net income |
| $ | 130,144 |
| $ | 37,833 |
| $ | 10,439 |
| $ | (48,272 | ) | $ | 130,144 |
|
|
|
|
|
|
|
|
16
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2005
|
| Parent |
| Subsidiary |
| Non- |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
| $ | 656,933 |
| $ | 3,216,985 |
| $ | 399,627 |
| $ | (204,710 | ) | $ | 4,068,835 |
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services |
|
| 363,176 |
|
| 1,883,651 |
|
| 138,953 |
|
| – |
|
| 2,385,780 |
|
Selling, general and administrative |
|
| 73,976 |
|
| 676,711 |
|
| 202,297 |
|
| (15,536 | ) |
| 937,448 |
|
Amortization of intangible assets |
|
| 1,331 |
|
| 1,427 |
|
| 18 |
|
| – |
|
| 2,776 |
|
Royalty (income) expense |
|
| (264,693 | ) |
| 264,693 |
|
| – |
|
| – |
|
| – |
|
Other operating expense, net |
|
| 8,288 |
|
| (1 | ) |
| 282 |
|
| – |
|
| 8,569 |
|
|
|
|
|
|
|
| ||||||||||
Total operating costs and expenses |
|
| 182,078 |
|
| 2,826,481 |
|
| 341,550 |
|
| (15,536 | ) |
| 3,334,573 |
|
|
|
|
|
|
|
| ||||||||||
Operating income |
|
| 474,855 |
|
| 390,504 |
|
| 58,077 |
|
| (189,174 | ) |
| 734,262 |
|
Non-operating expenses, net |
|
| (51,514 | ) |
| (175,436 | ) |
| (1,024 | ) |
| 189,174 |
|
| (38,800 | ) |
|
|
|
|
|
|
| ||||||||||
Income before taxes |
|
| 423,341 |
|
| 215,068 |
|
| 57,053 |
|
| – |
|
| 695,462 |
|
Income tax expense |
|
| 168,017 |
|
| 86,027 |
|
| 25,470 |
|
| – |
|
| 279,514 |
|
|
|
|
|
|
|
| ||||||||||
Income before equity earnings |
|
| 255,324 |
|
| 129,041 |
|
| 31,583 |
|
| – |
|
| 415,948 |
|
Equity earnings from subsidiaries |
|
| 160,624 |
|
| – |
|
| – |
|
| (160,624 | ) |
| – |
|
|
|
|
|
|
|
| ||||||||||
Net income |
| $ | 415,948 |
| $ | 129,041 |
| $ | 31,583 |
| $ | (160,624 | ) | $ | 415,948 |
|
|
|
|
|
|
|
|
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2004
|
| Parent |
| Subsidiary |
| Non- |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
| $ | 618,043 |
| $ | 3,030,825 |
| $ | 386,408 |
| $ | (191,963 | ) | $ | 3,843,313 |
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services |
|
| 348,111 |
|
| 1,753,149 |
|
| 132,022 |
|
| – |
|
| 2,233,282 |
|
Selling, general and administrative |
|
| 78,315 |
|
| 668,050 |
|
| 191,050 |
|
| (14,220 | ) |
| 923,195 |
|
Amortization of intangible assets |
|
| 1,407 |
|
| 4,352 |
|
| 27 |
|
| – |
|
| 5,786 |
|
Royalty (income) expense |
|
| (247,385 | ) |
| 247,385 |
|
| – |
|
| – |
|
| – |
|
Other operating expense, net |
|
| 9,883 |
|
| 19 |
|
| 547 |
|
| – |
|
| 10,449 |
|
|
|
|
|
|
|
| ||||||||||
Total operating costs and expenses |
|
| 190,331 |
|
| 2,672,955 |
|
| 323,646 |
|
| (14,220 | ) |
| 3,172,712 |
|
|
|
|
|
|
|
| ||||||||||
Operating income |
|
| 427,712 |
|
| 357,870 |
|
| 62,762 |
|
| (177,743 | ) |
| 670,601 |
|
Non-operating expenses, net |
|
| (54,139 | ) |
| (164,237 | ) |
| (2,872 | ) |
| 177,743 |
|
| (43,505 | ) |
|
|
|
|
|
|
| ||||||||||
Income before taxes |
|
| 373,573 |
|
| 193,633 |
|
| 59,890 |
|
| – |
|
| 627,096 |
|
Income tax expense |
|
| 153,112 |
|
| 77,453 |
|
| 23,409 |
|
| – |
|
| 253,974 |
|
|
|
|
|
|
|
| ||||||||||
Income before equity earnings |
|
| 220,461 |
|
| 116,180 |
|
| 36,481 |
|
| – |
|
| 373,122 |
|
Equity earnings from subsidiaries |
|
| 152,661 |
|
| – |
|
| – |
|
| (152,661 | ) |
| – |
|
|
|
|
|
|
|
| ||||||||||
Net income |
| $ | 373,122 |
| $ | 116,180 |
| $ | 36,481 |
| $ | (152,661 | ) | $ | 373,122 |
|
|
|
|
|
|
|
|
17
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
September 30, 2005
|
| Parent |
| Subsidiary |
| Non-Guarantor |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
| $ | 197,357 |
| $ | 2,429 |
| $ | 10,303 |
| $ | – |
| $ | 210,089 |
|
Accounts receivable, net |
|
| 33,981 |
|
| 77,701 |
|
| 582,110 |
|
| – |
|
| 693,792 |
|
Other current assets |
|
| 27,814 |
|
| 129,012 |
|
| 90,635 |
|
| – |
|
| 247,461 |
|
|
|
|
|
|
|
| ||||||||||
Total current assets |
|
| 259,152 |
|
| 209,142 |
|
| 683,048 |
|
| – |
|
| 1,151,342 |
|
Property, plant and equipment, net |
|
| 206,111 |
|
| 435,020 |
|
| 29,731 |
|
| – |
|
| 670,862 |
|
Goodwill and intangible assets, net |
|
| 156,690 |
|
| 2,332,136 |
|
| 45,594 |
|
| – |
|
| 2,534,420 |
|
Intercompany receivable (payable) |
|
| 363,805 |
|
| (64,622 | ) |
| (299,183 | ) |
| – |
|
| – |
|
Investment in subsidiaries |
|
| 2,244,260 |
|
| – |
|
| – |
|
| (2,244,260 | ) |
| – |
|
Other assets |
|
| 98,623 |
|
| 41,906 |
|
| 37,581 |
|
| – |
|
| 178,110 |
|
|
|
|
|
|
|
| ||||||||||
Total assets |
| $ | 3,328,641 |
| $ | 2,953,582 |
| $ | 496,771 |
| $ | (2,244,260 | ) | $ | 4,534,734 |
|
|
|
|
|
|
|
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses |
| $ | 379,541 |
| $ | 272,719 |
| $ | 34,347 |
| $ | – |
| $ | 686,607 |
|
Short-term borrowings and current portion of long-term debt |
|
| 35,296 |
|
| 238,704 |
|
| 230,900 |
|
| – |
|
| 504,900 |
|
|
|
|
|
|
|
| ||||||||||
Total current liabilities |
|
| 414,837 |
|
| 511,423 |
|
| 265,247 |
|
| – |
|
| 1,191,507 |
|
Long-term debt |
|
| 35,245 |
|
| 313,176 |
|
| 978 |
|
| – |
|
| 349,399 |
|
Other liabilities |
|
| 50,818 |
|
| 89,918 |
|
| 25,351 |
|
| – |
|
| 166,087 |
|
Stockholders’ equity |
|
| 2,827,741 |
|
| 2,039,065 |
|
| 205,195 |
|
| (2,244,260 | ) |
| 2,827,741 |
|
|
|
|
|
|
|
| ||||||||||
Total liabilities and stockholders’ equity |
| $ | 3,328,641 |
| $ | 2,953,582 |
| $ | 496,771 |
| $ | (2,244,260 | ) | $ | 4,534,734 |
|
|
|
|
|
|
|
|
Condensed Consolidating Balance Sheet
December 31, 2004
|
| Parent |
| Subsidiary |
| Non-Guarantor |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
| $ | 56,424 |
| $ | 6,058 |
| $ | 10,820 |
| $ | – |
| $ | 73,302 |
|
Accounts receivable, net |
|
| 22,365 |
|
| 75,359 |
|
| 551,557 |
|
| – |
|
| 649,281 |
|
Other current assets |
|
| 12,032 |
|
| 109,100 |
|
| 87,365 |
|
| – |
|
| 208,497 |
|
|
|
|
|
|
|
| ||||||||||
Total current assets |
|
| 90,821 |
|
| 190,517 |
|
| 649,742 |
|
| – |
|
| 931,080 |
|
Property, plant and equipment, net |
|
| 213,416 |
|
| 379,952 |
|
| 26,117 |
|
| – |
|
| 619,485 |
|
Goodwill and intangible assets, net |
|
| 158,021 |
|
| 2,315,015 |
|
| 45,376 |
|
| – |
|
| 2,518,412 |
|
Intercompany receivable (payable) |
|
| 493,578 |
|
| (124,047 | ) |
| (369,531 | ) |
| – |
|
| – |
|
Investment in subsidiaries |
|
| 2,109,612 |
|
| – |
|
| – |
|
| (2,109,612 | ) |
| – |
|
Other assets |
|
| 49,031 |
|
| 49,100 |
|
| 36,680 |
|
| – |
|
| 134,811 |
|
|
|
|
|
|
|
| ||||||||||
Total assets |
| $ | 3,114,479 |
| $ | 2,810,537 |
| $ | 388,384 |
| $ | (2,109,612 | ) | $ | 4,203,788 |
|
|
|
|
|
|
|
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses |
| $ | 368,363 |
| $ | 268,420 |
| $ | 32,204 |
| $ | – |
| $ | 668,987 |
|
Short-term borrowings and current portion of long-term debt |
|
| 244,713 |
|
| 167 |
|
| 129,921 |
|
| – |
|
| 374,801 |
|
|
|
|
|
|
|
| ||||||||||
Total current liabilities |
|
| 613,076 |
|
| 268,587 |
|
| 162,125 |
|
| – |
|
| 1,043,788 |
|
Long-term debt |
|
| 170,293 |
|
| 551,771 |
|
| 1,957 |
|
| – |
|
| 724,021 |
|
Other liabilities |
|
| 42,459 |
|
| 80,155 |
|
| 24,714 |
|
| – |
|
| 147,328 |
|
Stockholders’ equity |
|
| 2,288,651 |
|
| 1,910,024 |
|
| 199,588 |
|
| (2,109,612 | ) |
| 2,288,651 |
|
|
|
|
|
|
|
| ||||||||||
Total liabilities and stockholders’ equity |
| $ | 3,114,479 |
| $ | 2,810,537 |
| $ | 388,384 |
| $ | (2,109,612 | ) | $ | 4,203,788 |
|
|
|
|
|
|
|
|
18
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2005
|
| Parent |
| Subsidiary |
| Non-Guarantor |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
| $ | 415,948 |
| $ | 129,041 |
| $ | 31,583 |
| $ | (160,624 | ) | $ | 415,948 |
|
Extraordinary loss |
|
| – |
|
| – |
|
| – |
|
| – |
|
| – |
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
| 39,230 |
|
| 81,802 |
|
| 7,954 |
|
| – |
|
| 128,986 |
|
Provision for doubtful accounts |
|
| 4,180 |
|
| 29,897 |
|
| 143,877 |
|
| – |
|
| 177,954 |
|
Provisions for restructuring and other special activities |
|
| – |
|
| – |
|
| – |
|
| – |
|
| – |
|
Other, net |
|
| (124,588 | ) |
| (3,767 | ) |
| 9,994 |
|
| 160,624 |
|
| 42,263 |
|
Changes in operating assets and liabilities |
|
| 34,719 |
|
| (105,626 | ) |
| (146,070 | ) |
| – |
|
| (216,977 | ) |
|
|
|
|
|
|
| ||||||||||
Net cash provided by (used in) operating activities |
|
| 369,489 |
|
| 131,347 |
|
| 47,338 |
|
| – |
|
| 548,174 |
|
Net cash provided by (used in) investing |
|
| 28,940 |
|
| (142,788 | ) |
| (13,086 | ) |
| (112,049 | ) |
| (238,983 | ) |
Net cash used in provided by financing activities |
|
| (257,496 | ) |
| (7,812 | ) |
| (34,769 | ) |
| 112,049 |
|
| (172,404 | ) |
|
|
|
|
|
|
| ||||||||||
Net change in cash and cash equivalents |
|
| 140,933 |
|
| (3,629 | ) |
| (517 | ) |
| – |
|
| 136,787 |
|
Cash and cash equivalents, beginning of period |
|
| 56,424 |
|
| 6,058 |
|
| 10,820 |
|
| – |
|
| 73,302 |
|
|
|
|
|
|
|
| ||||||||||
Cash and cash equivalents, end of period |
| $ | 197,357 |
| $ | 2,429 |
| $ | 10,303 |
| $ | – |
| $ | 210,089 |
|
|
|
|
|
|
|
|
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2004
|
| Parent |
| Subsidiary |
| Non-Guarantor |
| Eliminations |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
| $ | 373,122 |
| $ | 116,180 |
| $ | 36,481 |
| $ | (152,661 | ) | $ | 373,122 |
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
| 42,786 |
|
| 76,047 |
|
| 7,622 |
|
| – |
|
| 126,455 |
|
Provision for doubtful accounts |
|
| 3,662 |
|
| 34,724 |
|
| 133,641 |
|
| – |
|
| 172,027 |
|
Other, net |
|
| (59,065 | ) |
| 406 |
|
| 9,616 |
|
| 152,661 |
|
| 103,618 |
|
Changes in operating assets and liabilities |
|
| 69,567 |
|
| (50,924 | ) |
| (258,658 | ) |
| – |
|
| (240,015 | ) |
|
|
|
|
|
|
| ||||||||||
Net cash provided by (used in) operating activities |
|
| 430,072 |
|
| 176,433 |
|
| (71,298 | ) |
| – |
|
| 535,207 |
|
Net cash (used in) investing activities |
|
| (140,390 | ) |
| (78,038 | ) |
| (5,466 | ) |
| 94,122 |
|
| (129,772 | ) |
Net cash (used in) provided by financing activities |
|
| (245,955 | ) |
| (97,149 | ) |
| 77,869 |
|
| (94,122 | ) |
| (359,357 | ) |
|
|
|
|
|
|
| ||||||||||
Net change in cash and cash equivalents |
|
| (43,727 | ) |
| 1,246 |
|
| 1,105 |
|
| – |
|
| 46,078 |
|
Cash and cash equivalents, beginning of period |
|
| 141,588 |
|
| 1,991 |
|
| 11,379 |
|
| – |
|
| 154,958 |
|
|
|
|
|
|
|
| ||||||||||
Cash and cash equivalents, end of period |
| $ | 185,315 |
| $ | 3,237 |
| $ | 12,484 |
| $ | – |
| $ | 201,036 |
|
|
|
|
|
|
|
|
19
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 2004 Annual Report on Form 10-K.
Pending Acquisition
On August 8, 2005, we signed a definitive agreement to acquire LabOne, Inc., or LabOne, under which we will acquire all of the outstanding shares of LabOne in an all-cash transaction valued at approximately $934 million, after the assumed settlement of LabOne’s convertible debt for $132 million. The total cash required to complete the transaction is approximately $980 million, which includes the $934 million payment for the common shares and settlement of the convertible debt. We expect the transaction to close during the first week of November 2005. See Note 7 to the interim consolidated financial statements for a discussion of this transaction.
Results of Operations
Three and Nine Months Ended September 30, 2005 Compared with Three and Nine Months Ended September 30, 2004
Net income for the three months ended September 30, 2005 increased to $135 million, or $0.66 per diluted share, compared to $130 million, or $0.62 per diluted share, in 2004. The increases were principally driven by revenue growth in our clinical laboratory testing operations; partially offset by the effect of hurricanes, which impacted the Gulf Coast of the United States during the third quarter of 2005, and the write-down of an investment in 2005. Net income for the quarter was reduced by $11 million ($0.05 per share) as a result of these items.
The 2005 hurricanes reduced revenues by approximately half a percent, operating income by $11 million and earnings per share by $0.03. This includes a pre-tax charge of $6.2 million ($0.02 per share) included in other operating expense, primarily related to forgiveness of amounts owed by patients and physicians in the affected areas and related property damage. During the third quarter of 2004, hurricanes in the Southeastern part of the United Stated reduced revenue by approximately one half percent and earnings per share by $0.01.
Also impacting the year over year comparison was a 2005 third quarter pre-tax charge of $7.1 million ($0.02 per share) to write down an investment, and the performance at our test kit manufacturing subsidiary (NID), which reduced operating income and earnings per share compared to the prior year by $10 million and $0.03, respectively.
For the nine months ended September 30, 2005, net income increased to $416 million, or $2.02 per diluted share, compared to $373 million, or $1.75 per diluted share, in 2004. The year-to-date comparisons were impacted by the items which affected the third quarter comparison, as well as 2004 charges totaling $13.2 million ($0.04 per share), related to the acceleration of certain pension obligations in connection with the succession of our prior CEO ($10.3 million) and a $2.9 million write-off of deferred financing costs associated with the refinancing of our bank debt and credit facility.
Net Revenues
Net revenues for the three and nine months ended September 30, 2005 grew by 6.4% and 5.9%, respectively, over the prior year levels. The increases in net revenues were driven by improvements in testing volumes, measured by the number of requisitions, and increases in average revenue per requisition in our clinical laboratory testing business. During the third quarter of 2005, revenues were reduced by approximately one half percent due to the impact of
20
hurricanes in the Gulf Cost of the United States. This is similar to the revenue impact of hurricanes in the third quarter of 2004. Therefore, the impact of hurricanes did not significantly impact the year over year comparisons for revenue and volume growth for either the quarter or the year to date period. The performance of NID, which accounts for approximately 1% of consolidated revenues, and whose operations have been impacted by a voluntary product hold instituted late in the second quarter of 2005 in connection with an additional quality review of all its products, reported revenues during the third quarter which were $4 million below the prior year level. NID’s performance served to reduce consolidated revenue growth for the quarter by about one half a percent. NID products, which previously contributed about $30 million in annual revenue, have not been released. NID is actively working to complete its product review and return products to market. However, we do not expect NID’s revenues to return to pre-product hold levels for the foreseeable future.
For the three and nine months ended September 30, 2005, clinical testing volume increased 4.0% compared to the prior year periods. Average revenue per requisition improved 3.0% and 2.2% for the three and nine months ended September 30, 2005, respectively, compared to the prior year periods. These improvements are primarily attributable to a continuing shift in test mix to higher value testing, including gene-based and esoteric testing, and increases in the number of tests ordered per requisition. Management continues to expect that average revenue per requisition will typically grow approximately 2% in a given year, with some fluctuations on a quarter-to-quarter basis.
Operating Costs and Expenses
Total operating costs and expenses for the three and nine months ended September 30, 2005 increased $70 million and $162 million, respectively, from the prior year periods primarily due to increases in our clinical testing volume. 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 efficiencies generated from our Six Sigma and standardization initiatives, we continue to make investments in sales, service, science, and information technology to further differentiate our Company. Additionally, costs incurred at NID associated with completing the quality review of its products and cooperating with the government regarding subpoenas, which were received during the fourth quarter of 2004, have served to increase costs over the prior year and are impacting costs of services and selling, general and administrative expense as a percentage of revenue.
Cost of services, which includes the costs of obtaining, transporting and testing specimens, was 58.8% of net revenues for the three months ended September 30, 2005, increasing from 58.0% of net revenues in the prior year period. Approximately half of this increase is related to the performance of NID. For the nine months ended September 30, 2005, cost of services, as a percentage of net revenues, increased to 58.6% from 58.1% in the prior year period. The performance of NID accounted for approximately 0.2% of the year-to-date change. The remainder of the increase in cost of services as a percentage of revenues for both the quarterly and year-to-date period is principally due to increased costs of testing supplies, initial installation costs associated with deploying our Internet-based orders and results systems in physicians’ offices, and an increase in the number of phlebotomists in our patient service centers to support an increasing percentage of our volume generated from these sites, partially offset by the increase in average revenue per requisition and efficiency gains resulting from our Six Sigma and standardization initiatives. At September 30, 2005, 44% of our orders and 75% of our test results were being transmitted via the Internet. The increased use of 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, and reducing the cost associated with specimen processing, which is included in cost of services.
Selling, general and administrative expenses, which include the costs of the sales force, billing operations, bad debt expense and general management and administrative support, was 22.8% of net revenues during the three months ended September 30, 2005, decreasing from 23.9% in the prior year period. For the nine months ended September 30, 2005, selling, general and administrative expenses, as a percentage of net revenues, decreased to 23.0% from 24.0% in the prior year period. These improvements were primarily due to revenue growth, which has allowed us to leverage our expense base, as well as efficiencies from our Six Sigma and standardization initiatives. The performance at NID served to reduce the improvement for the quarter and year-to-date periods by approximately 0.3%. For the three and nine months ended September 30, 2005, bad debt expense was 4.3% and 4.4% of net revenues, respectively, compared to 4.6% and 4.5% for the comparable prior year periods. 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.
Other operating (income) expense, net represents miscellaneous income and expense items related to operating activities including gains and losses associated with the disposal of operating assets. For the three and nine months ended
21
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
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.
Other Income (Expense)
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.
Impact of Contingent Convertible Debentures on Earnings per Common Share
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.
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. 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.
22
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
23
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. |
(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
Item 1. | Legal Proceedings |
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 |
|
| (b) Average Price |
|
| (c) Total Number of Shares |
|
| |
| ||||||
July 1, 2005 – |
|
| – |
|
|
| $ | – |
|
|
|
| – |
|
|
|
| $420,198 |
|
August 1, 2005 – |
|
| 838,900 |
|
|
| $ | 49.99 |
|
|
|
| 838,900 |
|
|
|
| $378,257 |
|
September 1, 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.
Item 6. | Exhibits |
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 |
|
|
| |
| Surya N. Mohapatra, Ph.D. |
|
|
|
By | /s/ Robert A. Hagemann |
|
| |
| Robert A. Hagemann |
|
|
|
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