1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 2001
Commission file number 1-12215
QUEST DIAGNOSTICS INCORPORATED
One Malcolm Avenue
Teterboro, NJ 07608
(201) 393-5000
DELAWARE
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ______
---------
As of April 23, 2001, there were outstanding 46,986,279 shares of Common Stock,
$.01 par value.
2
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, 2001 and 2000 2
Consolidated Balance Sheets as of
March 31, 2001 and December 31, 2000 3
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2001 and 2000 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 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations"
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
2001 2000
---- ----
NET REVENUES $ 882,553 $ 857,479
--------- ---------
COSTS AND EXPENSES:
Cost of services ........................ 529,065 529,037
Selling, general and administrative ..... 252,802 249,835
Interest, net ........................... 22,700 29,763
Amortization of intangible assets ....... 11,100 11,940
Minority share of income ................ 1,116 2,136
Other, net .............................. 298 (428)
--------- ---------
Total ................................. 817,081 822,283
--------- ---------
INCOME BEFORE TAXES ........................ 65,472 35,196
INCOME TAX EXPENSE ......................... 29,724 17,387
--------- ---------
NET INCOME ................................. $ 35,748 $ 17,809
========= =========
BASIC NET INCOME PER COMMON SHARE .......... $ 0.78 $ 0.40
DILUTED NET INCOME PER COMMON SHARE ........ $ 0.74 $ 0.39
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC ..................... 45,945 44,131
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - DILUTED ................... 48,310 45,616
The accompanying notes are an integral part of these statements.
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2001 AND DECEMBER 31, 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2001 2000
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................................ $ 120,730 $ 171,477
Accounts receivable, net of allowance of $130,164 and $120,358 at
March 31, 2001 and December 31, 2000, respectively ............................. 509,272 485,573
Inventories ...................................................................... 45,161 44,274
Deferred taxes on income ......................................................... 185,533 188,483
Prepaid expenses and other current assets ........................................ 92,118 90,882
----------- -----------
Total current assets ........................................................... 952,814 980,689
PROPERTY, PLANT AND EQUIPMENT, NET .................................................. 473,064 449,856
INTANGIBLE ASSETS, NET .............................................................. 1,297,679 1,261,603
DEFERRED TAXES ON INCOME ............................................................ 50,457 42,622
OTHER ASSETS ........................................................................ 129,221 129,766
----------- -----------
TOTAL ASSETS ........................................................................ $ 2,903,235 $ 2,864,536
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses ............................................ $ 654,989 $ 689,582
Short-term borrowings and current portion of long-term debt ...................... 265,030 265,408
----------- -----------
Total current liabilities ...................................................... 920,019 954,990
LONG-TERM DEBT ...................................................................... 758,481 760,705
OTHER LIABILITIES ................................................................... 124,519 117,046
COMMITMENTS AND CONTINGENCIES
PREFERRED STOCK ..................................................................... 1,000 1,000
COMMON STOCKHOLDERS' EQUITY:
Common stock, par value $0.01 per share; 100,000 shares authorized; 46,876
and 46,541 shares issued at March 31, 2001 and
December 31, 2000, respectively ................................................ 469 465
Additional paid-in capital ....................................................... 1,626,116 1,591,976
Accumulated deficit .............................................................. (489,392) (525,111)
Unearned compensation ............................................................ (28,243) (31,077)
Accumulated other comprehensive loss ............................................. (9,734) (5,458)
----------- -----------
Total common stockholders' equity .............................................. 1,099,216 1,030,795
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .......................................... $ 2,903,235 $ 2,864,536
=========== ===========
The accompanying notes are an integral part of these statements.
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5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(IN THOUSANDS)
(UNAUDITED)
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................... $ 35,748 $ 17,809
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ......................... 34,265 33,185
Provision for doubtful accounts ....................... 55,283 62,646
Deferred income tax benefit ........................... (2,743) (4,161)
Minority share of income .............................. 1,116 2,136
Stock compensation expense ............................ 6,933 3,455
Other, net ............................................ 2,370 521
Changes in operating assets and liabilities:
Accounts receivable ................................. (78,982) (76,657)
Accounts payable and accrued expenses ............... (28,622) (18,687)
Integration, settlement and other special charges ... (14,215) (6,313)
Other assets and liabilities, net ................... 29,578 19,223
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES ................ 40,731 33,157
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisition ..................................... (47,216) (925)
Capital expenditures ..................................... (43,615) (17,613)
Proceeds from disposition of assets ...................... 763 666
Increase in investments .................................. (200) (2,605)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES .................... (90,268) (20,477)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt ............................. (2,601) (11,248)
Distributions to minority partners ....................... (1,161) (1,414)
Exercise of stock options ................................ 3,101 1,331
Preferred stock dividends paid ........................... (118) (29)
Other .................................................... (431) (117)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES .................... (1,210) (11,477)
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS .................. (50,747) 1,203
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ............. 171,477 27,284
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................. $ 120,730 $ 28,487
========= =========
CASH PAID DURING THE PERIOD FOR:
Interest ................................................. $ 19,978 $ 25,529
Income taxes ............................................. 1,309 2,953
The accompanying notes are an integral part of these statements.
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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 anatomic pathology services and testing for
drugs of abuse. Through the Company's national network of laboratories and
patient service centers, and its leading esoteric testing laboratory and
development facility known as Nichols Institute, 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. Quest Informatics collects and analyzes 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 100 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 Form 10-K for the year ended December 31, 2000.
Earnings Per Share
Basic net income per common share is calculated by dividing net income,
less preferred stock dividends (approximately $30 per quarter), 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. 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 2.4 million shares and 1.5 million shares, respectively, for the
three months ended March 31, 2001 and 2000.
Financial Instruments
The Company's policy is to use financial instruments only to manage
exposure to market risks. The Company has established a control environment that
includes policies and procedures for risk assessment and the approval, reporting
and monitoring of derivative financial instrument activities. These policies
prohibit holding or issuing derivative financial instruments for trading
purposes.
The Company's credit agreement requires the Company to mitigate the
risk of changes in interest rates associated with its variable interest rate
indebtedness through the use of interest rate swap agreements. Under such
arrangements, the Company converts a portion of its variable rate indebtedness
to fixed rates based on a notional principal amount. The settlement dates are
correlated to correspond to the interest payment dates of the hedged debt. At
both March 31, 2001 and December 31, 2000, the aggregate notional principal
amount under interest rate swap
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
agreements, at a weighted average fixed interest rate of 6.2%, totaled
approximately $410 million. The interest rate swap agreements mature at various
dates through November 2002.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). In June 1999, the
FASB issued SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133", under
which SFAS 133 is effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000 (2001 for the Company). In June 2000, the FASB
issued SFAS 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities", which addresses a limited number of issues causing
implementation difficulties for entities applying SFAS 133. SFAS 133, as
amended, requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. Effective January 1, 2001, the Company adopted
SFAS 133, as amended.
The Company's interest rate swap agreements are considered to be 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 are reflected at fair value in the Company's
consolidated balance sheet as of March 31, 2001 and the related gains or losses
on these contracts are deferred in shareholders' equity as a component of
comprehensive income. These deferred gains or losses are then amortized as an
adjustment to interest expense over the same period in which the related
interest payments being hedged are recognized in earnings. The estimated net
amount of deferred losses expected to be recorded in earnings within the next
twelve months was approximately $0.7 million at March 31, 2001. The net effect
of this accounting on the Company's operating results is that interest expense
on the portion of the variable rate debt being hedged is generally recorded
based on fixed interest rates.
The cumulative effect of the change in accounting for derivative
financial instruments upon adoption of SFAS 133, as amended, reduced
comprehensive income by approximately $1 million as indicated in Note 5 which
highlights changes in stockholders' equity for the three months ended March 31,
2001 and 2000.
2. INTEGRATION OF SBCL AND QUEST DIAGNOSTICS BUSINESSES
During the fourth quarter of 1999, Quest Diagnostics finalized its plan
to integrate SmithKline Beecham Clinical Laboratories, Inc. ("SBCL") into Quest
Diagnostics' laboratory network. The plan focuses principally on laboratory
consolidations in geographic markets served by more than one of the Company's
laboratories, and the redirection of testing volume within the Company's
national network to provide more local testing and improve customer service.
While the Company is not exiting any geographic markets as a result of the plan,
laboratories that will be closed or reduced in size are located in the following
metropolitan areas: Boston, Baltimore, Cleveland, Dallas, Detroit, Miami, New
York and Philadelphia. The Company is also transferring esoteric testing
performed at SBCL's National Esoteric Testing Center in Van Nuys, California to
Nichols Institute. Employee groups to be impacted as a result of these actions
include those involved in the collection and testing of specimens, as well as
administrative and other support functions. During the fourth quarter of 1999,
the Company recorded the estimated costs associated with executing the
integration plan. The majority of these integration costs related to employee
severance, contractual obligations associated with leased facilities and
equipment, and the write-off of fixed assets which management believes will have
no future economic benefit upon combining the operations. Integration costs
related to planned activities affecting SBCL's operations and employees were
recorded as a cost of the acquisition. Integration costs associated with the
planned integration of SBCL affecting Quest Diagnostics' operations and
employees were recorded as a charge to earnings in the fourth quarter of 1999.
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
The following table summarizes the Company's accruals for integration
costs affecting the acquired operations and employees of SBCL (in millions):
Costs of
Employee Exiting
Severance Leased
Costs Facilities Other Total
----- ---------- ----- -----
Balance, December 31, 2000 ... $19.9 $ 1.9 $ 1.8 $23.6
Amounts utilized in 2001 ..... (5.7) (0.2) (1.1) (7.0)
----- ----- ----- -----
Balance, March 31, 2001 ...... $14.2 $ 1.7 $ 0.7 $16.6
===== ===== ===== =====
Of the 1,000 SBCL employees expected to be severed during the initial
phase of the SBCL integration, approximately 800 employees had been severed in
connection with integration activities through March 31, 2001, including
approximately 100 employees severed during 2001.
The following table summarizes the Company's accruals for restructuring
costs associated with the planned integration of SBCL affecting Quest
Diagnostics' operations and employees (in millions):
Costs
of
Employee Exiting
Severance Leased
Costs Facilities Other Total
----- ---------- ----- -----
Balance, December 31, 2000 ... $ 8.8 $ 6.6 $ 0.7 $16.1
Amounts utilized in 2001 ..... (2.9) (0.7) (0.2) (3.8)
----- ----- ----- -----
Balance, March 31, 2001 ...... $ 5.9 $ 5.9 $ 0.5 $12.3
===== ===== ===== =====
Of the 500 Quest Diagnostics employees expected to be severed during
the initial phase of the SBCL integration, approximately 400 employees had been
severed in connection with integration activities through March 31, 2001,
including approximately 50 severed during 2001.
The remaining planned integration of the Company's principal
laboratories, provided for in accruals for integration costs as of December 31,
2000, will be completed during the second quarter of 2001. While a significant
portion of the remaining accruals associated with the SBCL integration plan are
expected to be paid in 2001, there are certain severance and facility related
exit costs, principally lease obligations, that have payment terms extending
beyond 2001.
3. ACQUISITION OF BUSINESS
On February 1, 2001, the Company acquired the assets of Clinical
Laboratories of Colorado, LLC ("CLC") for $47 million which included $4 million
associated with non-competition agreements. At the closing of the acquisition,
the Company used existing cash to fund the purchase price and related
transaction costs of the acquisition. The acquisition of CLC was accounted for
under the purchase method of accounting. The historical financial statements of
Quest Diagnostics include the results of operations of CLC subsequent to the
closing of the acquisition. Goodwill in the amount of approximately $42 million,
representing acquisition costs in excess of the fair value of net assets
acquired, is being amortized on the straight-line basis over forty years. The
amounts paid under the non-compete agreements are being amortized on the
straight-line basis over five years.
4. 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
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
subject of prior settlements with various governmental payers. Several of the
cases involve the operations of SBCL prior to the closing of the SBCL
acquisition.
Corning Incorporated ("Corning") has agreed to indemnify the Company
against all monetary settlements for any governmental claims relating to the
billing practices of the Company and its predecessors based on investigations
that were pending on December 31, 1996. Corning also agreed to indemnify the
Company in respect of private claims relating to indemnified or previously
settled government claims that alleged overbillings by Quest Diagnostics or any
of its existing subsidiaries for services provided before January 1, 1997.
Corning will indemnify Quest Diagnostics in respect of private claims for 50% of
the aggregate of all judgment or settlement payments made by December 31, 2001
that exceed $42 million. The 50% share will be limited to a total amount of $25
million and will be reduced to take into account any deductions or tax benefits
realized by Quest Diagnostics. In accordance with the indemnity described above,
the Company received $8.1 million from Corning during the first quarter of 2001
in connection with the Company's civil settlement of claims in the fourth
quarter of 2000 with respect to Nichols Institute's former regional
laboratories.
Similar to Quest Diagnostics, SBCL has entered into settlement
agreements with various governmental agencies and private payers primarily
relating to its prior billing and marketing practices. Effective in 1997, SBCL
and the United States government and various states reached a settlement with
respect to the government's civil and administrative claims. SBCL is also
responding to claims from private payers relating to billing and marketing
issues similar to those that were the subject of the settlement with the
government. The claims include ten purported class actions filed in various
jurisdictions in the United States and two non-class action complaints by a
number of insurance companies. Nine of the purported class actions have been
consolidated into one complaint, which has been consolidated with one of the
insurers' suits for pre-trial proceedings. During April 2001, a settlement was
reached in two of the complaints against SBCL. The settlement was paid directly
by SmithKline Beecham plc ("SmithKline Beecham") in April 2001, under the terms
of the indemnity described below.
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, 2001, related to
indemnified billing, professional liability and other claims discussed above,
totaled approximately $59 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, 2001 recorded reserves, relating primarily to billing
claims including those indemnified by Corning and SmithKline Beecham,
approximated $85 million, including $2 million in other long-term liabilities.
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.
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
5. COMMON STOCKHOLDERS' EQUITY
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)
==== ========== ========= ======== =======
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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, 2000
were as follows:
Accumulated
Other
Additional Comprehensive Compre-
Common Paid-In Accumulated Unearned Income hensive
Stock Capital Deficit Compensation (Loss) Income
------ ---------- ----------- ------------ ------------- -------
BALANCE,
DECEMBER 31, 1999 $444 $1,502,551 $(627,045) $(11,438) $(2,450)
Net income 17,809 $17,809
Other comprehensive income 1,009 1,009
-------
Comprehensive income $18,818
=======
Preferred dividends declared (29)
Issuance of common stock under
benefit plans (643 common
shares) 6 23,555 (14,459)
Exercise of options (137 common
shares) 1 1,330
Tax benefits associated with
stock-based compensation
plans 1,291
Amortization of unearned
compensation 3,455
---- ---------- --------- -------- -------
BALANCE, MARCH 31, 2000 $451 $1,528,727 $(609,265) $(22,442) $(1,441)
==== ========== ========= ======== =======
6. PROPOSED STOCK SPLIT
On February 21, 2001, the Board of Directors approved a two-for-one
stock split of the Company's common stock, subject to stockholder approval of an
increase in the number of common shares authorized from 100 million shares to
300 million shares. The stock split will be effected by the issuance on May 31,
2001, 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. All references to
the number of common shares and per common share amounts, including earnings per
common share calculations, have not been restated to reflect this proposed stock
dividend, since the stock dividend is contingent upon stockholder approval.
7. SUBSEQUENT EVENT
On April 25, 2001, the Company signed a definitive agreement to acquire
the outstanding voting shares of MedPlus, Inc. ("MedPlus"), a leading developer
and integrator of clinical connectivity and data management solutions for
healthcare organizations and clinicians. The agreement calls for the Company to
pay $2 per share in cash for the remaining 82% of voting shares of MedPlus it
does not currently own. The closing of this transaction, which also is dependent
on approval by MedPlus shareholders, is expected to occur after the MedPlus
annual meeting in June 2001. At the closing of the acquisition, the Company
expects to use existing cash to fund the purchase price (estimated at
approximately $18 million) and related transaction costs of the acquisition. The
acquisition of MedPlus is expected to be accounted for under the purchase method
of accounting.
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
8. SUMMARIZED FINANCIAL INFORMATION
The Company's 10 3/4% senior subordinated notes due 2006 are
guaranteed, fully, jointly and severally, and unconditionally, on a senior
subordinated basis by substantially all of the Company's wholly-owned, domestic
subsidiaries ("Subsidiary Guarantors"). With the exception of Quest Diagnostics
Receivables Incorporated (see paragraph below), the non-guarantor subsidiaries
are foreign and less than wholly-owned subsidiaries.
In conjunction with the Company's receivables financing in the third
quarter of 2000, 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 receivables financing. 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.
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.
The following condensed consolidating financial data illustrates the
composition of the combined guarantors. The Company believes that separate
complete financial statements of the respective guarantors would not provide
additional material information which would be useful in assessing the financial
composition of the Subsidiary Guarantors.
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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, 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
========= ========= ========= ========= =========
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2000
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Net revenues ............................ $ 167,181 $ 661,892 $ 28,406 $-- $ 857,479
Costs and expenses:
Cost of services ...................... 110,032 403,206 15,799 -- 529,037
Selling, general and administrative ... 62,391 174,850 12,594 -- 249,835
Interest, net ......................... 3,528 26,083 152 -- 29,763
Amortization of intangibles ........... 1,917 9,937 86 -- 11,940
Royalty (income) expense .............. (19,223) 19,223 -- -- --
Other, net ............................ 438 (98) 1,368 -- 1,708
--------- --------- --------- --------- ---------
Total ................................ 159,083 633,201 29,999 -- 822,283
--------- --------- --------- --------- ---------
Income (loss) before taxes .............. 8,098 28,691 (1,593) -- 35,196
Income tax expense ...................... 2,478 14,571 338 -- 17,387
Equity earnings from subsidiaries ....... 12,189 -- -- (12,189) --
--------- --------- --------- --------- ---------
Net income (loss) ....................... $ 17,809 $ 14,120 $ (1,931) $ (12,189) $ 17,809
========= ========= ========= ========= =========
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Condensed Consolidating Balance Sheet
March 31, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents .................... $ -- $ 111,628 $ 9,102 $ -- $ 120,730
Accounts receivable, net ..................... 2,983 41,784 464,505 -- 509,272
Other current assets ......................... 214,677 110,771 9,174 (11,810) 322,812
----------- ----------- ----------- ----------- -----------
Total current assets ...................... 217,660 264,183 482,781 (11,810) 952,814
Property, plant and equipment, net ........... 137,475 322,122 13,467 -- 473,064
Intangible assets, net ....................... 71,813 1,217,173 8,693 -- 1,297,679
Intercompany receivable (payable) ............ 81,233 101,034 (182,267) -- --
Investment in subsidiaries ................... 1,038,684 -- -- (1,038,684) --
Other assets ................................. 80,591 68,162 30,925 -- 179,678
----------- ----------- ----------- ----------- -----------
Total assets .............................. $ 1,627,456 $ 1,972,674 $ 353,599 $(1,050,494) $ 2,903,235
=========== =========== =========== =========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ........ $ 388,020 $ 242,857 $ 35,922 $ (11,810) $ 654,989
Short-term borrowings and current portion of
long-term debt ............................. 845 7,829 256,356 -- 265,030
----------- ----------- ----------- ----------- -----------
Total current liabilities ................. 388,865 250,686 292,278 (11,810) 920,019
Long-term debt ............................... 90,821 659,320 8,340 -- 758,481
Other liabilities ............................ 47,554 65,218 11,747 -- 124,519
Preferred stock .............................. 1,000 -- -- -- 1,000
Common stockholders' equity .................. 1,099,216 997,450 41,234 (1,038,684) 1,099,216
----------- ----------- ----------- ----------- -----------
Total liabilities and stockholders' equity $ 1,627,456 $ 1,972,674 $ 353,599 $(1,050,494) $ 2,903,235
=========== =========== =========== =========== ===========
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Condensed Consolidating Balance Sheet
December 31, 2000
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents ..................... $ -- $ 163,863 $ 7,614 $-- $ 171,477
Accounts receivable, net ...................... 6,159 29,548 449,866 -- 485,573
Other current assets .......................... 191,693 129,881 9,030 (6,965) 323,639
----------- ----------- ----------- ----------- -----------
Total current assets ....................... 197,852 323,292 466,510 (6,965) 980,689
Property, plant and equipment, net ............ 121,159 316,630 12,067 -- 449,856
Intangible assets, net ........................ 72,514 1,180,341 8,748 -- 1,261,603
Intercompany receivable (payable) ............. (78,538) 253,994 (175,456) -- --
Investment in subsidiaries .................... 1,031,135 -- -- (1,031,135) --
Other assets .................................. 66,623 71,692 34,073 -- 172,388
----------- ----------- ----------- ----------- -----------
Total assets ............................... $ 1,410,745 $ 2,145,949 $ 345,942 $(1,038,100) $ 2,864,536
=========== =========== =========== =========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ......... $ 247,558 $ 418,147 $ 30,842 $ (6,965) $ 689,582
Short-term borrowings and current portion of
long-term debt .............................. 837 8,215 256,356 -- 265,408
----------- ----------- ----------- ----------- -----------
Total current liabilities .................. 248,395 426,362 287,198 (6,965) 954,990
Long-term debt ................................ 95,711 661,340 3,654 -- 760,705
Other liabilities ............................. 34,844 71,159 11,043 -- 117,046
Preferred stock ............................... 1,000 -- -- -- 1,000
Common stockholders' equity ................... 1,030,795 987,088 44,047 (1,031,135) 1,030,795
----------- ----------- ----------- ----------- -----------
Total liabilities and stockholders' equity . $ 1,410,745 $ 2,145,949 $ 345,942 $(1,038,100) $ 2,864,536
=========== =========== =========== =========== ===========
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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, 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
========= ========= ========= ========= =========
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2000
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income (loss) ............................. $ 17,809 $ 14,120 $ (1,931) $(12,189) $ 17,809
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization ............... 8,768 23,449 968 -- 33,185
Provision for doubtful accounts ............. 5,944 55,341 1,361 -- 62,646
Other, net .................................. (20,227) 8,420 1,569 12,189 1,951
Changes in operating assets and liabilities . 868 (80,670) (2,632) -- (82,434)
-------- -------- -------- -------- --------
Net cash provided by (used in) operating
activities .................................. 13,162 20,660 (665) -- 33,157
Net cash used in investing activities ......... (11,266) (11,000) (76) 1,865 (20,477)
Net cash (used in) provided by financing
activities .................................. (1,896) (8,146) 430 (1,865) (11,477)
-------- -------- -------- -------- --------
Net change in cash and cash equivalents ....... -- 1,514 (311) -- 1,203
Cash and cash equivalents, beginning of year .. -- 18,864 8,420 -- 27,284
-------- -------- -------- -------- --------
Cash and cash equivalents, end of period ...... $ -- $ 20,378 $ 8,109 $ -- $ 28,487
======== ======== ======== ======== ========
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTEGRATION OF SBCL AND QUEST DIAGNOSTICS BUSINESSES
We expect to continue to realize significant benefits from combining
our existing laboratory network with that of SmithKline Beecham Clinical
Laboratories, Inc. ("SBCL"). We have essentially completed the process of
reducing redundant facilities and infrastructure, including laboratory
consolidations in geographic markets served by more than one of our
laboratories, and redirecting testing volume within our national network to
provide more local testing and improve customer service. We have not exited any
geographic markets as a result of the plan. Employee groups impacted as a result
of these actions include those involved in the collection and testing of
specimens, as well as administrative and other support functions. During the
fourth quarter of 1999, we recorded the estimated costs associated with
executing the integration plan. The majority of these integration costs related
to employee severance, contractual obligations associated with leased facilities
and equipment, and the write-off of fixed assets which management believes will
have no future economic benefit upon combining the operations. Integration costs
related to planned activities affecting SBCL's operations and employees were
recorded as a cost of the acquisition. Integration costs associated with the
planned integration of SBCL affecting Quest Diagnostics' operations and
employees were recorded as a charge to earnings in the fourth quarter of 1999. A
full discussion and analysis of the reserves related to the SBCL integration is
contained in Note 2 to the Interim Consolidated Financial Statements.
Through the end of March 2001, we had completed the transition of
approximately 96% of our business affected by integration throughout our
national laboratory network, with approximately 98% transitioned by early April
2001. The remaining planned integration of the Company's principal laboratories,
provided for in accruals for integration costs as of December 31, 2000, will be
completed during the second quarter of 2001. Other activities, for which no
accruals had been recorded as of December 31, 2000, including the
standardization of information systems, will continue beyond 2001.
Management continues to expect that this integration will result in
approximately $150 million of annual synergies to be achieved by the end of
2002. During the first quarter of 2001, the Company estimates that it achieved
approximately $25 million in synergies, which represents approximately $100
million on an annual basis. For the full year 2001, management expects that the
Company will realize approximately $100 - $120 million of synergies driven by
cost reductions.
Management anticipates that additional charges may be recorded in 2001
associated with further consolidation activities. Management cannot estimate the
amount of these charges at this time, but expects to fund these charges with
cash from operations.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2001 COMPARED WITH THREE MONTHS ENDED
MARCH 31, 2000
Net income for the three months ended March 31, 2001 increased to $35.7
million from $17.8 million for the three months ended March 31, 2000. The
increase in net income was primarily due to an improvement in average revenue
per requisition, the realization of synergies from the SBCL integration and a
reduction in net interest expense, partially offset by increases in employee
compensation costs and investments in our Six Sigma quality initiative,
information technology strategy and strategic growth opportunities.
Results for the three months ended March 31, 2000 included the effects
of testing performed by third parties under our laboratory network management
arrangements. As laboratory network manager, we included in our consolidated
revenues and expenses the cost of testing performed by third parties. This
treatment added $32.4 million to both reported revenues and cost of services for
the three months ended March 31, 2000. This treatment also serves to increase
cost of services as a percentage of net revenues and decrease selling, general
and administrative expenses as a percentage of net revenues. During the first
quarter of 2000, we terminated a
16
18
laboratory network management arrangement with Aetna USHealthcare, and entered
into a new non-exclusive contract under which we are no longer responsible for
the cost of testing performed by third parties. In addition, during the third
quarter of 2000, we amended our laboratory network management contract with
Oxford Health to remove the financial risk associated with testing performed by
third parties. As a result of these contract modifications, we are no longer
required to include in our consolidated revenues and expenses, the cost of
testing performed by third parties. This impacts the comparability of results
between the periods presented and serves to reduce reported net revenues during
the three months ended March 31, 2001 by $32.4 million.
Net Revenues
Excluding the effect of testing performed by third parties under our
laboratory network management arrangements in 2000, net revenues for the three
months ended March 31, 2001 grew by 7%, compared to the prior year period,
primarily due to an increase in average revenue per requisition. The improvement
in average revenue per requisition was primarily attributable to improved
pricing on managed care business, a shift in test mix to higher value testing
and a shift in payer mix to fee-for-service reimbursement. Business contributed
to our unconsolidated joint ventures during 2000 in Phoenix, Indianapolis and
Dayton reduced our reported requisition volume by approximately 1.5% during the
first quarter of 2001, compared to the prior year period. After adjusting for
business contributed to unconsolidated joint ventures, clinical testing volume,
measured by the number of requisitions, for the first quarter of 2001 increased
approximately 1% over the prior year period. Contributing to this increase was
our acquisition of the assets of Clinical Laboratories of Colorado, LLC ("CLC"),
which increased volume by approximately 1%, and an increase in volume from our
principal customers, physicians and hospitals, of approximately 1.5%. Partially
offsetting these increases was a decline in testing volumes associated with our
drugs of abuse testing business, driven by a general slowing of the economy and
a corresponding slowdown in hiring, which reduced total company volume by about
1.5% during the first quarter of 2001, compared to the prior year period.
Overall, reported volumes decreased by approximately 1% during the first quarter
of 2001, compared to the prior year period.
Operating Costs and Expenses
Excluding the effect of testing performed by third parties under our
laboratory network management arrangements in 2000, total operating costs for
the three months ended March 31, 2001 increased approximately $35 million from
the year earlier period, primarily due to increases in 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, we continue to make investments to enhance our
infrastructure to pursue our overall business strategy. These investments
include those related to:
- Our Six Sigma quality initiative which we believe will provide us
with a competitive advantage in the market place and ultimately
serve to reduce costs;
- Skills training for all employees, which together with our
competitive pay and benefits, helps to increase employee
satisfaction and performance, thereby enabling us to provide the
best services to our customers;
- Our information technology strategy; and
- Our strategic growth opportunities such as direct-to-consumer
testing.
The following discussion and analysis regarding cost of services,
selling, general and administrative expenses and bad debt expense exclude the
effect of testing performed by third parties under our laboratory network
management arrangements in 2000, which serve to increase cost of services as a
percentage of net revenues and reduce selling, general and administrative
expenses as a percentage of net revenues. Cost of services, which include the
costs of obtaining, transporting and testing specimens, decreased during the
first quarter of 2001 as a percentage of net revenues to 59.9% from 60.2% a year
ago. This decrease was primarily attributable to the improvement in average
revenue per requisition, 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 2001 as a
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19
percentage of net revenues to 28.6% from 30.3% in the prior year period. This
decrease was primarily due to improvements in average revenue per requisition
and bad debt expense, partially offset by an increase in employee compensation
costs. During the first quarter of 2001, bad debt expense was 6.3% of net
revenues, compared to 7.6% of net revenues in the first quarter of 2000. The
improvement in bad debt expense was principally attributable to the significant
progress that we have made to improve the overall collection experience of the
combined company through process improvements around 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 substantial
opportunities continue to exist to improve our overall collection experience.
Interest, Net
Net interest expense for the first quarter of 2001 decreased from the
prior year period by $7.1 million. This reduction was primarily due to an
overall reduction in debt levels, the favorable impact of our receivables
financing which has served to lower the weighted average borrowing rate on our
outstanding debt and lower interest rates on our variable rate debt.
Amortization of Intangible Assets
Amortization of intangible assets for the first quarter of 2001
decreased from the prior year period by $0.8 million, principally as a result of
adjustments recorded in the third and fourth quarters of 2000 to reduce the
amount of goodwill associated with the SBCL acquisition by approximately $130
million.
Minority Share of Income
Minority share of income for the first quarter of 2001 decreased from
the prior year level, primarily due to start up losses associated with a new
joint venture in Oklahoma in which we hold a 51% interest.
Other, Net
Other, net for the first quarter of 2001 increased from the prior year
level, primarily due to the write-down of an impaired asset partially offset by
an increase in equity earnings from our unconsolidated joint ventures.
Income Taxes
Our effective tax rate is significantly impacted by goodwill
amortization, the majority of which is not deductible for tax purposes, and has
the effect of increasing the overall tax rate. The reduction in the effective
tax rate for the first quarter of 2001 was primarily due to pretax earnings
increasing at a faster rate than goodwill amortization and other non-deductible
items.
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. In accordance with the
terms of our credit agreement, we maintain interest rate swap agreements to
mitigate the risk of changes in interest rates associated with our variable rate
bank debt. We do not believe that our foreign exchange exposure is material to
our financial position or results of operations. See Note 1 to the Interim
Consolidated Financial Statements for additional information regarding our
adoption of Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended. See Note 2 to the
Consolidated Financial Statements contained in our 2000 Annual Report on Form
10-K for additional discussion of our financial instruments and hedging
activities.
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20
Interest Rates
At both March 31, 2001 and December 31, 2000, the fair value of our
debt was estimated at approximately $1.0 billion using quoted market prices and
yields for the same or similar types of borrowings, taking into account the
underlying terms of the debt instruments. At March 31, 2001 and December 31,
2000, the estimated fair value exceeded the carrying value of the debt by
approximately $6 million and $5 million, respectively. An assumed 10% increase
in interest rates (representing approximately 100 basis points) would
potentially reduce the estimated fair value of our debt by approximately $8
million at March 31, 2001.
At both March 31, 2001 and December 31, 2000, we had approximately $848
million of variable interest rate debt outstanding. Our credit agreement
requires us to mitigate the risk of changes in interest rates associated with a
portion of our variable interest rate indebtedness through the use of interest
rate swap agreements. Under such arrangements, we convert a portion of our
variable rate indebtedness to fixed rates based on a notional principal amount.
The settlement dates are correlated to correspond to the interest payment dates
of the hedged debt. During the term of the credit agreement, the notional
amounts under the interest rate swap agreements, plus the principal amount
outstanding of our fixed interest rate indebtedness, must be at least 50% of our
net funded debt (as defined in the credit agreement). At both March 31, 2001 and
December 31, 2000, the aggregate notional principal amount under the interest
rate swap agreements, which mature at various dates through November 2002,
totaled $410 million. At March 31, 2001 and December 31, 2000, the estimated
fair value of the interest rate swap agreements approximated a liability of $6
million and $2 million, respectively. An assumed 10% adverse change in interest
rates (representing approximately 100 basis points) would potentially increase
the estimated fair value of the liability associated with our interest rate swap
agreements by approximately $1 million at March 31, 2001.
Based on our net exposure to interest rate changes, an assumed 10%
increase in interest rates (representing approximately 100 basis points) would
result in a $0.4 million reduction in our after-tax earnings and cash flows for
the three months ended March 31, 2001 based on debt levels as of March 31, 2001,
after considering the impact of our interest rate swap agreements. 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.
LIQUIDITY AND CAPITAL RESOURCES
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 offset by investing
and financing activities which required cash of $91.5 million. Cash and cash
equivalents at March 31, 2000 totaled $28.5 million, an increase of $1.2 million
from December 31, 1999. Cash flows from operating activities in 2000 provided
cash of $33.2 million, which was offset by investing and financing activities
which required cash of $32.0 million.
Net cash from operating activities for 2001 was $7.6 million higher
than the 2000 level. The increase was primarily due to improved operating
performance offset by increases in spending associated with the SBCL integration
and employee incentive payments. Days sales outstanding, a measure of billing
and collection efficiency, improved to 51 days at March 31, 2001 from 56 days at
December 31, 2000.
Net cash used in investing activities in 2001 was $90.3 million for the
first quarter consisting primarily of the acquisition and related transaction
costs of $47.2 million to acquire the assets of CLC in Denver, and capital
expenditures of $43.6 million. Net cash used in investing activities in 2000 was
$20.5 million consisting primarily of capital expenditures of $17.6 million. The
increase in capital spending above the prior year level was primarily
attributable to facility expansions and reconfigurations initiated as part of
our integration plans and information technology investments.
Net cash used in financing activities for 2001 and 2000 was $1.2
million and $11.5 million, respectively, reflecting scheduled repayments of debt
and distributions to minority partners, offset by proceeds from the exercise of
stock options.
We estimate that we will invest approximately $140 million to $150
million during 2001 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
$13 million at March
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31, 2001, all of the revolving credit facility under our credit agreement was
available for borrowing at March 31, 2001.
We believe that cash from operations and the revolving credit facility
under our credit agreement, together with the indemnifications by Corning
Incorporated and SmithKline Beecham plc against monetary fines, penalties or
losses from outstanding government and other related claims, will provide
sufficient financial flexibility to integrate the operations of Quest
Diagnostics and SBCL, to meet seasonal working capital requirements and to fund
capital expenditures and additional growth opportunities for the foreseeable
future. Recent upgrades in the Company's credit ratings by both Standard &
Poor's and Moody's Investor Services are expected to have a favorable impact on
the Company's 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.
We do not anticipate paying dividends on our common stock in the
foreseeable future. Our credit agreement prohibits the payment of cash dividends
on our common stock and the indenture governing our 10 3/4% senior subordinated
notes due 2006 (the "Indenture") restricts our ability to pay cash dividends on
all classes of stock. These restrictions are primarily based on a percentage of
the Company's earnings as defined in the Indenture. Additionally, our credit
agreement contains various covenants and conditions including the maintenance of
certain financial ratios and tests, and restricts our ability to, among other
things, incur additional indebtedness and repurchase shares of our outstanding
common stock.
On February 21, 2001, the Board of Directors approved a two-for-one
stock split of the Company's common stock, subject to stockholder approval of an
increase in the number of common shares authorized from 100 million shares to
300 million shares. The stock split will be effected by the issuance on May 31,
2001, 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. All references to
the number of common shares and per common share amounts, including earnings per
common share calculations, have not been restated to reflect this proposed stock
dividend, since the stock dividend is contingent upon stockholder approval.
On April 25, 2001, the Company signed a definitive agreement to acquire
the outstanding voting shares of MedPlus, Inc. ("MedPlus"), a leading developer
and integrator of clinical connectivity and data management solutions for
healthcare organizations and clinicians. The agreement calls for the Company to
pay $2 per share in cash for the remaining 82% of voting shares of MedPlus it
does not currently own. The closing of this transaction, which also is dependent
on approval by MedPlus shareholders, is expected to occur after the MedPlus
annual meeting in June 2001. At the closing of the acquisition, the Company
expects to use existing cash to fund the purchase price (estimated at
approximately $18 million) and related transaction costs of the acquisition. The
acquisition of MedPlus is expected to be accounted for under the purchase method
of accounting.
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
of America since it is a meaningful measure of a company's performance and
ability to meet its future debt service requirements, fund capital expenditures
and meet working capital requirements. EBITDA is not a measure of financial
performance under accounting principles generally accepted in the United States
of America 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 of America) 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 2001 improved to $122.4 million, or
13.9% of net revenues, from $98.1 million, or 11.4% of net revenues, in the
prior year period. The improvement in EBITDA is primarily due to improvements in
the average revenue per requisition and cost synergies resulting from the SBCL
integration, partially offset by increases in employee compensation costs and
investments in our Six Sigma quality initiative, information technology strategy
and strategic growth opportunities.
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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 2000 Annual
Report on Form 10-K.
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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 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 March 15, 2001, the Company filed a current report on Form 8-K
in accordance with Regulation FD (Fair Disclosure) requirements.
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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 2, 2001
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 Corporate Vice President and
Chief Financial Officer
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