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 June 30, 1998
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 July 31, 1998, there were outstanding 30,165,325 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 Six Months Ended June 30, 1998 and 1997 2
Consolidated Balance Sheets as of
June 30, 1998 and December 31, 1997 3
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1998 and 1997 4
Notes to Consolidated Financial Statements 5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND
1997 (in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
---- ---- ---- ----
Net revenues.............................. $ 366,739 $ 401,523 $ 734,614 $ 789,626
Costs and expenses:
Cost of services........................ 217,806 239,593 435,846 478,907
Selling, general and administrative..... 116,133 127,854 236,579 251,827
Interest expense, net................... 9,036 10,499 18,150 21,112
Amortization of intangible assets....... 5,366 5,980 10,746 12,022
Other, net.............................. 139 1,153 1,364 897
--------- --------- --------- ---------
Total................................. 348,480 385,079 702,685 764,765
--------- --------- --------- ---------
Income before taxes....................... 18,259 16,444 31,929 24,861
Income tax expense ....................... 9,405 8,356 16,444 12,726
--------- --------- --------- ---------
Net income ............................... $ 8,854 $ 8,088 $ 15,485 $ 12,135
========= ========= ========= =========
Basic net income per common share......... $ 0.30 $ 0.28 $ 0.52 $ 0.42
Diluted net income per common share....... $ 0.29 $ 0.28 $ 0.51 $ 0.42
Basic weighted average common shares
outstanding............................ 29,783 29,102 29,736 28,987
Diluted weighted average common shares
outstanding............................ 30,579 29,497 30,290 29,318
The accompanying notes are an integral part of these statements.
2
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998 AND DECEMBER 31, 1997
(in thousands, except per share data)
June 30, December 31,
1998 1997
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 152,686 $ 161,661
Accounts receivable, net of allowance of $70,262 and $89,870
at June 30, 1998 and December 31, 1997, respectively.. 243,238 238,369
Inventories............................................... 29,221 30,360
Deferred taxes on income.................................. 85,862 97,471
Due from Corning Incorporated............................. 25,785 31,600
Prepaid expenses and other assets......................... 14,303 12,423
---------- ----------
Total current assets.................................. 551,095 571,884
Property, plant and equipment, net............................ 244,396 250,223
Intangible assets, net........................................ 505,624 513,779
Other assets.................................................. 62,966 65,042
---------- ----------
TOTAL ASSETS.................................................. $1,364,081 $1,400,928
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 226,117 $ 244,885
Short-term borrowings..................................... 42,656 32,648
Income taxes payable...................................... 9,623 17,613
---------- ----------
Total current liabilities............................. 278,396 295,146
Long-term debt................................................ 446,340 482,161
Other liabilities............................................. 78,730 81,961
---------- ----------
Total liabilities..................................... 803,466 859,268
Commitments and contingencies
Stockholders' equity:
Preferred stock........................................... 1,000 1,000
Common stock, par value $0.01 per share; 100,000 shares
authorized; 30,106 (excluding 119 shares held in
treasury) and 29,986 shares issued at June 30, 1998
and December 31, 1997, respectively................... 301 300
Additional paid-in capital................................ 1,202,610 1,198,194
Accumulated deficit....................................... (634,854) (650,281)
Accumulated other comprehensive loss...................... (2,209) (2,515)
Unearned compensation..................................... (6,233) (5,038)
---------- ----------
Total stockholders' equity............................ 560,615 541,660
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................... $1,364,081 $1,400,928
========== ==========
The accompanying notes are an integral part of these statements.
3
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(in thousands)
(unaudited)
1998 1997
---- ----
Cash flows from operating activities:
Net income.................................................... $ 15,485 $ 12,135
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization............................. 34,497 38,760
Provision for doubtful accounts........................... 44,999 59,825
Deferred income tax provision............................. 13,096 6,089
Other, net................................................ 3,735 3,412
Changes in operating assets and liabilities:
Accounts receivable................................... (49,868) (50,070)
Accounts payable and accrued expenses................. 2,791 7,814
Restructuring, integration and other special charges.. (15,719) (8,031)
Due from Corning Incorporated and affiliates.......... 5,815 8,494
Other assets and liabilities, net..................... (13,645) 2,056
-------- --------
Net cash provided by operating activities..................... 41,186 80,484
-------- --------
Cash flows from investing activities:
Capital expenditures...................................... (19,457) (12,973)
Proceeds from disposition of assets....................... 460 1,076
Acquisition of business................................... -- (16,000)
(Increase) decrease in investments........................ (482) 1,338
-------- --------
Net cash used in investing activities......................... (19,479) (26,559)
-------- --------
Cash flows from financing activities:
Repayment of long-term debt............................... (25,730) (711)
Repayments under Working Capital Facility................. -- (19,300)
Purchase of treasury stock............................... (4,994) --
Dividends paid............................................ (58) (40)
Exercise of stock options................................. 100 --
-------- --------
Net cash used in financing activities......................... (30,682) (20,051)
-------- --------
Net change in cash and cash equivalents....................... (8,975) 33,874
Cash and cash equivalents, beginning of year.................. 161,661 41,960
-------- --------
Cash and cash equivalents, end of period...................... $152,686 $ 75,834
======== ========
Cash paid during the period for:
Interest.................................................. $ 21,960 $ 21,760
Income taxes.............................................. $ 11,699 $ 4,389
8The accompanying notes are an integral part of these statements.
4
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
1. BASIS OF PRESENTATION
Background
Prior to January 1, 1997, Quest Diagnostics Incorporated and its
subsidiaries (the "Company") was a wholly-owned subsidiary of Corning
Incorporated ("Corning"). On December 31, 1996, Corning distributed all of the
outstanding shares of common stock of the Company to the stockholders of
Corning, with one share of common stock of the Company being distributed for
each eight shares of outstanding common stock of Corning (the "Spin-Off
Distribution").
Basis of Presentation
The interim consolidated financial statements reflect all adjustments which,
in the opinion of management, are necessary for a fair statement of the results
of operations for the periods presented. 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 period are not necessarily indicative of the results
that may by expected for the full year. These interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements included in the Company's Form 10-K for the year ended December 31,
1997.
Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This statement
establishes standards for the reporting and display of comprehensive income and
its components in the financial statements. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions with
stockholders) and includes net income, net unrealized capital gains or losses on
available-for-sale securities and foreign currency translation adjustments.
Comprehensive income was $15.8 million and $14.1 million for the six months
ended June 30, 1998 and 1997, respectively. Comprehensive income was $8.7
million and $9.8 million for the quarter ended June 30, 1998 and 1997,
respectively.
Earnings Per Share
Earnings per share are computed by dividing net income less dividends on the
Company's Preferred Stock (approximately $30 per quarter) by the weighted
average number of common shares outstanding during the period. The difference
between basic and dilutive weighted average common shares results primarily from
stock options.
2. COMMITMENTS AND CONTINGENCIES
The Company has entered into several settlement agreements with various
governmental and private payors during recent years relating primarily to
industry-wide billing and marketing practices that had been substantially
discontinued by early 1993. At present, a government investigation of certain
practices by Nichols Institute, a clinical laboratory company acquired in 1994,
and a former joint venture of Damon Corporation, a clinical laboratory acquired
in 1993, are ongoing. As part of the Spin-Off Distribution, Corning has agreed
to indemnify the Company against all settlements for any governmental claims
relating to billing practices of the Company and its predecessors that were
pending on December 31, 1996. Corning also agreed to indemnify the Company for
50% of the aggregate of all settlement payments made by the Company that are in
excess of $42 million to private parties that relate to indemnified or
previously settled governmental claims for services provided prior to December
31, 1996; however, the indemnification of private party claims will not exceed
$25 million and will be paid to the Company net of anticipated tax benefits to
be realized by the Company. Such indemnification does not cover any
non-governmental claims settled after December 31, 2001. At June 30, 1998, the
receivable from Corning totaled $25.8 million, representing management's best
estimate of amounts which are probable of being received from Corning to satisfy
the remaining indemnified governmental claims on an after-tax basis.
5
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
At June 30, 1998, settlement reserves totaled $68.8 million, including $27.5
million in other long-term liabilities. Although management believes that
established reserves for both indemnified and non-indemnified claims are
sufficient, it is possible that additional information 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, for non-indemnified claims, the Company's 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.
In April 1998, the Company entered into a settlement agreement with the U.S.
Attorney's office in Baltimore approximating $6.9 million related to the billing
of certain tests performed for which the Company had incomplete or missing order
forms from the physician. The occurrence of this practice was relatively rare
and was engaged in primarily to preserve the integrity of test results from
specimens subject to rapid deterioration. This settlement is covered by the
indemnification from Corning discussed above and was fully reserved for.
3. RESTRUCTURING RESERVES
The Company has recorded charges for restructuring plans in previous years.
Reserves relating to these programs totaled $24.6 million and $33.4 million at
June 30, 1998 and December 31, 1997, respectively. Management believes that the
costs of the restructuring plans will be financed through cash from operations
and does not anticipate any significant impact on its liquidity as a result of
the restructuring plans.
4. STOCKHOLDERS' EQUITY
Stock Purchase Program
In February 1998, the Board of Directors authorized the Company to
repurchase up to $27 million of common stock through 1999. The shares will be
reissued in connection with certain employee plans. In the first six months of
1998, the Company paid $5 million for approximately 250 thousand shares under
the program.
Unearned Compensation
Under the Company's Employees Equity Participation Program, approximately
300 thousand shares of restricted stock were granted in 1998, primarily to
executive employees. These shares are contingent on achievement of financial
performance goals and are subject to forfeiture if employment terminates prior
to the end of the prescribed period. The market value of the shares awarded
under the plan is recorded as unearned compensation. The unearned amounts are
amortized to compensation expense as earned.
5. SUMMARIZED FINANCIAL INFORMATION
The Company's 10.75% senior subordinated notes due 2006 are guaranteed,
fully, jointly and severally, and unconditionally, on a senior subordinated
basis by substantially all of the Company's wholly-owned, domestic subsidiaries
("Subsidiary Guarantors"). The non-guarantor subsidiaries are foreign and less
than wholly-owned subsidiaries.
The following condensed consolidating financial data illustrates the
composition of the combined guarantors. The Company believes that separate
complete financial statements of the respective guarantors would not provide
additional material information that would be useful in assessing the financial
composition of the Subsidiary Guarantors.
6
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 1998
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Net revenues........................ $ 304,085 $ 416,555 $ 13,974 $ -- $ 734,614
Costs and expenses:
Cost of services.................. 178,800 249,761 7,285 -- 435,846
Selling, general and
administrative.................... 131,025 99,904 5,650 -- 236,579
Interest expense, net............. 5,307 12,549 294 -- 18,150
Amortization of intangible assets. 3,385 7,153 208 -- 10,746
Royalty (income) expense.......... (36,987) 36,987 -- -- --
Other, net........................ (317) 7 1,674 -- 1,364
--------- --------- --------- --------- ---------
Total........................... 281,213 406,361 15,111 -- 702,685
--------- --------- --------- --------- ---------
Income (loss) before taxes.......... 22,872 10,194 (1,137) -- 31,929
Income tax expense.................. 15,553 886 5 -- 16,444
Equity income from subsidiaries..... 8,166 -- -- (8,166) --
--------- --------- --------- ---------- ----------
Net income (loss)................... $ 15,485 $ 9,308 $ (1,142) $ (8,166) $ 15,485
========= ========= ========== ======== =========
Condensed Consolidating Statement of Operations
Six Months Ended June 30, 1997
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Net revenues........................ $ 340,656 $ 437,935 $ 11,035 $ -- $ 789,626
Costs and expenses:
Cost of services.................. 198,005 275,207 5,695 -- 478,907
Selling, general and
administrative.................... 140,623 106,557 4,647 -- 251,827
Interest expense, net............. 8,198 12,618 296 -- 21,112
Amortization of intangible assets. 4,371 7,649 2 -- 12,022
Royalty (income) expense.......... (37,266) 37,266 -- -- --
Other, net........................ (353) 429 821 -- 897
--------- --------- --------- --------- ---------
Total........................... 313,578 439,726 11,461 -- 764,765
--------- --------- --------- --------- ---------
Income (loss) before taxes.......... 27,078 (1,791) (426) -- 24,861
Income tax expense (benefit)........ 14,057 (1,795) 464 -- 12,726
Equity loss from subsidiaries....... (886) -- -- 886 --
--------- --------- --------- --------- ---------
Net income (loss)................... $ 12,135 $ 4 $ (890) $ 886 $ 12,135
========= ========= ========= ========= =========
7
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
June 30, 1998
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Current assets:
Cash and cash equivalents........... $ 88,602 $ 61,604 $ 2,480 $ -- $ 152,686
Accounts receivable, net............ 74,347 164,980 3,911 -- 243,238
Other current assets................ 103,731 48,965 2,475 -- 155,171
---------- -------- --------- --------- ---------
Total current assets.............. 266,680 275,549 8,866 -- 551,095
Property, plant and equipment, net.. 98,165 141,252 4,979 -- 244,396
Intangible assets, net ............. 156,111 349,203 310 -- 505,624
Intercompany receivable (payable)... 37,252 (23,202) (14,050) -- --
Investment in subsidiaries.......... 419,068 -- -- (419,068) --
Other assets........................ 38,077 10,585 14,304 -- 62,966
---------- -------- --------- --------- ---------
Total assets...................... $1,015,353 $753,387 $ 14,409 $(419,068) $1,364,081
========== ======== ========= ========= ==========
Current liabilities:
Accounts payable and accrued
expenses............................ 166,108 67,283 2,349 -- 235,740
Short-term borrowings............... 20,280 21,963 413 -- 42,656
---------- -------- --------- --------- ---------
Total current liabilities......... 186,388 89,246 2,762 -- 278,396
Long-term debt...................... 208,629 233,516 4,195 -- 446,340
Other liabilities................... 59,721 16,904 2,105 -- 78,730
---------- -------- --------- --------- ---------
Total liabilities................... 454,738 339,666 9,062 -- 803,466
Stockholders' equity................ 560,615 413,721 5,347 (419,068) 560,615
---------- -------- --------- --------- ---------
Total liabilities and
stockholders' equity................ $1,015,353 $753,387 $ 14,409 $(419,068) $1,364,081
========== ======== ========= ========= ==========
Condensed Consolidating Balance Sheet
December 31, 1997
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Current assets:
Cash and cash equivalents........... $ 123,052 $ 35,527 $ 3,082 $ -- $ 161,661
Accounts receivable, net............ 87,231 148,618 2,520 -- 238,369
Other current assets................ 119,751 48,865 3,238 -- 171,854
---------- --------- --------- --------- ----------
Total current assets.............. 330,034 233,010 8,840 -- 571,884
Property, plant and equipment, net.. 101,700 144,849 3,674 -- 250,223
Intangible assets, net ............. 165,068 348,391 320 -- 513,779
Intercompany (payable) receivable... (14,134) 24,103 (9,969) -- --
Investment in subsidiaries.......... 412,413 -- -- (412,413) --
Other assets........................ 40,474 9,290 15,278 -- 65,042
---------- --------- --------- --------- ----------
Total assets...................... $1,035,555 $ 759,643 $ 18,143 $(412,413) $1,400,928
========== ========= ========= ========= ==========
Current liabilities:
Accounts payable and accrued
expenses............................ $ 188,966 $ 70,542 $ 2,990 $ -- $ 262,498
Short-term borrowings............... 15,688 16,640 320 -- 32,648
---------- --------- --------- --------- ----------
Total current liabilities......... 204,654 87,182 3,310 -- 295,146
Long-term debt...................... 225,145 252,480 4,536 -- 482,161
Other liabilities................... 64,096 15,568 2,297 -- 81,961
---------- --------- --------- --------- ----------
Total liabilities................. 493,895 355,230 10,143 -- 859,268
Stockholders' equity................ 541,660 404,413 8,000 (412,413) 541,660
---------- --------- --------- --------- ----------
Total liabilities and
stockholders' equity.......... $1,035,555 $ 759,643 $ 18,143 $(412,413) $1,400,928
========== ========= ========= ========= ==========
8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 1998
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Cash flows from operating activities:
Net income (loss) ................... $ 15,485 $ 9,308 $(1,142) $(8,166) $ 15,485
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization ..... 14,414 19,343 740 -- 34,497
Provision for doubtful accounts ... 25,522 19,075 402 -- 44,999
Other, net ........................ 16,725 632 (526) -- 16,831
Changes in operating assets and
liabilities ......................... (72,797) 498 162 1,511 (70,626)
--------- -------- ------- ------- ---------
Net cash (used in) provided by
operating activities ................ (651) 48,856 (364) (6,655) 41,186
Net cash used in investing activities (16,931) (9,146) (57) 6,655 (19,479)
Net cash used in financing activities (16,868) (13,633) (181) -- (30,682)
--------- -------- ------- ------- ---------
Net change in cash and cash
equivalents ......................... (34,450) 26,077 (602) -- (8,975)
Cash and cash equivalents, beginning
of year ............................. 123,052 35,527 3,082 -- 161,661
--------- -------- ------- ------- ---------
Cash and cash equivalents, end of
period .............................. $ 88,602 $ 61,604 $ 2,480 $ -- $ 152,686
========= ======== ======= ======= =========
Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 1997
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ----------- ------------
Cash flows from operating activities:
Net income (loss) ................... $ 12,135 $ 4 $ (890) $ 886 $ 12,135
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization ..... 16,707 21,893 160 -- 38,760
Provision for doubtful accounts ... 33,967 25,602 256 -- 59,825
Other, net ........................ 11,079 (2,746) 1,168 -- 9,501
Changes in operating assets and
liabilities ......................... (39,940) 38 85 80 (39,737)
-------- -------- ------- ----- --------
Net cash provided by operating
activities .......................... 33,948 44,791 779 966 80,484
Net cash used in investing activities (1,941) (23,629) (23) (966) (26,559)
Net cash used in financing activities (11,424) (8,192) (435) -- (20,051)
-------- -------- ------- ----- --------
Net change in cash and cash
equivalents ......................... 20,583 12,970 321 -- 33,874
Cash and cash equivalents, beginning
of year ............................. 26,975 12,882 2,103 -- 41,960
-------- -------- ------- ----- --------
Cash and cash equivalents, end of
period .............................. $ 47,558 $ 25,852 $ 2,424 $ -- $ 75,834
======== ======== ======= ===== ========
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Net income for the three and six months ended June 30, 1998 increased from
the prior year primarily as a result of operating cost and interest expense
reductions coupled with improved pricing. This was partially offset by lower
volume resulting from intensified competition, changes in physician ordering
patterns, actions taken on unprofitable accounts and the consolidation of
certain underperforming laboratories announced in December 1997. The second
quarter earnings improvement over the prior year was below the first quarter
improvement over the prior year. This change was primarily driven by lower year
over year price improvement and increased spending on information technology
capabilities. Net income for the six months ended June 30, 1998 includes a $2.5
million charge ($1.2 million, net of tax) recorded in the first quarter in
selling, general and administrative expenses, representing the final costs
associated with the Company's consolidation plan announced in December 1997.
Effective April 1, 1998, the Company implemented a new order form for
Medicare and Medicaid patients reflecting disease-oriented test panels developed
by the Health Care Financing Administration in conjunction with the American
Medical Association. While the Company did not see a significant impact during
the second quarter, these panels are likely to result in fewer tests ordered per
requisition and may put additional pressure on revenue and earnings.*
Net Revenues
Net revenues for the second quarter decreased by $34.8 million, or 8.7% from
the prior year level, principally due to a 10.1% decline in clinical testing
volume offset by an improvement in average prices of 1.4%. Net revenues for the
first half of 1998 decreased by $55.0 million, or 7.0% from the prior year
level, principally due to a 9.1% decline in clinical testing volume, partially
offset by an improvement in average prices of 2.2%. When adjusted for joint
venture and acquisition transactions completed last year, clinical testing
volume declined 8.6% and 8.0% for the second quarter and first half,
respectively. The volume decline for each period is primarily attributable to
intensified competition, changes in physician ordering patterns, actions taken
on unprofitable accounts and the consolidation of certain underperforming
laboratories announced in December 1997, which reduced volume by approximately
2.0% and 1.5% for the second quarter and first half, respectively.
Costs and Expenses
Total operating costs for the second quarter and first half of 1998 declined
by $33.5 million and $58.3 million, respectively, from the year earlier periods.
The Company's efforts to reduce its operating cost structure have had a
favorable impact on costs as a percentage of net revenue. However, this benefit
was partially offset by lower volume, increased spending on information
technology capabilities and a $2.5 million charge in the first quarter
representing the final costs associated with the Company's consolidation plan
announced in December 1997. Additional actions are being taken to further reduce
the Company's cost structure.*
Cost of services, which includes the costs of obtaining, transporting and
testing specimens, decreased
- --------
* This is a forward looking statement within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 27E of the Securities Act of
1934, as amended, and is based on current expectations. Forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from the forward looking statement. These risks and
uncertainties include heightened competition, impact of changes in payor mix,
the impact upon the Company's collection rates or general and administrative
expenses resulting from compliance with Medicare administrative policies, and
reduction in tests ordered by existing customers. See Item 1. "Business--
Cautionary Statement for Purposes of the `Safe Harbor' Provisions of the Private
Securities Litigation Reform Act of 1995" contained in the Company's 1997 Annual
Report on Form 10-K.
10
$21.8 million in the second quarter from the prior year, and as a percentage of
net revenues decreased to 59.4% from 59.7% in the prior year. Cost of services
in the first half of 1998 decreased $43.1 million from the prior year, and as a
percentage of net revenues decreased to 59.3% from 60.6% in the prior year.
These decreases reflect the Company's progress in reducing its cost structure.
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 from the prior year by $11.7 million in the
quarter and $15.2 million in the first half of 1998 and remained consistent with
the prior year as a percentage of net revenues. The second quarter decrease was
principally due to a $9.5 million reduction in bad debt expense to 5.8% of net
revenue from 7.7% of net revenues a year earlier. The first half decrease was
principally due to a $14.8 million reduction in bad debt expense to 6.1% of net
revenues from 7.6% of net revenues. The decrease in bad debt expense was
partially offset by an increase in information technology expenditures primarily
related to preparation for the Year 2000 and a $2.5 million charge in the first
quarter related to Company's consolidation of its laboratory network.
Net interest expense decreased from the prior year by $1.5 million and $3.0
million for the second quarter and first half of 1998, respectively, primarily
due to reduced debt levels and an increase in interest income resulting from
higher average cash balances.
Amortization of intangible assets decreased from the prior year by $0.6
million and $1.3 million for the second quarter and first half of 1998,
respectively, principally due to certain intangible assets having become fully
amortized.
Other, net for the second quarter decreased from the prior year level,
primarily due to the current year including a gain on the sale of a small
investment and the prior year including a charge related to the integration of a
small, strategic acquisition. For the first half of 1998, the change in other,
net is also affected by the prior year including a gain on the sale of an
investment and the current year including equity losses from a joint venture.
The Company's effective tax rate is significantly impacted by goodwill
amortization, a majority of which is not deductible for tax purposes, and has
the effect of increasing the overall tax rate.
Liquidity and Capital Resources
Cash decreased by $9.0 million from the year end balance, to $152.7 million
at June 30, 1998, due to operating activities which provided cash of $41.2
million, offset by investing and financing activities which used cash of $50.2
million. Net cash provided by operating activities was $39.3 million below the
prior year level. The decrease is primarily the result of changes in accounts
receivable and other asset and liability levels and increased payments
associated with restructuring and other special charges. The number of days
sales outstanding, a measure of billing and collection efficiency, was 61 days
at June 30, 1998 compared to 63 days at year end and 65 days a year earlier.
Decreased spending on investing activities is primarily the result of a
reduction in acquisition spending, partially offset by increased capital
spending in 1998. Capital spending for the first half of 1998 was $19.5 million
compared to $13.0 million for the comparable prior year period. The Company
estimates that it will invest approximately $60 million during 1998 for capital
expenditures, principally related to investments in information technology
infrastructure and equipment and facility upgrades.*
- --------
* This is a forward looking statement within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 27E of the Securities Act of
1934, as amended, and is based on current expectations. Forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from the forward looking statement. These risks and
uncertainties include computer or other system failures, development of
technologies that substantially alter the practice of medicine, and the failure
of third party payors and suppliers to adequately address the Year 2000 problem.
See Item 1. "Business--Cautionary Statement for Purposes of the `Safe Harbor'
Provisions of the Private Securities Litigation Reform Act of 1995" contained in
the Company's 1997 Annual Report on Form 10-K.
11
During the first half of 1998, the Company paid down $25.7 million of debt,
including a $10 million debt prepayment, and purchased $5.0 million
(approximately 250,000 shares) of its common stock. Other than for the reduction
for outstanding letters of credit, which currently approximate $5.4 million, all
of the revolving working capital credit facility is currently available for
borrowing. The Company plans to continue stock purchases as authorized under the
February 1998 limited share purchase program which permits the Company to
purchase up to $27 million of its outstanding common stock through 1999.
Adjusted EBITDA
Adjusted EBITDA represents earnings before interest, taxes, depreciation,
amortization and non-recurring charges. Adjusted EBITDA for the three months
ended June 30, 1998 was $44.5 million, or 12.1% of net revenues, compared to
$46.1 million, or 11.5% of net revenues, in the prior year period. Adjusted
EBITDA for the six months ended June 30, 1998 was $87.1 million, or 11.9% of net
revenues, compared to $84.7 million, or 10.7% of net revenues, in the prior year
period. The improvement in adjusted EBITDA for the six months reflects the
Company's continued progress in reducing its cost structure on a declining
revenue base. During the second quarter, the Company continued to make progress
reducing its cost structure to align costs with business conditions, but
adjusted EBITDA was below the prior year due primarily to increased spending on
information technology capabilities.
12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
See Part II, Item 1 of the Company's Form 10-Q for the quarterly period
ended March 31, 1998.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The first annual meeting of stockholders of the Company was held on May
12, 1998. At the meeting the matters described below were approved by the
stockholders.
(b) - (c) The following nominees for the office of director were elected for
terms expiring at the 2001 annual meeting of stockholders, by the following
votes:
For Withheld
--- --------
Kenneth D. Brody 27,381,649 92,561
Mary A. Cirillo 27,382,499 91,711
The following persons continue as directors:
Van C. Campbell
Kenneth W. Freeman
Dan C. Stanzione
Gail R. Wilensky
The Stock Option Plan for Non-Employee Directors, which authorizes the
annual grant to each non-employee director of non-qualified stock options to
acquire 9,000 shares of the Company's common stock, was approved by the
following number of stockholder votes for, against and abstained:
For: 26,154,770 Against: 1,188,501 Abstained: 130,939
The appointment of Price Waterhouse LLP (PricewaterhouseCoopers LLP as of
July 1, 1998) as independent accountants to audit the financial statements of
the registrant and its subsidiaries for the fiscal year ending December 31,
1998, was approved by the following number of stockholder votes for, against and
abstained:
For: 27,348,070 Against: 55,381 Abstained: 70,759
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Number Description
-------------- -----------
4 Warrant to acquire shares of common stock of the Company issued to Premier
Laboratory Services Limited Partnership.
27 Financial Data Schedule
(b) Reports on Form 8-K:
On June 3, 1998, the Company filed a current report on Form 8-K (Date
of Report: May 15, 1998) disclosing under Item 5 a strategic alliance with
Premier Inc ("Premier'). The Company has entered into a reference testing
agreement under which the Company would provide reference testing to Premier
13
hospitals that access the agreement. The reference agreement has a five year
term (ending in December 2003) and is renewable at the option of Premier for an
additional five year term. On signing the reference agreement, the Company
issued to Premier a ten year warrant to acquire approximately 170,000 shares of
common stock of the Company at $20.146 per share, subject to antidilution
adjustment. The Company will pay to Premier cash fees (a portion of which
Premier could at its option use to purchase common stock of the Company)
proportional to the amounts billed to Premier hospitals for testing under the
reference agreement. In addition, the Company would issue to Premier additional
ten year warrants to acquire common stock of the Company if the annual amount of
such billings exceeds $100 million. The exercise price would be based on the
market price of the Company's common stock on the issuance of the warrants and
the value of such warrants would not exceed $2 million in total (the same
valuation as the warrants issued at the execution of the agreement) using the
Black Scholes option pricing model. The alliance also contemplates that the
Company will enter individually negotiated strategic services agreements with
Premier hospitals, under which the lowest cost testing environment would be
identified and utilized, resulting in increased savings to hospitals beyond what
is available under the reference agreement. On entering into a strategic
services arrangement with a Premier hospital, the Company would issue equity
(which may include warrants) dependent on the size of the transaction, which
equity would initially be held in escrow and released to Premier periodically
over the term of the arrangement.
14
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.
August 10, 1998
Quest Diagnostics Incorporated
By /s/ Kenneth W. Freeman Chairman of the Board,
------------------- Chief Executive Officer
Kenneth W. Freeman and President
By /s/ Robert A. Hagemann Vice President and
------------------ Chief Financial Officer
Robert A. Hagemann
15