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 Quarter ended March 31, 2002
Commission file number 1-12215
Quest Diagnostics Incorporated
One Malcolm Avenue
Teterboro, NJ 07608
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
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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
--------- --------
As of April 30, 2002, there were outstanding 97,005,940 shares of Common Stock,
$.01 par value.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Index to consolidated financial statements filed as part of this report:
Page
Consolidated Statements of Operations for the
Three Months Ended March 31, 2002 and 2001 2
Consolidated Balance Sheets as of
March 31, 2002 and December 31, 2001 3
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2002 and 2001 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations"
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(in thousands, except per share data)
(unaudited)
2002 2001
---- ----
Net revenues.............................................................. $946,762 $882,553
-------- --------
Costs and expenses:
Cost of services....................................................... 557,738 529,065
Selling, general and administrative.................................... 258,403 252,802
Interest, net.......................................................... 12,675 22,700
Amortization of goodwill and other intangible assets................... 2,155 11,100
Minority share of income............................................... 3,882 1,116
Other, net............................................................. (614) 298
-------- --------
Total................................................................ 834,239 817,081
-------- --------
Income before taxes....................................................... 112,523 65,472
Income tax expense ....................................................... 45,834 29,724
-------- --------
Net income ............................................................... $ 66,689 $ 35,748
======== ========
Basic net income per common share......................................... $ 0.70 $ 0.39
Diluted net income per common share....................................... $ 0.67 $ 0.37
Weighted average common shares
outstanding - basic.................................................... 95,422 91,889
Weighted average common shares
outstanding - diluted.................................................. 99,307 96,619
2001 Results Adjusted for the Adoption of SFAS 142
Adjusted net income....................................................... $ 44,395
Adjusted basic net income per common share................................ 0.48
Adjusted diluted net income per common share.............................. 0.46
The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2002 AND DECEMBER 31, 2001
(in thousands, except per share data)
(unaudited)
March 31, December 31,
2002 2001
--------- ------------
Assets
Current assets:
Cash and cash equivalents............................................... $ 149,427 $ 122,332
Accounts receivable, net of allowance of $224,147 and $216,203 at
March 31, 2002 and December 31, 2001, respectively.................... 548,400 508,340
Inventories............................................................. 51,533 49,906
Deferred taxes on income................................................ 152,981 157,649
Prepaid expenses and other current assets............................... 47,526 38,287
---------- ----------
Total current assets.................................................. 949,867 876,514
Property, plant and equipment, net......................................... 519,944 508,619
Goodwill, net.............................................................. 1,352,398 1,351,123
Intangible assets, net..................................................... 26,164 28,020
Deferred taxes on income................................................... 52,473 52,678
Other assets............................................................... 104,870 113,601
---------- ----------
Total assets............................................................... $3,005,716 $2,930,555
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses................................... $ 622,282 $ 657,219
Short-term borrowings and current portion of long-term debt............. 1,405 1,404
---------- ----------
Total current liabilities............................................. 623,687 658,623
Long-term debt............................................................. 820,190 820,337
Other liabilities.......................................................... 116,241 115,608
Commitments and contingencies
Common stockholders' equity:
Common stock, par value $0.01 per share; 300,000 shares authorized;
96,729 and 96,024 shares issued at March 31, 2002 and December 31,
2001, respectively.................................................... 967 960
Additional paid-in capital.............................................. 1,754,527 1,714,676
Accumulated deficit .................................................... (296,237) (362,926)
Unearned compensation................................................... (10,724) (13,253)
Accumulated other comprehensive loss.................................... (2,935) (3,470)
---------- ----------
Total common stockholders' equity..................................... 1,445,598 1,335,987
---------- ----------
Total liabilities and stockholders' equity................................. $3,005,716 $2,930,555
========== ==========
The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(in thousands)
(unaudited)
2002 2001
---- ----
Cash flows from operating activities:
Net income................................................................... $ 66,689 $ 35,748
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization............................................. 30,310 34,265
Provision for doubtful accounts........................................... 55,315 55,283
Deferred income tax provision (benefit) .................................. 4,894 (2,743)
Minority share of income.................................................. 3,882 1,116
Stock compensation expense................................................ 2,457 6,933
Other, net................................................................ 394 2,370
Changes in operating assets and liabilities:
Accounts receivable..................................................... (95,375) (78,982)
Accounts payable and accrued expenses................................... (44,638) (28,622)
Integration, settlement and other special charges....................... (4,626) (14,215)
Other assets and liabilities, net....................................... 33,552 29,578
-------- --------
Net cash provided by operating activities.................................... 52,854 40,731
-------- --------
Cash flows from investing activities:
Business acquisition......................................................... (1,275) (47,216)
Capital expenditures......................................................... (41,266) (43,615)
Collection of note receivable ............................................... 10,660 -
Proceeds from disposition of assets.......................................... 127 763
Increase in other assets..................................................... (549) (200)
-------- --------
Net cash used in investing activities........................................ (32,303) (90,268)
-------- --------
Cash flows from financing activities:
Repayments of long-term debt................................................. (283) (2,601)
Distributions to minority partners........................................... (2,977) (1,161)
Exercise of stock options.................................................... 9,879 3,101
Preferred stock dividends paid............................................... - (118)
Other........................................................................ (75) (431)
-------- --------
Net cash provided by (used in) financing activities.......................... 6,544 (1,210)
-------- --------
Net change in cash and cash equivalents...................................... 27,095 (50,747)
Cash and cash equivalents, beginning of year................................. 122,332 171,477
-------- --------
Cash and cash equivalents, end of period..................................... $149,427 $120,730
======== ========
Cash paid during the period for:
Interest..................................................................... $ 22,284 $ 19,978
Income taxes................................................................. 1,230 1,309
The accompanying notes are an integral part of these statements.
4
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, unless otherwise indicated)
(unaudited)
1. BASIS OF PRESENTATION
Background
Quest Diagnostics Incorporated and its subsidiaries ("Quest
Diagnostics" or the "Company") is the largest clinical laboratory testing
business in the United States. As the nation's leading provider of diagnostic
testing and related services for the healthcare industry, Quest Diagnostics
offers a broad range of clinical laboratory testing services to physicians,
hospitals, managed care organizations, employers, governmental institutions and
other independent clinical laboratories. Quest Diagnostics has the leading
market share in clinical laboratory testing and esoteric testing, including
molecular diagnostics, as well as non-hospital based anatomic pathology services
and testing for drugs of abuse. Through the Company's national network of
laboratories and patient service centers, and its esoteric testing laboratory
and development facility, Quest Diagnostics offers comprehensive and innovative
diagnostic testing, information and related services used by physicians and
other healthcare customers to diagnose, treat and monitor diseases and other
medical conditions. Quest Diagnostics offers clinical testing and services to
support clinical trials of new pharmaceuticals worldwide, including collecting
and analyzing laboratory, pharmaceutical and other data to develop information
products to help pharmaceutical companies with their marketing and disease
management efforts, as well as to help healthcare customers better manage the
health of their patients.
Quest Diagnostics currently processes over 105 million requisitions
each year 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
and are subject to year-end adjustments. Operating results for the interim
periods are not necessarily indicative of the results that may be expected for
the full year. These interim consolidated financial statements should be read in
conjunction with the audited consolidated financial statements included in the
Company's 2001 Annual Report on Form 10-K.
Earnings Per Share
On May 8, 2001, the stockholders approved an amendment to the Company's
restated certificate of incorporation to increase the number of common shares
authorized from 100 million shares to 300 million shares. On May 31, 2001, 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 May 16, 2001. 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.
Basic net income per common share is calculated by dividing net income,
less preferred stock dividends (approximately $30 thousand per quarter in 2001)
by the weighted average number of common shares outstanding. Diluted net income
per common share is calculated by dividing net income, less preferred stock
dividends, by the weighted average number of common shares outstanding after
giving effect to all potentially dilutive common shares outstanding during the
period. The if-converted method is used in determining the dilutive effect of
the Company's 1 3/4% contingent convertible debentures in periods when the
holders of such securities are permitted to exercise their conversion rights.
Potentially dilutive common shares include outstanding stock options and
restricted common shares granted under the Company's Employees Equity
Participation Program. These dilutive securities increased the weighted average
number of common shares outstanding by 3.9 million shares and 4.7 million
shares, respectively, for the three months ended March 31, 2002 and 2001. During
the fourth quarter of 2001, the Company redeemed all of its then issued and
outstanding shares of preferred stock.
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
New Accounting Standard
In August 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 144 "Accounting for Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which supercedes SFAS No. 121. SFAS 144 further refines
SFAS 121's requirement that companies recognize an impairment loss if the
carrying amount of a long-lived asset is not recoverable based on its
undiscounted future cash flows and measure an impairment loss as the
difference between the carrying amount and fair value of the asset. In
addition, SFAS 144 provides guidance on accounting and disclosure issues
surrounding long-lived assets to be disposed of by sale. SFAS 144 also extends
the presentation of discontinued operations to include more disposal
transactions. SFAS 144 is effective for all fiscal quarters of all fiscal years
beginning after December 15, 2001 (January 1, 2002 for the Company). The
Company's adoption of SFAS 144 did not result in any impairment loss being
recorded.
2. ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), which broadens the criteria for recording
intangible assets separate from goodwill. SFAS 142 requires the use of a
nonamortization approach to account for purchased goodwill and certain
intangibles. Under a nonamortization approach, goodwill and certain intangibles
are not amortized into results of operations, but instead are reviewed for
impairment and an impairment charge is recorded in the periods in which the
recorded carrying value of goodwill and certain intangibles is more than its
estimated fair value. The Company adopted SFAS 142 effective January 1, 2002.
The provisions of SFAS 142 require that a transitional impairment test be
performed as of the beginning of the year the statement is adopted. The
provisions of SFAS 142 also require that a goodwill impairment test be performed
annually or in the case of other events that indicate a potential impairment.
The new criteria for recording intangible assets separate from goodwill did not
require the Company to reclassify any of its intangible assets. The Company's
transitional impairment test indicated that there was no impairment of goodwill
upon adoption of SFAS 142. The annual impairment test of goodwill will be
performed at the end of the Company's fiscal year on December 31st.
Effective January 1, 2002, we evaluate the recoverability and measure
the possible impairment of our goodwill under SFAS 142. The impairment test is a
two step process that begins with the estimation of the fair value of the
reporting unit. The first step screens for potential impairment and the second
step measures the amount of the impairment, if any. Our estimate of fair value
considers publicly available information regarding the market capitalization of
our Company as well as (i) publicly available information regarding comparable
publicly-traded companies in the clinical laboratory testing industry, (ii) the
financial projections and future prospects of our business, including its growth
opportunities and likely operational improvements, and (iii) comparable sales
prices, if available. As part of the first step to assess potential impairment,
we compare our estimate of fair value for the Company to the book value of our
consolidated net assets. If the book value of our consolidated net assets is
greater than our estimate of fair value, we would then proceed to the second
step to measure the impairment, if any. The second step compares the implied
fair value of goodwill with its carrying value. The implied fair value is
determined by allocating the fair value of the reporting unit to all of the
assets and liabilities of that unit as if the reporting unit had been acquired
in a business combination and the fair value of the reporting unit was the
purchase price paid to acquire the reporting unit. The excess of the fair value
of the reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. If the carrying amount of the reporting
unit's goodwill is greater than its implied fair value, an impairment loss will
be recognized in the amount of the excess.
On a quarterly basis, we perform a review of our business to determine
if events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the Company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would consult with
one or more valuation specialists in estimating the impact on our estimate of
fair value. Management believes the estimation methods are reasonable and
reflective of common valuation practices.
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The following table presents net income and basic and diluted earnings
per common share adjusted to reflect results as if the nonamortization
provisions of SFAS 142 had been in effect for the periods presented:
For the three months ended
March 31,
--------------------------
2002 2001
------- -------
Net income
Reported net income ...................................... $66,689 $35,748
Add back: Amortization of goodwill, net of taxes ......... - 8,647
------- -------
Adjusted net income ...................................... $66,689 $44,395
======= =======
Basic net income per common share
Reported net income ...................................... $ 0.70 $ 0.39
Amortization of goodwill ................................. - 0.09
------- -------
Adjusted net income ...................................... $ 0.70 $ 0.48
======= =======
Diluted net income per common share
Reported net income ...................................... $ 0.67 $ 0.37
Amortization of goodwill ................................. - 0.09
------- -------
Adjusted net income ...................................... $ 0.67 $ 0.46
======= =======
Other intangible assets consist of the following:
March 31, 2002 December 31, 2001
----------------------------------- -----------------------------------
Accumulated Accumulated
Cost Amortization Net Cost Amortization Net
------- -------- ------- ------- -------- -------
Non-compete
agreements ........ $43,943 $(28,016) $15,927 $43,943 $(26,566) $17,377
Customer lists....... 41,301 (32,290) 9,011 41,331 (31,787) 9,544
Other ............... 3,267 (2,041) 1,226 3,067 (1,968) 1,099
------- -------- ------- ------- -------- -------
Total ............ $88,511 $(62,347) $26,164 $88,341 $(60,321) $28,020
======= ======== ======= ======= ======== =======
For the three months ended March 31, 2002 and 2001, amortization
expense related to other intangible assets was $2,155 and $1,863, respectively.
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
The estimated amortization expense related to other intangible assets
for each of the five succeeding fiscal years as of March 31, 2002 is as follows:
Fiscal year ending
December 31,
--------------------------
Remainder of 2002 ................ $ 5,662
2003 ............................. 7,355
2004 ............................. 5,830
2005 ............................. 2,503
2006 ............................. 1,389
2007 ............................. 639
Thereafter ....................... 2,786
-------
Total .......................... $26,164
=======
3. COMMITMENTS AND CONTINGENCIES
The Company has entered into several settlement agreements with various
governmental and private payers during recent years relating to industry-wide
billing and marketing practices that had been substantially discontinued by
early 1993. In addition, the Company is aware of several pending lawsuits filed
under the qui tam provisions of the civil False Claims Act and has received
notices of private claims relating to billing issues similar to those that were
the subject of prior settlements with various governmental payers. Some of the
proceedings against the Company involve claims that are substantial in amount.
Some of the cases involve the operations of SmithKline Beecham Clinical
Laboratories, Inc. ("SBCL") prior to the closing of the SBCL acquisition.
SmithKline Beecham plc ("SmithKline Beecham") has agreed to
indemnify Quest Diagnostics, on an after-tax basis, against monetary payments
for governmental claims or investigations relating to the billing practices
of SBCL that had been settled before or were pending as of the closing date
of the SBCL acquisition. SmithKline Beecham has also agreed to indemnify
Quest Diagnostics, on an after-tax basis, against monetary payments to private
payers, relating to or arising out of the governmental claims. The
indemnification with respect to governmental claims is for 100% of those
claims. SmithKline Beecham will indemnify Quest Diagnostics, in respect of
private claims for: 100% of those claims, up to an aggregate amount of
$80 million; 50% of those claims to the extent the aggregate amount exceeds
$80 million but is less than $130 million; and 100% of such claims to the
extent the aggregate amount exceeds $130 million. The indemnification also
covers 80% of out-of-pocket costs and expenses relating to investigations of
the claims indemnified against by SmithKline Beecham. SmithKline Beecham has
also agreed to indemnify the Company with respect to pending actions relating
to a former SBCL employee that at times reused certain needles when drawing
blood from patients. In addition, SmithKline Beecham has agreed to indemnify
the Company against all monetary payments relating to professional liability
claims of SBCL for services provided prior to the closing of the SBCL
acquisition. Amounts due from SmithKline Beecham at March 31, 2002,
related principally to indemnified professional liability claims discussed
above, totaled approximately $16 million and represented management's best
estimate of the amounts which are probable of being received from SmithKline
Beecham to satisfy the indemnified claims on an after-tax basis. The estimated
reserves and related amounts due from SmithKline Beecham are subject to change
as additional information regarding the outstanding claims is gathered and
evaluated.
At March 31, 2002 recorded reserves, relating primarily to billing
claims, including those indemnified by SmithKline Beecham, approximated $13
million. Although management believes that established reserves for both
indemnified and non-indemnified claims are sufficient, it is possible that
additional information (such as the indication by the government of criminal
activity, additional tests being questioned or other changes in the government's
or private claimants' theories of wrongdoing) may become available which may
cause the final resolution of these matters to exceed established reserves by an
amount which could be material to the Company's results of operations and cash
flows in the period in which such claims are settled. The Company does not
believe that these issues will have a material adverse effect on its overall
financial condition.
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
In addition to the billing-related settlement reserves discussed above,
the Company is involved in various legal proceedings arising in the ordinary
course of business. Some of the proceedings against the Company involve claims
that are substantial in amount. Some of these claims involve contracts of SBCL
that were terminated following the Company's acquisition of SBCL. Although
management cannot predict the outcome of such proceedings or any claims made
against the Company, management does not anticipate that the ultimate outcome of
the various proceedings or claims will have a material adverse effect on the
Company's financial position but, may be material to the Company's results of
operations and cash flows in the period in which such claims are resolved.
4. COMMON STOCKHOLDERS' EQUITY
Changes in common stockholders' equity for the three months ended March
31, 2002 were as follows:
Accumulated
Additional Other Compre-
Common Paid-In Accumulated Unearned Comprehensive hensive
Stock Capital Deficit Compensation Loss Income
-------------------------------------------------------------------------
Balance,
December 31, 2001 .................. $960 $1,714,676 $(362,926) $(13,253) $(3,470)
Net income ............................ 66,689 $66,689
Other comprehensive income ............ 535 535
-------
Comprehensive income ................ $67,224
=======
Issuance of common stock under
benefit plans (165 common shares) ... 2 10,751
Exercise of options (540 common
shares) ............................. 5 9,874
Tax benefits associated with
stock-based compensation plans ...... 19,226
Amortization of unearned
compensation ........................ 2,529
- -------------------------------------------------------------------------------------------------
Balance,
March 31, 2002 $967 $1,754,527 $(296,237) $(10,724) $(2,935)
=======================================================
9
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Changes in common stockholders' equity for the three months ended March
31, 2001 were as follows:
Accumulated Compre-
Additional Other hensive
Common Paid-In Accumulated Unearned Comprehensive Income
Stock Capital Deficit Compensation Loss (Loss)
-------------------------------------------------------------------------
Balance,
December 31, 2000 .................. $465 $1,591,976 $(525,111) $(31,077) $(5,458)
Net income ............................ 35,748 $35,748
Cumulative effect of change in
accounting for derivative financial
instruments, net of $0.6 million
tax benefit ....................... (955) (955)
Increase in unrealized losses
on derivative financial
instruments, net of $1.7
million tax benefit ............... (2,516) (2,516)
Other comprehensive loss ............ (805) (805)
-------
Comprehensive income .................. $31,472
=======
Preferred dividends declared .......... (29)
Issuance of common stock under
benefit plans (165 common shares) ... 2 21,488 (4,099)
Exercise of options (171 common
shares) ............................. 2 3,099
Shares to cover employee
payroll tax withholdings on
exercised stock options (2
common shares) ...................... (190)
Tax benefits associated with
stock-based compensation plans ...... 9,743
Amortization of unearned
compensation ........................ 6,933
- -------------------------------------------------------------------------------------------------
Balance,
March 31, 2001 $469 $1,626,116 $(489,392) $(28,243) $(9,734)
=======================================================
During the three months ended March 31, 2001, two thousand common
shares were surrendered to cover employee payroll tax withholdings related to
the exercise of stock options. For reporting purposes, these shares were
accounted for as treasury purchases which were immediately retired.
For the three months ended March 31, 2001, other comprehensive loss
included the cumulative effect of the change in accounting for derivative
financial instruments upon adoption of SFAS 133, as amended, (January 1, 2001
for the Company) which increased comprehensive loss by approximately $1 million.
Prior to the Company's debt refinancing in June 2001, the Company's
then existing credit agreement required the Company to maintain interest rate
swap agreements to mitigate the risk of changes in interest rates associated
with a portion of its variable interest rate indebtedness. These interest rate
swap agreements were considered a hedge against changes in the amount of future
cash flows associated with the interest payments of the Company's variable rate
debt obligations. Accordingly, the interest rate swap agreements were recorded
at their estimated fair value on the consolidated balance sheet and the related
gains or losses on these contracts were deferred in shareholders' equity as a
component of comprehensive income. In conjunction with the debt refinancing in
June 2001, the interest rate swap agreements were
10
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
terminated and the losses included in shareholders' equity as a component of
comprehensive income were reflected in the consolidated statement of operations.
5. SUBSEQUENT EVENTS
Acquisition of American Medical Laboratories, Incorporated
On April 1, 2002, the Company completed its previously announced
acquisition of all of the outstanding voting stock of American Medical
Laboratories, Incorporated, ("AML") and an affiliated company of AML, LabPortal,
Inc. ("LabPortal"), a provider of electronic connectivity products, in an
all-cash transaction with a combined value of approximately $500 million, which
included the assumption of approximately $160 million in debt.
Through the acquisition of AML, Quest Diagnostics acquired all of AML's
operations, including two full-service laboratories, 51 patient service
centers, and hospital sales, service and logistics capabilities. The all-cash
purchase price of approximately $335 million and related transaction costs,
together with the repayment of approximately $150 million of principal and
related accrued interest representing substantially all of the acquired debt was
financed by Quest Diagnostics with cash on-hand and $300 million of borrowings
under its existing secured receivables credit facility and $175 million of
borrowings under its existing unsecured revolving credit facility. The
acquisition of AML will be accounted for under the purchase method of
accounting.
On May 2, 2002, Quest Diagnostics repaid $100 million of the $175
million borrowed under the Company's unsecured revolving credit facility.
The following table summarizes the Company's preliminary purchase price
allocation related to the acquisition of AML based on the estimated fair value
of the assets acquired and liabilities assumed on the acquisition date:
Estimated
Fair Values
as of
April 1, 2002
-------------
Current assets .............................................. $ 83,517
Property, plant and equipment ............................... 34,450
Goodwill .................................................... 417,302
Other assets ................................................ 2,554
--------
Total assets acquired ..................................... 537,823
--------
Current portion of long-term debt............................ 11,834
Other current liabilities ................................... 40,369
Long-term debt .............................................. 139,465
Other liabilities............................................ 6,105
--------
Total liabilities assumed ................................. 197,773
--------
Net assets acquired ....................................... $340,050
========
Based on management's review of the net assets acquired and
consultations with valuation specialists, no intangible assets meeting the
criteria under SFAS 141, "Business Combinations", were identified. Of the $417
million allocated to goodwill, approximately $18 million is expected to be
deductible for tax purposes.
The all-cash purchase price for LabPortal of approximately $4 million
and related transaction costs, together with the repayment of all of LabPortal's
outstanding debt of approximately $7 million and related accrued interest was
financed by Quest Diagnostics with cash on-hand. The acquisition of LabPortal
will be accounted for under the purchase method of accounting.
11
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Acquisition of Unilab Corporation
On April 2, 2002, the Company entered into a definitive agreement with
Unilab Corporation ("Unilab") under which Quest Diagnostics will acquire all of
the outstanding shares of Unilab common stock and assume Unilab's existing debt
of approximately $200 million. In exchange for their Unilab shares, Unilab
stockholders may elect to receive $26.50 in cash, 0.3256 shares of Quest
Diagnostics common stock or a combination of cash and stock. The aggregate
amount of cash available to Unilab stockholders will be limited to 30% of the
total consideration available for the Unilab shares. Unilab has approximately
37.4 million shares of common stock outstanding on a fully diluted basis. If
Unilab stockholders elect to receive 30% of the consideration in cash and if all
options are exercised, Quest Diagnostics would issue approximately 8.5 million
shares and pay $297 million in cash to the stockholders of Unilab.
The transaction, which has been approved by the Boards of Directors of both
companies, is subject to the satisfaction of customary conditions, including the
tender of a majority of Unilab's common stock on a fully diluted basis, and
regulatory review. The Company expects that the transaction will close late in
the second quarter of 2002. As part of the acquisition, Quest Diagnostics will
acquire all of Unilab's operations, including its primary testing facilities in
Los Angeles, San Jose and Sacramento, California, its more than 400 regional
service and testing facilities located throughout California and its operations
in Arizona. The Company expects to finance the cash portion of the purchase
price and any retirements of Unilab's existing debt with the proceeds from a new
$550 million one-year bridge loan facility, which the Company expects to
refinance shortly after the closing of the Unilab acquisition. The Company has
received a commitment for the bridge loan facility. Since the transaction has
yet to close, a preliminary purchase price allocation is not practical at this
time.
6. SUMMARIZED FINANCIAL INFORMATION
The Company's 6 3/4% senior notes due 2006, 7 1/2% senior notes due
2011 and 1 3/4% contingent convertible debentures due 2021 are guaranteed by the
Company's wholly owned subsidiaries that operate clinical laboratories in the
United States (the "Subsidiary Guarantors"). With the exception of Quest
Diagnostics Receivables Incorporated (see paragraph below), the non-guarantor
subsidiaries are primarily foreign and less than wholly owned subsidiaries.
In conjunction with the Company's secured receivables credit facility,
the Company formed a new wholly-owned non-guarantor subsidiary, Quest
Diagnostics Receivables Incorporated ("QDRI"). The Company and the Subsidiary
Guarantors 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. QDRI utilized the
transferred receivables to collateralize the 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 eliminate investments in subsidiaries and
intercompany balances and transactions.
12
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Net revenues ........................ $168,208 $730,552 $120,939 $(72,937) $946,762
Costs and expenses:
Cost of services .................. 119,948 405,068 32,722 -- 557,738
Selling, general and administrative 41,278 153,764 67,120 (3,759) 258,403
Interest, net ..................... 18,178 60,943 2,732 (69,178) 12,675
Amortization of intangibles ....... 590 1,565 -- -- 2,155
Royalty (income) expense .......... (61,521) 61,521 -- -- --
Other, net ........................ 2,994 (18) 292 -- 3,268
-------- -------- -------- -------- --------
Total ............................ 121,467 682,843 102,866 (72,937) 834,239
-------- -------- -------- -------- --------
Income before taxes ................. 46,741 47,709 18,073 -- 112,523
Income tax expense .................. 23,270 15,391 7,173 -- 45,834
Equity earnings from subsidiaries ... 43,218 -- -- (43,218) --
-------- -------- -------- -------- --------
Net income .......................... $ 66,689 $ 32,318 $ 10,900 $(43,218) $ 66,689
======== ======== ======== ======== ========
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Net revenues ........................ $146,089 $700,864 $93,072 $(57,472) $882,553
Costs and expenses:
Cost of services .................. 97,526 407,916 23,623 -- 529,065
Selling, general and administrative 41,652 152,668 62,074 (3,592) 252,802
Interest, net ..................... 14,386 54,791 7,403 (53,880) 22,700
Amortization of intangibles ....... 791 10,168 141 -- 11,100
Royalty (income) expense .......... (59,983) 59,983 -- -- --
Other, net ........................ (974) (882) 3,270 -- 1,414
-------- -------- ------- -------- --------
Total ............................ 93,398 684,644 96,511 (57,472) 817,081
-------- -------- ------- -------- --------
Income (loss) before taxes .......... 52,691 16,220 (3,439) -- 65,472
Income tax expense (benefit) ........ 25,100 5,858 (1,234) -- 29,724
Equity earnings from subsidiaries ... 8,157 -- -- (8,157) --
-------- -------- ------- -------- --------
Net income (loss) ................... $ 35,748 $ 10,362 $(2,205) $ (8,157) $ 35,748
======== ======== ======= ======== ========
13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
March 31, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents ......... $ -- $ 141,911 $ 7,516 $ -- $ 149,427
Accounts receivable, net .......... 3,915 61,072 483,413 -- 548,400
Other current assets .............. 92,872 46,637 112,531 -- 252,040
---------- ---------- ----------- ----------- ----------
Total current assets ........... 96,787 249,620 603,460 -- 949,867
Property, plant and equipment, net 166,644 331,331 21,969 -- 519,944
Intangible assets, net ............ 154,073 1,188,186 36,303 -- 1,378,562
Intercompany receivable (payable) . 532,720 19,554 (552,274) -- --
Investment in subsidiaries ........ 1,144,658 -- -- (1,144,658) --
Other assets ...................... 70,642 48,877 37,824 -- 157,343
---------- ---------- ----------- ----------- ----------
Total assets ................... $2,165,524 $1,837,568 $ 147,282 $(1,144,658) $3,005,716
========== ========== =========== =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 365,792 $ 224,024 $ 32,466 $ -- $ 622,282
Short-term borrowings and current
portion of long-term debt ....... 21 1,041 343 -- 1,405
---------- ---------- ----------- ----------- ----------
Total current liabilities ...... 365,813 225,065 32,809 -- 623,687
Long-term debt .................... 310,735 502,327 7,128 -- 820,190
Other liabilities ................. 43,378 57,716 15,147 -- 116,241
Common stockholders' equity ....... 1,445,598 1,052,460 92,198 (1,144,658) 1,445,598
---------- ---------- ----------- ----------- ----------
Total liabilities and stockholders'
equity ....................... $2,165,524 $1,837,568 $ 147,282 $(1,144,658) $3,005,716
========== ========== =========== =========== ==========
14
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
December 31, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents ............... $ -- $ 110,571 $ 11,761 $ -- $ 122,332
Accounts receivable, net ................ 9,083 52,232 447,025 -- 508,340
Other current assets .................... 93,144 52,755 99,943 -- 245,842
---------- ---------- --------- ----------- ----------
Total current assets ................. 102,227 215,558 558,729 -- 876,514
Property, plant and equipment, net ..... 170,494 320,244 17,881 -- 508,619
Intangible assets, net .................. 154,809 1,188,031 36,303 -- 1,379,143
Intercompany receivable (payable) . .... 425,735 92,378 (518,113) -- --
Investment in subsidiaries .............. 1,096,647 -- -- (1,096,647) --
Other assets ............................ 75,633 54,998 35,648 -- 166,279
---------- ---------- --------- ----------- ----------
Total assets ......................... $2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555
========== ========== ========= =========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses .. $ 334,666 $ 290,039 $ 32,514 $ -- $ 657,219
Short-term borrowings and current portion of
long-term debt ........................ 21 1,040 343 -- 1,404
---------- ---------- --------- ----------- ----------
Total current liabilities ............ 334,687 291,079 32,857 -- 658,623
Long-term debt .......................... 310,690 502,519 7,128 -- 820,337
Other liabilities ....................... 44,181 57,469 13,958 -- 115,608
Common stockholders' equity ............. 1,335,987 1,020,142 76,505 (1,096,647) 1,335,987
---------- ---------- --------- ----------- ----------
Total liabilities and stockholders'
equity ............................. $2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555
========== ========== ========= =========== ==========
15
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2002
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income ..................................... $66,689 $32,318 $10,900 $(43,218) $66,689
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization ................ 11,351 17,600 1,359 -- 30,310
Provision for doubtful accounts .............. 1,729 4,243 49,343 -- 55,315
Other, net ................................... (45,134) 8,354 5,189 43,218 11,627
Changes in operating assets and liabilities... (32,729) (609) (77,749) -- (111,087)
--------- -------- --------- --------- ---------
Net cash provided by (used in) operating
activities ................................... 1,906 61,906 (10,958) -- 52,854
Net cash used in investing activities........... (11,620) (30,374) (533) 10,224 (32,303)
Net cash provided by (used in) financing
activities ................................... 9,714 (192) 7,246 (10,224) 6,544
--------- -------- --------- --------- ---------
Net change in cash and cash equivalents......... -- 31,340 (4,245) -- 27,095
Cash and cash equivalents, beginning of year.... -- 110,571 11,761 -- 122,332
--------- -------- --------- --------- ---------
Cash and cash equivalents, end of period........ $ -- $141,911 $ 7,516 $ -- $ 149,427
========= ======== ========= ========= =========
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income (loss) ............................... $ 35,748 $ 10,362 $ (2,205) $(8,157) $ 35,748
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization ................. 9,010 24,130 1,125 -- 34,265
Provision for doubtful accounts ........ ..... (114) 5,303 50,094 -- 55,283
Other, net .................................... (27,084) 19,158 7,445 8,157 7,676
Changes in operating assets and liabilities ... 4,983 (33,963) (63,261) -- (92,241)
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating
activities .................................... 22,543 24,990 (6,802) -- 40,731
Net cash used in investing activities .... ...... (17,671) (69,479) (484) (2,634) (90,268)
Net cash (used in) provided by financing
activities .................................... (4,872) (7,746) 8,774 2,634 (1,210)
--------- --------- --------- --------- ---------
Net change in cash and cash equivalents .. ...... -- (52,235) 1,488 -- (50,747)
Cash and cash equivalents, beginning of year .... -- 163,863 7,614 -- 171,477
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period . ...... $ -- $111,628 $ 9,102 $ -- $120,730
========= ========= ========= ========= =========
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions and select accounting policies that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
While many operational aspects of our business are subject to complex
federal, state and local regulations, the accounting for our business is
generally straight-forward with net revenues primarily recognized upon
completion of the testing process. Our revenues are primarily comprised of a
high volume of relatively low dollar transactions, and about half of all our
costs and expenses consist of employee compensation and benefits. Due to the
nature of our business, several of our accounting policies involve significant
estimates and judgments. These accounting policies have been described in our
2001 Annual Report on Form 10-K, with the following accounting policy adopted
effective January 1, 2002:
Accounting for and recoverability of goodwill
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
provisions of SFAS 142 are summarized in Note 2 to the interim consolidated
financial statements. The new criteria for recording intangible assets separate
from goodwill did not require us to reclassify any of our intangible assets. Our
transitional impairment test indicated that there was no impairment of goodwill
upon adoption of SFAS 142. Our annual impairment test of goodwill will be
performed at the end of our fiscal year on December 31st. Assuming the
nonamortization provisions of SFAS 142 had been effective at the beginning of
fiscal 2001, net income for the three months ended March 31, 2001 would have
increased by $8.6 million, representing the reduction in goodwill amortization,
net of taxes.
Effective January 1, 2002, we evaluate the recoverability and measure
the possible impairment of our goodwill under SFAS 142. The impairment test is a
two step process that begins with the estimation of the fair value of the
reporting unit. The first step screens for potential impairment and the second
step measures the amount of the impairment, if any. Our estimate of fair value
considers publicly available information regarding the market capitalization of
our Company as well as (i) publicly available information regarding comparable
publicly-traded companies in the clinical laboratory testing industry, (ii) the
financial projections and future prospects of our business, including its growth
opportunities and likely operational improvements, and (iii) comparable sales
prices, if available. As part of the first step to assess potential impairment,
we compare our estimate of fair value for the Company to the book value of our
consolidated net assets. If the book value of our consolidated net assets is
greater than our estimate of fair value, we would then proceed to the second
step to measure the impairment, if any. The second step compares the implied
fair value of goodwill with its carrying value. The implied fair value is
determined by allocating the fair value of the reporting unit to all of the
assets and liabilities of that unit as if the reporting unit had been acquired
in a business combination and the fair value of the reporting unit was the
purchase price paid to acquire the reporting unit. The excess of the fair value
of the reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. If the carrying amount of the reporting unit
goodwill is greater than its implied fair value, an impairment loss will be
recognized in the amount of the excess.
On a quarterly basis, we perform a review of our business to determine
if events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the Company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would consult with
one or more valuation specialists in estimating the impact on our estimate of
fair value. We believe the estimation methods are reasonable and reflective of
common valuation practices.
17
Integration of Acquired Businesses
American Medical Laboratories, Incorporated & Unilab Corporation
On April 1, 2002, we completed our previously announced acquisition of
all of the outstanding voting stock of American Medical Laboratories,
Incorporated, ("AML"). On April 2, 2002, we entered into a definitive agreement
with Unilab Corporation ("Unilab") under which we will acquire all of the
outstanding shares of Unilab common stock. We expect that the Unilab transaction
will close late in the second quarter of 2002. See Note 5 to the interim
consolidated financial statements for a full discussion of these transactions.
We estimate that we will incur up to $20 million of costs to integrate
Quest Diagnostics and AML and up to $20 million of additional costs to integrate
Quest Diagnostics and Unilab. A significant portion of these costs is expected
to require cash outlays and are expected to primarily relate to severance and
other integration-related activities for 2002 and 2003, including the
elimination of duplicate facilities and excess capacity, operational realignment
and related workforce reductions. These estimates are preliminary and will be
subject to revisions as integration plans are developed and finalized. To the
extent that the costs relate to actions that impact the employees and operations
of the acquired companies, such costs will be accounted for as a cost of the
acquisitions. To the extent that the costs relate to actions that impact Quest
Diagnostics' employees and operations, such costs will be accounted for as a
charge to earnings in the periods that the integration plans are approved and
communicated. We expect to finalize and record these costs during the second or
third quarter of 2002.
Results of Operations
Three Months Ended March 31, 2002 Compared with Three Months Ended
March 31, 2001
Net income for the three months ended March 31, 2002 increased to $66.7
million from $35.7 million for the three months ended March 31, 2001. As a
result of the adoption of SFAS 142 as of January 1, 2002, net income increased
$8.6 million, representing the reduction in goodwill amortization, net of taxes.
The remaining $22.4 million increase in earnings was primarily attributable to
revenue growth, driven by improvements in average revenue per requisition and
clinical testing volume, the realization of the remaining benefits associated
with the integration of SmithKline Beecham Clinical Laboratories, Inc. ("SBCL"),
improved efficiencies generated from our Six Sigma and Standardization
initiatives, and a reduction in net interest expense, partially offset by
increases in employee compensation and supply costs and investments in our
information technology strategy and strategic growth opportunities.
Net Revenues
Net revenues for the three months ended March 31, 2002 grew by 7.3%,
compared to the prior year period, primarily due to a 6.7% increase in revenues
in our core testing business. This increase was due to improvements in average
revenue per requisition of 4.1% and an increase in requisition volume of 2.5%.
The improvement in average revenue per requisition was primarily attributable to
a shift in test mix to higher value testing and a shift in payer mix to
fee-for-service reimbursement. Our drugs-of-abuse testing business reduced total
Company volume growth by 1.4% in the first quarter of 2002, reflecting continued
softness in hiring as well as an increasing acceptance of alternative drug
screening methods.
Operating Costs and Expenses
Total operating costs for the three months ended March 31, 2002
increased approximately $34.3 million from the year earlier period, primarily
due to increases in our clinical testing volume, employee compensation and
supply costs, partially offset by a reduction in bad debt expense. While our
cost structure has been favorably impacted by the synergies realized as a result
of the SBCL integration and the improved efficiencies generated from our Six
Sigma and Standardization initiatives, we continue to make investments to
enhance our infrastructure to pursue our overall business strategy. These
investments include those related to:
o Skills training for all employees, which together with our
competitive pay and benefits, helps to increase employee
satisfaction and performance, which we believe will result in
better service to our customers;
18
o Our information technology strategy; and
o Our strategic growth opportunities.
Cost of services, which include the costs of obtaining, transporting
and testing specimens, decreased during the first quarter of 2002 as a
percentage of net revenues to 58.9% from 59.9% a year ago. This decrease was
primarily attributable to the improvement in average revenue per requisition and
efficiencies from our Six Sigma and Standardization efforts, partially offset by
increases in employee compensation and supply costs.
Selling, general and administrative expenses, which include the costs
of the sales force, billing operations, bad debt expense, general management and
administrative support, decreased during the first quarter of 2002 as a
percentage of net revenues to 27.3% from 28.6% in the prior year period. This
decrease was primarily due to improvements in average revenue per requisition
and bad debt expense, as well as efficiencies generated from our Six Sigma and
Standardization initiatives, partially offset by an increase in employee
compensation costs. During the first quarter of 2002, bad debt expense was 5.8%
of net revenues, compared to 6.3% of net revenues in the first quarter of 2001.
The improvement in bad debt expense was principally attributable to the
continued progress we have made in our overall collection experience through
process improvements, primarily related to the collection of diagnosis, patient
and insurance information necessary to effectively bill for services performed.
Based on prior experience as well as the continued sharing of internal best
practices in the billing functions, we believe that additional opportunities
exist to improve our overall collection experience.
Interest, Net
Net interest expense for the first quarter of 2002 decreased from the
prior year period by $10.0 million. The reduction was primarily due to an
overall reduction in debt levels, the favorable impact of our debt refinancings
in 2001 and lower interest rates, all of which have served to lower the weighted
average borrowing rate on our outstanding debt.
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets for the first
quarter of 2002 decreased from the prior year period by $8.9 million,
principally as the result of adopting SFAS 142, effective January 1, 2002.
See "Critical Accounting Policies - Accounting for and recoverability of
goodwill" for further details regarding the impact of SFAS 142.
Minority Share of Income
Minority share of income for the first quarter of 2002 increased from
the prior year level, primarily due to the improved performance of our
consolidated joint ventures.
Other, Net
Other, net for the first quarter of 2002 decreased from the prior year
level, primarily due to an increase in equity earnings from our unconsolidated
joint ventures.
Income Taxes
During 2001, our effective tax rate was significantly impacted by
goodwill amortization, the majority of which was not deductible for tax
purposes, and had the effect of increasing the overall tax rate. The reduction
in the effective tax rate for the first quarter of 2002 was primarily due to the
reduction in amortization of goodwill (as a result of adopting SFAS 142,
effective January 1, 2002) the majority of which was not deductible for tax
purposes.
EBITDA
EBITDA represents income before income taxes, net interest expense,
depreciation and amortization. EBITDA is presented and discussed because
management believes that EBITDA is a useful adjunct to net income and other
measurements under accounting principles generally accepted in the United States
since it is a meaningful measure of a company's performance and ability to meet
its future debt service requirements, fund capital expenditures and meet working
capital requirements. EBITDA is not a measure of financial performance under
19
accounting principles generally accepted in the United States and should not be
considered as an alternative to (i) net income (or any other measure of
performance under accounting principles generally accepted in the United States)
as a measure of performance or (ii) cash flows from operating, investing or
financing activities as an indicator of cash flows or as a measure of liquidity.
EBITDA for the first quarter of 2002 improved to $155.5 million, or
16.4% of net revenues, from $122.4 million, or 13.9% of net revenues, in the
prior year period. The improvement in EBITDA is primarily due to revenue growth,
driven by improvements in average revenue per requisition and clinical testing
volume, the realization of the remaining benefits associated with the SBCL
integration and improved efficiencies resulting from our Six Sigma and
Standardization initiatives. These increases were offset in part by increases in
employee compensation and supply costs and investments in our information
technology strategy and strategic growth opportunities.
Impact of Contingent Convertible Debentures on Earnings per Common
Share
On November 26, 2001, we completed our $250 million offering of 1 3/4%
contingent convertible debentures due 2021 (the "Debentures"). Each one thousand
dollar principal amount of Debentures is convertible into 11.429 shares of our
common stock, which represents an initial conversion price of $87.50 per share.
Holders may surrender the Debentures for conversion into shares of our common
stock under any of the following circumstances: (i) if the sales price of our
common stock is above 120% of the conversion price (or $105 per share) for
specified periods; (ii) if we call the Debentures or (iii) if specified
corporate transactions have occurred. See Note 12 to the Consolidated Financial
Statements contained in our 2001 Annual Report on Form 10-K for a further
discussion of the Debentures.
The if-converted method is used in determining the dilutive effect of
the Debentures in periods when the holders of such securities are permitted to
exercise their conversion rights. As of and for the three months ended March 31,
2002, the holders of our Debentures did not have the ability to exercise their
conversion rights. Had the requirements to allow the holders to exercise their
conversion rights been met as of March 31, 2002, diluted net income per common
share would have been reduced by approximately 2% during the first quarter of
2001.
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
includes the use of derivative financial instruments. We do not hold or issue
derivative financial instruments for trading purposes. We do not believe that
our foreign exchange exposure is material to our financial position or results
of operations. See Note 2 to the Consolidated Financial Statements contained in
our 2001 Annual Report on Form 10-K for additional discussion of our financial
instruments and hedging activities.
At March 31, 2002 and December 31, 2001, the fair value of our debt was
estimated at approximately $868 million and $857 million, respectively, using
quoted market prices and yields for the same or similar types of borrowings,
taking into account the underlying terms of the debt instruments. At March 31,
2002 and December 31, 2001, the estimated fair value exceeded the carrying value
of the debt by approximately $47 million and $35 million, respectively. An
assumed 10% increase in interest rates (representing approximately 60 basis
points) would potentially reduce the estimated fair value of our debt by
approximately $24 million and $26 million at March 31, 2002 and December 31,
2001, respectively.
At both March 31, 2002 and December 31, 2001, we had approximately $7
million of variable interest rate debt outstanding. Based on our net exposure to
interest rate changes, an assumed 10% increase in interest rates (representing
approximately 35 basis points) would not have a material impact on our after-tax
earnings and cash flows for the three months ended March 31, 2002 based on debt
levels as of March 31, 2002. The primary interest rate exposures on the variable
interest rate debt are with respect to interest rates on United States dollars
as quoted in the London interbank market.
Our Debentures have a contingent interest component that will require
us to pay contingent interest based on certain thresholds, as outlined in the
Indenture. The contingent interest component which is more fully described in
Note 12 to the Consolidated Financial Statements contained in our 2001 Annual
Report on Form 10-K, is considered to be a derivative instrument subject to SFAS
133, "Accounting for
20
Derivative Instruments and Hedging Activities", as amended. As such, the
derivative is recorded at its fair value in the consolidated balance sheet with
changes in its fair value recorded each period in current earnings. On a
quarterly basis, management consults with one or more valuation specialists to
estimate the fair value of the contingent interest derivative. The fair value of
the derivative at March 31, 2002 and December 31, 2001 was not material.
Borrowings under our unsecured revolving credit facility under our
Credit Agreement and our secured receivables credit facility are subject to
variable interest rates. Interest rates on our unsecured revolving credit
facility are also subject to a pricing schedule that fluctuates based on changes
in our credit ratings from Standard & Poor's and Moody's Investor Services. As
such, our borrowing cost under these credit facilities will be subject to both
fluctuations in interest rates and changes in our credit profile. At March 31,
2002 and December 31, 2001, there were no borrowings outstanding under our $325
million unsecured revolving credit facility and our $300 million secured
receivables credit facility. At the close of the AML acquisition on April 1,
2002, we borrowed $300 million under our secured receivables credit facility and
$175 million under our unsecured revolving credit facility to finance the cash
purchase price and related transaction costs associated with the AML acquisition
and to repay substantially all of AML's then outstanding debt. On May 2, 2002,
we repaid $100 million of the $175 million borrowed under our unsecured
revolving credit facility at the closing of the AML acquisition.
Liquidity and Capital Resources
Cash and Cash Equivalents
Cash and cash equivalents at March 31, 2002 totaled $149.4 million, an
increase of $27.1 million from December 31, 2001. Cash flows from operating and
financing activities in 2002 provided cash of $52.9 million and $6.5 million,
respectively, which was used to fund investing activities which required cash of
$32.3 million. Cash and cash equivalents at March 31, 2001 totaled $120.7
million, a decrease of $50.7 million from December 31, 2000. Cash flows from
operating activities in 2001 provided cash of $40.7 million, which was used to
fund investing and financing activities which required cash of $91.5 million.
Cash From Operating Activities
Net cash from operating activities for 2002 was $12.1 million higher
than the 2001 level. The increase was primarily due to improved operating
performance. Days sales outstanding, a measure of billing and collection
efficiency, improved to 52 days at March 31, 2002 from 54 days at December 31,
2001.
Cash From Investing Activities
Net cash used in investing activities in 2002 was $32.3 million for the
first quarter, consisting primarily of capital expenditures of $41.3 million
offset by a $10.7 million collection of a note receivable. Net cash used in
investing activities in 2001 was $90.3 million for the first quarter, consisting
primarily of acquisition and related costs of $47.2 million to acquire the
assets of Clinical Laboratories of Colorado, LLC in Denver, Colorado and capital
expenditures of $43.6 million.
Cash From Financing Activities
Net cash provided by financing activities for 2002 was $6.5 million,
consisting primarily of $9.9 million of proceeds from the exercise of stock
options, partially offset by $3.0 million of distributions to minority partners.
Net cash used in financing activities for 2001 was $1.2 million, consisting
primarily of $2.6 million of debt repayments and $1.2 million of distributions
to minority partners, partially offset by $3.1 million of proceeds from the
exercise of stock options.
Stock Split
On May 8, 2001, the stockholders approved an amendment to the Company's
restated certificate of incorporation to increase the number of common shares
authorized from 100 million shares to 300 million shares. On May 31, 2001, we
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 May 16, 2001. References to the number of common
shares and per common share amounts in the accompanying consolidated balance
sheets and
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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.
Dividend Policy
We have never declared or paid cash dividends on our common stock and
do not anticipate paying dividends on our common stock in the foreseeable
future. We currently intend to retain all available funds and any future
earnings to fund the growth of our business.
Contractual Obligations and Commitments
A full description of the terms of our indebtedness, related debt
service requirements and our future payments under certain of our contractual
obligations is contained in Note 12 to the Consolidated Financial Statements in
our 2001 Annual Report on Form 10-K. A full discussion and analysis regarding
our minimum rental commitments under noncancelable operating leases,
noncancelable commitments to purchase products or services, and reserves with
respect to insurance claims is contained in Note 17 to the Consolidated
Financial Statements in our 2001 Annual Report on Form 10-K. See Note 3 to the
interim consolidated financial statements for information regarding the status
of billing-related claims.
On April 1, 2002, we completed our previously announced acquisition of
all of the outstanding voting stock of AML and an affiliated company of AML,
LabPortal, Inc. ("LabPortal"), a provider of electronic connectivity products in
an all-cash transaction with a combined value of approximately $500 million,
which included the assumption of approximately $160 million in debt. See Note 5
to the interim consolidated financial statements for a full discussion and
analysis regarding the transactions.
On May 2, 2002, we repaid $100 million of the $175 million borrowed
under our unsecured revolving credit facility used to finance the acquisition
of AML.
On April 2, 2002, we entered into a definitive agreement with Unilab
to acquire all of the outstanding shares of Unilab common stock and assume
Unilab's debt of approximately $200 million. See Note 5 to the interim
consolidated financial statements for a full discussion and analysis regarding
the transactions.
Our Credit Agreement contains various covenants and conditions,
including the maintenance of certain financial ratios, that could impact our
ability to, among other things, incur additional indebtedness, repurchase shares
of our outstanding common stock, make additional investments and consummate
acquisitions. We do not expect these covenants to adversely impact our ability
to execute our growth strategy or conduct normal business operations.
Unconsolidated Joint Ventures
At March 31, 2002 and December 31, 2001, we had investments in
unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and
Dayton, Ohio, which are accounted for under the equity method of accounting. We
believe that our transactions with our joint ventures are conducted at arm's
length, reflecting current market conditions and pricing. Total annual net
revenues of our unconsolidated joint ventures, on a combined basis, are less
than 6% of our consolidated net revenues. As of March 31, 2002 and December
31, 2001, total assets associated with our unconsolidated joint ventures are
less than 3% of our consolidated total assets. We have no material obligations
or guarantees to, or in support of, our unconsolidated joint ventures and their
operations.
Requirements and Capital Resources
We estimate that we will invest approximately $160 million to $170
million during 2002 for capital expenditures, principally related to investments
in information technology, equipment, and facility upgrades and expansions.
Other than the reduction for outstanding letters of credit, which approximated
$24 million, all of our $325 million unsecured revolving credit facility and all
of our $300 million secured receivables credit facility remained available to us
for future borrowing at March 31, 2002. After considering the $475 million
borrowed to fund the acquisition of AML on April 1, 2002 and the subsequent
repayment of $100 million of such borrowings on May 2, as well as a $5 million
increase in outstanding letters of
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credit, approximately $221 million of the unsecured revolving credit facility
remains available to us for future borrowings.
We believe that cash from operations, our borrowing capacity under our
unsecured revolving credit facility and our secured receivables credit facility,
together with the indemnification by SmithKline Beecham plc against monetary
fines, penalties or losses from outstanding government and other related
claims, will provide sufficient financial flexibility to meet seasonal working
capital requirements and to fund capital expenditures, debt service
requirements and additional growth opportunities for the foreseeable future.
Our credit ratings from both Standard & Poor's and Moody's Investor Services
have had a favorable impact on our cost of and access to capital.
Additionally, we believe that our improved financial performance should
provide us with access to additional financing, if necessary, to fund growth
opportunities which cannot be funded from existing sources.
Forward Looking Statements
Some statements and disclosures in this document are forward-looking
statements. Forward-looking statements include all statements that do not relate
solely to historical or current facts and can be identified by the use of words
such as "may", "believe", "will", "expect", "project", "estimate", "anticipate",
"plan" or "continue". These forward-looking statements are based on our current
plans and expectations and are subject to a number of risks and uncertainties
that could significantly cause our plans and expectations, including actual
results, to differ materially from the forward-looking statements. The Private
Securities Litigation Reform Act of 1995 provides a "safe harbor" for
forward-looking statements to encourage companies to provide prospective
information about their companies without fear of litigation.
We would like to take advantage of the "safe harbor" provisions of the
Litigation Reform Act in connection with the forward-looking statements included
in this document. The risks and other factors that could cause our actual
financial results to differ materially from those projected, forecasted or
estimated by us in forward-looking statements are detailed in our 2001 Annual
Report on Form 10-K.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Note 3 to the interim consolidated financial statements for
information regarding the status of government investigations and private
claims, including those related to SBCL.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Number Description
None.
(b) Reports on Form 8-K:
On April 12, 2002, the Company filed a current report on Form 8-K
(Date of Report: April 1, 2002) reporting under Item 5 on the
acquisition of American Medical Laboratories, Incorporated and the
guarantee of certain indebtedness of the Company by certain of the
Company's subsidiaries.
On April 2, 2002, the Company filed a current report on Form 8-K
(Date of Report: April 2, 2002) reporting under Item 5 on the
execution of a definitive agreement and plan of merger with Unilab
Corporation and the execution of a stockholders agreement with
certain stockholders of Unilab Corporation.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
May 9, 2002
Quest Diagnostics Incorporated
By /s/Kenneth W. Freeman
---------------------
Kenneth W. Freeman Chairman of the Board and
Chief Executive Officer
By /s/Robert A. Hagemann
---------------------
Robert A. Hagemann Vice President and
Chief Financial Officer
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