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 September 30, 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 October 29, 2001, there were outstanding 95,571,648 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 and Nine Months Ended September 30, 2001 and 2000 2
Consolidated Balance Sheets as of
September 30, 2001 and December 31, 2000 3
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 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 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations"
1
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
NET REVENUES........................................ $ 903,189 $ 850,236 $ 2,717,331 $ 2,584,828
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of services................................. 535,564 504,742 1,614,020 1,554,216
Selling, general and administrative.............. 251,048 251,219 760,324 753,900
Interest expense, net............................ 14,810 29,463 57,968 89,430
Amortization of intangible assets................ 11,442 11,486 34,681 35,380
Provision for special charges.................... - - 5,997 2,100
Minority share of income......................... 2,876 2,110 6,843 7,486
Other, net....................................... (2,437) (2,803) (3,571) (5,112)
----------- ----------- ----------- -----------
Total.......................................... 813,303 796,217 2,476,262 2,437,400
----------- ----------- ----------- -----------
INCOME BEFORE TAXES AND EXTRAORDINARY LOSS 89,886 54,019 241,069 147,428
INCOME TAX EXPENSE ................................. 39,764 25,307 108,095 70,739
----------- ----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY LOSS 50,122 28,712 132,974 76,689
EXTRAORDINARY LOSS, NET OF TAXES -- -- (21,609) --
----------- ----------- ----------- -----------
NET INCOME ......................................... $ 50,122 $ 28,712 $ 111,365 $ 76,689
=========== =========== =========== ===========
BASIC NET INCOME PER COMMON SHARE:
Income before extraordinary loss.................... $ 0.54 $ 0.32 $ 1.43 $ 0.86
Extraordinary loss, net of taxes.................... -- -- (0.23) --
----------- ----------- ----------- -----------
Net income.......................................... $ 0.54 $ 0.32 $ 1.20 $ 0.86
=========== =========== =========== ===========
DILUTED NET INCOME PER COMMON SHARE:
Income before extraordinary loss.................... $ 0.51 $ 0.30 $ 1.37 $ 0.82
Extraordinary loss, net of taxes.................... -- -- (0.23) --
----------- ----------- ----------- -----------
Net income.......................................... $ 0.51 $ 0.30 $ 1.14 $ 0.82
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC.............................. 93,382 89,944 92,612 89,120
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - DILUTED............................ 98,046 95,771 97,323 93,655
The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2001 AND DECEMBER 31, 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------ -----------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents............................................... $ 238,879 $ 171,477
Accounts receivable, net of allowance of $207,508 and $204,358 at
September 30, 2001 and December 31, 2000, respectively................ 513,637 485,573
Inventories............................................................. 46,188 44,274
Deferred taxes on income................................................ 148,182 188,483
Prepaid expenses and other current assets............................... 41,519 90,882
----------- -----------
Total current assets.................................................. 988,405 980,689
PROPERTY, PLANT AND EQUIPMENT, NET......................................... 493,197 449,856
GOODWILL, NET ............................................................. 1,256,222 1,235,933
INTANGIBLE ASSETS, NET..................................................... 26,456 25,670
DEFERRED TAXES ON INCOME................................................... 53,016 42,622
OTHER ASSETS............................................................... 116,174 129,766
----------- -----------
TOTAL ASSETS............................................................... $ 2,933,470 $ 2,864,536
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued expenses................................... $ 608,047 $ 689,582
Short-term borrowings and current portion of long-term debt............. 280,618 265,408
----------- -----------
Total current liabilities............................................. 888,665 954,990
LONG-TERM DEBT............................................................. 677,913 760,705
OTHER LIABILITIES.......................................................... 122,970 117,046
COMMITMENTS AND CONTINGENCIES
PREFERRED STOCK............................................................ 1,000 1,000
COMMON STOCKHOLDERS' EQUITY:
Common stock, par value $0.01 per share; 300,000 shares authorized; 95,357
and 93,083 shares issued and outstanding at
September 30, 2001 and December 31, 2000, respectively............... 954 465
Additional paid-in capital.............................................. 1,676,594 1,591,976
Accumulated deficit..................................................... (413,834) (525,111)
Unearned compensation................................................... (17,552) (31,077)
Accumulated other comprehensive loss.................................... (3,240) (5,458)
----------- -----------
Total common stockholders' equity..................................... 1,242,922 1,030,795
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 2,933,470 $ 2,864,536
=========== ===========
The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(IN THOUSANDS)
(UNAUDITED)
2001 2000
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................... $ 111,365 $ 76,689
Extraordinary loss, net of taxes............................................. 21,609 -
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization............................................. 108,000 100,792
Provision for doubtful accounts........................................... 165,670 181,646
Provision for special charges............................................. 5,997 2,100
Deferred income tax provision............................................. 5,224 5,883
Stock compensation expense................................................ 16,457 17,580
Minority share of income.................................................. 6,843 7,486
Other, net................................................................ 1,078 (3,467)
Changes in operating assets and liabilities:
Accounts receivable..................................................... (193,734) (224,824)
Accounts payable and accrued expenses................................... (2,254) 71,169
Integration, settlement and special charges............................. (41,397) (40,152)
Other assets and liabilities, net....................................... 96,422 51,552
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES.................................... 301,280 246,454
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures......................................................... (110,183) (67,961)
Business acquisitions........................................................ (55,746) (925)
Proceeds from disposition of assets.......................................... 21,562 2,714
Increase in investments...................................................... (11,206) (24,255)
Decrease in note receivable.................................................. 2,989 -
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES........................................ (152,584) (90,427)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt................................................. (790,126) (284,292)
Proceeds from borrowings..................................................... 722,439 256,000
Costs paid in connection with debt refinancing............................... (25,164) (1,531)
Exercise of stock options.................................................... 17,512 16,127
Distributions to minority partners........................................... (5,779) (7,800)
Preferred stock dividends paid............................................... (176) (29)
---------- ----------
NET CASH USED IN FINANCING ACTIVITIES........................................ (81,294) (21,525)
---------- ----------
NET CHANGE IN CASH AND CASH EQUIVALENTS...................................... 67,402 134,502
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................................. 171,477 27,284
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD..................................... $ 238,879 $ 161,786
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest..................................................................... $ 56,300 $ 78,373
Income taxes................................................................. 23,048 24,033
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 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 presentation 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. Certain prior year amounts have been reclassified between gross
accounts receivable and the allowance for doubtful accounts to conform to the
September 30, 2001 presentation, with no corresponding impact on net accounts
receivable. 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
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), 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 Employee Equity
Participation Program. These dilutive securities increased the weighted average
number of common shares outstanding by 4.7 million shares and 5.8 million
shares, respectively, for the three months ended September 30, 2001 and 2000.
The dilutive effect of these securities for the nine months ended September 30,
2001 and 2000 increased the weighted average number of common shares outstanding
by 4.7 million shares and 4.5 million shares, respectively.
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
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.
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 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 during the nine months ended
September 30, 2001.
Prior to the Company's debt refinancing in June 2001 (see Note 2), the
Company's 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, the
interest rate swap agreements were terminated and the losses included in
shareholders' equity as a component of comprehensive income were reflected in
the consolidated statement of operations for the nine months ended September 30,
2001 (See Note 5).
New Accounting Standards
In July 2001, the FASB issued SFAS No. 141, "Business Combinations"
("SFAS 141") and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142") requiring business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadening 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 will not be amortized into results of operations, but instead will
be reviewed for impairment and an impairment charge will be recorded in the
periods in which the recorded carrying value of goodwill and certain intangibles
is more than its estimated fair value. The provisions of SFAS 141 will be
adopted for any business combination consummated after June 30, 2001. Goodwill
acquired in a business combination for which the acquisition date is after June
30, 2001 will not be amortized. The remaining provisions of SFAS 142, related to
goodwill acquired prior to June 30, 2001 and intangible assets, will be adopted
by the Company on January 1, 2002. The adoption of these accounting standards is
expected to reduce the amount of amortization of intangible assets recorded in
the Company's consolidated financial statements by approximately $35 million
annually, commencing January 1, 2002. Management currently does not expect that
the new criteria for recording intangible assets separate from goodwill will
require the Company to reclassify any of its intangible assets.
In October 2001, the FASB issued SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The provisions of
SFAS 144 require the use of a consistent accounting model for long-lived assets
to be disposed of by sale, whether previously held and used, or newly acquired,
and extend 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 (2002 for the Company). Management believes
that the adoption of SFAS 144 will not have a material effect on the Company's
consolidated results of operations or financial position.
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
2. DEBT REFINANCING
On June 27, 2001, the Company refinanced a majority of its long-term
debt on a senior unsecured basis to reduce overall interest costs and obtain
less restrictive covenants. Specifically, the Company completed a $550 million
senior notes offering (the "Senior Notes") and entered into a new $500 million
senior unsecured credit facility (the "Credit Agreement") which included a $175
million term loan. The Company used the net proceeds from the senior notes
offering and new term loan, together with its cash on hand, to repay all of the
$584 million which was outstanding under its then existing senior secured credit
agreement, including the costs to settle existing interest rate swap agreements,
and to consummate a cash tender offer and consent solicitation for its 10-3/4%
senior subordinated notes due 2006 (the "Subordinated Notes").
In conjunction with the cash tender offer for the Company's
Subordinated Notes, approximately $147 million in aggregate principal amount, or
98% of the $150 million of outstanding Subordinated Notes was tendered. In
addition, the Company received the requisite consents from the holders of
Subordinated Notes to amend the indenture governing the Subordinated Notes to
eliminate substantially all of its restrictive provisions. The Company has made
payments of approximately $160 million to holders with respect to the cash
tender offer and consent solicitation, including tender premium and related
solicitation and banking fees, and accrued interest.
The Company incurred approximately $31 million of costs associated with
the debt refinancing. Of that amount, $12 million represented costs associated
with placing the new debt, which will be amortized over the term of the Senior
Notes and Credit Agreement and $6 million represented the cost to terminate the
interest rate swap agreements on the debt which was refinanced. The remaining
$13 million represented primarily the tender premium incurred in conjunction
with the Company's cash tender offer of the Subordinated Notes which was
included in the extraordinary loss recorded in the second quarter of 2001 (see
Note 6).
The Senior Notes were issued in two tranches: (a) $275,000,000
aggregate principal amount of 6-3/4% senior notes due 2006 ("Senior Notes due
2006"), issued at a discount of approximately $1.6 million and (b) $275,000,000
aggregate principal amount of 7-1/2% senior notes due 2011 ("Senior Notes due
2011"), issued at a discount of approximately $1.1 million. After considering
the discounts, the effective interest rate on the Senior Notes due 2006 and
Senior Notes due 2011 is 6.9% and 7.6%, respectively. The Senior Notes require
semiannual interest payments commencing January 12, 2002. The Senior Notes are
unsecured obligations of the Company and rank equally with the Company's other
unsecured senior obligations. The Senior Notes are guaranteed by each of the
Company's wholly owned subsidiaries that operate clinical laboratories in the
United States (the "Subsidiary Guarantors").
The Company's new senior unsecured credit facility consists of a
five-year $175 million amortizing term loan and a five-year $325 million
revolving credit facility. Interest is based on certain published rates plus an
applicable margin that will vary based on changes in the Company's credit
ratings. At the option of the Company, it may elect to enter into LIBOR based
interest rate contracts for periods up to 180 days. Interest on any outstanding
amounts not covered under the LIBOR based interest rate contracts is based on an
alternate base rate which is calculated by reference to the prime rate or
federal funds rate (as defined in the Credit Agreement). Additionally, the
Company has the ability to borrow up to $200 million under the five year $325
million revolving credit facility at rates determined by a competitive bidding
process among the lenders. As of September 30, 2001, the Company's borrowing
rate on LIBOR-based loans was LIBOR plus 1.3125%. The obligations of the Company
under the Credit Agreement are guaranteed by the Subsidiary Guarantors (i.e.,
the same subsidiaries that guarantee the Senior Notes). The Credit Agreement
contains various covenants, including the maintenance of certain financial
ratios, which could impact the Company's ability to, among other things, incur
additional indebtedness, repurchase shares of its outstanding common stock, make
additional investments and consummate acquisitions.
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
3. 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 focused 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 did not exit any geographic markets as a result of the plan,
laboratories that were closed or reduced in size were located in the following
metropolitan areas: Boston, Baltimore, Cleveland, Dallas, Detroit, Miami, New
York and Philadelphia. The Company also transferred esoteric testing performed
at SBCL's National Esoteric Testing Center in Van Nuys, California to Nichols
Institute. Employee groups impacted as a result of these actions included 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 believed would 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.
The following table summarizes the Company's accruals for integration
costs affecting the acquired business 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............................. (13.5) (1.1) (1.2) (15.8)
------- ------- ------- -------
Balance, September 30, 2001.......................... $ 6.4 $ 0.8 $ 0.6 $ 7.8
======= ======= ======= =======
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............................. (6.7) (2.3) (0.5) (9.5)
------- ------- ------- -------
Balance, September 30, 2001.......................... $ 2.1 $ 4.3 $ 0.2 $ 6.6
======= ======= ======= =======
The actions associated with the SBCL integration plan, provided for in
accruals for integration costs as of December 31, 2000, including those related
to severed employees, were completed as of June 30, 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.
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
4. BUSINESS ACQUISITIONS
On February 1, 2001, the Company acquired the assets of Clinical
Laboratories of Colorado, LLC ("CLC") for $47.0 million, which included $4.0
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 (see Note 1 - New Accounting Standards). The amounts paid under the
non-compete agreements are being amortized on the straight-line basis over five
years.
During the second quarter of 2001, the Company paid $8.5 million to
acquire the minority ownership interest of a consolidated joint venture from its
joint venture partner.
5. PROVISION FOR SPECIAL CHARGES
During the second quarter of 2001, the Company recorded a special
charge of $6.0 million in connection with the refinancing of its debt and
settlement of the Company's interest rate swap agreements. Prior to the
Company's debt refinancing in June 2001 (see Note 2), the Company's 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 in the Company's consolidated balance sheet and the related losses on
these contracts were deferred in shareholders' equity as a component of
comprehensive income. In conjunction with the debt refinancing, the interest
rate swap agreements were terminated and the losses included in shareholders'
equity as a component of comprehensive income were reflected as a special charge
in the consolidated statement of operations for the nine months ended September
30, 2001.
During the second quarter of 2000, the Company recorded a net special
charge of $2.1 million. Of the special charge, $13.4 million represented the
costs to cancel certain contracts that management believed were not economically
viable as a result of the SBCL acquisition. These costs were principally
associated with the cancellation of a co-marketing agreement for clinical trials
testing services. These charges were in large part offset by a reduction in
reserves attributable to a favorable resolution of outstanding claims for
reimbursements associated with billings of certain tests.
6. EXTRAORDINARY LOSS
In conjunction with the Company's debt refinancing in the second
quarter of 2001, the Company recorded an extraordinary loss of $36.0 million,
($21.6 million, net of taxes). The loss represented the write-off of deferred
financing costs of $23.2 million, associated with the Company's debt which was
refinanced, and $12.8 million of payments related primarily to the tender
premium incurred in connection with the Company's cash tender offer of the
Subordinated Notes (see Note 2).
7. 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. 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
9
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
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 included 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 were
consolidated into one complaint, which was consolidated with one of the
insurers' suits for pre-trial proceedings. During both the second and third
quarters of 2001, settlements were reached in a number of the complaints against
SBCL for approximately $30 million and $31 million, respectively. The
settlements were paid directly by SmithKline Beecham plc ("SmithKline Beecham"),
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 September 30,
2001, related to indemnified billing, professional liability and other claims
discussed above, totaled approximately $24 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 September 30, 2001 recorded reserves, relating primarily to billing
claims, including those indemnified by Corning and SmithKline Beecham,
approximated $22 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.
10
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
8. COMMON STOCKHOLDERS' EQUITY
Changes in common stockholders' equity for the nine months ended
September 30, 2001 were as follows:
Accumulated
Additional Other
Common Paid-In Accumulated Unearned Comprehensive Comprehensive
Stock Capital Deficit Compensation (Loss) Income
------ ---------- ----------- ------------ ------------- -------------
BALANCE,
DECEMBER 31, 2000 ............. $ 465 $1,591,976 $ (525,111) $ (31,077) $ (5,458)
Net income....................... 111,365 $ 111,365
Other comprehensive income..... 2,218 2,218
-------------
Comprehensive income............. $ 113,583
=============
Two-for-one stock split (47,149
common shares)................. 472 (472)
Preferred dividends declared (88)
Issuance of common stock under
benefit plans (247 common
shares)........................ 3 26,517 (3,599)
Exercise of options (1,422
common shares).............. 14 17,498
Shares to cover employee
payroll tax withholdings on
exercised options (2 common
shares)........................ (189)
Tax benefits associated with
stock-based compensation plans 40,664
Amortization of unearned
compensation................... 17,124
Other............................ 600
------ ---------- ----------- ------------ -------------
BALANCE,
SEPTEMBER 30, 2001............ $ 954 $1,676,594 $ (413,834) $ (17,552) $ (3,240)
====== ========== =========== ============ =============
During the nine months ended September 30, 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 nine months ended September 30, 2001, other comprehensive
income included the cumulative effect of the change in accounting for derivative
financial instruments upon adoption of SFAS 133, as amended, which reduced
comprehensive income by approximately $1 million. In addition, in conjunction
with the Company's debt refinancing, the interest rate swap agreements were
terminated and the losses included in shareholders' equity as a component of
comprehensive income were reflected as a special charge in the consolidated
statement of operations for the nine months ended September 30, 2001 (See Note
5).
11
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Changes in common stockholders' equity for the nine months ended
September 30, 2000 were as follows:
Accumulated
Additional Other
Common Paid-In Accumulated Unearned Comprehensive Comprehensive
Stock Capital Deficit Compensation (Loss) Income
------ ---------- ----------- ------------ -------------- -------------
BALANCE,
DECEMBER 31, 1999 $ 444 $1,502,551 $ (627,045) $ (11,438) $ (2,450)
Net income.................... 76,689 $ 76,689
Other comprehensive loss.... 516 516
-------------
Comprehensive income.......... $ 77,205
=============
Preferred dividends declared.. (87)
Issuance of common stock under
benefit plans (866 common
shares)..................... 9 56,767 (43,814)
Exercise of options (1,157
common shares).............. 11 16,116
Shares to cover employee
payroll tax withholdings on
exercised stock options (264
common shares).............. (3) (21,929)
Tax benefits associated with
stock-based compensation plans 27,578
Adjustment to Corning receivable (5,858)
Amortization of unearned
compensation................ 17,580
------ ---------- ----------- ------------ --------------
BALANCE,
SEPTEMBER 30, 2000 $ 461 $1,575,225 $ (550,443) $ (37,672) $ (1,934)
====== ========== =========== ============ ==============
During the nine months ended September 30, 2000, two hundred sixty-four
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.
9. PENDING ACQUISITIONS
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. At the closing of the acquisition, the Company expects
to use existing cash to fund the purchase price (approximately $18 million) and
related transaction costs of the acquisition. The acquisition, which is expected
to close on November 1, 2001, will be accounted for under the purchase method of
accounting. During the second quarter of 2001, the Company adopted the equity
method of accounting for its investment in MedPlus. Equity losses of $0.8
million and $2.3 million, respectively, have been recorded in the consolidated
statements of operations for the three and nine months ended September 30, 2001,
representing the Company's share of losses in MedPlus.
In October 2001, the Company signed a definitive agreement to acquire
Clinical Diagnostic Services, Inc. ("CDS"). CDS operates a diagnostic testing
laboratory and over 50 patient service centers in New York and New Jersey. The
transaction is subject to review and clearance by the Federal Trade Commission.
The Company expects to use existing cash to fund the purchase price and related
transaction costs of the acquisition. The acquisition of CDS will be accounted
for under the purchase method of accounting.
12
10. SUBSEQUENT EVENT
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
In October 2001, the Company used existing cash to repay the entire
balance outstanding of $125 million under the term loan included in the
Company's Credit Agreement.
11. SUMMARIZED FINANCIAL INFORMATION
The Senior Notes are guaranteed by each of 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 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.
The following condensed consolidating financial data illustrates the
composition of the combined guarantors. Investments in subsidiaries are
accounted for by the parent using the equity method for purposes of the
supplemental consolidating presentation. Earnings (losses) of subsidiaries are
therefore reflected in the parent's investment accounts and earnings. The
principal elimination entries relate to investments in subsidiaries and
intercompany balances and transactions.
13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
----------- ---------- ------------ ------------ ------------
Net revenues................................ $ 446,000 $2,156,202 $ 328,614 $ (213,485) $ 2,717,331
Costs and expenses:
Cost of services.......................... 327,934 1,209,313 76,773 - 1,614,020
Selling, general and administrative....... 115,682 467,581 188,065 (11,004) 760,324
Interest, net............................. 47,987 194,931 17,531 (202,481) 57,968
Amortization of intangibles............... 3,436 30,803 442 -- 34,681
Provision for special charges............. 5,997 -- -- -- 5,997
Royalty (income) expense.................. (183,325) 183,325 -- -- --
Other, net................................ 2,820 (938) 1,390 -- 3,272
----------- ----------- ---------- ----------- -----------
Total.................................... 320,531 2,085,015 284,201 (213,485) 2,476,262
----------- ----------- ---------- ----------- -----------
Income before taxes and extraordinary loss.. 125,469 71,187 44,413 -- 241,069
Income tax expense.......................... 52,584 36,482 19,029 -- 108,095
----------- ----------- ---------- ----------- -----------
Income before equity earnings and
extraordinary loss....................... 72,885 34,705 25,384 -- 132,974
Equity earnings from subsidiaries........... 42,360 -- -- (42,360) --
------------ ------------ ----------- ------------ ------------
Income before extraordinary loss............ 115,245 34,705 25,384 (42,360) 132,974
Extraordinary loss, net of taxes............ (3,880) (15,567) (2,162) -- (21,609)
------------ ------------ ----------- ------------ ------------
Net income.................................. $ 111,365 $ 19,138 $ 23,222 $ (42,360) $ 111,365
=========== =========== ========== =========== ===========
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2000
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
----------- ---------- ------------ ------------ ------------
Net revenues................................ $ 532,652 $2,002,706 $ 103,590 $ (54,120) $ 2,584,828
Costs and expenses:
Cost of services.......................... 331,584 1,164,535 58,097 -- 1,554,216
Selling, general and administrative....... 225,184 507,388 42,293 (20,965) 753,900
Interest, net............................. 18,864 92,089 11,632 (33,155) 89,430
Amortization of intangibles............... 4,922 30,130 328 -- 35,380
Provision for special charges............. 170 (1,710) 3,640 -- 2,100
Royalty (income) expense.................. (57,539) 57,539 -- -- --
Other, net................................ (1,255) (276) 3,905 -- 2,374
------------ ----------- ------------ ------------ ------------
Total.................................... 521,930 1,849,695 119,895 (54,120) 2,437,400
------------ ----------- ------------ ------------ ------------
Income (loss) before taxes.................. 10,722 153,011 (16,305) -- 147,428
Income tax expense (benefit)................ 6,299 70,605 (6,165) -- 70,739
Equity earnings from subsidiaries........... 72,266 -- -- (72,266) --
------------ ---------- ------------ ------------ ------------
Net income (loss)........................... $ 76,689 $ 82,406 $ (10,140) $ (72,266) $ 76,689
=========== ========== =========== =========== ===========
14
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Condensed Consolidating Balance Sheet
September 30, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
----------- ---------- ------------ ------------ ------------
Assets
Current assets:
Cash and cash equivalents................... $ -- $ 230,875 $ 8,004 $ -- $ 238,879
Accounts receivable, net.................... 11,039 43,737 458,861 -- 513,637
Other current assets........................ 92,782 48,854 94,253 -- 235,889
----------- ---------- ----------- ----------- -----------
Total current assets..................... 103,821 323,466 561,118 -- 988,405
Property, plant and equipment, net.......... 147,127 331,471 14,599 -- 493,197
Intangible assets, net ..................... 77,577 1,196,094 9,007 -- 1,282,678
Intercompany receivable (payable)........... 210,680 40,026 (250,706) -- --
Investment in subsidiaries.................. 1,072,843 -- -- (1,072,843) --
Other assets................................ 77,791 58,750 32,649 -- 169,190
----------- ---------- ----------- ----------- -----------
Total assets............................. $ 1,689,839 $1,949,807 $ 366,667 $(1,072,843) $ 2,933,470
=========== ========== =========== =========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses....... $ 322,601 $ 262,238 $ 23,208 $ -- $ 608,047
Short-term borrowings and current portion of
long-term debt............................ 3,512 20,667 256,439 -- 280,618
----------- ---------- ----------- ----------- -----------
Total current liabilities................ 326,113 282,905 279,647 -- 888,665
Long-term debt.............................. 76,445 593,816 7,652 -- 677,913
Other liabilities........................... 43,359 66,860 12,751 -- 122,970
Preferred stock............................. 1,000 -- -- -- 1,000
Common stockholders' equity................. 1,242,922 1,006,226 66,617 (1,072,843) 1,242,922
----------- ---------- ----------- ----------- -----------
Total liabilities and stockholders' equity $ 1,689,839 $1,949,807 $ 366,667 $(1,072,843) $ 2,933,470
=========== ========== =========== =========== ===========
15
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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
=========== ========== =========== =========== ===========
16
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2001
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
----------- ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income.................................. $ 111,365 $ 19,138 $ 23,222 $ (42,360) $ 111,365
Extraordinary loss, net of taxes 3,880 15,567 2,162 -- 21,609
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization............. 29,291 75,083 3,626 -- 108,000
Provision for doubtful accounts........... 664 15,554 149,452 -- 165,670
Provision for special charges............. 5,997 -- -- -- 5,997
Other, net................................ (18,867) 41,771 (35,662) 42,360 29,602
Changes in operating assets and liabilities (106,461) 45,270 (79,772) -- (140,963)
----------- ---------- ----------- ----------- -----------
Net cash provided by operating activities... 25,869 212,383 63,028 -- 301,280
Net cash used in investing activities....... (38,730) (107,404) (894) (5,556) (152,584)
Net cash provided by (used in) financing
activities................................ 12,861 (37,967) (61,744) 5,556 (81,294)
----------- ---------- ----------- ----------- -----------
Net change in cash and cash equivalents..... -- 67,012 390 -- 67,402
Cash and cash equivalents, beginning of year -- 163,863 7,614 -- 171,477
----------- ---------- ----------- ----------- -----------
Cash and cash equivalents, end of period.... $ -- $ 230,875 $ 8,004 $ -- $ 238,879
=========== ========== =========== =========== ===========
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2000
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
----------- ---------- ------------ ------------ ------------
Cash flows from operating activities:
Net income (loss)........................... $ 76,689 $ 82,406 $ (10,140) $ (72,266) $ 76,689
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization............. 30,310 68,194 2,288 -- 100,792
Provision for doubtful accounts........... 27,948 151,516 2,182 -- 181,646
Provision for special charges............. 170 (1,710) 3,640 -- 2,100
Other, net................................ (25,557) 69,989 6,741 (23,691) 27,482
Changes in operating assets and liabilities (33,038) 46,076 (69,645) (85,648) (142,255)
----------- ---------- ----------- ----------- -----------
Net cash provided by (used in) operating
activities................................ 76,522 416,471 (64,934) (181,605) 246,454
Net cash used in investing activities....... (60,880) (33,746) (183,151) 187,350 (90,427)
Net cash provided by (used in) financing
activities................................ (15,642) (252,854) 252,716 (5,745) (21,525)
----------- ---------- ----------- ----------- -----------
Net change in cash and cash equivalents..... -- 129,871 4,631 -- 134,502
Cash and cash equivalents, beginning of year -- 18,864 8,420 -- 27,284
----------- ---------- ----------- ----------- -----------
Cash and cash equivalents, end of period.... $ -- $ 148,735 $ 13,051 $ -- $ 161,786
=========== ========== =========== =========== ===========
17
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"). During the second quarter of 2001, we 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. A full discussion and
analysis of the reserves related to the SBCL integration is contained in Note 3
to the interim consolidated financial statements.
The actions associated with the SBCL integration plan, provided for in
accruals for integration costs as of December 31, 2000, including those related
to severed employees, were completed as of June 30, 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.
We continue to expect that the SBCL integration will result in
approximately $150 million of annual synergies to be achieved by the end of
2002. During 2000, we estimate that we realized approximately $50 million of
these synergies, and at the end of 2000 we had achieved an annual rate of
synergies approaching $100 million. We expect that during 2001 we will realize
additional synergies driven by cost reductions, and we anticipate that by the
end of 2001, we will achieve an annual rate of synergies of at least $120
million. For the three and nine months ended September 30, 2001, we estimate
that we realized approximately $30 million and $85 million, respectively, of
these synergies, and at the end of the third quarter of 2001, we had achieved an
annual rate of synergies of approximately $120 million.
Management anticipates that additional charges may be recorded
associated with further consolidation activities. Management cannot estimate the
amount or the timing of these charges at this time, but expects to fund these
charges with cash from operations.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 2000
Net income for the three months ended September 30, 2001 increased to
$50.1 million from $28.7 million for the three months ended September 30, 2000.
For the nine months ended September 30, 2001, net income increased to $111.4
million from $76.7 million for the prior year period. In conjunction with our
debt refinancing in the second quarter of 2001, results for the nine months
ended September 30, 2001 included an extraordinary loss of $36.0 million ($21.6
million, net of tax). For the nine months ended September 30, 2001, income
before an extraordinary loss increased to $133.0 million from $76.7 million for
the prior year period. In addition, results for the nine months ended September
30, 2001 and 2000 included special charges of $6.0 million ($3.6 million, net of
tax) and $2.1 million ($1.3 million, net of tax), reflected on the face of the
consolidated statements of operations. Excluding the special charges and
extraordinary loss, income for the nine months ended September 30, 2001
increased to $136.6 million, compared to $78.0 million for the prior year
period, an increase of approximately 75%.
These earnings increases were primarily attributable to revenue growth
driven by improvements in average revenue per requisition, improved operating
performance, including the benefits to our cost structure resulting from the
SBCL integration and a reduction in net interest expense, partially offset by
increases in employee compensation and supply costs and investments in our Six
Sigma quality and Standardization initiatives, information technology strategy
and strategic growth opportunities.
Results for the three and nine months ended September 30, 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 $2.0 million and $48.8 million to both reported
revenues and cost of services for the three and nine months ended September 30,
2000, respectively. 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 laboratory network management arrangement with AetnaUSHealthcare,
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
18
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 the
increase in reported net revenues during the three and nine months ended
September 30, 2001 by $2.0 million and $48.8 million, respectively.
We estimate that the September 11th national tragedy reduced our net
revenues for the third quarter of 2001 by approximately $8 million, or 1% of net
revenues, and reduced net income during the third quarter of 2001 by
approximately $3 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
and nine months ended September 30, 2001 grew by 6.5% and 7.1%, respectively,
when compared to the prior year period, primarily due to improvements in average
revenue per requisition of 6.2% and 7.4%, respectively. 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 during
2000 to our unconsolidated joint ventures in: Phoenix, Arizona; Indianapolis,
Indiana; and Dayton, Ohio reduced our reported requisition volume for the three
and nine months ended September 30, 2001 by approximately 1.0% and 1.3%,
respectively, compared to the prior year period. Additionally, we estimate the
September 11th national tragedy impacted revenues by approximately $8 million
and requisition volume by approximately 1% during the third quarter of 2001.
After adjusting for business contributed to unconsolidated joint ventures and
the estimated impact of the September 11th national tragedy, clinical testing
volume, measured by the number of requisitions, for the three and nine months
ended September 30, 2001 increased approximately 2.0% and 1.6%, respectively,
over the prior year period. Contributing to this increase was our acquisition of
the assets of Clinical Laboratories of Colorado, LLC ("CLC") in the first
quarter of 2001, which increased volume for both the three and nine months ended
September 30, 2001 by approximately 1%, and an increase in volume from our
principal customers, physicians and hospitals, of approximately 2.4% and 2.2%,
respectively. 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 for the three and nine months ended September 30, 2001 by
about 1.5% and 1.8%, respectively, compared to the prior year period. Overall,
reported volumes for the three months ended September 30, 2001 were equal to the
level for the prior year period. For the nine months ended September 30, 2001,
reported volumes decreased by approximately 0.2%, 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 and nine months ended September 30, 2001 increased approximately $33
million and $115 million, respectively, from the earlier period. These increases
were 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 in
support of our overall business strategy. These investments include those
related to:
- Our Six Sigma quality and Standardization initiatives which we
believe will provide us with a competitive advantage in the
market place and ultimately serve to reduce costs by $150
million annually by 2004;
- 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
better services to our customers;
- Our information technology strategy; and
- Our strategic growth opportunities.
19
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 include the costs of
obtaining, transporting and testing specimens. Costs of services as a percentage
of net revenues for the three and nine months ended September 30, 2001, was
59.3% and 59.4%, respectively, which are consistent with the prior year's
levels, as improvements in average revenue per requisition were offset by
increased employee compensation and supply costs.
Selling, general and administrative expenses, which include the costs
of the sales force, billing operations, bad debt expense and general management
and administrative support, decreased during the three months ended September
30, 2001 as a percentage of net revenues to 27.8% from 29.6% in the prior year
period. For the nine months ended September 30, 2001, selling, general and
administrative expenses decreased as a percentage of net revenues to 28.0% from
29.7% in the prior year period. These decreases were primarily due to
improvements in average revenue per requisition and bad debt expense, partially
offset by an increase in employee compensation costs and investments to enhance
our infrastructure in support of our overall business strategy. During the third
quarter of 2001, bad debt expense was 6.1% of net revenues, compared to 6.8% of
net revenues a year ago. For the nine months ended September 30, 2001, bad debt
expense was 6.1% of net revenues, compared to 7.2% of net revenues in the prior
year. The improvements in bad debt expense were principally attributable to the
continued progress we have made to improve the overall collection experience of
the combined company 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 substantial opportunities continue to exist to improve our overall
collection experience.
Interest Expense, Net
Net interest expense for the three and nine months ended September 30,
2001 decreased from the prior year periods by $14.7 million and $31.4 million,
respectively. These reductions were primarily due to an overall reduction in
debt levels, and the favorable impact of our debt refinancing in the second
quarter of 2001 and our receivables credit facility, both of which have served
to lower the weighted average borrowing rate on our outstanding debt.
Amortization of Intangible Assets
Amortization of intangible assets for the nine months ended September
30, 2001 decreased $0.7 million 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, partially offset by the
amortization of intangible assets related to our acquisition of CLC and the
amortization of goodwill associated with certain investments accounted for under
the equity method of accounting.
In July 2001, the Financial Accounting Standards Board issued two new
accounting standards related to business combinations and goodwill and other
intangible assets. The adoption of these accounting standards is expected to
reduce our amortization of intangible assets, commencing January 1, 2002. See
"Impact of New Accounting Standards" below for further details.
Provision for Special Charges
During the second quarter of 2001, we recorded a special charge of $6.0
million in connection with the refinancing of our debt and settlement of our
interest rate swap agreements. Prior to our debt refinancing in June 2001, our
credit agreement required us to maintain interest rate swap agreements to
mitigate the risk of changes in interest rates associated with a portion of our
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 our variable rate debt obligations. Accordingly,
the interest rate swap agreements were recorded at their estimated fair value in
our consolidated balance sheet and the related losses on these contracts were
deferred in shareholders' equity as a component of comprehensive income. In
conjunction with the debt refinancing, the interest rate swap agreements were
terminated and the losses reflected in shareholders' equity as a component of
comprehensive income were reclassified to earnings and classified as a special
charge in the consolidated statement of operations for the nine months ended
September 30, 2001.
During the second quarter of 2000, we recorded a net special charge of
$2.1 million. Of the special charge, $13.4 million represented the costs to
cancel certain contracts that we believed were not economically viable as a
result of the SBCL acquisition. These costs were principally associated with the
cancellation of a co-marketing agreement for clinical trials
20
testing services. We believe that the cancellation of this agreement will not
have an adverse effect on net revenues. These charges were in large part offset
by a reduction in reserves attributable to a favorable resolution of outstanding
claims for reimbursements associated with billings of certain tests.
Minority Share of Income
Minority share of income for the three months ended September 30, 2001
increased by $0.8 million to $2.9 million compared to the prior year level,
primarily due to improved operating performance at our joint ventures. For the
nine months ended September 30, 2001, minority share of income decreased by $0.7
million to $6.8 million compared to the prior year level. This decrease is
primarily attributable to start up losses associated with a new joint venture in
Oklahoma in which we hold a 51% interest, partially offset by improved operating
performance at our other joint ventures.
Other, Net
Other, net for the nine months ended September 30, 2001 increased by
$1.5 million, compared to the prior year level, primarily due to the write-off
of certain impaired assets of $9.6 million, partially offset by a $6.3 million
gain on the sale of an investment, and an increase in equity earnings primarily
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 three and nine months ended September 30, 2001 was primarily
due to pretax earnings increasing at a faster rate than goodwill amortization
and other non-deductible items.
Extraordinary Loss
In conjunction with our debt refinancing in the second quarter of 2001,
we recorded an extraordinary loss of $36.0 million, ($21.6 million, net of
taxes). The loss represented the write-off of deferred financing costs of $23.2
million, associated with our debt which was refinanced, and $12.8 million of
payments related primarily to the tender premium incurred in connection with our
cash tender offer of our 10-3/4% senior subordinated notes due 2006 (the
"Subordinated Notes"). Our debt refinancing is more fully described under "Debt
Refinancing" and in Note 2 to the interim consolidated financial statements.
Adjusted EBITDA
Adjusted EBITDA represents income before extraordinary loss, income
taxes, net interest expense, depreciation, amortization and special charges.
Adjusted EBITDA for the three and nine months ended September 30, 2000 also
excludes $2.7 million and $7.2 million, respectively, of costs associated with
the SBCL integration plan which were included in operating costs and expensed as
incurred. Adjusted EBITDA is presented and discussed because management believes
it 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.
Adjusted EBITDA is not a measure of financial performance under 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.
Adjusted EBITDA for the three months ended September 30, 2001 improved
to $141.8 million, or 15.7% of net revenues, from $119.6 million, or 14.1% of
net revenues, in the prior year period. For the nine months ended September 30,
2001, Adjusted EBITDA improved to $413.0 million, or 15.2% of net revenues, from
$346.9 million, or 13.4% of net revenues, in the prior year period. The
improvements in Adjusted EBITDA were 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 and supply
costs and investments in our Six Sigma quality and Standardization initiatives,
information technology strategy and strategic growth opportunities.
21
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 2000 Annual Report on Form 10-K for additional discussion of our financial
instruments and hedging activities. Prior to our debt refinancing in June 2001,
our credit agreement required us to maintain interest rate swap agreements to
mitigate the risk of changes in interest rates associated with a portion of our
variable rate bank debt. In conjunction with our debt refinancing, the interest
rate swap agreements were terminated. Our debt refinancing is more fully
described under "Debt Refinancing" and in Note 2 to the interim consolidated
financial statements.
At both September 30, 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 September 30, 2001 and December 31,
2000, the estimated fair value exceeded the carrying value of the debt by
approximately $34 million and $5 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 $19.8 million at
September 30, 2001.
At September 30, 2001 and December 31, 2000, we had approximately $388
million and $848 million, respectively, of variable interest rate debt
outstanding. Based on our net exposure to interest rate changes, an assumed 10%
increase in interest rates (representing approximately 60 basis points) would
result in a $0.5 million reduction in our after-tax earnings and cash flows for
the nine months ended September 30, 2001 based on debt levels as of September
30, 2001. 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.
DEBT REFINANCING
On June 27, 2001, we refinanced a majority of our long-term debt on a
senior unsecured basis to reduce overall interest costs and obtain less
restrictive covenants. Specifically, we completed a $550 million senior notes
offering (the "Senior Notes") and entered into a new $500 million senior
unsecured credit facility (the "Credit Agreement") which included a $175 million
term loan. We used the net proceeds from the senior notes offering and new term
loan, together with cash on hand, to repay all of the $584 million which was
outstanding under our then existing senior secured credit agreement, including
the costs to settle existing interest rate swap agreements, and to consummate a
cash tender offer and consent solicitation for our Subordinated Notes. The
refinancing, excluding the impact of changes in market interest rates, is
expected to lower annual interest expense by approximately $23 million. The
Senior Notes and Credit Agreement are further described in Note 2 to the interim
consolidated financial statements.
In conjunction with the cash tender offer for the Subordinated Notes,
approximately $147 million in aggregate principal amount, or 98% of the $150
million of outstanding Subordinated Notes was tendered. In addition, we received
the requisite consents from the holders of Subordinated Notes to amend the
indenture governing the Subordinated Notes to eliminate substantially all of its
restrictive provisions. We have made payments of approximately $160 million to
holders with respect to the cash tender offer and consent solicitation,
including tender premium and related solicitation and banking fees, and accrued
interest.
We incurred approximately $31 million of costs associated with the debt
refinancing. Of that amount, $12 million represented costs associated with
placing the new debt which will be amortized over the term of the Senior Notes
and Credit Agreement and $6 million represented the cost to terminate the
interest rate swap agreements on the debt which was refinanced. The remaining
$13 million represented primarily the tender premium incurred in conjunction
with our cash tender offer of the Subordinated Notes which was included in the
extraordinary loss recorded in the second quarter of 2001 as discussed in Note 6
to the interim consolidated financial statements.
22
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at September 30, 2001 totaled $238.9 million,
an increase of $67.4 million from December 31, 2000. Cash flows from operating
activities in 2001 provided cash of $301.3 million, which was used to fund
investing and financing activities which required cash of $233.9 million. Cash
and cash equivalents at September 30, 2000 totaled $161.8 million, an increase
of $134.5 million from December 31, 1999. Cash flows from operating activities
in 2000 provided cash of $246.5 million, which was used to fund investing and
financing activities which required cash of $112.0 million. We maintain
zero-balance bank accounts for the majority of our cash disbursements. Prior to
the second quarter of 2000, we maintained our largest disbursement accounts and
primary concentration accounts at the same financial institution, giving that
financial institution the legal right of offset. As such, book overdrafts
related to the disbursement accounts were offset against cash balances in the
concentration accounts for reporting purposes. During the second quarter of
2000, we moved our primary concentration account to another financial
institution such that no offset existed at June 30, 2000. As a result, book
overdrafts in the amount of $48.4 million at September 30, 2000, representing
outstanding checks, were classified as liabilities and not reflected as a
reduction of cash at September 30, 2000.
Net cash from operating activities for 2001 was $54.8 million higher
than the 2000 level. Excluding the $48.4 million increase in 2000 cash from
operations associated with the accounting for book overdrafts discussed above,
the increase in net cash from operating activities for 2001 was $103.2 million,
compared to the prior year period. This increase was primarily due to improved
operating performance, partially offset by increased employee incentive payments
and the costs to settle our interest rate swap agreements. Days sales
outstanding, a measure of billing and collection efficiency, was 53 days at
September 30, 2001 compared to 56 days at December 31, 2000.
Net cash used in investing activities in 2001 was $152.6 million,
consisting primarily of capital expenditures of $110.2 million, acquisition and
related costs of $55.7 million, including $47.2 million to acquire the assets of
CLC in Denver, and $21.6 million in proceeds from the disposition of assets,
including $20.6 million from the sale of an investment in the second quarter of
2001. Net cash used in investing activities in 2000 was $90.4 million,
consisting primarily of capital expenditures of $68.0 million and an increase in
investments of $24.3 million, representing investments in two companies. 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 was $81.3 million
consisting primarily of the net cash activity associated with our debt
refinancing in the second quarter of 2001 and debt prepayments of $56 million in
the third quarter of 2001, partially offset by $17.5 million of proceeds from
the exercise of stock options. During the second quarter of 2001, we refinanced
the majority of our long-term debt. The gross proceeds of $722.3 million from
the Senior Notes offering and the new term loan under the Credit Agreement,
together with cash on hand, was used to repay the entire outstanding principal
under our then existing credit agreement and to consummate the cash tender offer
and consent solicitation for our Subordinated Notes. Of the $790.1 million in
debt repayments for the nine months ended September 30, 2001, $584.0 million
related to the repayment of the entire outstanding principal under our then
existing credit agreement and $147.0 million represented the aggregate principal
amount of outstanding Subordinated Notes which were tendered. During 2001, we
incurred approximately $31 million of costs associated with the debt
refinancing. Of that amount, $25.2 million was included in financing activities
and principally represented $12.4 million of costs associated with placing the
new debt, and a $12.8 million tender premium incurred in conjunction with our
cash tender offer of the Subordinated Notes, which was included in the
extraordinary loss recorded in the second quarter of 2001. The remaining $6
million was reflected in cash from operations and represented the cost to settle
the interest rate swap agreements on the debt which was refinanced. In October
2001, we used existing cash to repay the entire balance outstanding of $125
million under the term loan included in our Credit Agreement. Net cash used in
financing activities for 2000 was $21.5 million, consisting primarily of $284.3
million of repayments of debt under the Company's then existing credit agreement
and $7.8 million of distributions to minority partners, partially offset by
proceeds from the completion of a $256 million receivables-backed financing
transaction and $16.1 million of 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
$24 million, all of the new $325 million revolving credit facility under our
Credit Agreement was available for borrowing at September 30, 2001.
23
We believe that cash from operations and the revolving credit facility
under our new 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 meet seasonal working capital requirements
and to fund capital expenditures and additional growth opportunities for the
foreseeable future. Our improved 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, including
utilizing our $650 million shelf registration, 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.
On April 25, 2001, we 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 us to pay $2 per share in
cash for the remaining 82% of voting shares of MedPlus that we do not currently
own. At the closing of the acquisition, we expect to use existing cash to fund
the purchase price (approximately $18 million) and related transaction costs of
the acquisition. The acquisition, which is expected to close on November 1,
2001, will be accounted for under the purchase method of accounting.
On May 31, 2001, we effected a two-for-one stock split of our common
stock by means 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.
In October 2001, we signed a definitive agreement to acquire Clinical
Diagnostic Services, Inc. ("CDS"). CDS operates a diagnostic testing laboratory
and over 50 patient service centers in New York and New Jersey. The transaction
is subject to review and clearance by the Federal Trade Commission. We expect to
use existing cash to fund the purchase price and related transaction costs of
the acquisition. The acquisition of CDS will be accounted for under the purchase
method of accounting.
IMPACT OF NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations"
("SFAS 141") and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142") requiring business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadening 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 will not be amortized into results of operations, but instead will
be reviewed for impairment and an impairment charge will be recorded in the
periods in which the recorded carrying value of goodwill and certain intangibles
is more than its estimated fair value. The provisions of SFAS 141 will be
adopted for any business combination consummated after June 30, 2001. Goodwill
acquired in a business combination for which the acquisition date is after June
30, 2001 will not be amortized. The remaining provisions of SFAS 142, related to
goodwill acquired after June 30, 2001 and intangible assets, will be adopted by
us on January 1, 2002. The adoption of these accounting standards is expected to
reduce our amortization of intangible assets by approximately $35 million
annually, commencing January 1, 2002. Management currently does not expect that
the new criteria for recording intangible assets separate from goodwill will
require us to reclassify any of our intangible assets.
In October 2001, the FASB issued SFAS No. 144, " Accounting for
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The provisions of
SFAS 144 require the use of a consistent accounting model for long-lived assets
to be disposed of by sale, whether previously held and used or newly acquired
and extend 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 (2002 for the Company). Management believes
that the adoption of SFAS 144 will not have a material effect on the Company's
consolidated results of operations or financial position.
24
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.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 7 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 No. Description
----------- -----------
10.1 Amended and Restated Credit and Security Agreement,
dated as of September 28, 2001, among Quest Diagnostics
Receivables Inc., as Borrower, the Company, as Initial
Servicer, each of the Lenders party thereto and Wachovia
Bank, N.A., as Administrative Agent
10.2 Amendment No. 1 to the Amended and Restated Credit and
Security Agreement, dated as of October 30, 2001,
among Quest Diagnostics Receivables Inc., as Borrower,
the Company, as Initial Servicer, each of the Lenders
party thereto and Wachovia Bank, N.A., as Administrative
Agent
(b) Reports on Form 8-K:
None.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
October 30, 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
26