-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DmKzuJ/gCeb+x0arBnAaZBygk6Ev0GrveKkc3039ww309a+akuSvlw4SdZ8lK15H OGsmcO7H0psmodrSg+z2Lw== 0000947871-96-000096.txt : 19960924 0000947871-96-000096.hdr.sgml : 19960924 ACCESSION NUMBER: 0000947871-96-000096 CONFORMED SUBMISSION TYPE: 10-12B PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 19960923 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CORNING CLINICAL LABORATORIES INC CENTRAL INDEX KEY: 0001022079 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 161387862 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-12B SEC ACT: 1934 Act SEC FILE NUMBER: 001-12215 FILM NUMBER: 96633035 BUSINESS ADDRESS: STREET 1: ONE MALCLOM AVE CITY: TETERBORO STATE: NJ ZIP: 07601 BUSINESS PHONE: 2013935143 MAIL ADDRESS: STREET 1: ONE MALCOLM AVE CITY: TETERBORO STATE: NJ ZIP: 07601 10-12B 1 CORNING CLINICAL LABORATORIES INC. - FORM 10 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10 General Form For Registration of Securities Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 CORNING CLINICAL LABORATORIES INC. (Exact name of registrant as specified in its charter) Delaware 16-1387862 - -------------------------------------------- --------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) One Malcolm Avenue, Teterboro, New Jersey 07608 - -------------------------------------------- --------------------------------- (Address of principal executive offices) (Zip Code) 201 393 5000 ---------------------------------------------------- (Registrant's telephone number, including area code) Securities to be registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which to be so registered each class is to be registered Common Stock, with attached Preferred Stock Purchase Right New York Stock Exchange Securities to be registered pursuant to Section 12(g) of the Act: None - -------------------------------------------------------------------------------- (Title of class) 2 CORNING CLINICAL LABORATORIES INC. INTRODUCTION This Registration Statement on Form 10 relates to the registration under the Securities Exchange Act of 1934, as amended, of the common stock, with attached Preferred Stock Purchase Right of the Registrant which is being issued as described in the Information Statement, subject to completion or amendment (the "Information Statement"), dated September 20, 1996, of Corning Incorporated. Selected pages of the Information Statement which are related to the Registrant and the securities being registered hereunder (the "CCL Information") are attached hereto as Exhibit 99.1 and are incorporated herein by reference in answer to the items of this Registration Statement set forth below. Item 1. Business The information required by this item is contained under the sections "Risk Factors -- Risks Relating to CCL," "Business of CCL" and "The Relationship Among Corning, CCL and CPS After the Distributions"of the CCL Information and such sections are incorporated herein by reference. Item 2. Financial Information The information required by this item is contained under the sections "Capitalization of CCL," "Pro Forma Financial Information of CCL," "Selected Historical Financial Data of CCL" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL" of the CCL Information and such sections are incorporated herein by reference. Item 3. Properties The information required by this item is contained under the section "Business of CCL--Properties" of the CCL Information and such section is incorporated herein by reference. Item 4. Security Ownership of Certain Beneficial Owners and Management The information required by this item is contained under the section "Security Ownership of Certain Beneficial Owners and Management of CCL" of the CCL Information and such section is incorporated herein by reference. 3 Item 5. Directors and Executive Officers The information required by this item is contained under the section "Management of CCL" of the CCL Information and such section is incorporated herein by reference. Item 6. Executive Compensation The information required by this item is contained under the section "Management of CCL" of the CCL Information and such section is incorporated herein by reference. Item 7. Certain Relationships and Related Transactions The information required by this item is contained under the section "Management of CCL" of the CCL Information and such section is incorporated herein by reference. Item 8. Legal Proceedings The information required by this item is contained under the sections "Business CCL--OIG Investigations" and "--Legal Proceedings" of the CCL Information and such sections are incorporated herein by reference. Item 9. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters The information required by this item is contained under the sections "Risk Factors--Risks Relating to CCL--Absence of Dividends," "Risk Factors--Risks Relating to CCL--Absence of Prior Public Market," "Risk Factors--Risks Relating to CCL--Potential Volatility of Stock Price," "Description of CCL Capital Stock--CCL Common Stock--Dividend Policy," "--CCL Common Stock--Listing and Trading" and "Management of CCL" of the CCL Information and such sections are incorporated herein by reference. Item 10. Recent Sales of Unregistered Securities Not applicable. Item 11. Description of Registrant's Securities to be Registered The information required by this item is contained under the sections "Description of CCL Capital Stock" and "Antitakeover Effects of Certain Provisions of the 4 CCL Certificate of Incorporation and By-Laws" of the CCL Information and such sections are incorporated herein by reference. Item 12. Indemnification of Directors and Officers The information required by this item is contained under the section "Liability and Indemnification of Directors and Officers of CCL" of the CCL Information and such section is incorporated herein by reference. Item 13. Financial Statements and Supplementary Data The information required by this item is contained under the sections "Capitalization of CCL," "Pro Forma Financial Information of CCL," "Selected Historical Financial Data of CCL," "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL" and "Financial Statements of Corning Clinical Laboratories Inc." of the CCL Information and such sections are incorporated herein by reference. Item 14. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. Item 15. Financial Statements and Exhibits (a) Financial Statements The information required by this item is contained under the section "Financial Statements of Corning Clinical Laboratories Inc." of the CCL Information and such section is incorporated herein by reference. 5 (b) Exhibits Exhibit Number Description - ------ ----------- 2.1* Form of Transaction Agreement among Corning Incorporated, Corning Clinical Laboratories Inc. and Corning Pharmaceutical Services Inc., dated [ ____________ ], 1996 3.1* Certificate of Incorporation of the Registrant 3.2* By-Laws of the Registrant 4.1* Form of Common Stock certificate 4.2* Form of Rights Agreement between Corning Clinical Laboratories Inc. and [___], dated [___], 1996 10.1* Form of Tax Sharing Agreement among Corning Incorporated, Corning Clinical Laboratories Inc. and Corning Pharmaceutical Services Inc., dated [ ], 1996 10.2* Form of Tax Indemnification Agreement between Corning Incorporated and Corning Clinical Laboratories Inc. dated [ ], 1996 10.3* Form of Tax Indemnification Agreement between Corning Clinical Laboratories Inc. and Corning Pharmaceutical Services, Inc. dated [ ], 1996 10.4* Form of Corning Clinical Laboratories Inc. Employee Stock Ownership Plan, dated [___], 1996 10.5* Form of Stock Purchase Savings Plan of Corning Clinical Laboratories Inc., dated [____], 1996 10.6* Form of Corning Clinical Laboratories Inc. Employees Stock Purchase Program, dated [____], 1996 10.7* Form of Corning Clinical Laboratories Inc. Employee Equity Participation Program, dated [___], 1996 21* Subsidiaries of the Registrant 27* Financial Data Schedules 99.1 Selected pages of the Information Statement, subject to completion or amendment, of Corning Incorporated dated September 20, 1996 *To be filed by amendment. 6 SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. CORNING CLINICAL LABORATORIES INC. Dated: September 20, 1996 By: /s/ Kenneth W. Freeman --------------------------- Kenneth W. Freeman, President and Chief Executive Officer EX-99.1 2 EXHIBIT TO FORM 10 FOR CORNING CLINICAL LABS Information contained herein is subject to completion or amendment. A registration statement on Form 10 relating to these securities has been filed with the Securities and Exchange Commission. This preliminary Information Statement shall not constitute an offer to sell or the solicitation of an offer to buy these securities. SUBJECT TO COMPLETION OR AMENDMENT, DATED SEPTEMBER 20, 1996 INFORMATION STATEMENT CORNING CLINICAL LABORATORIES INC. Common Stock with attached Preferred Stock Purchase Rights AND CORNING PHARMACEUTICAL SERVICES INC. Common Stock with attached Preferred Stock Purchase Rights [CORNING LOGO] This information statement (the "Information Statement") is being furnished in connection with the distributions to holders of common stock with attached preferred share purchase rights (the "Corning Common Stock") of Corning Incorporated ("Corning"), a New York corporation, of all of the outstanding common stock with attached preferred stock purchase rights, of (i) Corning Clinical Laboratories Inc. ("CCL"), a Delaware corporation which will be, at the time of such distributions, a direct wholly owned subsidiary of Corning, and (ii) Corning Pharmaceutical Services Inc. ("CPS"), a Delaware corporation which currently is and, at the time of such distributions, will be a direct wholly owned subsidiary of CCL. The distribution (the "CCL Spin-Off Distribution") of all of the outstanding common stock with attached preferred stock purchase rights of CCL (the "CCL Common Stock") to the holders of Corning Common Stock will be immediately followed by the distribution (the "CPS Spin-Off Distribution" and, together with the CCL Spin-Off Distribution, the "Distributions") of all of the outstanding common stock with attached preferred stock purchase rights of CPS (the "CPS Common Stock") to the holders of CCL Common Stock. Since the CPS Spin-Off Distribution will be immediately after (but on the same day as) the CCL Spin-Off Distribution, each holder of Corning Common Stock will, immediately after the Distributions, not only hold shares of Corning Common Stock but also shares of CCL Common Stock and CPS Common Stock. The CCL Common Stock and CPS Common Stock will be distributed at 11:59 p.m. on ____, 1996 (the "Distribution Date") to holders of record of Corning Common Stock as of the close of business on ____, 1996 (the "Record Date"). Each such holder will receive one share of CCL Common Stock for every eight shares of Corning Common Stock held on the Record Date and one share of CPS Common Stock for every four shares of Corning Common Stock held on the Record Date, with cash being paid to holders in lieu of fractional shares. No consideration will be paid by Corning's shareholders for shares received in the Distributions nor will such shareholders be required to surrender or exchange shares of Corning Common Stock. There have been no public trading markets for the CCL Common Stock or the CPS Common Stock, although "when issued" markets are expected to develop prior to the Distribution Date. Applications will be made to list the shares of CCL Common Stock and CPS Common Stock on the New York Stock Exchange ("NYSE") under the symbols "__" and "__," respectively, subject to official notice of the Distributions. -------------------------------- NO SHAREHOLDER APPROVAL OF THE DISTRIBUTIONS IS REQUIRED OR SOUGHT. WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS INFORMATION STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS INFORMATION STATEMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES. -------------------------------- Corning Shareholders with inquiries related to the Distributions should contact Investor Relations, Corning Incorporated, One Riverfront Plaza, Corning, New York 14831, telephone (607) 974-9000, or Corning's stock transfer agent Harris Trust and Savings Bank, Shareholder Services Division, P.O. Box 755, Chicago, Illinois 60690-0755, Telephone (800) 255-0461. The date of this Information Statement is ____, 1996. TABLE OF CONTENTS Page SUMMARY ................................................................ 3 INTRODUCTION............................................................. 15 CORNING ................................................................ 16 SELECTED CONSOLIDATED FINANCIAL DATA OF CORNING..................... 17 CAPITALIZATION OF CORNING........................................... 22 THE DISTRIBUTIONS........................................................ 23 THE RELATIONSHIP AMONG CORNING, CCL AND CPS AFTER THE DISTRIBUTIONS....................................................... 27 CORNING CLINICAL LABORATORIES INC. RISK FACTORS........................................................ 30 CAPITALIZATION OF CCL............................................... 35 SELECTED HISTORICAL FINANCIAL DATA OF CCL........................... 36 PRO FORMA FINANCIAL INFORMATION OF CCL.............................. 40 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CCL................................ 47 BUSINESS OF CCL..................................................... 56 MANAGEMENT OF CCL................................................... 80 SECURITY OWNERSHIP BY CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF CCL........................................... 92 DESCRIPTION OF CCL CAPITAL STOCK.................................... 93 ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE CCL CERTIFICATE OF INCORPORATION AND BY-LAWS........................ 97 DESCRIPTION OF CERTAIN INDEBTEDNESS OF CCL.......................... 101 LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS OF CCL...... 102 CORNING PHARMACEUTICAL SERVICES INC. RISK FACTORS........................................................ 103 CAPITALIZATION OF CPS.................................................... 109 SELECTED HISTORICAL FINANCIAL DATA OF CPS........................... 110 PRO FORMA FINANCIAL INFORMATION OF CPS.............................. 112 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CPS................................ 117 BUSINESS OF CPS..................................................... 125 MANAGEMENT OF CPS................................................... 145 SECURITY OWNERSHIP BY CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF CPS............................................... 156 DESCRIPTION OF CPS CAPITAL STOCK.................................... 157 ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE CPS CERTIFICATE OF INCORPORATION AND BY-LAWS........................ 161 DESCRIPTION OF CERTAIN INDEBTEDNESS OF CPS.......................... 165 LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS OF CPS...... 166 AVAILABLE INFORMATION.................................................... 167 INDEX TO FINANCIAL STATEMENTS............................................ F-1 2 THE RELATIONSHIP AMONG CORNING, CCL AND CPS AFTER THE DISTRIBUTIONS After the Distributions, Corning will not have any ownership interest in either CCL or CPS, and CCL and CPS will be independent public companies. Corning, CCL and CPS will enter into certain agreements, summarized below, to provide for an orderly transition to the status of three separate independent companies, to govern their relationship subsequent to the Distributions and to provide for the allocation of tax and certain other liabilities and obligations arising from periods prior to the Distributions. Copies of the forms of such agreements are filed as exhibits to the Registration Statements of which this Information Statement is a part. The following description summarizes the material terms of such agreements, but is qualified by reference to the texts of such agreements as filed. Transaction Agreement Corning, CCL and CPS will enter into the Transaction Agreement (the "Transaction Agreement") providing for, among other things, certain conditions precedent to the Distributions, certain corporate transactions required to effect the Distributions and other arrangements between Corning, CCL and CPS subsequent to the Distributions. See "The Distributions--Conditions; Termination." The Transaction Agreement will provide for, among other things, assumptions of liabilities and cross- indemnities designed to allocate generally, effective as of the Distribution Date, financial responsibility for the liabilities arising out of or in connection with (i) the clinical laboratory business to CCL and its subsidiaries, (ii) the contract research business to CPS and its subsidiaries and (iii) all other business conducted by Corning prior to the Distribution Date to Corning and its subsidiaries other than CCL and CPS. The Transaction Agreement will provide that Corning, CCL and CPS will use their respective commercially reasonable efforts to achieve an allocation of consolidated indebtedness of Corning and a capital structure that reflects the capital structure after the Distributions of Corning, CCL and CPS as contemplated in the discussion under "Capitalization of CCL" and "Capitalization of CPS." Each of Corning, CCL and CPS will agree to indemnify the other parties to the Transaction Agreement in connection with losses that may result from certain liabilities or the breach of any provision of the Transaction Agreement. In addition, Corning will agree to indemnify CCL against all monetary penalties, fines or settlements arising out of any governmental criminal, civil or administrative investigations or claims that are pending as of the Distribution Date to the extent that such investigations or claims arise out of or are related to alleged violations of federal laws by reason of CCL, its affiliates, officers or directors billing any federal program or agency for services rendered to beneficiaries of such program or agency. Corning will not indemnify CCL against losses of revenues and profits as a consequence of any exclusion from participation in federal or state health care programs or against any governmental claims that arise after the Distribution Date, even though related to periods prior to the Distributions. The Transaction Agreement will also provide that, except as otherwise set forth therein or in any other agreement, all costs or expenses incurred on or prior to the Distribution Date in connection with the Distributions will be allocated among the parties. Except as set forth in the Transaction Agreement or any related agreement, each party shall bear its own costs and expenses incurred after the Distribution Date. Spin-Off Tax Indemnification Agreements Corning and CCL will enter into a tax indemnification agreement (the "Corning/CCL Spin-Off Tax Indemnification Agreement") pursuant to which (1) CCL will represent to Corning that, to the best of its knowledge, the materials relating to CCL submitted to the IRS in connection with the request for ruling submitted to the IRS are complete and accurate in all material respects, (2) CCL will represent that it has no present intention to 27 undertake the transactions described in part (3)(iii) hereafter or to cease to engage in the active conduct of providing clinical laboratory testing services, (3) CCL will covenant and agree that for a period of two years following the Distribution Date (the "Restricted Period"), (i) CCL will continue to engage in the clinical laboratory testing business, (ii) CCL will continue to manage and own at least 50% of the assets which it owns directly and indirectly immediately after the Distribution Date and (iii) neither CCL, nor any related corporation nor any of their respective directors, officers or other representatives will undertake, authorize, approve, recommend, permit, facilitate, or enter into any contract, or consummate any transaction with respect to: (A) the issuance of CCL Common Stock (including options and other instruments convertible into CCL Common Stock) which would exceed fifty percent (50%) of the outstanding shares of CCL Common Stock immediately after the Distribution Date; (B) the issuance of any other instrument that would constitute equity for federal tax purposes ("Disqualified CCL Stock"); (C) the issuance of options and other instruments convertible into Disqualified CCL Stock; (D) any repurchases of CCL Common Stock, unless such repurchases satisfy certain requirements; (E) the dissolution, merger, or complete or partial liquidation of CCL or any announcement of such action; or (F) the waiver, amendment, termination or modification of any provision of the CCL Rights Plan (as defined therein) in connection with, or in order to permit or facilitate, any acquisition of CCL Common Stock or other equity interest in CCL, and (4) CCL will agree to indemnify Corning for Taxes arising from violations of (1), (2) or (3) above and for Taxes arising as a result of an acquisition of 20% or more of the stock of CCL by a person or related persons during the Restricted Period. If obligations of CCL under this agreement were breached and as a result thereof one or both of the Distributions do not qualify for the treatment stated in the IRS Ruling, CCL would be required to indemnify Corning for Taxes imposed and such indemnification obligations could exceed the net asset value of CCL at such time. Corning and CPS will enter into a tax indemnification agreement (the "Corning/CPS Spin-Off Tax Indemnification Agreement") pursuant to which (1) CPS will represent to Corning that to the best of its knowledge, the materials relating to CPS submitted to the IRS in connection with the request for ruling submitted to the IRS are complete and accurate in all material respects, (2) CPS will represent that it has no present intention to undertake the transactions described in part (3)(iii) hereafter or to cease to engage in the active conduct of providing contract research services, (3) CPS will covenant and agree that during the Restricted Period, (i) CPS will continue to engage in the contract research business, (ii) CPS will continue to manage and own at least 50% of the assets which it owns directly and indirectly immediately after the Distribution Date and (iii) neither CPS, nor any related corporations nor any of their respective directors, officers or other representatives will undertake, authorize, approve, recommend, permit, facilitate, or enter into any contract, or consummate any transaction with respect to: (A) the issuance of CPS Common Stock (including options and other instruments convertible into CPS Common Stock) which would exceed fifty percent (50%) of the outstanding shares of CPS Common Stock immediately after the Distribution Date; (B) the issuance of any other instrument that would constitute equity for federal tax purposes ("Disqualified CPS Stock"); (C) the issuance of options and other instruments convertible into Disqualified CPS Stock; (D) any repurchases of CPS Common Stock, unless such repurchases satisfy certain requirements; (E) the dissolution, merger, or complete or partial liquidation of CPS or any announcement of such action; or (F) the waiver, amendment, termination or modification of any provision of the CPS Rights Plan (as defined therein) in connection with, or in order to permit or facilitate, any acquisition of CPS Common Stock or other equity interest in CPS and (4) CPS will agree to indemnify Corning for Taxes arising from violations of (1), (2) or (3) above and for Taxes arising as a result of an acquisition of 20% or more of the stock of CPS by a person or related persons during the Restricted Period. If obligations of CPS under this agreement were breached and as a result thereof one or both of the Distributions do not qualify for the treatment stated in the IRS Ruling, CPS would be required to indemnify Corning for Taxes imposed and such indemnification obligations could exceed the net asset value of CPS at such time. CCL and CPS will enter into a tax indemnification agreement (the "CCL/CPS Spin-Off Tax Indemnification Agreement"). The CCL/CPS Tax Spin-Off Tax Indemnification Agreement will be essentially the same as the Corning/CPS Spin-Off Tax Indemnification Agreement except that CPS will make representations to and indemnify CCL as opposed to Corning. If obligations of CPS under this agreement were breached and as a result thereof one or both of the Distributions do not qualify for the treatment stated in the IRS Ruling, CPS would be required to 28 indemnify CCL for Taxes imposed and such indemnification obligations could exceed the net asset value of CPS at such time. The Spin-Off Tax Indemnification Agreements will also require CCL and CPS to take such actions as Corning may reasonably request to preserve the favorable tax treatment provided for in any rulings obtained from the IRS in respect of the Distributions. Tax Sharing Agreement Corning, CCL and CPS will enter into the Tax Sharing Agreement which will allocate responsibility for federal income and various other taxes ("Taxes") among the three companies. The Tax Sharing Agreement provides that, except for Taxes arising as a result of the failure of either or both of the Distributions to qualify for the treatment stated in the IRS Ruling (which Taxes are allocated either pursuant to the Spin-Off Tax Indemnification Agreements or as described below), Corning is liable for and will pay the federal income taxes of the consolidated group that includes CCL and CPS and their subsidiaries, provided, however, that CCL and CPS are required to reimburse Corning for taxes for periods in which they are members of the Corning consolidated group and for which tax returns have not been filed as of the Distribution Date. This reimbursement obligation is based on the hypothetical separate federal tax liability of CCL and CPS, including their respective subsidiaries, calculated on a separate consolidated basis, subject to certain adjustments. Under the Tax Sharing Agreement, in the case of adjustments by a taxing authority of a consolidated federal income tax or certain other tax returns prepared by Corning which includes CCL or CPS, then, subject to certain exceptions, Corning is liable for and will pay any tax assessments, and is entitled to any tax refunds, resulting from such audit. The Tax Sharing Agreement further provides that, if either of the Distributions fails to qualify for the tax treatment stated in the IRS Ruling (for reasons other than those indemnified against under one or more of the Spin- Off Tax Indemnification Agreements), Taxes imposed upon or incurred by Corning, CCL or CPS as a result of such failure are allocated among Corning, CCL and CPS in such a manner as will take into account the extent to which the actions or inactions of each may have contributed to such failure, and Corning, CCL and CPS each will indemnify and hold harmless the other from and against the taxes so allocated. If it is determined that none of the companies contributed to the failure of such distribution to qualify for the tax treatment stated in the IRS Ruling, the liability for taxes will be borne by each in proportion to its relative average market capitalization as determined by the average closing price for the common stock of each during the 20 trading-day period immediately following the Distribution Date. In the event that either of the Distributions fails to qualify for the tax treatment stated in the IRS Ruling and the liability for taxes as a result of such failure is allocated among Corning, CCL and CPS, the liability so allocated to CCL or CPS could exceed the net asset value of CCL or CPS, respectively. 29 CORNING CLINICAL LABORATORIES INC. RISK FACTORS Corning shareholders should be aware that the Distributions and ownership of the CCL Common Stock involve certain risks, including those described below, which could adversely affect the value of their holdings. Neither Corning nor CCL makes, nor is any other person authorized to make, any representations as to the future market value of CCL Common Stock. Risks Relating to the Distributions Effects on Corning Stock. Following the Distributions, Corning Common Stock will continue to be listed and traded on the NYSE and certain other stock exchanges. As a result of the Distributions, the trading price of Corning Common Stock is expected to be lower than the trading price of Corning Common Stock immediately prior to the Distributions. There can be no assurance that the combined trading prices of Corning Common Stock, CCL Common Stock and CPS Common Stock after the Distributions will be equal to or greater than the trading price of Corning Common Stock prior to the Distributions. Risks Relating to CCL Financial Impact of the Distributions on CCL. While CCL has a substantial operating history, it has not operated as an independent company since 1982. As a Corning subsidiary, CCL's working capital requirements have been financed by Corning and CCL's major acquisitions have been financed through the issuance of Corning common stock and borrowings from Corning. Subsequent to the Distributions, CCL's activities will no longer be financed by Corning. In addition, it is anticipated that the rating of CCL's long-term debt will be non-investment grade. This may impact, among other things, CCL's ability to raise capital, fund working capital requirements or expand, through acquisitions or otherwise, and could thereby have an adverse effect on CCL's operating earnings and cash flow. Debt and Debt Service Requirements. After the Distributions and as a result of the incurrence of debt under the CCL Credit Facility and the issuance of Notes in the CCL Notes Offering, CCL will have substantial debt. At June 30, 1996, after giving effect to the transactions and adjustments described in "Pro Forma Financial Information of CCL," CCL would have had $518 million of total debt and total capitalization of $1,089 million, on a pro forma basis, and CCL's total debt as a percentage of total capitalization would have been approximately 48%. In addition to creating significant debt service obligations for CCL, the terms of the CCL Credit Facility will include financial and affirmative and negative operational covenants. The degree to which CCL is leveraged could have important consequences to holders of CCL Common Stock, including the following: (1) CCL's ability to obtain additional financing in the future for working capital, capital expenditures, product development, acquisitions, general corporate purposes or other purposes may be impaired; (ii) a portion of CCL's and its subsidiaries' cash flow from operations must be dedicated to the payment of the principal of and interest on its indebtedness; (iii) the CCL Credit Facility will contain certain restrictive financial and operating covenants, including, among others, requirements that CCL satisfy certain financial ratios; (iv) a significant portion of borrowings will be at floating rates of interest, causing CCL to be vulnerable to increases in interest rates; (v) CCL's degree of leverage may make it more vulnerable in a downturn in general economic conditions; and (vi) CCL's financial position may limit its flexibility in responding to changing business and economic conditions. In addition, the Notes will contain certain financial covenants. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL--Liquidity and Capital Resources" and "Description of Certain Indebtedness of CCL." 30 Competition. The independent clinical laboratory industry in the United States is intensely competitive. CCL believes that in 1995 approximately 56% of the revenues of the clinical laboratory testing industry was generated by hospital-affiliated laboratories, approximately 36% by independent clinical laboratories and 8% by thousands of individual physicians in their offices and laboratories. Independent clinical laboratories fall into two separate categories: (1) smaller, generally local, laboratories that generally offer fewer tests and services and have less capital than the larger laboratories, and (2) larger laboratories such as CCL that provide a broader range of tests and services. CCL has two major competitors that operate in the national market--SmithKline Beecham Clinical Laboratories, Inc. ("SmithKline") and Laboratory Corporation of America Holdings, Inc. ("LabCorp"). Both SmithKline and LabCorp are affiliated with larger corporations that have greater financial resources than CCL. There are also many independent clinical laboratories that operate regionally and that compete with CCL in these regions. In addition, hospitals are in general both competitors and customers of independent clinical laboratories. The independent clinical laboratory testing industry has experienced intense price competition over the past several years, which has negatively impacted CCL's profitability. The following factors, among others, are often used by health care providers in selecting a laboratory: (i) pricing of the laboratory's testing services; (ii) accuracy, timeliness and consistency in reporting test results; (iii) number and type of tests performed; (iv) service capability and convenience offered by the laboratory; and (v) its reputation in the medical community. See "Business of CCL--The Clinical Laboratory Testing Industry" and "Business of CCL--Competition." Role of Managed Care. Managed care organizations play a significant role in the health care industry and their role is expected to increase over the next several years. Managed care organizations typically negotiate capitated payment contracts, whereby a clinical laboratory receives a fixed monthly fee per covered individual, regardless of the number or cost of tests performed during the month (excluding certain tests, such as esoteric tests and anatomic pathology services). Laboratory services agreements with managed care organizations have historically been priced aggressively due to competitive pressure and the expectation that a laboratory would capture not only the volume of testing to be covered under the contract, but also the additional fee-for-service business from patients of participating physicians who are not covered under the managed care plan. However, as the number of patients covered under managed care plans continues to increase, there is less such fee-for-service business and, accordingly, less high margin business to offset the low margin (and often unprofitable) managed care business. Furthermore, increasingly, physicians are affiliated with more than one managed care organization and as a result may be required to refer clinical laboratory tests to different clinical laboratories, depending on the coverage of their patients. As a result, a clinical laboratory might not receive any fee-for-service testing from such physicians. See "Business of CCL--Customers and Payors" and "Business of CCL--Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business." During the six months ended June 30, 1996, services to managed care organizations under capitated rate agreements accounted for approximately 6% of CCL's net revenues from clinical laboratory testing and approximately 15% of the tests performed by CCL. CCL is currently reviewing its pricing structures for agreements with managed care organizations and intends to insure that all of its future agreements with managed care organizations are profitably priced. However, there can be no assurance that CCL will be able to increase the prices charged to managed care organizations or that CCL will not lose market share in the managed care market to other clinical laboratories who continue to aggressively price laboratory services agreements with managed care organizations. CCL may experience declines in per-test revenue as managed care organizations continue to increase their share of the health care insurance market. Reliance on Medicare/Medicaid Reimbursements. Approximately 23% and 22% of CCL's net revenues for the year ended December 31, 1995 and the six months ended June 30, 1996, respectively, were attributable to tests performed for Medicare and Medicaid beneficiaries. CCL's business and financial results depend substantially on reimbursements paid to CCL under these programs. CCL is legally required to accept the government's reimbursement for most Medicare and Medicaid testing as payment in full. Such reimbursements are generally made pursuant to fee schedules, which are subject to certain limitations the levels of which have declined steadily since late 1984. Congress enacted a phased-in set of reductions in the reimbursement limitations as part of its 1993 budget legislation that reduced the Medicare national limitations in 1994 to 84% of the 1984 national median, in 1995 to 80% of the 1984 national median and in 1996 to 76% of the 1984 national median. In 1995, both houses 31 of Congress passed a bill (the Medicare Preservation Act) that would have reduced the fee cap schedule from 75% to 65% of the 1984 national median, but the bill was vetoed by the President. Effective January 1, 1996, the Health Care Financing Administration ("HCFA") adopted a new policy on reimbursement for chemistry panel tests. As of January 1, 1996, 22 automated tests (rather than 19 tests) became reimbursable by Medicare as part of an automated chemistry profile. An additional allowance of $0.50 per test is authorized when more than 19 tests are billed in a panel. HCFA retains the authority to expand in the future the list of tests included in a panel. Effective as of March 1, 1996, HCFA eliminated its prior policy of permitting payment for all tests contained in an automated chemistry panel when at least one of the tests in the panel is medically necessary. Under the new policy, Medicare payment will not exceed the amount that would be payable if only the tests that are "medically necessary" had been ordered. In addition, since 1995 most Medicare carriers have begun to require clinical laboratories to submit documentation supporting the medical necessity, as judged by ordering physicians, for many commonly ordered tests. CCL expects to incur additional reimbursement reductions and additional costs associated with the implementation of these requirements of HCFA and Medicare carriers. The amount of the reductions in reimbursements and additional costs cannot be determined at this time. These and other proposed changes affecting the reimbursement policy of Medicare and Medicaid programs could have a material adverse effect on the business, financial condition, results of operations or prospects of CCL. See "Business of CCL--Regulation and Reimbursement--Regulation of Reimbursement for Clinical Laboratory Services." A failure of CCL to properly and promptly process its bills to Medicare may result in an increase in CCL's bad debt expense. See "Business of CCL--Billing" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL--Results of Operations." Government Regulation. The clinical laboratory industry is subject to extensive governmental regulations at the federal, state and local levels. See "Business of CCL--Regulation and Reimbursement." At the federal level, CCL's laboratories are required to be certified under the Clinical Laboratory Improvement Amendments of 1988 ("CLIA") and approved to participate in the Medicare/Medicaid programs. Currently, all clinical laboratories, including most physician-office laboratories ("POLs"), are required to comply with CLIA. However, the Medicare Preservation Act, passed in 1995 by both Houses of Congress, would have largely exempted POLs from having to comply with CLIA (except with respect to pap smear tests). Although this provision was not maintained by the House-Senate conference and was not included in the subsequent legislation, it could be reintroduced at any time. The exemption of POLs from CLIA would significantly reduce their costs, making them more financially viable and a greater competitive challenge to CCL and would more likely encourage physicians to establish laboratories in their offices. A wide array of Medicare/Medicaid fraud and abuse provisions apply to clinical laboratories participating in such programs. Penalties for violations of these federal laws include exclusion from participation in the Medicare/Medicaid programs, asset forfeitures, civil and criminal penalties. Civil penalties for a wide range of offenses may be up to $2,000 per item and twice the amount claimed. These penalties will be increased effective January 1, 1997 to up to $10,000 per item plus three times the amount claimed. In the case of certain offenses, exclusion from participation in Medicare and Medicaid is a mandatory administrative penalty. The Office of the Inspector General ("OIG") of the Department of Health and Human Services ("HHS") interprets these fraud and abuse administrative provisions liberally and enforces them aggressively. Provisions in a bill enacted in August 1996 are likely to expand the federal government's involvement in curtailing fraud and abuse due to the establishment of (i) an anti-fraud and abuse trust fund funded through the collection of penalties and fines for violations of such laws and (ii) a health care anti-fraud and abuse task force. See "Business of CCL--Regulation and Reimbursement." Government Investigations. CCL has entered into several settlement agreements with various governmental and private payors during recent years. At present, government investigations of certain practices by clinical laboratories acquired in recent years are ongoing. In addition, certain payors are reviewing their reimbursement practices for laboratory tests. The results of those investigations and reviews may result in additional settlement 32 payments or reductions in reimbursements for certain tests. There are also a number of pending OIG investigations of Damon and Nichols Institute, two companies acquired by CCL in 1993 and 1994, respectively, with respect to Medicare and Medicaid billing practices of these companies prior to their acquisition by Corning. Available penalties include exclusion from participation in Medicare and Medicaid, asset forfeitures, civil administrative penalties and criminal penalties. Application of such remedies and penalties could adversely affect CCL's business, financial condition, results of operations or prospects. In connection with the Distributions, Corning will agree to indemnify CCL against all monetary penalties, fines or settlements arising out of certain governmental investigations and claims that are pending on the Distribution Date and that arise out of billings to federal programs by companies that CCL acquired. Corning will not indemnify CCL against losses of revenues and profits as a consequence of any exclusion from participation in federal or state health care programs or against any governmental claims that arise after the Distribution Date, even though related to periods prior to the Distributions. See "The Relationship Among Corning, CCL and CPS After the Distributions--Transaction Agreement." CCL believes that future settlements of private and other claims, as to which Corning will not agree to indemnify CCL, will not have a material adverse effect on CCL's financial condition and results of operations after the Distributions. See "Business of CCL--OIG Investigations" and Note 13 to the Audited CCL Financial Statements. Professional Liability Litigation. As a general matter, providers of clinical laboratory testing services may be subject to lawsuits alleging negligence or other similar legal claims, which suits could involve claims for substantial damages. Damages assessed in connection with, and the costs of defending any such actions could be substantial. Litigation could also have an adverse impact on CCL's client base. CCL maintains liability insurance (subject to maximum limits and self-insured retentions) for professional liability claims. While there can be no assurance, CCL management believes that the levels of coverage are adequate to cover currently estimated exposures. Although CCL believes that it will be able to obtain adequate insurance coverage in the future at acceptable costs, there can be no assurance that CCL will be able to obtain such coverage or will be able to do so at an acceptable cost or that CCL will not incur significant liabilities in excess of policy limits. Absence of Dividends. It is currently contemplated that, following the Distributions, CCL will not pay cash dividends in the foreseeable future, but will retain earnings to provide funds for the operation and expansion of its business. In addition, the CCL Credit Facility and the Indenture governing the Notes that are the subject of the CCL Notes Offering will contain covenants that will limit the ability of CCL to pay dividends on the CCL Common Stock. See "Description of Capital Stock of CCL--CCL Common Stock--Dividend Policy." Potential Liability under the Spin-Off Tax Indemnification Agreements. CCL will enter into the Corning/CCL Spin-Off Tax Indemnification Agreement that will prohibit CCL for a period of two years after the Distribution Date from taking certain actions, including a sale of 50% or more of the assets of CCL or engaging in certain equity or financing transactions, that might jeopardize the favorable tax treatment of the Distributions under Code section 355 and will provide Corning with certain rights of indemnification against CCL. The Corning/CCL Spin-Off Tax Indemnification Agreement will also require CCL to take such actions as Corning may reasonably request to preserve the favorable tax treatment provided for in any rulings obtained from the IRS in respect of the Distributions. CCL and CPS will enter into the CCL/CPS Spin-Off Tax Indemnification Agreement, that will be essentially the same as the Corning/CPS Spin-Off Tax Indemnification except that CPS will make representations to and indemnify CCL as opposed to Corning. If obligations of CCL under either agreement were breached and primarily as a result thereof the Distributions do not receive such treatment, CCL would be required to indemnify Corning or CPS, as the case may be, for Taxes imposed and such indemnification obligations could exceed the net asset value of CCL at such time. See "The Relationship Among Corning, CCL and CPS After the Distributions--Spin-Off Tax Indemnification Agreements." Absence of a Prior Public Market. Prior to the Distributions, there has been no public market for the CCL Common Stock. Although it is expected that the CCL Common Stock will be approved for listing on the NYSE, there is no existing market for the CCL Common Stock and there can be no assurance as to the liquidity of any markets that may develop, the ability of CCL stockholders to sell their shares of CCL Common Stock or at what 33 price CCL stockholders will be able to sell their shares of CCL Common Stock. Future trading prices will depend on many factors including, among other things, prevailing interest rates, CCL's operating results and the market for similar securities. Potential Volatility of Stock Price. The market price of CCL Common Stock could be subject to wide fluctuations in response to seasonal variations in operating results, changes in earnings estimates by analysts, market conditions in the clinical laboratory industry, prospects for health care reform, changes in government regulation and general economic conditions. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have been unrelated to the operating performance of particular companies. Moreover, CCL Common Stock could be subject to wide fluctuations for some time after the Distributions as a result of heavy trading volume stemming from sales by shareholders of Corning Common Stock who decide not to continue owning CCL Common Stock. Certain of such sales may include those to be made on behalf of investment plans maintained for the benefit of Corning employees. These plans currently hold slightly less than 5% of the outstanding Corning Common Stock and, as a result of the Distributions, are expected to hold a similar percentage of the CCL Common Stock. From time to time as market conditions warrant, and as the administrator of the plans believes to be in the best interests of the employee beneficiaries, the administrator will sell all of the CCL Common Stock held by the plans. Such sales are expected to occur within a period of three years after the Distribution Date. See "Security Ownership by Certain Beneficial Owners and Management of CCL." These market fluctuations could have an adverse effect on the market price of CCL Common Stock. CCL stockholders should be aware, and must be willing to bear the risk, of such fluctuations in earnings and stock price. Dependence on Key Employees. CCL's affairs are managed by a small number of key management personnel, the loss of any of whom could have an adverse impact on CCL. CCL does not have any employment contracts with such persons. There can be no assurance that CCL can retain its key managerial and technical employees or that it can attract, assimilate or retain other skilled technical personnel in the future. See "Business of CCL--Recent Organizational Changes" and "Management of CCL." Certain Provisions Relating to Change in Control. CCL's amended and restated certificate of incorporation, (the "CCL Certificate") and by-laws (the "CCL By-Laws"), and the Delaware General Corporation Law ("DGCL"), contain several provisions that could have the effect of delaying, deferring or preventing a change in control of CCL in a transaction not approved by the CCL Board, or, in certain circumstances, by the disinterested members of the CCL Board. In addition, an acquisition of certain securities or assets of CCL within two years after the Distribution Date might jeopardize the tax treatment of the Distributions and could result in CCL being required to indemnify Corning and CPS. See "--Potential Liability under the Spin-Off Tax Indemnification Agreements" and "Antitakeover Effects of Certain Provisions of the CCL Certificate of Incorporation and By-Laws." 34 CAPITALIZATION OF CCL The following table sets forth CCL's capitalization as of June 30, 1996 giving effect to (i) the consummation of the CCL Notes Offering and the estimated initial borrowings under the CCL Credit Facility, (ii) the Distributions and (iii) the CCL Accounting Policy Change, as if such transactions occurred on such date. This table should be read in conjunction with the CCL Financial Statements and notes thereto and the CCL Pro Forma Financial Information and notes thereto included elsewhere herein. Historical combined and pro forma combined financial information may not be indicative of CCL's future capitalization as an independent company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL" and "Business of CCL."
Pro Forma Historical Adjustments Pro Forma ---------- ----------- --------- (in thousands) Cash.............................. $ 37,605(a) $ $ 37,605 ========== =========== ========== Short-term Debt: Current portion of long-term debt $ 12,421 $ (10,000)(b) $ 2,421(g) Revolving credit facility.... (c) ---------- ----------- ---------- Total Short-term Debt...... $ 12,241 $ (10,000) $ 2,421 ========== =========== ========== Long-term Debt: Term loans................... $ 15,557 $ 300,000(b) $ 315,557(g) Notes........................ 200,000(b) 200,000 Payable to Corning........... 1,210,473 (1,210,473)(b,d) ---------- ----------- ---------- Total Long-term Debt....... 1,226,030 (710,473) 515,557 ---------- ----------- ---------- Stockholder's Equity: Contributed capital.......... 297,823 756,541(d,e) 1,054,364 Accumulated deficit.......... (43,722) (438,239)(e,f) (481,961) Cumulative translation adjustment 1,741 1,741 Market valuation adjustment.. (2,719) (2,719) ---------- ----------- ---------- Total Stockholder's Equity 253,123 318,302 571,425 ---------- ----------- ---------- Total Capitalization.................... $1,479,153 $ (392,171) $1,086,982 ========== =========== ========== - -------------- (a) Historically, CCL has participated in Corning's centralized treasury and cash management processes. Cash received from operations was generally transferred to Corning on a daily basis. Cash disbursements for operations and investments were funded as needed from Corning. The cash balance at the Distribution Date will range from $30 million to $40 million. (b) The pro forma adjustment to current portion of long-term debt, term loans, Notes, and payable to Corning ($465 million) reflects borrowings by CCL, immediately prior to the CCL Spin-Off Distribution, to repay Corning for certain income tax liabilities and intercompany borrowings. The assumed interest rates on these new borrowings are 7.50% and 11.25% for the CCL Credit Facility and the Notes, respectively. (c) The CCL Credit Facility will include a revolving credit facility of approximately $100 million to $150 million which can be used to fund working capital and investment activities. CCL management believes that the entire facility will be available at the Distribution Date. (d) The pro forma adjustment to Payable to Corning and contributed capital of approximately $745 million reflects Corning's capital contribution to CCL of the remaining intercompany borrowings. (e) The pro forma adjustment to contributed capital ($11.2 million) and accumulated deficit ($13.2 million) represents costs directly related to the CCL Spin-Off Distribution that CCL expects to record coincident with the CCL Spin-Off Distribution. These costs, which are estimated to be $20.2 million ($13.2 million after tax), include $11.2 million related to the establishment of an employee stock ownership plan. This amount is subject to change based on the market price of the CCL Common Stock on the Distribution Date. (f) The pro forma adjustment to accumulated deficit ($425 million) represents the estimated impact of the CCL Accounting Policy Change. CCL management estimates the charge to reduce the carrying value of intangible assets to fair value will be in the range of $400 million to $450 million. The midpoint of the range has been utilized for the preparation of the Unaudited Pro Forma Combined Balance Sheet. (g) The current portion of long-term debt and the term loans, exclusive of the pro forma adjustment, consists primarily of a mortgage note payable and capital lease obligations.
35 SELECTED HISTORICAL FINANCIAL DATA OF CCL The following table presents selected historical financial data of CCL at the dates and for each of the periods indicated. The selected financial data as of and for each of the years ended December 31, 1995, 1994 and 1993 have been derived from the audited combined financial statements of CCL and the notes thereto included elsewhere herein. The selected financial data as of and for the three and six months ended June 30, 1996 and 1995 and the years ended December 31, 1992 and 1991 have been derived from the unaudited combined financial statements of CCL. In the opinion of management, the unaudited combined financial statements include all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair presentation of the financial position and results of operations for these periods. The unaudited interim results of operations for the three and six months ended June 30, 1996 are not necessarily indicative of the results for the entire year ending December 31, 1996. The selected financial data should be read in conjunction with the CCL Financial Statements and notes thereto, and the CCL Pro Forma Financial Information and notes thereto included elsewhere herein. Historical combined financial data may not be indicative of CCL's future performance as an independent company. See the CCL Financial Statements and notes thereto and CCL Pro Forma Financial Information. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL" and "Business of CCL." 36
Three Months Ended Six Months Ended June 30, June 30, ---------------------------------- --------------------- 1996 1995 1996 1995 ---------------- --------------- ------------- --------- Statement of Operations Data: Net revenues ............................. $ 424,543 $ 421,853 $ 825,938 $ 839,515 Costs and expenses: Cost of services ....................... 266,301 246,060 513,419 495,116 Selling, general and administrative .... 120,205 114,289 246,249 218,289 Provision for restructuring and other special charges(c) ..................... 46,000 33,035 46,000 45,885 Interest expense, net .................. 19,879 20,743 40,021 40,550 Amortization of intangible assets ...... 10,655 11,411 21,444 22,385 Other, net ............................. (979) 1,403 (2,035) 2,551 ----------- ----------- ----------- ----------- Total ................................ 462,061 426,941 865,098 824,776 ----------- ----------- ----------- ----------- Income (loss) before taxes ............... (37,518) (5,088) (39,160) 14,739 Income tax expense (benefit) ............. 404 (1,236) 273 14,168 ----------- ----------- ----------- ----------- Income (loss) before cumulative effect of change in accounting principle ......... (37,922) (3,852) (39,433) 571 ----------- ----------- ----------- ----------- Cumulative effect of change in accounting principle ----------- ----------- ----------- ----------- Net income (loss) ........................ $ (37,922) $ (3,852) $ (39,433) $ 571 =========== =========== =========== =========== Balance Sheet Data (at end of period): Cash ................................... $ 37,605 $ 43,756 $ 37,605 $ 43,756 Working capital ........................ 189,791 166,872 189,791 166,872 Total assets ........................... 1,843,256 1,955,166 1,843,256 1,955,166 Long-term debt ......................... 1,226,030 1,122,735 1,226,030 1,122,735 Total debt ............................. 1,238,451 1,234,978 1,238,451 1,234,978 Stockholder's equity ................... 253,123 367,995 253,123 367,955 Supplemental Data: EBITDA(d) .............................. $ 7,644 $ 41,323 $ 51,093 $ 105,757 EBITDA as a % of net revenues .......... 1.8% 9.8% 6.2% 12.6% Adjusted EBITDA(e) ..................... $ 53,644 $ 74,358 $ 97,093 $ 151,642 Adjusted EBITDA as a % of net revenues ......................... 12.6% 17.6% 11.8% 18.1%
(Footnotes on page 39) 37
Year Ended December 31, ------------------------------------------------------------------------------ 1995 1994(a) 1993 1992 1991 ---------------- ---------------- ---------------- ---------------- ---------- Statement of Operations Data: Net revenues ........................... $ 1,629,388 $ 1,633,699 $ 1,416,338 $ 1,228,964 $ 941,116 Costs and expenses: Cost of services ..................... 980,232 969,844 805,729 657,354 553,810 Selling, general and administrative .. 523,271(b) 411,939 363,579 334,665 193,934 Provision for restructuring and other special charges(c) ............ 50,560 79,814 99,600 13,000 Interest expense, net ................ 82,016 63,295 41,898 31,775 14,205 Amortization of intangible assets .... 44,656 42,588 28,421 21,359 16,556 Other, net ........................... 6,221 3,464 6,423 16,300 6,636 ----------- ----------- ----------- ----------- ----------- Total .............................. 1,686,956 1,570,944 1,345,650 1,074,453 785,141 ----------- ----------- ----------- ----------- ----------- Income (loss) before taxes ............. (57,568) 62,755 70,688 154,511 155,975 Income tax expense (benefit) ........... (5,516) 34,410 25,929 52,115 52,128 ----------- ----------- ----------- ----------- ----------- Income (loss) before cumulative effect of change in accounting principle ....... (52,052) 28,345 44,759 102,396 103,847 Cumulative effect of change in accounting principle ................. (10,562) ----------- ----------- ----------- ----------- ----------- Net income (loss) ...................... $ (52,052) $ 28,345 $ 34,197 $ 102,396 $ 103,847 =========== =========== =========== =========== =========== Balance Sheet Data (at end of period): Cash ................................. $ 36,446 $ 38,719 $ 39,410 $ 20,528 $ 24,068 Working capital ...................... 200,740 214,358 139,771 161,759 126,406 Total assets ......................... 1,853,385 1,882,663 1,861,162 1,024,806 764,087 Long-term debt ....................... 1,195,566 1,153,054 1,025,787 431,624 270,682 Total debt ........................... 1,207,714 1,165,626 1,123,307 474,175 287,973 Stockholder's equity ................. 295,801 386,812 395,509 408,149 291,973 Supplemental Data: EBITDA(d) ............................ $ 125,961(b) $ 215,567 $ 179,065 $ 242,527 $ 213,593 EBITDA as a % of net revenues ........ 7.7% 13.2% 12.6% 19.7% 22.7% Adjusted EBITDA(e) ................... $ 176,521(b) $ 295,381 $ 278,665 $ 255,527 $ 213,593 Adjusted EBITDA as a % of net revenues ....................... 10.8% 18.1% 19.7% 20.8% 22.7%
(Footnotes on page 39) 38 (Footnotes for preceding pages) (a) In August 1993, CCL acquired Damon, a national clinical-testing laboratory with approximately $280 million in annualized revenues, excluding Damon's California-based laboratories, which were sold in April 1994. In November 1993, CCL acquired certain clinical-testing laboratories of Unilab, with approximately $90 million in annualized revenues. The Damon and Unilab acquisitions were accounted for as purchases. CCL acquired MML, Nichols Institute and Bioran in June, August and October 1994, respectively, and accounted for these acquisitions as poolings of interest. Results presented include the results of CCL, MML, Nichols Institute and Bioran on a pooled basis. The increase in 1994 net revenues compared to 1993 net revenues was primarily due to the Damon and Unilab acquisitions. (b) Includes a third quarter 1995 charge of $62.0 million to increase the reserve for doubtful accounts and allowances resulting from billing systems implementation and integration problems at certain laboratories and increased regulatory requirements. (c) Provision for restructuring and other special charges includes charges for restructurings primarily for work force reduction programs, the write-off of fixed assets and the costs of exiting a number of leased facilities. Other special charges is primarily comprised of settlement reserves for claims related to billing practices. See Note 5 to the Audited CCL Financial Statements and Note 2 to the CCL Interim Financial Statements. (d) EBITDA represents income (loss) before income taxes plus net interest expense, depreciation and amortization. EBITDA is presented because management believes it is a widely accepted financial indicator of a company's ability to service and incur debt. EBITDA does not represent net income or cash flows from operations as those terms are defined by generally accepted accounting principles and does not necessarily indicate whether cash flows will be sufficient to fund cash needs or service debt. (e) Adjusted EBITDA represents income (loss) before income taxes plus net interest expense, depreciation and amortization and restructuring and other special charges, but does not include any adjustment relating to the levels of bad debt expense. Adjusted EBITDA is presented because management believes it is an accepted financial indicator of a company's ability to service and incur debt. Adjusted EBITDA does not represent net income or cash flows from operations as those terms are defined by generally accepted accounting principles and does not necessarily indicate whether cash flows will be sufficient to fund cash needs or service debt. 39 PRO FORMA FINANCIAL INFORMATION OF CCL The unaudited pro forma combined statements of operations for the three and six months ended June 30, 1996 and for the year ended December 31, 1995 present the results of operations of CCL assuming that the Distributions and the CCL Accounting Policy Change had been completed as of January 1, 1995. The unaudited pro forma combined balance sheet as of June 30, 1996 presents the combined financial position of CCL assuming that the Distributions and the CCL Accounting Policy Change had been completed on that date. In the opinion of CCL management, the CCL Pro Forma Financial Information includes all material adjustments necessary to restate CCL's historical results. The adjustments required to reflect such assumptions are described in the Notes to the CCL Pro Forma Financial Information and are set forth in the "Pro Forma Adjustments" column. The CCL Pro Forma Financial Information should be read in conjunction with the CCL Financial Statements and notes thereto included elsewhere herein. The CCL Pro Forma Financial Information presented is for informational purposes only and may not necessarily reflect the future results of operations or financial position or what the results of operations or financial position would have been had the Distributions and the CCL Accounting Policy Change occurred as assumed herein, or had CCL been operated as an independent company during the periods shown. 40 CORNING CLINICAL LABORATORIES INC. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS Three Months Ended June 30, 1996
Pro Forma Historical Adjustments Pro Forma ---------- ----------- --------- (in thousands, except share and per share data) Net revenues .......................... $ 424,543 $ $ 424,543 Costs and expenses Cost of services .................... 266,301 266,301 Selling, general and administrative.. 120,205 800(a) 121,005 Provision for restructuring and other special charges ............. 46,000 46,000 Interest expense, net ............... 19,879 (7,610)(b) 12,269 Amortization of intangible assets ... 10,655 (2,656)(c) 7,999 Other, net .......................... (979) (979) ------------ ------------ ------------ Loss before taxes ..................... (37,518) 9,466 (28,052) Income tax (benefit) provision ........ 404 2,690(d) 3,094 ------------ ------------ ------------ Net income (loss) ..................... $ (37,922) $ 6,776 $ (31,146) ============ ============ ============ Pro forma shares outstanding .......... 28,856,932(e) ============ Pro forma net loss per share .......... $ (1.08)(f) ============
The accompanying notes to unaudited pro forma combined financial information are an integral part hereof. 41 CORNING CLINICAL LABORATORIES INC. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS Six Months Ended June 30, 1996
Pro Forma Historical Adjustments Pro Forma ---------- ----------- --------- (in thousands, except share and per share data) Net revenues ............................ $ 825,938 $ $ 825,938 Costs and expenses Cost of services ...................... 513,419 513,419 Selling, general and administrative.... 246,249 1,600(a) 247,849 Provision for restructuring and other special charges ............... 46,000 46,000 Interest expense, net ................. 40,021 (15,272)(b) 24,749 Amortization of intangible assets ..... 21,444 (5,313)(c) 16,131 Other, net ............................ (2,035) (2,035) ------------ ------------ ------------ Loss before taxes ....................... (39,160) 18,985 (20,175) Income tax (benefit) provision .......... 273 5,400(d) 5,673 ------------ ------------ ------------ Net income (loss) ....................... $ (39,433) $ 13,585 $ (25,848) ============ ============ ============ Pro forma shares outstanding ............ 28,856,932(e) ============ Pro forma net loss per share ............ $ (0.90)(f) ============
The accompanying notes to unaudited pro forma combined financial information are an integral part hereof. 42 CORNING CLINICAL LABORATORIES INC. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS Year Ended December 31, 1995
Pro Forma Historical Adjustments Pro Forma ---------- ----------- --------- (in thousands, except share and per share data) Net revenues ............................ $ 1,629,388 $ $ 1,629,388 Costs and expenses Cost of services ...................... 980,232 980,232 Selling, general and administrative.... 523,271 3,200(a) 526,471 Provision for restructuring and other special charges ........... 50,560 50,560 Interest expense, net ................. 82,016 (31,268)(b) 50,748 Amortization of intangible assets ..... 44,656 (10,625)(c) 34,031 Other, net ............................ 6,221 6,221 ------------ ------------ ------------ Loss before taxes ....................... (57,568) 38,693 (18,875) Income tax (benefit) provision .......... (5,516) 11,087(d) 5,571 ------------ ------------ ------------ Net income (loss) ....................... $ (52,052) $ 27,606 $ (24,446) ============ ============ ============ Pro forma shares outstanding ............ 28,856,932(e) ============ Pro forma net loss per share ............ $ (0.85)(f) ============
The accompanying notes to unaudited pro forma combined financial information are an integral part hereof. 43 CORNING CLINICAL LABORATORIES INC. UNAUDITED PRO FORMA COMBINED BALANCE SHEET June 30, 1996
Pro Forma Historical Adjustments Pro Forma ---------- ----------- --------- (in thousands) Assets Current Assets: Cash and cash equivalents ............... $ 37,605 $ $ 37,605 Accounts receivable ..................... 321,212 321,212 Inventories ............................. 25,855 25,855 Deferred taxes on income ................ 91,829 91,829 Prepaid expenses and other assets ....... 18,883 18,883 ----------- ----------- Total current assets .................... 495,384 495,384 ----------- ----------- Property, plant and equipment, net ....... 306,497 306,497 Intangible assets, net ................... 1,011,507 (425,000)(g) 586,507 Other assets ............................. 29,868 29,868 ----------- ----------- ----------- Total Assets ............................. $ 1,843,256 $ (425,000) $ 1,418,256 =========== =========== =========== Liabilities and Stockholder's Equity Current Liabilities: Accounts payable and accrued expenses... $ 252,483 $ 9,000(h) $ 261,483 Current portion of long-term debt ...... 12,421 (10,000)(i) 2,421 Income taxes payable ................... 28,503 (19,643)(h,i) 8,860 Due to Corning Incorporated and affiliates ........................... 12,186 (12,186)(i) ----------- ----------- ----------- Total current liabilities .............. 305,593 (32,829) 272,764 ----------- ----------- ----------- Long-term debt, third-party .............. 15,557 500,000(i) 515,557 Payable to Corning ....................... 1,210,473 (1,210,473)(i,j) Other liabilities ........................ 58,510 58,510 ----------- ----------- ----------- Total liabilities ...................... 1,590,133 (743,302) 846,831 ----------- ----------- ----------- Stockholder's Equity: Contributed capital .................... 297,823 756,541(h,j) 1,054,364 Accumulated deficit .................... (43,722) (438,239)(g,h) (481,961) Cumulative translation adjustment ...... 1,741 1,741 Market valuation adjustment ............ (2,719) (2,719) ----------- ----------- ----------- Total stockholder's equity ............. 253,123 318,302 571,425 ----------- ----------- ----------- Total Liabilities and Stockholder's Equity $ 1,843,256 $ (425,000) $ 1,418,256 =========== =========== ===========
The accompanying notes to unaudited pro forma combined financial information are an integral part hereof. 44 CORNING CLINICAL LABORATORIES INC. NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION Statements of Operations (a) The pro forma adjustment to selling, general and administrative expense represents incremental estimated overhead costs associated with being a publicly traded company. (b) The pro forma adjustment to interest expense, net represents the difference between historical intercompany interest expense and interest expense on the third party debt to be incurred in connection with the CCL Spin-Off Distribution. CCL will borrow, immediately prior to the CCL Spin-Off Distribution, approximately $500 million in long-term debt to repay Corning for certain intercompany borrowings. The debt is assumed to consist of $300 million of CCL Credit Facility borrowings and $200 million of Notes to be issued under the CCL Notes Offering. The assumed interest rates on these new borrowings are 7.50% and 11.25% for the CCL Credit Facility and the Notes, respectively. If the interest rate on the CCL Credit Facility fluctuates by 1/8%, interest expense fluctuates by approximately $400,000 annually. Depending on market conditions at the time of the CCL Notes Offering and the consummation of the CCL Credit Facility, the total combined debt amount, the interest rates, and the amounts of each of the CCL Credit Facility and the Notes may vary from that indicated herein. (c) The pro forma adjustment to amortization of intangible assets represents the estimated reduction of amortization expense due to the CCL Accounting Policy Change. CCL management estimates that the reduction of amortization expense will approximate between $10.0 million and $11.3 million annually and $2.5 million and $2.8 million quarterly. The midpoint of the range has been utilized for the preparation of the Unaudited Pro Forma Combined Statements of Operations. (d) The pro forma adjustment to income tax (benefit) provision represents the estimated income tax expense of pro forma adjustments (a) and (b) at the incremental tax rate of 39.5%. Pro forma adjustment (c) will not impact income taxes as the amortization is not deductible for tax purposes. (e) The pro forma common shares outstanding represents CCL management's current estimate of the number of shares to be outstanding after the CCL Spin-Off Distribution. Management's estimate includes (a) the issuance of approximately 27.9 million shares of CCL Common Stock at an exchange ratio of one share of CCL Common Stock issued for every eight shares of Corning Common Stock outstanding at June 30, 1996 and (b) the issuance of an estimated 900,000 shares into the employee stock ownership plan. CCL management's estimate of shares outstanding is subject to change as the result of normal issuances and repurchases of Corning Common Stock prior to the date of the CCL Spin-Off Distribution and finalization of the proposed structure of the employee stock ownership plan. (f) Pro forma net loss per share is computed by dividing net loss by the pro forma shares outstanding during each period. Common stock equivalents are not included in the loss per share computation because they do not result in material dilution. Historical net loss per share data is not presented as CCL's historical capital structure is not comparable to periods subsequent to the CCL Spin-Off Distribution. Balance Sheet (g) The pro forma adjustment to intangible assets, net and accumulated deficit ($425 million) represents the estimated impact of the CCL Accounting Policy Change. CCL management estimates the charge to 45 reduce the carrying value of intangible assets to fair value will be in the range of $400 million to $450 million. The midpoint of the range has been utilized for the preparation of the Unaudited Pro Forma Combined Balance Sheet. This charge has not been reflected in the Unaudited Pro Forma Combined Statements of Operations because it is non-recurring. (h) The pro forma adjustment to accounts payable and accrued expenses, income taxes payable ($7.0 million), contributed capital ($11.2 million) and accumulated deficit ($13.2 million) represents costs directly related to the CCL Spin-Off Distribution that CCL expects to record coincident with the CCL Spin-Off Distribution. These costs, which are estimated to be $20.2 million ($13.2 million after tax), include $11.2 million related to the establishment of an employee stock ownership plan. This amount is subject to change based on the market price of the CCL Common Stock on the Distribution Date. Such costs have not been reflected in the Unaudited Pro Forma Combined Statements of Operations because they are non-recurring. (i) The pro forma adjustment to current portion of long-term debt, income taxes payable ($12.6 million), due to Corning Incorporated and affiliates, long-term debt third party and payable to Corning ($465 million) reflects borrowings by CCL, immediately prior to the CCL Spin-Off Distribution, to repay Corning for certain income tax liabilities and intercompany borrowings. The debt is assumed to consist of $300 million of bank borrowings under the CCL Credit Facility and $200 million of Notes to be issued under the CCL Notes Offering. (j) The pro forma adjustment to payable to Corning and contributed capital of approximately $745 million reflects Corning's capital contribution to CCL of the remaining intercompany borrowings. 46 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CCL Overview In the last several years, CCL's business has been affected by significant government regulation, price competition and rapid change resulting from payors' efforts to control cost, utilization and delivery of health care services. As a result of these factors, CCL's profitability has been impacted by changes in the volume of testing, the prices and costs of its services, the mix of payors and the level of bad debt expense. Payments for clinical laboratory services are made by government, managed care organizations, insurance companies, physicians and patients. Increased government regulation focusing on health care cost containment has reduced prices and added costs for the clinical laboratory industry by increasing complexity and adding new regulatory requirements. Also, in recent years there has been a significant shift away from traditional fee-for-service health care to managed health care, as employers and other payors of health care costs aggressively move the populations they control into lower cost plans. Managed care organizations typically negotiate capitated payment contracts whereby CCL receives a fixed monthly fee per covered individual for all services included under the contract. Capitated contract arrangements shift the risks of additional routine testing beyond that covered by the capitated payment to the clinical laboratory. The managed care industry is growing as well as undergoing rapid consolidation which has created large managed care companies that control the delivery of health care services for millions of people, and have significant bargaining power in negotiating fees with providers, including clinical laboratories. These market factors have had a significant adverse impact on prices in the clinical laboratory industry, and are major contributors to CCL's decline in profitability over the last two years. This growth of managed care and use of capitated agreements are expected to continue for the foreseeable future. See "Business of CCL--Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business." A substantial portion of CCL's growth has come from acquisitions in the last four years. The largest of these acquisitions were the purchases of Damon and certain operations of Unilab in 1993 and the acquisitions of MML, Nichols Institute and Bioran in 1994. As a result of these acquisitions, CCL has recorded a number of special charges for restructuring and integration costs since 1993. See Note 5 to the Audited CCL Financial Statements. The MML, Nichols Institute and Bioran transactions were accounted for as poolings of interests. The accompanying financial statements of CCL have been restated to include the results of operations of these pooled entities on a combined basis for all periods presented. The results of operations for Damon and Unilab, as well as all other acquisitions accounted for as purchases, have been included since their respective dates of acquisition. Acquisitions accounted for as purchases have generated large amounts of goodwill which are not deductible for tax purposes, giving rise to a high effective income tax rate and increased sensitivity of the income tax rate to changes in pre-tax income. See Note 3 to the Audited CCL Financial Statements. The clinical laboratory industry is subject to seasonal fluctuations in operating results. CCL's cash flows are influenced by seasonal factors. During the summer months, year-end holiday periods and other major holidays, volume of testing declines, reducing net revenues and resulting cash flows below annual averages during the third and fourth quarters of the year. Winter months are also subject to declines in testing volume due to inclement weather, which varies in severity from year to year. The clinical laboratory industry is labor intensive. Approximately half of CCL's total costs and expenses are associated with employee compensation and benefits. Cost of services, which have approximated sixty percent of net revenues over the past several years, consists principally of costs for obtaining, transporting and testing 47 specimens. Selling, general and administrative expenses consist principally of the cost of the sales force, billing operations (including bad debt expense), and general management and administrative support. Results of Operations Three Months Ended June 30, 1996 Compared with Three Months Ended June 30, 1995. Earnings for the second quarter of 1996 were significantly below those for the prior year due principally to price declines and the impact of special charges. Growth in base volume partially offset these factors. Net Revenues Net revenues increased by $2.7 million, or less than 1%, over the three months ended June 30, 1995 due to increased revenues from CCL's nonclinical testing businesses. Volume of clinical testing increased by 1.5% but was offset by average price declines of 3.6%. The majority of the price decline resulted from changes in reimbursement policies of various third-party payors, shifts in volume to lower-priced managed care business and intense price competition in the industry. Also contributing to the price decline was a reduction in Medicare fee schedules effective January 1, 1996, which accounted for approximately a 1% decrease in net revenues. Costs and Expenses Cost of services increased by $20.2 million from the prior period and as a percentage of net revenues increased to 62.7% in 1996 from 58.3% in 1995. These increases were due principally to the effects of declining prices and increases in salaries and wages associated with improving customer service levels and wage adjustments. Selling, general and administrative expense increased by $5.9 million from the prior period and as a percentage of revenues increased to 28.3% in 1996 from 27.1% in 1995. These increases were due principally to an increase in bad debt expense, which increased by $0.6 million, from $23.0 million to $23.6 million, and as a percentage of net revenues increased from 5.4% to 5.6%, and costs associated with developing and implementing strategic action plans and operating improvement plans. Rigorous programs implemented during the fourth quarter of 1995 to improve the effectiveness of CCL's billing and collection operations are expected to lower bad debt expense below the prior year level during the second half of 1996.* However, the expected decrease in the amount of bad debt expenses is anticipated to be partially offset by the costs of complying with additional requirements to provide documentation of the "medical necessity" of testing. See "Business of CCL -- Billings." Adjusted EBITDA, which represents income (loss) before income taxes plus net interest expense, depreciation and amortization and restructuring and other special charges, for the second quarter of 1996 was $53.6 million, or 12.6% of net revenues. Adjusted EBITDA in the prior year period was $74.4 million, or 17.6% of net revenues. The decline in Adjusted EBITDA is principally due to an increase in cost of services (which increased $20.2 million) and an increase in selling, general and administrative expense (which increased $5.9 million), partially offset by an increase in net revenues of $2.7 million. In the second quarter of 1996, as a consequence of an investigation begun in 1993, the Department of Justice ("DOJ") notified CCL that it has taken issue with payments related to certain tests received by Damon from federally funded health care programs prior to the acquisition of Damon by CCL. CCL management has met with the DOJ several times to evaluate the substance of the government's allegations. A special charge of $46.0 million was recorded in the second quarter of 1996 to establish additional reserves equal to management's estimate of the - -------- * This is a forward looking statement. See "Business of CCL--Cautionary Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995." In particular see (c), (d), (i) and (j). 48 low end of the range of potential amounts which could be required to satisfy the government's claims. See Note 2 to the CCL Interim Financial Statements. In the second quarter of 1995, CCL recorded a provision for restructuring totalling $33 million primarily for work force reduction programs and the costs of exiting a number of leased facilities. Net interest expense declined from the prior year's level due to lower average borrowings during 1996. Amortization of intangible assets decreased below the prior year's level due to certain intangible assets having been fully amortized. A gain on the partial sale of an investment in 1996 accounted for the majority of the change in "other, net" compared to the prior year. CCL's effective tax rate is significantly impacted by goodwill amortization which is not deductible for tax purposes and which had the effect of decreasing the tax benefit rate for the second quarter of 1996. Six Months Ended June 30, 1996 Compared with Six Months Ended June 30, 1995. Earnings were substantially below those for the prior year due principally to price declines, increases in salaries and wages, higher bad debt expense, and unusually severe winter weather experienced during the first quarter of 1996. Net Revenues Net revenues decreased by $13.6 million, or 1.6%, from the prior period, principally due to average price declines of approximately 4%, partially offset by an increase in clinical testing of 1%. Adversely affecting the volume growth was unusually severe winter weather in the northeastern and central parts of the United States during the first quarter of 1996. The majority of the price declines resulted from changes in reimbursement policies of various third-party payors, shifts in volume to lower-priced managed care business, and intense price competition in the industry. Also contributing to the price declines was a reduction in Medicare fee schedules effective January 1, 1996, which accounted for approximately a 1% decrease in net revenues. Costs and Expenses Cost of services increased by $18.3 million from the prior period and as a percentage of net revenues increased to 62.2% in 1996 from 59.0% in 1995. These increases were due principally to the effects of declining prices and increases in salaries and wages associated with improving customer service levels and wage adjustments. Selling, general and administrative expense increased by $28.0 million from the prior period and as a percentage of net revenues increased to 29.8% in 1996 from 26.0% in 1995. These increases were due principally to an increase in bad debt expense, which increased, by $9.9 million, from $41.5 million to $51.4 million, and from 4.9% of net revenues to 6.2% of net revenues, and costs associated with developing and implementing strategic action plans and operating improvement plans. Rigorous programs implemented during the fourth quarter of 1995 to improve the effectiveness of CCL's billing and collection operations are expected to lower bad debt expense below the prior year level during the second half of 1996.* However, the expected decrease in the amount of bad debt expense is anticipated to be partially offset by the costs of complying with additional payor requirements to provide documentation of the "medical necessity" of testing. Adjusted EBITDA for the six months ended June 30, 1996 was $97.1 million, or 11.8% of net revenues. Adjusted EBITDA in the prior year period was $151.6 million, or 18.1% of net revenues. The decline in Adjusted - -------- * This is a forward looking statement. See "Business of CCL--Cautionary Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995." In particular see (c), (d), (i) and (j). 49 EBITDA is principally due to an increase in cost of services (which increased $18.3 million) and an increase in selling, general and administrative expense (which increased $28.0 million). In the second quarter of 1996, as a consequence of an investigation begun in 1993, the DOJ notified CCL that it has taken issue with payments related to certain tests received by Damon from federally funded health care programs prior to the acquisition of Damon by CCL. CCL management has met with the DOJ several times to evaluate the substance of the government's allegations. A special charge of $46.0 million was recorded in the second quarter of 1996 to establish additional reserves equal to management's estimate of the low end of the range of potential amounts which could be required to satisfy the government's claims. See Note 2 to the CCL Interim Financial Statements. In the second quarter of 1995, CCL recorded a provision for restructuring totalling $33 million primarily for work force reduction programs and the costs of exiting a number of leased facilities. Additionally, in the first quarter of 1995 CCL recorded a special charge of $12.8 million for the settlement of claims related to the inadvertent billing errors of certain laboratory tests that were not completely and/or successfully performed or reported due to insufficient samples and/or invalid results. Net interest expense remained relatively unchanged from the prior year level. Amortization of intangible assets decreased below the prior year level due to certain intangible assets having been fully amortized. A gain on the partial sale of an investment and the favorable settlement of a contractual obligation, both of which occurred in 1996, accounted for the majority of the change in "other, net" compared to the prior year. CCL's effective tax rate is significantly impacted by goodwill amortization which is not deductible for tax purposes. This had the effect of reducing the tax benefit rate of CCL in 1996 while increasing the overall tax rate in 1995. The effect of this non-deductibility is particularly apparent when amortization increases in proportion to pre-tax earnings, as was the case in 1995. Year Ended December 31, 1995 Compared with Year Ended December 31, 1994. Earnings for 1995 were significantly below those for the prior year as a result of price declines, higher bad debt expense, and the impact of restructuring and other special charges. The 1995 bad debt expense included a $62.0 million charge to increase accounts receivable reserves in the third quarter. Net Revenues Net revenues of $1.6 billion in fiscal 1995 remained essentially unchanged from the prior year. Average price declines, estimated to be 3.7%, were offset by estimated growth of approximately 4% in requisition volume. The majority of the price declines resulted from changes in reimbursement policies of various third-party payors, an accelerated shift in volume to lower-priced managed care business, and intense price competition in the industry. Also contributing to the price declines was a reduction in Medicare fee schedules effective January 1, 1995 which accounted for approximately a 1% decrease in net revenues. Costs and Expenses Cost of services increased $10.4 million from 1994 and as a percentage of net revenues increased to 60.2% in 1995 from 59.4% in 1994. These increases were due principally to the impact of price declines and the added cost of doing business in an increasingly complex environment. Partially offsetting these factors were synergies realized from integration of acquisitions. Selling, general and administrative expense increased $111.3 million from 1994 and as a percentage of net revenues increased to 32.1% in 1995 from 25.2% in 1994. These increases resulted primarily from a higher level of bad debt expense, which included a charge of $62.0 million to increase receivables reserves. Bad debt expense increased to 9.4% of net revenues in 1995 from 3.6% in 1994, as a result of the $62.0 million charge and an increase in bad debt expense in the fourth quarter of 1995. Excluding bad debt expense, selling, general and 50 administrative expenses as a percentage of net revenues were approximately 22.7% as compared to 21.6% in 1994. The $62.0 million charge was attributable to integration problems at certain laboratories, the cost of compliance with increased regulatory requirements and a failed billing system implementation at CCL's largest facility in Teterboro, New Jersey. All of these factors contributed to a significant growth in the backlog of unbilled receivables, which caused the deterioration in the collection of receivables during the third quarter of 1995. In addition to the $62.0 million charge, the accrual rate for bad debt expense was increased to 6.4% of net revenues after the charge from 5.0% of net revenues prior to the charge. CCL has put in place a rigorous program to improve the effectiveness of its billing and collection operations which it expects will reduce bad debt expense below the 1995 levels during the second half of 1996.* Additionally, CCL has stabilized the current billing system in Teterboro. See "Business of CCL--Information Systems" and "Business of CCL--Billings." However, the expected decrease in the level of bad debt expenses is expected to be partially offset by the increased cost of complying with additional payor requirements to provide documentation of the "medical necessity" of testing. Adjusted EBITDA for 1995 was $176.5 million, or 10.8% of net revenues. Adjusted EBITDA for the prior year period was $295.4 million, or 18.1% of net revenues. The decline in Adjusted EBITDA is principally due to an increase in cost of services (which increased $10.4 million) and an increase in selling, general and administrative expense (which increased $111.3 million). In the second quarter of 1995, CCL recorded a provision for restructuring totalling $33.0 million, consisting primarily of costs for work force reduction programs and exiting a number of leased facilities. In the first quarter of 1995, CCL recorded a special charge of $12.8 million for the settlement of claims related to inadvertent billing errors of certain laboratory tests that were not completely and/or successfully performed or reported due to insufficient samples and/or invalid results. In the third quarter of 1994, CCL recorded a provision for restructuring and other special charges totalling $79.8 million which included $48.2 million of integration costs, $21.6 million of transaction expenses, and $10.0 million of other reserves primarily related to the Nichols Institute, MML and Bioran acquisitions. See Note 5 to the Audited CCL Financial Statements. Net interest expense increased by $18.7 million over the 1994 level due to an increase in average debt levels, resulting principally from funding investing activities and cash requirements associated with restructuring and other special charges. Amortization expense increased principally due to additional intangible assets arising from acquisitions completed in 1994 and 1995. CCL's effective tax rate is significantly impacted by goodwill amortization which is not deductible for tax purposes. This had the effect of reducing the tax benefit rate to CCL in 1995 while increasing the overall tax rate in 1994. See Note 4 to the Audited CCL Financial Statements. Year Ended December 31, 1994 Compared with Year Ended December 31, 1993. Earnings for 1994 were below those for the prior year due principally to price declines, which outpaced the cost efficiencies realized from the integration of acquisitions and other activities to reduce costs. Net Revenues Net revenues increased by $217.4 million, or 15.3%, over the prior year, due principally to the net impact of acquisitions and dispositions which increased net revenues by approximately $240 million. The net effect of average price declines, estimated at 4%, offset by an increase in requisition volume, estimated at 3%, accounted for the remaining change in net revenues. The majority of the price declines resulted from a shift in volume to - -------- * This is a forward looking statement. See "Business of CCL--Cautionary Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995." In particular see (c), (d), (i) and (j). 51 lower-priced managed care business, changes in reimbursement policies of various third-party payors, and intense price competition. Also contributing to the price declines was a reduction in Medicare fee schedules effective January 1, 1994 which accounted for approximately a 1% decrease in net revenues. Costs and Expenses Cost of services increased $164.1 million over 1993 and as a percentage of net revenues increased to 59.4% in 1994 from 56.9% in 1993. These increases were due principally to the impact of price declines and the added cost of doing business in an increasingly complex environment. Partially offsetting these factors were synergies realized from integration of acquisitions. Selling, general and administrative expense increased $48.4 million over 1993 and as a percentage of net revenues decreased slightly from 25.7% in the prior year to 25.2%. Synergies associated with merging the sales and administrative functions of acquired entities with those of CCL were partially offset by an increase in bad debt expense, which increased by $12.3 million, from $47.2 million to $59.5 million, and increased from 3.3% of net revenues in 1993 to 3.6% in 1994. Adjusted EBITDA for 1994 was $295.4 million, or 18.1% of net revenues. Adusted EBITDA in the prior year period was $278.7 million, or 19.7% of net revenues. The increase in Adjusted EBITDA is principally due to an increase in revenues (which increased $217.4 million), partially offset by an increase in cost of services (which increased $164.1 million) and an increase in selling, general and administrative expenses (which increased $48.4 million). In the third quarter of 1994, CCL recorded a provision for restructuring and other special charges totalling $79.8 million, which included $48.2 million of integration costs, $21.6 million of transaction expenses, and $10.0 million of other reserves primarily related to the Nichols Institute, MML and Bioran acquisitions. Integration costs represented the expected costs for closing clinical laboratories in certain markets where duplicate CCL and Nichols Institute, MML or Bioran facilities existed at the time of the acquisitions. In the third quarter of 1993, CCL recorded a provision for restructuring costs and other special charges totalling $99.6 million. The restructuring component of this special charge aggregated $56.6 million related principally to the integration of CCL's operations with those acquired in the Damon acquisition. The special charge consisted primarily of a $36.5 million charge to reflect the settlement and related legal expenses associated with a compromise agreement with the DOJ to settle claims brought on behalf of the OIG. In making the settlement, CCL did not admit any wrongdoing in connection with its marketing or business practices. See "--DOJ Investigations," "Business of CCL--OIG Investigations" and Note 5 to the Audited CCL Financial Statements. Net interest expense increased by $21.4 million over the prior year, due principally to increased borrowings associated with financing acquisitions and, to a lesser degree, increased borrowing rates. Amortization of intangibles increased due to additional intangible assets arising from acquisitions completed in 1993 and 1994. CCL's effective tax rate is significantly impacted by goodwill amortization which is not deductible for tax purposes, and has the effect of increasing the overall tax rate, particularly when amortization increases in proportion to pre-tax earnings. This situation was the principal contributor to the increase in the 1994 effective tax rate over the prior year. See Note 4 to the Audited CCL Financial Statements. Liquidity and Capital Resources After the Distributions Concurrently with the CCL Spin-Off Distribution, CCL's debt will be restructured and equity recapitalized. CCL plans to complete the CCL Notes Offering of approximately $200 million principal amount of Notes, and incur 52 approximately $300 million of borrowings under the CCL Credit Facility. The proceeds from these borrowings will be used to repay amounts owed to Corning. Any amounts owed to Corning in excess of the proceeds from these borrowings will be contributed by Corning to CCL's capital. As a result of these actions, management estimates that CCL's debt will be reduced by approximately $720 million to approximately $515 million, and annual interest expense will be reduced by approximately $31 million. The CCL Credit Facility will include a revolving credit facility of $100 million to $150 million, all of which is expected to be available for borrowing at the time of the Distributions. CCL estimates that it will invest approximately $40 million during the second half of 1996 for capital expenditures, principally related to facility upgrades and investments in information technology. Capital expenditures in 1997 are estimated to be approximately $95 million. CCL expects to expand its operations principally through internal growth and accelerated growth in strategic markets and related lines of business. CCL expects such activities will be funded from existing cash and cash equivalents, cash flow from operations, and borrowings under the revolving credit facility. CCL does not anticipate paying dividends in the foreseeable future. As a result, CCL believes it has sufficient financial flexibility and sufficient access to funds to meet seasonal working capital requirements, capital expenditures and growth opportunities. Coincident with the Distributions, CCL plans to record a non-recurring charge of approximately $20 million associated with the Distributions. The largest component of the charge will be the cost of establishing an employee stock ownership plan. The remainder of the charge will consist principally of the costs for advisors and other fees associated with establishing CCL as a separate publicly traded entity. The amount of the charge is subject to change based on the price of the CCL Common Stock on the Distribution Date. Although CCL has no present acquisition agreements or arrangements, there may be acquisitions or other growth opportunities which will require additional external financing, and CCL may from time to time seek to obtain funds from public or private issuances of equity or debt securities. There can be no assurance that such financing will be available on terms acceptable to CCL. See "Risk Factors - Risks Relating to CCL - Potential Liability under the Spin-Off Tax Indemnification Agreements." CCL management believes that the recapitalization of CCL and the indemnification by Corning against monetary fines, penalties or losses from outstanding government claims, together with the successful implementation of its business strategy, will generate more predictable and improved cash flows. Additionally, CCL management believes that these actions, together with CCL's leading market position or low cost provider status in a number of geographic regions accounting for the majority of its net revenues, will aid CCL in meeting the ongoing challenges in the clinical laboratory industry brought on by growth in managed care and increased regulatory complexity. The immediately preceding paragraph includes forward-looking statements which involve risks and uncertainties. CCL's actual performance may differ materially from that discussed above. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors" as well as future events that have the effect of reducing CCL's available cash flows, such as unexpected operating losses, restructuring activities and cash payments or losses of revenues related to settlement of claims by non-governmental entities that arise out of the governmental investigations or other claims which are instituted after the Distributions (which are not covered by Corning's indemnity). Prior to the Distributions Historically, CCL has financed its operations and growth with cash flow from operations, borrowings from Corning, and stock issued by Corning to finance certain acquisitions on behalf of CCL. Investing activities have included business acquisitions and capital expenditures for facility expansions and upgrades and information systems improvements. Replacement of laboratory equipment has typically been financed through operating leases. 53 Net cash provided by operating activities for the six months ended June 30, 1996 exceeded the level for the comparable period of the prior year, despite reduced earnings, as a result of an improved collection rate of accounts receivable and a reduction in restructuring spending. This improvement in accounts receivable is a direct result of specific programs initiated in the fourth quarter of 1995 to improve billing operations. Although these programs are continuing, additional requirements of customers to provide documentation of the "medical necessity" of testing are expected to increase receivable levels in the future. The number of days sales outstanding in accounts receivable ("DSOs") for the clinical testing business is one measure used by CCL to monitor the effectiveness of its billing operations. DSOs were 72 days at June 30, 1996, 74 days at December 31, 1995, 81 days at December 31, 1994, and 90 days at December 31, 1993. Net cash provided by operating activities during 1995 increased above the prior year despite reduced earnings, due primarily to changes in accounts payable and accrued expenses and reduced spending for restructuring integration and other special charges. Net cash provided by operating activities in 1994 declined from the 1993 level principally due to larger increases in accounts receivables and higher levels of spending for restructuring, integration and other special charges during 1994. Cash used for investing activities for the six months ended June 30, 1996 was below the prior year level due to reduced acquisition activity during 1996. Investing activities during 1995, 1994 and 1993 were funded principally by cash flow from operations and borrowings from Corning, and were principally for capital expenditures and acquisitions. Cash used in investing activities in 1995 exceeded the prior year level due principally to cash proceeds generated from the sale of certain California operations in 1994. See Note 3 to the Audited CCL Financial Statements. Net cash provided by financing activities for the six months ended June 30, 1996 was below the prior year level due primarily to reduced acquisition activity during 1996. Financing activities in 1995, 1994 and 1993 consisted principally of dividend payments to and net borrowing activities with Corning. Changes in Accounting Policies Coincident with the CCL Spin-Off Distribution, CCL management will adopt a new accounting policy for evaluating the recoverability of intangible assets and measuring possible impairment under Statement of the Accounting Principles Board No. 17. Most of CCL's intangible assets resulted from purchase business combinations in 1993. Significant changes in the clinical laboratory and health care industries subsequent to 1993, including increased government regulation and movement from traditional fee-for-service care to managed cost health care, have caused the fair value of CCL's intangible assets to be significantly less than carrying value. CCL management believes that a valuation of intangible assets based on the amount for which each regional laboratory could be sold in an arms-length transaction is preferable to using projected undiscounted pre-tax cash flows. CCL believes fair value is a better indicator of the extent to which the intangible assets may be recoverable and therefore, may be impaired. This change in method of evaluating the recoverability of intangible assets will result in CCL recording a charge of between $400 million and $450 million coincident with the CCL Spin-Off Distribution to reflect the other than temporary impairment of intangible assets. This will result in a reduction of amortization expense of approximately $10 million to $11.3 million annually and $2.5 million to $2.8 million quarterly. See Note 15 to the Audited CCL Financial Statements. In October 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). This statement defines a fair value-based method of accounting for employee stock options and similar equity investments and encourages adoption of that method of accounting for employee stock compensation plans. However, it also allows entities to continue to measure compensation cost for employee stock compensation plans using the intrinsic value-based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Entities which elect to continue accounting for stock compensation plans utilizing APB 25 are required to disclose pro forma net income and earnings per share, as if the fair value-based method of accounting under SFAS 123 had been applied. CCL intends to account for stock 54 compensation plans pursuant to APB 25 and, as such, will include the pro forma disclosures required by SFAS 123 in the financial statements beginning in 1996. DOJ Investigations Corning has agreed to indemnify CCL against all monetary penalties, fines or settlements for the government claims discussed below which are pending at the Distribution Date. However, Corning will not indemnify CCL against private actions arising out of those claims or claims brought after the Distributions, even if the claims relate to events prior to the Distributions. The Corning indemnity also does not cover litigation expense, including expenses incurred by former employees. CCL believes that future settlement of these claims will not have a material adverse effect on CCL's financial condition or results of operations after the Distributions. At present, government investigations of certain practices by several clinical laboratories acquired in recent years are ongoing. These investigations may result in additional settlement payments. CCL has recorded reserves for the estimated exposure from these investigations. However, it is possible that claims could arise that could be materially in excess of amounts reserved. CCL fully expects to settle outstanding government claims prior to the Distribution Date, or, if not settled, CCL management expects to be in a position to determine a materially accurate estimate of CCL's ultimate liability for these and other similar claims. In either case, the additional charge, if any, will be recorded in CCL's statement of operations. See "Business of CCL--OIG Investigations." 55 BUSINESS OF CCL Overview CCL is one of the largest clinical laboratory testing companies in the United States, offering a broad range of routine and esoteric testing services used by the medical profession in the diagnosis, monitoring and treatment of disease and other medical conditions. CCL is the successor by merger to MetPath Inc. ("MetPath"), a New York corporation organized in 1967. Corning acquired MetPath in 1982 and in 1992 merged MetPath into CCL, which had been organized in 1990 as a holding company for the clinical laboratory testing business and contract research business. In 1994, CCL expanded its presence in the esoteric testing market through the acquisition of Nichols Institute, now known as Corning Nichols Institute ("Nichols"), which is one of the leading esoteric clinical laboratories in the world. Since its founding in 1967, CCL's clinical laboratory testing business has grown into a network of 17 regional laboratories across the United States, the Nichols esoteric testing laboratory in San Juan Capistrano, California and one branch laboratory in Mexico City. In addition, CCL has 14 smaller branch laboratories, approximately 200 "STAT" laboratories and approximately 850 patient service centers located throughout the United States. A substantial portion of this growth has resulted from acquisitions. See "--Acquisitions and Dispositions." Recent Organizational Changes Between 1990 and 1995, Corning tripled the size of its clinical laboratory testing business, principally through acquisitions. Historically, prior management pursued a strategy of growth through acquisitions, including diversification outside of the clinical laboratory testing business. As a result of difficult integrations and increased pricing pressures and regulatory complexity in the clinical testing industry, a new strategy was needed. Corning responded by appointing Kenneth Freeman, then an Executive Vice President of Corning, as President and Chief Executive Officer of CCL, who was charged with the responsibility to formulate a new strategy. Mr. Freeman has over 24 years of key financial and managerial experience at Corning, including assignments during which profitability improved at two of Corning's operations. Mr. Freeman immediately suspended CCL's acquisition program. Under his direction, CCL began to refocus on its core clinical laboratory testing business and reorganize its senior management team. As a result, CCL is implementing the best practices in each region throughout CCL; standardizing processes and systems; analyzing the cost of serving various customers; intensifying efforts to correct persistent billing errors to both enhance customer satisfaction and reduce the cost of billing operations; enhancing its compliance program to audit and correct system defaults and to better train employees in the laws and rules governing the industry; and improving communications with employees by improving systems and the kind and amount of current information available to employees. Mr. Freeman revamped the senior management team by appointing four new senior executives and changing the responsibilities of five other senior executives. Additionally, approximately one-half of the existing laboratory facility general managers were replaced. Mr. Freeman also changed the management structure, appointing three of the senior executives to newly created key positions - Douglas VanOort, who will focus exclusively on laboratory operations, Donald Hardison, who will focus on commercial activities, and Dr. Gregory Critchfield, who will lead the efforts in the science and medical areas and pursue innovations. All three report directly to Mr. Freeman. See "Management of CCL--Executive Officers." CCL believes that this new management structure will greatly enhance CCL's ability to pursue its business strategy. Mr. VanOort and the regional and facility operations leaders who report to him will focus their primary attention on laboratory operations, efficiencies and standardization. Mr. Hardison and the 56 regional and local commercial leaders who report to him will develop and coordinate national, regional and local sales and marketing efforts, and will cultivate national and regional client relationships and provider alliances. Dr. Critchfield will pursue scientific excellence in the laboratory as well as seek out, develop and assimilate those new tests and technologies that will differentiate CCL and propel its growth in the future. This three-prong management structure is designed to implement CCL's Business Strategy to make CCL the best supplier (i.e., lowest-cost, highest quality) of quality testing services; the preferred provider of fairly priced and useful health care services and information; and the industry's leading innovator of new clinical tests, methodologies and services. Business Strategy CCL's overall goal is to be recognized by its competitors, customers and employees as the best provider of comprehensive and innovative clinical testing, information and services. To achieve this, CCL has set several strategic goals and put in place organizational structures to implement them. Best Supplier. CCL seeks to be the best supplier of the highest quality and the lowest-cost testing services. Health care providers and patients expect accurate, timely and consistent laboratory test results at a fair price. o Lowest Cost Provider. Currently, approximately 28% of CCL's net revenues are from laboratories that CCL believes are the lowest-cost providers in their respective markets. CCL currently receives approximately 60 million requisitions for testing each year. Currently, CCL's average cost per requisition varies significantly among its regional laboratories: an approximately $7.00 difference in cost per requisition between the most efficient regional laboratory and the average and an approximately $13.00 difference in cost per requisition between the most and the least efficient regional laboratories. In many cases, these variations do not relate to testing volumes or mixes, space costs, service requirements or regional labor cost differences. Management is seeking to identify its best practices and implement them throughout its entire laboratory network. Standardization of equipment and supplies, as well as leveraging of CCL's purchasing power, is also part of this strategy. Management expects to achieve significant cost savings within the next three years as these programs are fully implemented, the majority of which are expected to be achieved by the end of 1998.* o Highest Quality Provider. CCL is dedicated to providing accurate and timely testing results and to being viewed by its customers as the highest quality provider of clinical testing services. CCL believes that the current quality of its customer services is comparable to its principal competitors, but believes that implementation of best practices already developed in certain regions will permit CCL to be viewed by its customers as the highest quality provider of clinical testing services. For example, as part of its best practices policy, CCL is identifying the most common service failures in each regional laboratory and establishing procedures to substantially reduce these service failures. Management believes that implementing these best practices will increase the level of - -------- * This is a forward looking statement. See "--Cautionary Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995." In particular see factors (c), (d) and (j). 57 quality while lowering costs.** Historically, CCL's experience has been that the regions with the highest quality of services have also had the lowest costs. Preferred Provider. CCL seeks to be the preferred provider of laboratory testing services to existing and new health care networks on a selective basis determined by profitability of accounts. CCL believes that it will become the preferred provider to these networks as (1) large networks typically prefer to utilize large independent clinical laboratories that can service them on a national or regional basis and (2) CCL continues to pursue its primary strategy of becoming the highest quality, lowest cost provider. To achieve this, CCL will employ a rigorous national and regional process to identify prospective customers and to efficiently allocate resources to support these efforts. CCL will also pursue innovative alliances and seek to assist its partners in achieving their business objectives. o Account Profitability. CCL intends to refocus its sales efforts on pursuing and keeping profitable accounts. CCL is engaging in an active program with current accounts, including those with managed care organizations, to evaluate their profitability and either increase pricing or eliminate accounts that cannot be serviced profitably. Throughout the independent clinical laboratory industry, there are substantial differences in pricing among, as well as the cost of serving, various categories of payors and health care providers. CCL is beginning to provide clear pricing guidelines to its sales force and changing its commission structure so that compensation is tied to the profitability of (rather than revenues from) new business. Management expects to achieve significant benefits from these programs within the next three years, the majority of which are expected to be achieved by the end of 1998.*** o Regional Profitability. CCL presently believes that it has the leading market share among independent clinical laboratories in most routine testing markets of the northeast, mid-Atlantic and midwest regions. Approximately 65% of CCL's revenues and almost all of its EBITDA is generated from markets in which CCL believes that it has the leading market share. In most of these markets, CCL believes that it also is the lowest cost provider. CCL is evaluating its strategic alternatives relative to units whose profitability does not meet its internal goals. These alternatives may include joint ventures, alliances, or dispositions. CCL believes that, while the clinical laboratory industry is becoming national in scope, CCL can subcontract with other clinical laboratories to perform testing for national accounts in any markets in which CCL chooses not to compete. CCL may also make selected local acquisitions where appropriate. Leading Innovator. CCL intends to remain a leading innovator in the clinical laboratory industry by continuing to introduce new tests, technology and services. Through its relationship with the academic community and pharmaceutical and biotechnology firms and a research and development budget exceeding $15 million per year, CCL believes it is one of the leaders in transferring innovation from academic biotechnology laboratories to the market. For example, CCL (through its subsidiary Nichols) believes that it is currently the only clinical laboratory that is using both molecular signal amplification (branched DNA) and polymerase chain reaction (PCR) technologies for HIV testing. These technologies permit the detection of lower levels of HIV than can be achieved using other technologies, which in turn permits health care providers to better tailor drug therapies for HIV-infected patients. - -------- ** This is a forward looking statement. See "--Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995." In particular see factors (b), (c), (d), (f) and (j). *** This is a forward looking statement. See "--Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995." In particular see factors (a), (b), (c), (d) and (j). 58 Nichols continues to be one of the leading esoteric testing laboratories in the world. Nichols serves approximately 2,000 of the country's estimated 6,400 hospitals and counts among its largest customers both LabCorp and SmithKline. CCL hopes to leverage Nichols' existing relationships with hospitals into increased routine testing to hospitals, which continue to perform over half of the clinical laboratory testing in the United States. The Clinical Laboratory Testing Industry Laboratory tests and procedures are used generally by physicians and other health care providers to assist in the diagnosis, evaluation, monitoring and treatment of diseases and other medical conditions through the measurement and analysis of chemical and cellular components in blood, tissues and other specimens. Clinical laboratory testing is generally categorized as either clinical testing, which is performed on body fluids such as blood and urine, or anatomical pathology testing, which is performed on tissue and other samples, including human cells. Clinical and anatomical pathology procedures are frequently ordered as part of regular physician office visits and hospital admissions. Most clinical laboratory tests ordered by health care providers are considered "routine" and can be performed by most independent clinical laboratories, while "esoteric" tests (which generally require more sophisticated equipment, materials and personnel) are generally referred to laboratories, such as the Nichols facility in San Juan Capistrano, that specialize in such tests. CCL believes that in 1995 the entire United States clinical laboratory industry had revenues exceeding $30 billion. The clinical laboratory industry consists primarily of three types of providers: hospital-affiliated laboratories, independent clinical laboratories, such as those owned by CCL, and physician-office laboratories. CCL believes that in 1995 approximately 56% of the clinical testing revenues in the United States were attributable to hospital-affiliated laboratories, approximately 36% were attributable to independent clinical laboratories and approximately 8% were attributable to physicians in their offices and laboratories. CCL believes that a number of factors are likely to positively influence the volume of clinical laboratory testing performed in the United States in the future, including (1) the general aging of the population in the United States; (2) an expanded base of scientific knowledge which has led to the development of more sophisticated specialized tests and an increase in the awareness of physicians of the value of clinical laboratory testing as a cost-effective means of early detection of disease and monitoring of treatment; (3) an increase in the number and types of tests which are, due to advances in technology and increased cost efficiencies, readily available on a more affordable basis to physicians; (4) expanded substance-abuse testing by corporations and governmental agencies; and (5) increased testing for sexually transmitted diseases such as AIDS. The impact of these factors is expected to be offset in part by increased controls over the utilization of clinical laboratory tests by both Medicare and the private sector, particularly managed care organizations. CCL believes that the clinical laboratory industry will continue to be subject to pricing pressures as a result of (1) continued growth of the managed care sector; (2) a shift toward capitated payment contracts within the managed care sector; and (3) decreases in Medicare reimbursement rates. In addition, increased regulatory requirements in the billing of Medicare are expected to result in reimbursement reductions and additional costs to clinical laboratory testing companies in the United States. CCL has formulated strategies to address these challenges. See "--Business Strategy." Services Provided by CCL CCL's laboratory business is comprised of routine testing, which CCL management estimates currently generates approximately 88% of CCL's net revenues; and esoteric testing, which is performed at the Nichols facility in San Juan Capistrano and which CCL management estimates generates approximately 10% of CCL's net revenues. The balance of CCL's net revenues is derived principally from the manufacture of clinical laboratory test kits. 59 Routine Testing Services and Operations. Routine tests, which are performed at CCL's regional laboratories, include procedures in the area of blood chemistry, hematology, urine chemistry, virology, tissue pathology and cytology. Commonly ordered individual tests include red and white blood cell counts, Pap smears, blood cholesterol level tests, AIDS-related tests, urinalyses, pregnancy tests, and alcohol and other substance-abuse tests. Routine test groups include tests to determine the function of the kidney, heart, liver and thyroid, as well as other organs, and several health screens that measure various important bodily health parameters. CCL provides services through 17 regional laboratories located in major metropolitan areas throughout the United States, as well as 14 branch laboratories, approximately 200 STAT laboratories and 850 patient service centers. CCL also operates a branch laboratory in Mexico. Regional laboratories are full-service facilities that offer approximately 1,000 routine clinical testing procedures. "STAT" laboratories are local laboratory facilities where CCL can quickly perform and report results of certain routine tests for customers that require such emergency testing services. "Branch laboratories" have a test menu that is smaller than that of regional laboratories but larger than that of STAT laboratories. A "patient service center" is a facility maintained by CCL, typically in or near a medical professional building, to which patients can be referred by physicians for specimen collection. CCL operates 24 hours a day, 365 days a year, utilizing a fully integrated collection and processing system. CCL generally performs and reports most routine procedures within 24 hours, employing a variety of sophisticated and computerized laboratory testing instruments. On an average work day, CCL processes approximately 220,000 requisitions. CCL provides daily pickup of specimens from most customers principally through an in-house courier system. The specimens are sent to one of CCL's laboratories (generally a regional or branch laboratory) where one or more tests are performed. Each patient specimen is accompanied by a test requisition form, which is completed by the customer, that indicates the tests to be performed and provides the necessary billing information. Each specimen and related requisition form is checked for completeness and then given a unique bar-coded identification number. The unique identification number assigned to each specimen helps to assure that the results are attributed to the correct patient. The requisition form is sent to a data entry department where a file is established for each patient and the necessary testing and billing information is entered. Once this information is entered into the computer system, the tests are performed and the results are entered, primarily through computer interface or manually, depending upon the type of testing equipment involved. Most of CCL's computerized testing equipment is directly linked with CCL's information systems. Most routine testing is performed and completed during the evening following receipt of the specimens to be tested, and test results are readied for distribution the following morning either electronically or by service representatives. Many customers have local printer capability enabling laboratory medical reports to be printed in their offices. Customers who request that they be called with a result are so notified in the morning. It is CCL's policy to notify the customer immediately if a life-threatening result is found at any point during the course of the testing process. Esoteric Testing Services and Operations. Through Nichols, CCL operates one of the leading esoteric clinical testing laboratories in the world. Esoteric tests are performed in cases where the information provided by routine tests is not specific enough or is inconclusive as to the existence or absence of disease or when a physician requires more information. Typically, unlike routine testing, only one test is performed per requisition. The logistics for esoteric testing are similar to that for routine testing except that, due to the complexity of the testing, approximately 60% of the tests are performed within 24 hours, with almost all of the rest being performed within one week. During 1995 Nichols performed approximately 3.9 million esoteric tests, of which 77% were referred by sources other than CCL regional laboratories. Esoteric tests generally require more sophisticated equipment and materials as well as more highly skilled personnel to perform test procedures and analyze results than what is required for routine testing. Consequently, esoteric tests are generally priced substantially higher than routine tests. New medical discoveries lead to the development of new esoteric tests. However, over time esoteric tests may become routine tests as a result of 60 improved technology or increased volume. The volume of esoteric tests required by most health care providers, including hospitals, is relatively low compared to the volume of routine tests. Because it is generally not cost effective for such health care providers to perform the low volume of esoteric tests in-house, a significant portion of esoteric tests are referred to clinical laboratories like Nichols that specialize in such tests. Some examples of esoteric testing procedures include capillary electrophoresis, cell culture technology, chemiluminescent immunoassays, certain enzyme immunoassays, flow cytometry, fluorescent in situ hybridization (FISH), inductively coupled plasma mass spectroscopy (ICPMS), molecular tissue pathology, molecular signal amplification (branched DNA), and polymerase chain reaction (PCR) technologies. Nichols's laboratory is comprised of 18 individual laboratory departments, which in the aggregate offer approximately 1,400 individual tests or "assays" in such fields as endocrinology, genetics, immunology, microbiology, molecular biology, oncology, serology, special chemistry and toxicology. Nichols believes that it has been one of the leaders in transferring technological innovation from academic biotechnology laboratories to the marketplace. Nichols was the first to introduce a number of esoteric tests, including immunoassay methods for measurement of circulating hormone levels and sensitive tests to predict breast cancer prognosis. Among more recent developments have been tests to detect a variety of tumor types, a common form of mental retardation, leukemia, cystic fibrosis, osteoporosis, hepatitis and neurological disorder and to monitor success of therapy in cancer and AIDS. The branched DNA and PCR technologies can be applied to a variety of infectious agents and permit the detection of lower levels of HIV than can be achieved under other technologies. The ability to measure the amount of HIV permits health care providers to better tailor drug therapies for HIV-infected patients. Nichols has generated revenues of approximately $1.1 million per month as a result of such HIV testing since January 1996 and believes that revenues from these tests will continue to increase. As part of its research and development efforts, Nichols maintains a relationship with the academic community through its Academic Associates program, under which approximately sixty scientists from academia and biotechnology firms work directly with Nichols's staff scientists to monitor and consult on existing test procedures and develop new esoteric test methods. In addition, Nichols relies on internal resources for the development of new tests as well as on license arrangements and co- development agreements with biotechnology companies and academic medical centers. Nichols also provides clinical laboratory testing in connection with pre-marketing clinical trials of pharmaceutical drugs. This testing is competitive with the testing performed by a subsidiary of CPS and is expected to continue in the future. CCL management estimates that net revenues from such testing accounted for less than 1% of CCL's net revenues in 1995. Diagnostics. Through its Nichols Institute Diagnostics ("NID") subsidiaries, which were acquired as a result of the acquisition of Nichols Institute in August 1994, CCL manufactures and markets clinical laboratory kits primarily for esoteric testing. Test kits are sold principally to hospital and clinical laboratories. Customers and Payors CCL provides testing services to a broad range of health care providers. The primary types of customers served by CCL are as follows: Independent Physicians and Physician Groups. Physicians requesting testing for their patients who are unaffiliated with a managed care plan remain the principal source of CCL's clinical laboratory business. Fees for clinical laboratory testing services rendered for these physicians are billed either to the physician, to the patient, or to the patient's third-party payor such as insurance companies, Medicare and Medicaid. In four states, including New York and Michigan, CCL is required to bill patients directly. The clinical laboratory industry is supporting legislative efforts to expand direct patient billing. Billings are typically on a fee-for-service basis. If the billings are to the physician, they are based on the laboratory's wholesale or customer fee schedule and are typically subject to negotiation. Otherwise, the billings are based on the laboratory's retail or patient fee schedule, subject to limitations on fees imposed by third parties and to negotiation by physicians on behalf of their patients. Medicare 61 and Medicaid billings are based on fee schedules set by governmental authorities. See "--Regulation and Reimbursement." HMOs and Other Managed Care Groups. HMOs and other managed care organizations typically contract with a limited number of clinical laboratories and then designate the laboratory or laboratories to be used for tests ordered by their participating physicians. In an effort to control costs, the managed care groups generally negotiate discounts to the fees usually charged by such laboratories. Most testing for managed care organizations is being performed on a capitated basis. Under a capitated payment contract, the clinical laboratory and the managed care organization agree to a monthly payment per covered individual to cover all laboratory tests during the month, regardless of the number or cost of tests actually performed. Such contracts shift the risks of additional routine testing beyond that covered by the capitated payment to the clinical laboratory. In certain cases, however, the monthly payment may be subject to prospective or retroactive adjustment if the number of tests performed exceeds (or is less than) certain thresholds. The types of tests covered by capitated contracts are negotiated for each contract, with esoteric tests and anatomic pathology services generally not being covered under the capitation rate. Large regional and national HMOs and preferred provider organization networks typically prefer to utilize large independent clinical laboratories such as CCL that can service the managed care groups on a national or regional basis. See "--Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business." Hospitals. CCL serves approximately 3,000 hospitals with services that vary from providing esoteric testing to management contracts, where CCL manages the hospital's laboratory for a fee. Hospitals generally maintain an on-site laboratory to perform testing on patients receiving care and refer less frequently needed procedures to outside laboratories. Hospitals are typically charged for such tests a negotiated fee-for-service which is based on the laboratory's customer fee schedule. Some hospitals actively encourage community physicians to send their testing to the hospital's laboratory. In addition, some hospitals have been purchasing physician practices and requiring that the physicians/employees send their testing to the hospital's affiliated laboratory. As a result, hospital-affiliated laboratories can be both a customer and a competitor for independent clinical laboratories such as CCL. Other Institutions. CCL also serves other institutions, including governmental agencies, such as the Department of Defense and prison systems, large employers and independent clinical laboratories that do not have the full range of CCL's testing capabilities. These institutions are typically charged on a negotiated or bid fee-for-service basis. CCL's services to employers principally involve the provision of substance abuse testing services. In 1995, no single customer or affiliated group of customers accounted for more than 2% of CCL's net revenues. CCL believes that the loss of any one of its customers would not have a material adverse effect on CCL's results of operations or cash flows. Payors. Most clinical laboratory testing is billed to a party other than the "customer" that ordered the test. Tests performed for various patients of a single physician may be billed to different payors besides the ordering physician, including third-party payors (generally an insurance company or managed care organization), Medicare, Medicaid or the patient. 62 The following table sets forth current estimates of the breakdown by payor of CCL's total volume of requisitions and average approximate revenues per requisition: Requisition Volume as % of Total Revenue Per Requisition ---------- ----------------------- Patient 5% - 10% $60 - $80 Medicare & Medicaid 20% - 25% $20 - $25 Monthly Bill (Physician, Hospital, Employer, Other) 35% - 40% $15 - $35 Third Party Fee-For-Service 15% - 20% $30 - $40 Managed Care - Capitated 15% - 20% $5 - $15 For a discussion of the mix shift and the impact of the managed care sector on volume and price trends, see "--Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business." Average Revenue per Requisition Trends. Since the fourth quarter of 1995, declines in CCL's average revenue per requisition have moderated. Average revenue per requisition for the quarter ended June 30, 1996 was approximately 3.6% below the comparable period in 1995. This decline in revenue per requisition was smaller than the approximate 4.8% decline experienced in the first quarter of 1996. Since August of 1995, the company-wide average revenue per requisition has remained relatively stable and is effectively unchanged during the first two quarters of 1996. Sales and Marketing CCL markets and services its customers through its direct sales force of approximately 430 sales representatives, 300 account representatives and 2,200 couriers. Most sales representatives market the mainstream or traditional routine laboratory services primarily to physicians, while others concentrate on individual market segments, such as hospitals or managed care organizations, or on testing niches, such as substance abuse testing. CCL's sales representatives are compensated through a combination of salaries, commissions and bonuses, at levels commensurate with each individual's qualifications and responsibilities. Commissions are based primarily upon the individual's results in generating new business for CCL. CCL is currently changing its commission structure so that compensation is tied to the profitability of (rather than revenues from) new business. See "--Business Strategy--Preferred Provider." CCL's account representatives interact with customers on an ongoing basis. Account representatives monitor the status of services being provided to customers, act as problem-solvers, provide information on new testing developments and serve as the customer's regular point of contact with CCL. Account representatives are compensated with a combination of salaries and bonuses commensurate with each individual's qualifications and responsibilities. CCL believes that the clinical laboratory service business is shifting away from the traditional direct sales structure and into one in which the purchasing decisions for laboratory services are increasingly made by managed care organizations, integrated health delivery systems, insurance plans, employers and by patients themselves. In 63 view of these changes, CCL has completed a rigorous regional market strategy process and has reorganized its sales and marketing organization structure to support these strategies and emerging customers. CCL believes that, given the increasing regulation and complexity of the clinical laboratory marketplace, training of its sales force is of paramount importance. With this goal in mind, during 1995 CCL enhanced its comprehensive sales training program and compliance training. See "--Compliance Program." Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business The managed care industry is growing as well as undergoing rapid consolidation which has created large managed care companies that control the delivery of health care services for millions of people, and have significant bargaining power in negotiating fees with health care providers, including clinical laboratories. CCL believes that there are potential opportunities for large, low-cost, clinical laboratories such as CCL to capture additional testing volume from managed care organizations. The larger regional and national managed care organizations typically prefer to utilize large independent clinical laboratories, like CCL, that can service their organizations on a national or a regional basis. In addition, smaller laboratories are unlikely to be able to achieve the low cost structures necessary to profitably service managed care organizations. The growth of the managed care sector presents various challenges to independent clinical laboratories, including CCL. Managed care organizations typically negotiate capitated payment contracts, whereby the clinical laboratory receives a monthly fee per covered individual. The fixed monthly payment generally covers all laboratory tests (excluding certain tests, such as esoteric tests and anatomic pathology services) performed during the month, regardless of the number or cost of the tests performed. Unlike fee-for-service indemnity insurance, such contracts shift the risks of additional routine testing beyond that covered by the capitated payment to the clinical laboratory. In certain cases, however, the monthly payment may be subject to prospective or retroactive adjustment if the number of tests performed exceeds (or is less than) certain thresholds. CCL expects the amount of clinical laboratory testing performed for managed care organizations under capitated rate agreements to continue to grow. Laboratory services agreements with managed care organizations have historically been priced aggressively due to competitive pressures and the expectation that a laboratory would capture not only the volume of testing to be covered under the contract, but also the additional fee-for-service business from patients of participating physicians who are not covered under the managed care plan. However, as the number of patients covered under managed care plans continues to increase, there is less such fee-for-service business and, accordingly, less high margin business to offset the low margin (and often unprofitable) managed care business. Furthermore, increasingly, physicians are affiliated with more than one managed care organization and as a result may be required to refer clinical laboratory tests to different clinical laboratories, depending on the coverage of their patients. As a result, a clinical laboratory might not receive any fee-for-service testing from such physicians. The level of pricing charged to managed care organizations, including under capitated payment contracts, if continued, may adversely affect the pricing of the clinical laboratory industry. During the six months ended June 30, 1996, services to managed care organizations under capitated rate agreements accounted for approximately 6% of CCL's net revenues from clinical laboratory testing and approximately 15% of the number of tests performed by CCL. CCL believes that the prices charged by the independent clinical laboratory testing companies to managed care organizations can and must be increased. CCL is currently reviewing its pricing structures for agreements with managed care organizations and intends to insure that all such agreements are profitably priced. However, there can be no assurance that CCL will be able to increase the prices charged to managed care organizations or that CCL will not lose market share in the managed care market to other clinical laboratories who continue to aggressively price laboratory services agreements with managed care organizations. CCL believes that the growth of the managed care sector presents both challenges and opportunities. CCL, as part of its preferred provider strategy, will seek to capitalize on the opportunity and meet the challenge by seeking to secure large-volume, profitable managed care contracts through providing low cost, high quality testing services at rational prices. 64 Potential New Markets Hospital Alliances. In response to the growth of the managed care sector and the developments described under "--Effects of the Growth of the Managed Care Sector on the Clinical Laboratory Business," many health care providers have established new alliances. Hospital-physician networks are emerging in many markets in order to offer comprehensive, integrated service capabilities, either to managed care plans or directly to employers. Since CCL has traditionally derived a substantial portion of its esoteric testing revenues from referrals from hospitals, which perform approximately half of all clinical laboratory tests in the United States, CCL established a hospital business venture group whose primary goal is to develop additional nontraditional hospital arrangements, including management and consulting agreements, shared service arrangements and joint ventures. Under federal cost containment legislation enacted in 1985, treatment provided to hospital inpatients covered by Medicare is classified into diagnosis-related groups ("DRGs") which prescribe the maximum reimbursable payments for all services, including laboratory testing services, provided on behalf of an inpatient under each DRG. As a result of this payment structure, and similar price constraints from managed care organizations and other third-party payors, hospitals have an economic incentive to seek the most cost-effective laboratory testing services for their patients. CCL believes that in many cases, by managing a hospital laboratory or entering into a joint venture with a hospital, CCL can improve a hospital laboratory's economic structure and preserve hospital capital that would be required for needed laboratory improvements while providing accurate and timely testing services due to greater economies of scale, increased utilization of expensive testing and data processing equipment through optimization of the mix between on-site and off-site testing and more efficient use of laboratory employees. CCL has several such arrangements with hospitals, including a joint venture with two hospitals in Erie, Pennsylvania that performs outreach testing and a management agreement with a group of approximately 25 hospitals in eastern Nebraska and Sioux City, Iowa. These two laboratory arrangements, which provide testing for both the hospitals and the commercial outreach markets in their geographical areas, serve as two of CCL's laboratory facilities. CCL also manages the laboratories at several hospitals in the eastern United States. However, despite the potential cost savings and additional revenues available to hospitals through such arrangements, CCL believes that only a small percentage of the hospitals in the United States have entered into such arrangements with independent clinical laboratories. Nonetheless, CCL expects to enter into alliances with various hospitals in the future and believes that this market has potential. As an alternative service for hospitals that are entering into integrated delivery systems, CCL is beginning to market consulting support and technical solutions for integrating diverse laboratory infrastructures, systems and data. Employer Market. CCL is considering expanding its business in the employer market to include the provision of laboratory services to large employers on a basis comparable to that offered to managed care organizations, whereby laboratory services paid under self-insured indemnity plans may be relatively fixed (rather than on a fee-for-service basis). These services could be offered in alliance with other service providers, including pharmaceutical benefits and diagnostic imaging services. CCL recently organized National Imaging Associates Inc. ("NIA"), a company offering diagnostic imaging benefit management services to employers, payors and managed care organizations. NIA seeks to carve out the imaging component of a health care plan service offering and manage it at lower cost through utilization controls and provider price concessions. Medical Information. In a rapidly growing market for integrated medical information, CCL has developed relational database capabilities to meet new and emerging customer needs. Through CCL's Corning Medical Informatics (CMI) division, information products based on CCL's extensive database of clinical and anatomic testing results are designed and sold to large customers such as managed care organizations and other insurers. Developed internally, a combination of information technology and analytical clinical skills provides the foundation for more informed health care decisions. Examples of customer-driven products include patient outcome measures, provider profiles and benchmarks, high-risk patient registries, normative comparisons and other customized clinical insights. 65 CCL believes that these professional services are becoming increasingly important for the success of the disease management programs, marketing efforts and business planning activities of CCL's customers. Information Systems The need for information systems to support laboratory, billing, customer service, logistics, medical data, and other business requirements is significant and will continue to place high demands on CCL's information systems staff. CCL has historically not standardized the billing, laboratory and other information systems at laboratories that it has acquired. As a result, CCL has numerous different information systems to handle billing, test result reporting and financial data and transactions. CCL believes that the efficient handling of information involving customers, patients, payors, and other parties will be critical to CCL's future success. To this end, CCL has chosen standard billing and laboratory systems. The standard billing system has been implemented in seven of its 22 billing sites, which account for 34% of CCL's net revenues. The standard laboratory system is already operational in nine of its 22 billing sites, which account for 16% of CCL's net revenues. Such sites are not necessarily the same sites as those with standard billing systems. CCL is beginning to convert the remaining non-standard billing and laboratory systems to the standard systems, prioritized on an impact basis. The most critical conversions will be completed within three years. The conversion costs are expected to be approximately $1 million to $3 million per billing system and $1 million to $3 million per laboratory system. CCL is developing systems that will permit managed care organizations and other providers to have electronic access to test orders and results for participating physicians, which will permit managed care organizations to better monitor and control the utilization of testing services. Billing Billing for laboratory services is a complicated process. Laboratories must bill different payors such as doctors, patients, insurance companies, Medicare, Medicaid and employer groups, all of whom have different billing requirements. CCL believes that less than 30% of its bad debt expense is attributable to specific credit or payment issues of its customers. The remainder of the bad debt expense is the result of many non-credit related issues which slow the billing process, create backlogs of unbilled requisitions and generally increase the aging of accounts receivable. A primary cause of bad debt expense is missing or incorrect billing information on requisitions. Typically approximately one-third of the requisitions that CCL receives either do not provide all the necessary data or provide incorrect data. CCL believes that this experience is similar to that of its primary competitors. CCL performs the requested tests and reports back the test results regardless of whether billing information has been provided at all or has been provided incorrectly. CCL subsequently attempts to obtain any missing information or rectify any incorrect billing information received from the health care provider. Among the many other factors complicating the billing process are pricing differences between the fee schedules of CCL and the payor, disputes between payors as to the party responsible for payment of the bill and auditing for specific compliance issues. Ultimately, if all issues are not resolved in a timely manner, the related receivables are written off to bad debt expense. CCL's bad debt expense has increased each year since 1993 due principally to four developments that have further complicated the billing process: (1) increased complexity in the health care system; (2) increased requirements in complying with fraud and abuse regulations; (3) deterioration in reimbursement as payor class mix; and (4) changes in Medicare reimbursement policies. These four factors have placed additional requirements on the billing process, including the need for specific test coding, additional research on processing rejected claims that comply with prior practices, increased audits for compliance, and management of a large number of contracts which have very different information requirements for pricing and reimbursement. See "Management's Discussion and Analysis of Financial Condition and Results of Operation of CCL." CCL's billing has also been hampered by the existence of multiple billing information systems. In 1995 CCL had severe billing problems at its largest laboratory site in Teterboro, New Jersey. A new billing information system developed with outside consultants experienced 66 significant implementation problems, including excessive downtime, which severely impacted CCL's ability to efficiently bill for its services from the Teterboro location. The problem was compounded by a lack of experienced staff as the result of work force reductions made to meet cost reduction initiatives undertaken in anticipation of greater efficiencies from the new billing information system. As a result of all of these factors, CCL recorded a charge to bad debt of $62 million in the third quarter of 1995. Of this amount, approximately $34 million was attributable to the Teterboro location. At the time of charge, the backlog of unbilled requisitions was estimated at over 2 million requisitions and DSOs for the clinical testing business were 90 days. In addition, significant backlogs existed in (1) reconciling cash received to payment of specific bills, (2) rejected claims that needed to be researched and (3) correspondence from customers attempting to resolve billing problems. CCL has focused on improving its billing operations in the last year. As of June 30, 1996, the backlog of unbilled requisitions has been reduced by approximately 30%, DSOs for the clinical testing business have been reduced to 72 days, bad debt expense as a percentage of net revenues has stabilized, the percentage of requisitions received with missing billing information has been reduced by approximately 30% and backlogs in rejected claims, unapplied cash and customer correspondence have been significantly reduced. These improvements were achieved in spite of a higher level of information requirements necessary for correct billing, especially those bills relating to Medicare. See "--Regulation and Reimbursement--Regulation of Reimbursement for Clinical Laboratory Services." Acquisitions and Dispositions MetPath, CCL's predecessor, originally commenced operations in 1967 with laboratories only in the New York metropolitan area. Most of CCL's other regional laboratories have been added through acquisitions. Principally as the result of the acquisitions discussed below that were completed in 1993 and 1994, CCL's revenues have almost tripled since 1991. However, this increase in revenues is not reflected in the CCL Financial Statements because several of the major acquisitions are accounted for as a pooling of interests. Acquisition activity has diminished significantly since May 1995, in part so that CCL could concentrate on the integration of the laboratory networks that had been acquired in 1993 and 1994. CCL may resume making acquisitions in the future, most likely focusing on acquisitions of smaller laboratories that can be folded into existing laboratories where CCL can expect to achieve significant cost savings and other benefits resulting from the elimination of redundant facilities and equipment and reductions in staffing or personnel. CCL is evaluating its strategic alternatives relative to units whose profitability does not meet its internal goals. These alternatives may include joint ventures, alliances or dispositions. However, there are no negotiations or definitive plans with respect to any such dispositions. During 1994 Corning acquired three large clinical laboratory testing companies, each of which was accounted for as a pooling of interests. In June 1994, Corning acquired Maryland Medical Laboratory, Inc. ("MML"), a regional laboratory based in Baltimore, Maryland with approximately $90 million in annual revenues. In August 1994, Corning acquired the stock of Nichols Institute, a national esoteric clinical laboratory with approximately $280 million in annual revenues. In October 1994, Corning acquired Bioran, a regional laboratory based in Cambridge, Massachusetts with approximately $65 million in annual revenues. In August 1993, Corning acquired Damon, a national clinical testing laboratory with approximately $330 million in annualized revenue. The acquisition was accounted for as a purchase. The assets of Damon's California- based laboratories were sold in April 1994 to Physicians Clinical Laboratory Inc. In November 1993, CCL acquired the clinical testing laboratories of Unilab in Dallas, Denver and Phoenix, in exchange for CCL's then 43% ownership of Unilab and the assumption of approximately $70 million of indebtedness of Unilab. In a separate transaction, CCL transferred to Unilab CCL's investment in J.S. Pathology PLC, a clinical testing laboratory based in the United Kingdom, in exchange for a small equity interest in Unilab. CCL currently owns approximately 4% of Unilab's outstanding common stock. In May 1993, Corning acquired and contributed to CCL DeYor Laboratory Inc., a regional laboratory based in Ohio, Pennsylvania and Tennessee with approximately $20 million of annual revenues. This transaction was accounted for under the pooling of interests method, although CCL's consolidated financial statements for prior periods have not been restated since this acquisition is not material. See Note 3 to 67 the Audited CCL Financial Statements. In addition to the acquisitions discussed above, since January 1993 CCL has acquired approximately 25 other smaller clinical laboratories and customer lists, principally in assets acquisitions. Only one such acquisition has been completed since May 1995. Competition The clinical laboratory testing business is intensely competitive. CCL believes that in 1995 the entire United States clinical laboratory testing industry had revenues exceeding $30 billion; approximately 56% of such revenues were attributable to hospital-affiliated laboratories, approximately 36% were attributable to independent clinical laboratories and approximately 8% were attributable to physicians in their offices and laboratories. As recently as 1993, there were seven laboratories that provided clinical laboratory testing services on a national basis: CCL, SmithKline, National Health Laboratories Inc. ("NHL"), Roche Biomedical Laboratories Inc. ("Roche"), Damon, Allied Clinical Laboratories Inc. ("Allied") and Nichols Institute. In April 1995 Roche merged into NHL (under the name LabCorp), which had acquired Allied in June 1994. CCL acquired Nichols Institute in August 1994 and Damon in August 1993. In addition, in the last several years a number of large regional laboratories have been acquired by national clinical laboratories. There are presently three national independent clinical laboratories: CCL, which had approximately $1.63 billion in revenues from clinical laboratory testing in 1995; LabCorp, which had approximately $1.68 billion in revenues from clinical laboratory testing in 1995 on a pro forma basis, after giving effect to the April 1995 merger of Roche into NHL; and SmithKline, which had approximately $1.29 billion in revenues from clinical laboratory testing in 1995. Both LabCorp and SmithKline are affiliated with large corporations that have greater financial resources than CCL. SmithKline is wholly owned by SmithKline Beecham Ltd. and R. Hoffman La Roche S.A. beneficially owns approximately 49.9% of the outstanding capital stock of LabCorp. In addition to the three national clinical laboratories, CCL competes on a regional basis with many smaller regional independent clinical laboratories as well as laboratories owned by hospitals and physicians. CCL has the leading market share in most of the northeast, mid-Atlantic and midwest routine testing markets, while its market share is much lower in the routine testing market in the rest of the country. Approximately 65% of CCL's net revenues and almost all of its EBITDA currently is generated from markets in which CCL believes that it has the largest market share. In most of these markets CCL believes that it also is the lowest cost provider. CCL does not generally compete in the California routine testing market other than in the San Diego metropolitan area. CCL believes that the following factors, among others, are often used by health care providers in selecting a laboratory: (i) pricing of the laboratory's testing services; (ii) accuracy, timeliness and consistency in reporting test results; (iii) number and type of tests performed; (iv) service capability and convenience offered by the laboratory; and (v) its reputation in the medical community. CCL believes that it competes favorably with its principal competitors in each of these areas and is currently implementing strategies to improve its competitive position. See " -- Business Strategy." CCL believes that consolidation will continue in the clinical laboratory testing business. In addition, CCL believes that it and the other large independent clinical laboratory testing companies will be able to increase their share of the overall clinical laboratories testing market due to a number of external factors including cost efficiencies afforded by large-scale automated testing, Medicare reimbursement reductions and the growth of managed health care entities which require low-cost testing services and large service networks. In addition, legal restrictions on physician referrals and the ownership of laboratories as well as increased regulation of laboratories are expected to contribute to the continuing consolidation of the industry. Quality Assurance CCL maintains a comprehensive quality assurance program for all of its laboratories and patient service centers. The goal is to ensure optimal patient care by continually improving the processes used for collection, 68 storage and transportation of patient specimens, as well as the precision and accuracy of analysis and result reporting. The CCL quality assurance efforts focus on: proficiency testing, process audits, statistical process control, credentialing and personnel training. Internal Quality Control and Audits. Quality control samples are processed in parallel with the analysis of patient specimens. The results of tests on such samples are then monitored to identify drift, shift or imprecision in the analytical processes. In addition, CCL administers an extensive internal program of "blind" proficiency testing. These samples are processed through the CCL system as routine patient samples, unknown to the laboratory as quality control samples. Samples are then handled, processed and reported with patient specimens. This provides a system to assure accuracy of the entire pre- and post-analytical testing process. Another element of the CCL comprehensive quality assurance program includes performance of internal process audits. External Proficiency Testing and Accreditation. All CCL laboratories participate in numerous externally conducted, blind sample quality surveillance programs. These include proficiency testing programs administered by the College of American Pathologists ("CAP"), as well as many state agencies. These programs supplement all other quality assurance procedures. All CCL laboratories are accredited by CAP. Accreditation includes on-site inspections and participation in the CAP Proficiency Test Program. CAP is an independent nongovernmental organization of board certified pathologists that offers an accreditation program to which laboratories may voluntarily subscribe. CAP is approved by HCFA to inspect clinical laboratories to determine compliance with the standards required by the Clinical Laboratory Improvement Amendments of 1988 ("CLIA"). Regulation and Reimbursement Overview. The clinical laboratory industry is subject to significant governmental regulation at the federal and state levels. All CCL laboratories and patient service centers are appropriately licensed and accredited by various state and federal agencies. The health care industry is undergoing significant change as third-party payors, such as Medicare (which principally serves patients 65 and older), Medicaid (which principally serves indigent patients), private insurers and large employers increase their efforts to control the cost, utilization and delivery of health care services. In an effort to address the problem of increasing health care costs, legislation has been proposed or enacted at both the federal and state levels to regulate health care delivery in general and clinical laboratories in particular. Some of the proposals include managed competition, global budgeting and price controls. Although the Clinton Administration's health care reform proposal, initially advanced in 1994, was not enacted, such proposal or other proposals may be considered in the future. In particular, CCL believes that reductions in reimbursement for Medicare services will continue to be implemented from time to time. Reductions in the reimbursement rates of other third-party payors are likely to occur as well. CCL cannot predict the effect health care reform, if enacted, would have on its business, and there can be no assurance that such reforms, if enacted, would not have a material adverse effect on CCL's business and operations. Regulation of Clinical Laboratory Operations. The CLIA standards were designed to ensure that all clinical laboratory testing services are uniformly accurate and of high quality by using a single set of requirements. On February 28, 1992, the final rules implementing CLIA were published in the Federal Register. These regulations extended federal oversight, with few exceptions, to virtually all clinical laboratories regardless of size, type, location or ownership of the laboratory. The regulations generally became effective in 1992. However, certain quality control and proficiency testing requirements are still being phased in. The standards for laboratory personnel, quality control, quality assurance and patient test management are based on complexity and risk factors. 69 Laboratories categorized as "high" complexity are required to meet more stringent requirements than either "moderate" or "waived" (tests regarded as having a low potential for error and requiring little or no oversight) laboratories. Most of the CCL laboratories are categorized as high complexity and these laboratories are in compliance with the more stringent standards for personnel, quality control, quality assurance and patient test management. A few CCL laboratories are categorized as moderate complexity (some STAT laboratories) or waived (only patient service centers). The sanction for failure to comply with these regulations may be suspension, revocation or limitation of a laboratory's CLIA certificate necessary to conduct business, significant fines or criminal penalties. The loss of a license, imposition of a fine or future changes in such federal, state and local laws and regulations (or in the interpretation of current laws and regulations) could have a material adverse effect on CCL. CCL is also subject to state regulation. CLIA permits states to adopt regulations that are more stringent than federal law. For example, state law may require that laboratory personnel meet certain more stringent qualifications, specify certain quality control standards, maintain certain records and undergo additional proficiency testing. For example, certain of CCL's laboratories are subject to the State of New York's clinical laboratory regulations, which contain provisions that are significantly more stringent than federal law. CCL believes it is in material compliance with the foregoing standards. See "--Compliance Program." Drug Testing. Drug testing for public sector employees is regulated by the Substance Abuse and Mental Health Services Administration ("SAMHSA") (formerly the National Institute on Drug Abuse), which has established detailed performance and quality standards that laboratories must meet in order to be approved to perform drug testing on employees of federal government contractors and certain other entities. To the extent that CCL's laboratories perform such testing, each must be certified by HHS as meeting SAMHSA standards. Seven of CCL's laboratories are SAMHSA certified. Controlled Substances. The use of controlled substances in testing for drug abuse is regulated by the federal Drug Enforcement Administration ("DEA"). All CCL laboratories using controlled substances for testing purposes are licensed by the DEA. Medical Wastes and Radioactive Materials. CCL is subject to licensing and regulation under federal, state and local laws relating to the handling and disposal of medical specimens and hazardous waste and radioactive materials as well as to the safety and health of laboratory employees. All CCL laboratories are operated in material compliance with applicable federal and state laws and regulations relating to disposal of all laboratory specimens. CCL utilizes outside vendors for disposal of specimens. Although CCL believes that it is currently in compliance in all material respects with such federal, state and local laws, failure to comply could subject CCL to denial of the right to conduct business, fines, criminal penalties and other enforcement actions. Occupational Safety. In addition to its comprehensive regulation of safety in the workplace, the federal Occupational Safety and Health Administration ("OSHA") has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to chemicals and transmission of blood-borne and airborne pathogens. Specimen Transportation. Regulations of the Department of Transportation, the Public Health Service and the Postal Service apply to the surface and air transportation of clinical laboratory specimens. 70 Regulation of Reimbursement for Clinical Laboratory Services. Containment of health care costs, including reimbursement for clinical laboratory services, has been a focus of ongoing governmental activity. In 1984, Congress established a Medicare fee schedule for clinical laboratory services performed for patients covered under Part B of the Medicare program. Subsequently, Congress imposed a national ceiling on the amount that would be paid under the Medicare fee schedule. Laboratories must bill the program directly and must accept the scheduled amount as payment in full for most tests performed on behalf of Medicare beneficiaries. In addition, state Medicaid programs are prohibited from paying more (and in most instances, pay significantly less) than the Medicare fee schedule for clinical laboratory testing services furnished to Medicaid recipients. In 1995, CCL derived approximately 20% and 3% of its net revenues from tests performed for beneficiaries of Medicare and Medicaid programs, respectively. Since 1984, Congress has periodically reduced the ceilings on Medicare reimbursement to clinical laboratories from previously authorized levels. In 1993, pursuant to the Omnibus Budget and Reconciliation Act of 1993 ("OBRA '93"), Congress reduced, effective January 1, 1994, the Medicare national fee schedule limitations from 88% of the 1984 national median to 76% of the 1984 national median, which reductions were phased in from 1994 through 1996 (to 84% in 1994, 80% in 1995 and 76% in 1996, in each case as a percentage of the 1984 national median). The 1996 reduction to 76% was implemented as scheduled on January 1, 1996. OBRA '93 also eliminated the provision for annual fee schedule increases based upon the consumer price index for 1994 and 1995. Medicare reimbursement reductions have a direct adverse effect on CCL's net earnings and cash flows. CCL cannot predict if additional Medicare reductions will be implemented. The Senate and House Medicare proposal (the Medicare Preservation Act of 1995) passed in October 1995 would have reduced the national limitation to 65% beginning in 1997 and would have eliminated all annual consumer price index adjustments through 2002. This reduction in laboratory reimbursement rates was retained in the House-Senate conference report agreed upon in November 1995. The President vetoed this bill in December 1995. Effective January 1, 1996, HCFA adopted a new policy on reimbursement for chemistry panel tests. As of January 1, 1996, 22 automated tests (rather than 19 tests) became reimbursable by Medicare as part of an automated chemistry profile. An additional allowance of $0.50 per test is authorized when more than 19 tests are billed in a panel. HCFA retains the authority to expand in the future the list of tests included in a panel. Effective as of March 1, 1996, HCFA eliminated its prior policy of permitting payment for all tests contained in an automated chemistry panel when at least one of the tests in the panel is medically necessary. Under the new policy, Medicare payment will not exceed the amount that would be payable if only the tests that are "medically necessary" had been ordered. In addition, since 1995 most Medicare carriers have begun to require clinical laboratories to submit documentation supporting the medical necessity, as judged by ordering physicians, for many commonly ordered tests. CCL expects to incur additional reimbursement reductions and additional costs associated with the implementation of these requirements of HCFA and Medicare carriers. The amount of the reductions in reimbursements and additional costs cannot be determined at this time. See "--Billing." Major clinical laboratories, including CCL, use dual fee schedules: "client" fees charged to physicians, hospitals, and institutions with which a laboratory deals on a bulk basis and "patient" fees charged to individual patients and third-party payors, including Medicare and Medicaid, who generally require separate bills or claims for each requisition. Medicare and other third party payors also set maximum fees that they will pay which are substantially lower than the patient fees otherwise charged by CCL, but are generally higher than CCL's client fees, which may be subject to negotiation or discount. Federal and some state regulatory programs prohibit clinical laboratories from charging government programs more than certain charges to other customers. During 1992, in issuing final regulations implementing the federal statutory prohibition against charging Medicare substantially in excess of a provider's usual charge, the OIG declined to provide any guidance concerning the interpretation of this legislation, including whether or not discounting or the dual fee structure employed by clinical laboratories might raise issues under the provision. Medicare budget proposals developed by the Clinton Administration in 1993 and 1994, along with proposals incorporated in many major health reform bills considered by Congress in 1994, called for the reinstatement of 20% Medicare clinical laboratory co-insurance (which was last in effect in 1984). While co-insurance was in effect, 71 clinical laboratories received from Medicare carriers only 80% of their Medicare reimbursement rates and were required to bill Medicare beneficiaries for the balance of the charges. A co-insurance proposal was not included in any of the Congressional Medicare reform packages considered to date in the 1995 and 1996 legislative sessions. However, it is still possible a co-insurance provision will be proposed in the future and, if enacted, such a proposal could materially adversely affect the revenues and costs of the clinical laboratory industry, including CCL, by exposing the testing laboratory to the credit of individuals and by increasing the number of bills. In addition, a laboratory could be subject to potential fraud and abuse violations if adequate procedures to bill and collect the co-insurance payments are not established and followed. Proposals have also been developed to procure Medicare and Medicaid laboratory testing services through competitive bidding mechanisms. To date, none of the Congressional Medicare reform packages introduced in the 1995 and 1996 legislative sessions have included a competitive bidding provision for clinical laboratory tests. However, President Clinton's Medicare reform proposal would have established competitive bidding for clinical laboratory services. If competitive bidding were implemented, such action could materially adversely affect the revenues of the clinical laboratory industry, including CCL. HCFA is currently developing a demonstration project to determine whether competitive bidding can be used to provide quality laboratory services at prices below current Medicare reimbursement rates. The demonstration is expected to be conducted in Kentucky and to commence in 1997. Future changes in federal, state and local regulations (or in the interpretation of current regulations) affecting governmental reimbursement for clinical laboratory testing could have a material adverse effect on CCL. CCL is unable to predict, however, whether and what type of legislation will be enacted into law. Fraud and Abuse Regulations. The Medicare and Medicaid anti-kickback laws prohibit clinical laboratories from, among other things, making payments or furnishing other benefits to influence the referral of tests billed to Medicare, Medicaid or other federal programs. Penalties for violations of these federal laws include exclusion from participation in the Medicare/Medicaid programs, assets forfeitures, and civil and criminal penalties. Civil administrative penalties for a wide range of offenses may be up to $2,000 per item and twice the amount claimed. Under the Health Insurance Portability and Accountability Act of 1996 (the "Health Insurance Act"), the penalties will be increased, effective January 1, 1997 to up to $10,000 per item plus three times the amount claimed. In the case of certain offenses, exclusion from participation in Medicare and Medicaid is a mandatory penalty. The fraud and abuse provisions are interpreted liberally and enforced aggressively by various enforcing agencies of the federal government, including the Federal Bureau of Investigation ("FBI") and the OIG. According to public statements by the DOJ, health care fraud has been elevated to the second-highest priority of the DOJ, and FBI agents have been transferred from investigating counterintelligence activities to health care provider fraud. The OIG also is involved in such investigations and has, according to recent workplans, targeted certain laboratory practices for study, investigation and prosecution. The federal government's involvement in curtailing fraud and abuse is likely to increase as a result of the enactment in August 1996 of the Health Insurance Act which will require, by January 1, 1997, the U.S. Attorney General and the OIG to jointly establish a program to (a) coordinate federal, state and local enforcement programs to control fraud and abuse with respect to health care, (b) conduct investigations, audits, evaluations and inspections relating to the delivery and payment for health care, (c) facilitate the enforcement of the health care fraud and abuse laws, (d) provide for the modification and establishment of safe harbors and to issue advisory opinions and Special Fraud Alerts and (e) provide for a data collection system for the reporting and disclosure of adverse actions taken against health care providers. The Health Insurance Act also authorizes the establishment of an anti-fraud and abuse trust fund funded through the collection of penalties and fines for violations of the health care anti-fraud laws as well as amounts authorized therefor by Congress. The Health Insurance Act also requires HHS to establish a program to encourage Medicare beneficiaries and others to report violations of the health care anti-fraud laws, including by paying to the reporting person a portion of any fines and penalties collected. 72 In October 1994, the OIG issued a Special Fraud Alert, which set forth a number of practices allegedly engaged in by clinical laboratories and health care providers that the OIG believes violate the anti-kickback laws. These practices include providing employees to collect patient samples at physician offices if the employees perform additional services for physicians that are typically the responsibility of the physicians' staff; selling laboratory services to renal dialysis centers at prices that are below fair market value in return for referrals of Medicare tests which are billed to Medicare at higher rates; providing free testing to a physician's HMO patients in situations where the referring physicians benefit from lower utilization; providing free pickup and disposal of bio-hazardous waste for physicians for items unrelated to a laboratory's testing services; providing facsimile machines or computers to physicians that are not exclusively used in connection with the laboratory services performed; and providing free testing for health care providers, their families and their employees (professional courtesy testing). The OIG stressed in the Special Fraud Alert that when one purpose of the arrangements is to induce referral of program-reimbursed laboratory testing, both the clinical laboratory and the health care provider or physician may be liable under the anti-kickback laws and may be subject to criminal prosecution and exclusion from participation in the Medicare and Medicaid programs. The Special Fraud Alert was issued in part at the request of the American Clinical Laboratory Association, which requested clarification of certain of these rules. CCL does not believe that it has been negatively affected by the issuance of the Special Fraud Alert. According to the 1995 work plan of the OIG, its recently established Office of Civil Fraud and Administrative Adjudication ("OCFAA") will be responsible for protecting the government-funded health care programs and deterring fraudulent conduct by health care providers through the negotiation and imposition of civil monetary penalties, assessments and program exclusions. The OCFAA works very closely with the DOJ, the Office of General Counsel of HHS and the OIG investigative and audit offices in combating fraud and abuse. In addition, the OIG stated in its 1995 work plan that it will determine the extent to which laboratories supply physicians' offices with phlebotomists (blood-drawing technicians), offer management services or medical waste pick-up to physicians, provide training to physicians or engage in other financial arrangements with purchasers of laboratories' services. The OIG will assess the potential benefits of such arrangements as well as the extent to which such arrangements might be unlawful. A federal "self-referral" law commonly known as the "Stark" law has, since 1992, generally prohibited (with certain exceptions) Medicare payments for laboratory tests referred by physicians who have (personally or through a family member) an investment interest in, or a compensation arrangement with, the testing laboratory. Since January 1995, these restrictions apply to Medicaid-covered services as well. Physicians may, however, be reimbursed by Medicare and Medicaid for testing performed by or under the supervision of the physician or the group practice to which the physician belongs. In addition, a physician may refer specimens to a laboratory owned by a company, such as CCL, whose stock is traded on a public exchange and which has stockholders' equity exceeding $75 million even if the physician owns stock of that company. An amendment to the Stark law in August 1993 makes it clear that ordinary day-to-day transactions between laboratories and their customers, including, but not limited to, discounts granted by laboratories to their customers, are not covered by the compensation arrangement provisions of the Medicare statute. Sanctions for laboratory violations of the prohibition include denial of Medicare payments, refunds, civil money penalties of up to $15,000 for each service billed in violation of the prohibition and exclusion from the Medicare and Medicaid programs. The 1995 House Medicare reform proposal contained, and the House-Senate report adopted, provisions that would significantly narrow the scope of the Stark anti-referral laws. That proposal would, among other changes, have ended the ban on physician referrals to laboratories based on any "compensation arrangements" between the laboratory and the physician. The President vetoed this bill on December 6, 1995. OIG Investigations In connection with the Distributions, Corning will agree to indemnify CCL against all monetary penalties, fines or settlements for the governmental claims discussed below which are pending on the Distribution Date. However, Corning will not indemnify CCL against private actions arising out of those claims or governmental 73 claims brought after the Distributions, even if they relate to events prior to the Distributions. The Corning indemnity also does not cover litigation expenses, including expenses incurred by former employees. See "The Relationship Among Corning, CCL and CPS After the Distributions--Transaction Agreement." In September 1993, CCL and MetWest Inc. ("MetWest"), then a wholly owned subsidiary of Unilab, in which CCL had at the time an interest of approximately 43%, entered into a Settlement Agreement (the "1993 Settlement Agreement") with the DOJ and OIG and paid a total of $39.8 million in settlement of civil claims that CCL and MetWest had wrongfully induced physicians to order serum ferritin and HDL-cholesterol laboratory tests without the physicians realizing that such tests would be billed to Medicare. Several state and private insurers have made claims based on the practices covered by the 1993 Settlement Agreement. Several claims have been settled but it is not clear at this time what, if any, additional exposure CCL may have to these entities and to other persons who may assert claims on the basis of these or other practices. CCL believes that future settlements of these claims, as to which Corning will not indemnify CCL, will not be material to CCL after the Distributions. During August 1993, CCL, MetWest and Damon (which was acquired by Corning earlier that month) together with other participants in the industry received subpoenas from the OIG seeking information regarding their practices with respect to 14 enumerated tests offered in conjunction with automatic chemical test panels. CCL, MetWest and Damon submitted information pursuant to these subpoenas and the investigation into CCL and MetWest has been closed. Damon was also served with two additional subpoenas in November 1994 and January 1995 from the OIG and was directed by the United States Attorney's Office in Boston, to which its investigation has been referred, to submit additional information in response to the August 1993 subpoena. The November 1994 subpoena supplements the August 1993 subpoena and requires the submission of additional information. The January 1995 subpoena seeks information regarding the addition of the 14 enumerated tests to organ function profiles rather than the automated multichannel chemistry profiles as in earlier subpoenas. Damon has completed its production to each of the foregoing subpoenas. In March 1995, Damon received a subpoena from the Department of Defense Criminal Investigative Service on behalf of the Civilian Health and Medical Program for the Uniformed Services ("CHAMPUS"), apparently covering the same practices as the earlier subpoenas. Compliance with that subpoena has been completed. In April 1995, CCL learned that a grand jury in Boston is investigating Damon for possible criminal violations of the anti-fraud and abuse provisions of the Social Security Act. In August 1995, CCL and Damon received subpoenas from the OIG seeking documents with regard to 14 Physicians' Current Procedural Terminology codes that describe and identify medical and medically related services used to bill Medicare, Medicaid and other payors for certain hematology tests. CCL and Damon have completed production pursuant to these subpoenas. In September 1996, CCL entered into a settlement agreement with the DOJ and OIG and paid a total of $6.9 million in settlement of civil claims that CCL and MetWest had wrongfully induced physicians to order certain hemotology tests without the physicians realizing that such tests would be billed to Medicare. In April 1996, Damon received a letter from the Boston United States Attorney's Office designating Damon as a target of a criminal investigation involving the alleged submission of false claims to the Medicare program and indicating that the United States Attorney's Office will recommend prosecution of Damon for those offenses. CCL has been advised that the Boston United States Attorney's Office has also designated certain former officers of Damon as targets of the investigation. Under the agreement and plan of merger under which Damon was acquired by Corning, CCL is obligated to indemnify former officers and directors of Damon to the fullest extent permitted by the Delaware General Corporation Law with respect to this investigation. Such indemnification obligations will remain the responsibility of CCL and CCL will not be indemnified by Corning for such costs. In August 1996, Corning Life Sciences, Inc. ("CLSI"), the parent company of CCL, was served with a federal grand jury subpoena in connection with an investigation of possible destruction of documents in connection with the subpoenas described in the preceding paragraph and of possible Medicare billing violations in connection with dialysis patient testing performed at its Atlanta, Georgia laboratory. While it is too early to predict the outcome of this matter, CCL has through its counsel conducted its own investigation and does not believe that there is any basis for the investigation. 74 In August 1993, Nichols Institute (which Corning acquired in August 1994) received a subpoena from the OIG comparable to those received by CCL, MetWest and Damon. Compliance with that subpoena has been completed. However, the government has requested additional documents pursuant to that subpoena, and identification and production of these additional documents is ongoing. In January 1996, Nichols received a subpoena from the OIG relating to specific individuals who had tests performed at the Nichols laboratory in Portland, Oregon. Compliance with that subpoena is ongoing. In May 1994, CCL received a subpoena from the OIG and a subpoena from a federal grand jury, both investigating billing for tests not performed or reported for which CCL had voluntarily made corrective payments in 1993. The civil matter was concluded by a payment by CCL of $8.6 million, and the criminal investigation was closed. The possibility of additional action by the OIG or other federal agencies and claims or settlements with parties other than the DOJ and OIG cannot be excluded. In September 1995, CCL began voluntarily providing documents and information to the DOJ concerning CCL's efforts to detect and correct billings for tests not reported or performed. As part of these activities, which are ongoing, CCL made certain supplemental payments to the United States in August 1995 and in March 1996. In December 1995, CCL received a subpoena from the OIG seeking information as to CCL policies in instances in which specimens were received by the laboratory without specific test requisitions. Compliance with the subpoena is ongoing. In April 1995, CLSI received a subpoena from the OIG concerning possible additions of the 14 enumerated tests to automated multichannel chemistry profiles by Bioran (acquired by Corning in September 1994). CLSI also received a comparable subpoena from the Department of Defense Criminal Investigative Service on behalf of CHAMPUS. On February 20, 1996, CCL and Bioran entered into an agreement with the DOJ, CHAMPUS, several state Medicaid programs, the OIG and several other government agencies settling entirely the matters covered in the foregoing subpoenas for a cash payment of $6.7 million. In June 1996, CLSI received a subpoena from a Boston federal grand jury seeking documents from CCL's Florida facilities concerning new and terminated customers of that facility and sales of testing services to such customers. Compliance with that subpoena was completed and CCL has been advised that the investigation is closed. During 1996, CCL voluntarily self-reported to the government a few isolated events that may have resulted in overpayments by Medicare and Medicaid to CCL. It is CCL's policy to internally investigate all such incidents and to self-report and reimburse payors as appropriate. Although CCL has commenced internal investigations to quantify the amounts that may be recouped by the government and corrective action has been taken as to each such event, it is too early to predict the outcome of these disclosures. If the DOJ or OIG were to pursue and successfully prove a violation of the laws related to the Medicare and Medicaid programs, potential sanctions could include significant fines, recovery of the amounts paid to the clinical laboratory for the tests involved and, in the case of a criminal conviction, mandatory exclusion from the Medicare and Medicaid programs for a period of at least five years. If the OIG asserts a claim against Damon and Nichols and is successful in pursuing such a claim, CCL's business and financial condition could be adversely affected. Although neither the CCL Settlement Agreement nor, based on published reports, any settlement agreements with the DOJ or OIG entered into by other major clinical laboratory companies, provided for exclusion from participation in the Medicare and Medicaid programs, there can be no assurance that CCL will be able to negotiate settlement agreements with similar terms if the government asserts (or threatens to assert) a claim. In addition, a criminal conviction or the successful prosecution of a civil fraud or false claims action could result in the exclusion of the defendant from the Medicare and Medicaid programs. Any such exclusion would likely also have a material adverse effect on CCL's non-Medicare and non-Medicaid testing business. In light of Corning's indemnity, CCL does not believe that any liability arising out of these investigations will have a material adverse effect on CCL's financial condition or results of operations after the Distributions. 75 Compliance Program Because of evolving interpretations of regulations and the national debate over health care, compliance with all Medicare, Medicaid and other government-established rules and regulations has become a significant concern throughout the clinical laboratory industry. CCL began the implementation of a compliance program early in 1993. The objective of the program is to develop aggressive and reliable compliance safeguards. Emphasis is placed on developing training programs for personnel intended to assure the strict implementation and observance of all applicable rules and regulations. Further, in-depth reviews of procedures, personnel and facilities are conducted to assure regulatory compliance throughout CCL. CCL's current compliance plan establishes a Compliance Committee of the CCL Board and requires periodic reporting of compliance operations by management to the Compliance Committee. Such sharpened focus on regulatory standards and procedures will continue to be a priority for CCL in the future. CCL has established a comprehensive program designed to ensure that it is in compliance in all material respects with all statutes, regulations and other requirements applicable to its clinical laboratory operations. The clinical laboratory testing industry is, however, subject to extensive regulation. Many of these statutes and regulations, including those relating to joint ventures and alliances, are vague or indefinite and have not been interpreted by the courts. In addition, regulators have generally offered little guidance to the clinical laboratory industry. Despite requests from the American Clinical Laboratory Association for clarification of the anti-fraud and abuse rules, since 1992, OIG has issued only two fraud alerts specifically with regard to clinical laboratory practices and has insisted that it lacked statutory authority to issue advisory opinions. Legislation requiring OIG to issue fraud alerts and advisory opinions was enacted in August 1996, and as a result CCL is hopeful that additional regulatory guidance will be given to the clinical laboratory industry. CCL believes that it is in all material respects in compliance with all applicable statutes and regulations. However, there can be no assurance that any statutes or regulations might not be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect CCL. Potential sanctions for violation of these statutes and regulations include significant fines and the loss of various licenses, certificates and authorizations. Insurance CCL maintains liability insurance (subject to maximum limits and self-insured retentions) for claims, which may be substantial, that could result from providing or failing to provide clinical laboratory testing services, including inaccurate testing results. While there can be no assurance that coverage will be adequate to cover all future exposure, management believes that the present levels of coverage are adequate to cover currently estimated exposures. Although CCL believes that it will be able to obtain adequate insurance coverage in the future at acceptable costs, there can be no assurance that CCL will be able to obtain such coverage or will be able to do so at an acceptable cost or that CCL will not incur significant liabilities in excess of policy limits. Employees At June 30, 1996, CCL employed approximately 18,000 people. These include approximately 15,800 full-time employees and approximately 2,200 part-time employees. CCL has no collective bargaining agreements with any unions and believes that its overall relations with its employees are good. Seasonality During the summer months, year-end holiday periods and other major holidays, volume of testing declines, reducing net revenues and resulting cash flows below annual averages during the third and fourth quarters each year. Winter months are also subject to declines in testing volume due to inclement weather. As a result, comparisons of the results of successive quarters may not accurately reflect trends or results for the full year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of CCL--Overview." 76 Properties CCL's principal laboratories are located in the following metropolitan areas:
Location Type of Laboratory Leased or Owned - -------- ------------------ --------------- Phoenix, Arizona Regional Leased San Diego, California Regional Leased San Juan Capistrano, California Esoteric Owned Denver, Colorado Regional Leased New Haven, Connecticut Regional Owned Miami, Florida Branch Leased Tampa, Florida Regional Leased Atlanta, Georgia Regional Leased Chicago, Illinois Regional Leased Indianapolis, Indiana Branch Leased Baltimore, Maryland Regional Owned Boston, Massachusetts Regional Owned subject to put/call with option to lease Detroit, Michigan Regional Leased Grand Rapids, Michigan Branch Leased Kansas City, Missouri Branch Leased St. Louis, Missouri Regional Leased Billings, Montana Branch Leased Teterboro, New Jersey/New York, New York Regional Owned Lincoln, Nebraska Regional Managed (hospital) Albuquerque, New Mexico Branch Leased Buffalo, New York Branch Owned Long Island, New York Branch Leased Cleveland, Ohio Branch Owned Columbus, Ohio Branch Leased Portland, Oregon Regional Leased Erie, Pennsylvania Branch Leased by joint venture Philadelphia, Pennsylvania Regional Leased Pittsburgh, Pennsylvania Regional Leased Nashville, Tennessee Branch Owned Dallas, Texas Regional Leased El Paso, Texas Branch Leased Salt Lake City, Utah Branch Leased
CCL executive offices are located in Teterboro, New Jersey in the building that serves as CCL's regional laboratory in the New York City metropolitan area. CCL owns its branch laboratory facility in Mexico City. CCL believes that, in general, its laboratory facilities are suitable and adequate for its current and anticipated future levels of operation. CCL believes that if it were unable to renew the lease on any of its testing facilities, it could find alternative space at competitive market rates and relocate its operations to such new locations. 77 Legal Proceedings In addition to the investigations described in "--OIG Investigations," CCL is involved in various legal proceedings arising in the ordinary course of business. Some of the proceedings against CCL involve claims that are substantial in amount. Although it is not feasible to predict the outcome of such proceedings or any claims made against CCL, CCL does not anticipate that the ultimate liability of such proceedings will have a material adverse effect on CCL's financial position or results of operations. CCL maintains professional liability insurance for its professional liability claims. See "--Insurance." CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The Private Securities Litigation Reform Act of 1995 provides a new "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. CCL desires to take advantage of the new "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 in connection with the information included herein and is including this section in order to do so. Accordingly, CCL hereby identifies the following important factors that could cause CCL's actual financial results to differ materially from those projected, forecast, estimated, or budgeted by CCL in forward-looking statements. (a) Heightened competition, including the intensification of price competition. See "Risk Factors-- Competition." (b) Impact of changes in payor mix, including the shift from traditional, fee-for-service medicine to managed-cost health care. (c) Adverse actions by governmental or other third-party payors, including unilateral reduction of fee schedules payable to CCL. (d) The impact upon CCL's collection rates or general or administrative expenses resulting from compliance with Medicare administrative policies, including specifically the recent requirements of Medicare carriers to provide diagnosis codes for commonly ordered tests and the policy of HCFA to limit Medicare reimbursement for tests contained in automated chemistry panels to the amount that would have been paid if only the covered tests, determined on the basis of demonstrable "medical necessity," had been ordered. (e) Adverse results from pending governmental investigations of Damon and Nichols including specifically significant monetary damages and/or exclusion from the Medicare and Medicaid programs and/or other significant litigation matters. (f) Failure to obtain new customers, retain existing customers or reduction in tests ordered or specimens submitted by existing customers. (g) Inability to obtain professional liability insurance coverage or a material increase in premiums for such coverage. (h) Denial of CLIA certification or other licensure of any of CCL's clinical laboratories under CLIA, by HCFA for Medicare and Medicaid programs or other federal, state and local agencies. (i) Adverse publicity and news coverage about CCL or the clinical laboratory industry. 78 (j) Computer or other system failures that affect the ability of CCL to perform tests, report test results or properly bill customers. (k) Development of technologies that substantially alter the practice of laboratory medicine. 79 MANAGEMENT OF CCL Management Directors. Certain information with respect to the persons who will serve as directors of CCL following the Distributions is set forth below. As provided in the CCL Certificate, the CCL Board will be divided into three classes effective upon the Distributions and one class of the CCL Board will be elected for a three-year term at each annual meeting of stockholders. Included in the information set forth below are the names of the directors of each class and their original terms. CCL is contemplating the selection of additional directors, which selection may occur prior to the Distributions. CCL does not intend to hold an annual meeting of stockholders until the Spring of 1998. Name Age Year Term Expires ---- --- ----------------- Kenneth W. Freeman 46 Van C. Campbell 58 David A. Duke 60 Kenneth W. Freeman was elected President and Chief Executive Officer of CCL in 1995. Prior to 1995, he served in a variety of key financial and managerial positions at Corning, which he joined in 1972. He was elected controller and a vice president of Corning in 1985, senior vice president in 1987, and general manager of the Science Products Division in 1989. He was appointed president and chief operating officer of Corning Asahi Video Products Company in 1990. In 1993, he was elected executive vice president. Van C. Campbell is the Vice Chairman of Corning, which he joined in 1964. He was elected assistant treasurer in 1971, treasurer in 1972, a vice president in 1973, financial vice president in 1975 and senior vice president for finance in 1980. He became general manager of the Consumer Products Division in 1981. Mr. Campbell was elected vice chairman and a director in 1983 and during 1995 was appointed to the additional position of chairman of Corning Life Sciences, Inc. He is a director of Armstrong World Industries, Inc. and General Signal Corporation. David A. Duke is a Retired Vice Chairman of Corning. Dr. Duke joined Corning in 1962 and served in a succession of research and management positions. He was elected vice president - Telecommunications Products in 1980, elected a senior vice president in 1984 and named director of Research and Development in 1985. He became responsible for Engineering in March 1987 and was elected as a director and Vice Chairman of Corning in 1988. He resigned as a director of Corning in April 1996 and retired in June 1996. Dr. Duke is a director of Armco, Inc. Directors' Compensation. Each director of CCL, other than a director who is an employee of CCL, will receive $18,000 annually for service as a director and will also be paid $1,000 for each meeting of the CCL Board and $500 for each meeting of any committee thereof which he attends. In lieu of a meeting fee, chairmen of committees of the CCL Board will be paid an annual retainer of $1,000. CCL has adopted, effective the Distribution Date, a deferred compensation plan for directors pursuant to which each director may elect to defer until a date specified by him receipt of all or a portion of his compensation. Such plan provides that amounts deferred may be allocated to (i) a cash account upon which amounts deferred may 80 earn interest, compounded quarterly, at the prime rate of Citibank, N.A. in effect on certain specified dates, (ii) a market value account, the value of which will be based upon the market value of CCL Common Stock from time to time, or (iii) a combination of such accounts. As of the Distribution Date, it is anticipated that there will be _____ non-employee directors eligible to participate in the plan. CCL has adopted, effective the Distribution Date, a restricted stock plan for non-employee directors, pursuant to which CCL will issue to each non-employee director elected 750 shares of CCL Common Stock for each year specified in the term of service for which such director was elected, subject to forfeiture and restrictions on transfer, and 5,000 shares upon such director's election, subject to forfeiture and restrictions on transfer. Committees of the Board of Directors. Prior to the Distributions, the CCL Board is expected to establish and designate specific functions and areas of oversight to an Audit and Finance Committee, a Compensation Committee ("CCL Compensation Committee") and a Compliance Committee. The Audit and Finance Committee will examine and consider matters relating to the financial affairs of CCL, including reviewing CCL's annual financial statements, the scope of the independent and internal audits and the independent auditor's letter to management concerning the effectiveness of CCL's internal financial and accounting controls. The CCL Compensation Committee will make recommendations to the CCL Board with respect to programs for human resource development and management organization and succession, determine senior executive compensation, make recommendations to the CCL Board with respect to compensation matters and policies and employee benefit and incentive plans, administer such plans, and administer CCL's stock option and equity based plans and grant stock options and other rights under such plans. The Compliance Committee will oversee CCL's compliance program, which is administered by management's compliance council. The council will prepare for review and action by the Compliance Committee reports on such matters as audits and investigations. See "Business of CCL--Compliance Program." Executive Officers of CCL. In addition to Mr. Freeman, the following persons will serve as executive officers of CCL after the Distributions: Robert A. Carothers (60) will become Vice President and Chief Financial Officer at the Distribution Date. Mr. Carothers joined Corning in 1959 and has served in a number of key financial positions in the United States and Japan. He was elected Assistant Controller in 1991. In January 1996 he was appointed Assistant to the President of CCL. James D. Chambers (39) is Vice President-Billing. Mr. Chambers joined Corning in 1986 and has served in a variety of managerial and financial positions for Corning and its subsidiaries, becoming Assistant Treasurer in 1991. Mr. Chambers joined CCL in 1992 as Treasurer and served as Chief Financial Officer from 1993 through 1995. In 1995 Mr. Chambers assumed his current responsibilities overseeing CCL's billing process. Gregory C. Critchfield, M.D. (45) is Senior Vice President, and Chief Medical and Science Officer. Dr. Critchfield joined CCL in 1995 as Chief Laboratory Officer and assumed his current responsibilities in May 1996. Dr. Critchfield has served as a consultant to the National Institutes of Health in the capacity of a reviewer for more than ten years and was selected as Study Section Chair of several Multidisciplinary Review Teams during the last two years. Prior to joining CCL, Dr. Critchfield was a clinical pathologist with Intermountain Health Care ("IHC") for eight years and served in various director positions with IHC Laboratory Services, including Director of Clinical Pathology. Dr. Critchfield also served as Chairman of the Department of Pathology at Utah Valley Regional Medical Center from 1992 through 1995. Kurt R. Fischer (41) is Vice President-Human Resources. Mr. Fischer joined Corning in 1976 and has served in a variety of Human Resources positions. He was appointed Human Resource Manager for the Research, Development and Engineering Group in 1986 and Director-Quality and Performance Management for the Specialty Materials Group in 1991. Mr. Fischer assumed his present responsibilities with CCL in December 1995. 81 Raymond Gambino, M.D. (69) is Chief Medical Officer Emeritus. Dr. Gambino joined CCL in 1983 as President of the Eastern Region. From 1984 to 1994, Dr. Gambino served as Chief Medical Officer and Executive Vice President, at which time his appointment was changed to emeritus. He continues to serve CCL as a senior medical advisor. Donald M. Hardison, Jr. (45) is Senior Vice President-Sales and Marketing, with overall responsibility for all commercial activities. Mr. Hardison joined CCL in January 1996. Prior to joining CCL, Mr. Hardison had 18 years experience in health care with subsidiaries of SmithKline Beecham and its predecessor entities, including seven years with the clinical laboratory division of SmithKline, where he held a succession of positions including Director of Marketing; Vice President of Sales-Northern; Vice President-General Manager of the Atlanta Operation; and Vice President of Sales and Marketing. Paul A. Krieger, M.D. (49) is Vice President-Anatomic Pathology with responsibility for all aspects of CCL's anatomic pathology testing. Dr. Krieger joined CCL in 1975 and served as Vice President, Director of Anatomic Pathology at CCL's regional laboratory in Teterboro, New Jersey until 1995, when he was appointed to his present position. Concurrent with his employment with CCL, Dr. Krieger has served as an Adjunct Assistant Professor at the College of Physicians and Surgeons of Columbia University. Raymond C. Marier (51) is Vice President, Secretary and General Counsel. Mr. Marier joined Corning's Legal Department in 1973 as an Assistant Counsel, where he worked with a number of Corning's operating units, including its Medical and Science Products Divisions. He has held his present position since 1992. C. Kim McCarthy (41) is Vice President-Compliance and Government Affairs. Ms. McCarthy joined Corning in 1987 as Director of Federal Government Affairs and Legislative Counsel. She became Vice President of Public Affairs of CCL in 1992 and Senior Vice President of Corporate Affairs in 1994. Ms. McCarthy assumed her present responsibilities in June 1996. Alister W. Reynolds (39) is Vice President-Information Technology. Mr. Reynolds joined CCL in 1982 and has served in a variety of staff, executive and general management positions. Mr. Reynolds assumed his current responsibilities in 1995. Douglas M. VanOort (40) will become Senior Vice President-Operations at the Distribution Date. Mr. VanOort joined Corning in 1982 and has served in various finance, analysis and control positions. He became Vice President and Chief Financial Officer of CCL in 1990, Senior Vice President-Finance and New Business Development of CCL in 1993 and Executive Vice President and Chief Financial Officer of CCL in 1995. Executive Compensation Historical Compensation. The following table sets forth information with respect to annual and long-term compensation expected to be paid by CCL and its subsidiaries to each of the chief executive officer and the four other most highly compensated executive officers (the "named executive officers") of CCL for services to be rendered in all capacities in fiscal year 1996 and such compensation paid or accrued during the years ended December 31, 1995 and December 31, 1994 for services rendered by each of the named executive officers. All references in the following tables to stock and stock options relate to awards of, and options to purchase, Corning Common Stock. 82 SUMMARY COMPENSATION TABLE
Long-Term Compensation ---------------------- Annual Compensation Awards Payouts ------------------- ------ ------- Restricted Securities Incentive Name and Other Annual Stock Underlying Plan All Other Principal Position Year Salary Bonus Compensation(2) Awards(3) Options Payouts Compensation(4) - ------------------ ---- ------ ----- --------------- --------- ------- ------- ---------------- Kenneth W. Freeman, 1996 (1) President and Chief 1995 Executive Officer 1994 Douglas M. VanOort, 1996 Senior Vice President - 1995 Operations 1994 Gregory C. Critchfield, Senior Vice President and 1996 Chief Medical and Science 1995 Officer 1994 Donald M. Hardison, Jr., 1996 Senior Vice President 1995 Sales and Marketing 1994 1996 [Name] 1995 [Title] 1994
(1) Includes amounts paid or to be paid and deferred. (2) Includes dividends on shares of restricted stock granted but not earned within one year from date of grant and tax gross-up payments. (3) Messrs. Freeman, VanOort, Hardison and ___________ held an aggregate of _______, _______ and _______ shares of restricted stock, respectively, having an aggregate value on ___________, 1996 of $_________, $_________ and $_________, respectively. Certain of such shares, net of forfeitures, were subject to performance-based conditions on vesting and are subject to forfeiture upon termination and restrictions on transfer prior to stated dates. Certain other shares ("Career Shares") are subject to restrictions on transfer until the executive officer retires at or after age 60 and are subject to forfeiture prior to age 60 in whole if such officer voluntarily terminates employment with CCL and in part if such officer's employment is terminated by CCL. On or prior to the Distribution Date (a) all forfeiture conditions and transfer restrictions will be removed from performance-based shares, (b) all restrictions on transfer will be removed from shares which are no longer subject to forfeiture and (c) Career Shares which are subject to forfeiture conditions and transfer restrictions will be forfeited, and restricted shares and/or options to purchase shares of CCL Common Stock will thereafter be granted pursuant to the terms of the CCL Incentive Stock Plan (as defined below). Dividends are paid to such individuals on all shares of restricted Corning Common Stock held by them. (4) Includes the following amounts to be contributed by CCL to the CCL Profit Sharing Plan (as defined below) for 1996: $______ for Mr. Freeman, $______ for Mr. VanOort, $______ for Dr. Critchfield, $______ for Mr. Hardison and $______ for Mr. _______. Also includes $_______ automobile allowance received by each of Messrs. Freeman, Hardison and _________ and $________ for Dr. Critchfield. Also includes 50% of a $______ interest-free loan made by CCL to Dr. Critchfield together with imputed interest thereon, which loan is to be forgiven over a two-year period provided Dr. Critchfield continues to be employed by CCL and was made to assist Dr. Critchfield in relocating to the New Jersey area. 83 Option Grants. The following table sets forth certain information regarding options granted in 1995 (except for Mr. Hardison whose options were granted on February 7, 1996) to the named executive officers pursuant to Corning stock option plans. No other options were granted to the named executive officers in 1996. Employees of CCL who hold at the Distribution Date Corning stock options other than those granted on December 6, 1995 and February 7, 1996 will continue to hold Corning stock options following the CCL Spin-Off Distribution. It is anticipated that appropriate adjustments to the number of shares subject to options and to the exercise prices will be made to reflect the CCL Spin-Off Distribution. A portion of the options granted on December 6, 1995 and February 7, 1996 will be converted into options to purchase shares of CCL Common Stock ("New Options") under the CCL Stock Option Plan (as defined below). The remainder of the options granted on December 6, 1996 and February 7, 1996 will be cancelled. It is anticipated that such cancelled options will be replaced by options to be granted under the CCL Stock Option Plan. The exercise prices and the number of shares of CCL Common Stock subject to New Options will be determined as of the time of the Distributions so as to preserve the investment basis and intrinsic gain associated with the Corning options surrendered as of the date of the CCL Spin-Off Distribution. Generally, the expiration dates and the dates on which New Options are exercisable will be identical to those under the corresponding Corning options at the time of the Distributions. Certain New Options will provide that upon exercise of such option through the surrender of previously owned shares of CCL Common Stock, the participant will be entitled to receive options covering the same number of shares so surrendered, with an exercise price equal to the fair market value of the shares at the time of the exercise of the New Option. 84 OPTION/SAR GRANTS IN FISCAL YEAR 1995 (1)
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term (3) ----------------- --------------- Number of % of Total Securities Options Underlying Granted Options to Employees Exercise Expiration Gain at Gain at Gain at Name Granted in Fiscal Year Price Date 0% (4) 5% 10% - -------------------------- --------------- -------------- ---------- ----------- ------------ --------- --------- Kenneth W. Freeman (2) Douglas M. VanOort (2) Gregory C. Critchfield (2) Donald M. Hardison, Jr. (2) [Name] (2)
(1) No SARs were granted. (2) The stock option agreements with Messrs. Freeman, VanOort, ____________ and Hardison provide that one-half of the options will become exercisable on February 1, 1999 and all options will become exercisable on February 1, 2000. The stock option agreement with Dr. Critchfield provides that one-half of the options will become exercisable on October 4, 1996 and all of the options will become exercisable on October 4, 1997. All such agreements also provide that an additional option may be granted when the optionee uses shares of Corning Common Stock to pay the purchase price of an option. The additional option will be exercisable for the number of shares tendered in payment of the option price, will be exercisable at the then fair market value of the Corning Common Stock, will become exercisable only after the lapse of twelve months and will expire on the expiration date of the original option. (3) The dollar amounts set forth under these columns are the result of calculations at 0% and at the 5% and 10% rates established by the Commission and therefore are not intended to forecast future appreciation of Corning's stock price. (4) No gain to the optionees is possible without an appreciation in stock price, an event which will also benefit all stockholders. If the stock price does not appreciate, the optionees will realize no benefit. Option Exercises and Fiscal Year-End Values. The following table sets forth the number of shares of Corning Common Stock covered by both exercisable and unexercisable stock options as of December 31, 1995, for the named executive officers. The named executive officers exercised no options in 1996. 85 AGGREGATED OPTION/SAR EXERCISES IN FISCAL YEAR 1995 AND 1995 FISCAL YEAR-END OPTION/SAR VALUES (1)
Number of Securities Underlying Unexercised Value of Unexercised Options at In-the-Money Options Fiscal Year End At Fiscal Year End --------------- ------------------ Shares Acquired Value Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable - --------------------------- ----------------- -------------- ----------- ------------- ----------- ------------- Kenneth W. Freeman Douglas M. VanOort Gregory C. Critchfield Donald M. Hardison, Jr. [Name]
(1) There are no SARs outstanding. Corporate Performance Plan Activity. Awards of performance-based shares of Corning Common Stock have been granted to CCL's executive officers pursuant to a series of performance-based plans (the "Corporate Performance Plan"). The Corporate Performance Plan provides the mechanisms to reward improvement in corporate performance as measured by net income, earnings per share and/or return on equity. Each year minimum, target and maximum goals are set and shares awarded (at target levels) which are subject to forfeiture in whole or in part if performance goals are not met. The percentage of awards that may be earned ranges from 0% to 150% of target. Shares earned remain subject to forfeiture and restrictions on transfer for two years following the end of the performance period. The following table sets forth the number of performance-based shares awarded under the Corporate Performance Plan. The dollar value of shares earned for 1995 is reflected in the "Restricted Stock Awards" column of the Summary Compensation Table appearing on page __. In late 1996, the Compensation Committee of the Corning Board will assess performance against goals, determine the number of shares earned of those granted on December 6, 1995 and February 7, 1996 and remove all possibility of forfeiture and restrictions on transfer from such shares. CORPORATE PERFORMANCE PLAN ACTIVITY TABLE
Number Number Number Vesting Date Grant of Shares Performance of Shares of Shares of Name Year Date Granted Period Forfeited Earned Earned Shares - ------------------------------- ---- ----------- ------------ ---------------- ------------- ----------- --------------- Kenneth W. Freeman Douglas M. VanOort Gregory C. Critchfield Donald M. Hardison, Jr. [Name]
86 Variable Compensation. CCL has adopted, effective upon the Distributions, a variable compensation plan (the "Plan"), an annual incentive cash compensation plan for approximately 950 supervisory, management and executive employees similar to an annual performance plan currently maintained by CCL. The terms of the Plan are as follows. The performance-based annual cash incentive awards payable under the Plan will be grounded in financial goals such as net income, cash flow, operating margin, return on equity, or earnings per share, or a combination thereof, and quantifiable non-financial goals. Each participant will be assigned a target award, as a percentage of base salary in effect at the end of the performance year for which the target is set, payable if the target is achieved. Actual results will be compared to the scale of targets with each gradation of desired result corresponding to a percentage, which will be multiplied by the employee's assigned target award. If the actual result is below target, awards will be less than target, down to a point below which no awards are earned. If the desired result is above target, awards will be greater than target, up to a stated maximum award. The maximum award assigned to the chief executive officer may not exceed 200% of base salary in effect on the date the CCL Compensation Committee sets the target for the performance year. The CCL Compensation Committee retains the right to reduce any award if it believes individual performance does not warrant the award calculated by reference to the result. Employee Equity Participation Program. CCL has adopted, effective upon the Distributions, the Employee Equity Participation Program (the "Program") consisting of two plans: (a) a stock option plan (the "CCL Stock Option Plan") and (b) an incentive stock plan (the "CCL Incentive Stock Plan"). The Program is designed to provide a flexible mechanism to permit key employees of CCL and of any subsidiary to obtain significant equity ownership in CCL, thereby increasing their proprietary interest in the growth and success of CCL. The Program, which will be administered by the CCL Compensation Committee, provides for the grant to eligible employees of either non-qualified or "incentive stock" options, or both, to purchase shares of CCL Common Stock at no less than fair market value on the date of grant. The CCL Compensation Committee may also provide that options may not be exercised in whole or in part for any period or periods of time; provided, however, that no option will be exercisable until at least twelve months from the date of grant. All options shall expire not more than ten years from the date of grant. Options will not be assignable or transferable except for limited circumstances on death. During the lifetime of the employee an option may be exercised only by him. The option price must be paid to CCL by the optionee in full prior to delivery of the stock. The optionee may pay the option price in cash or with shares of CCL Common Stock owned by him. The optionee will have no rights as a stockholder with respect to the shares subject to option until shares are issued upon exercise of the option. The CCL Compensation Committee may grant options pursuant to which an optionee who uses shares of CCL Common Stock to pay the purchase price of an option will receive automatically on the date of exercise an additional option to purchase shares of CCL Common Stock. Such additional option will cover the number of shares tendered in payment of the option price, will be exercisable at the then fair market value of CCL Common Stock, will become exercisable only after the lapse of twelve months and will expire on the expiration date of the original option. The Program also authorizes the CCL Compensation Committee to award to eligible employees shares, or the right to receive shares, of CCL Common Stock, the equivalent value in cash or a combination thereof (as determined by the CCL Compensation Committee). The CCL Compensation Committee shall determine the number of shares which are to be awarded to individual employees and the number of rights covering shares to be issued upon attainment of predetermined performance objectives for specified periods. The shares awarded directly to individual employees may be made subject to certain restrictions prohibiting sale or other disposition and may be made subject to forfeiture in certain events. Shares may be issued to recognize past performance either generally or upon attainment of specific objectives. Shares issuable for performance (based upon specific predetermined objectives) will be payable only to the extent that the CCL Compensation Committee determines that an eligible employee has met such objectives and will be valued as of the date of such determination. Upon issuance, such shares may (but need not) be made subject to the possibility of forfeiture or certain restrictions on transfer. 87 Key executive, managerial and technical employees (including officers and employees who are directors) of CCL and of any subsidiary will be eligible to participate in the Program and the plans thereunder. The selection of employees eligible to participate in any plan under the Program is within the discretion of the CCL Compensation Committee. Approximately 150 employees would have been eligible to participate in the plans under the Program had the Program been in effect in 1996. Under the Program, the maximum number of shares of CCL Common Stock which may be optioned or granted to eligible employees will be _________. Shares from expired or terminated options under the CCL Stock Option Plan will be available again for option grant under the Program. Shares which are issued but not earned because performance targets have not been satisfied, or which are forfeited under the CCL Incentive Stock Plan, will be available again for issuance under the Program. The Program provides for appropriate adjustments in the aggregate number of shares subject to the Program and in the number of shares and the price per share, or either, of outstanding options in the case of changes in the capital stock of CCL resulting from any recapitalization, stock or unusual cash dividend, stock distribution, stock split or any other increase or decrease effected without receipt of consideration by CCL, or a merger or consolidation in which CCL is the surviving corporation. The Program has a term of five years and no shares may be optioned or awarded and no rights to receive shares may be granted after the expiration of the Program. The CCL Board is authorized to terminate or amend the Program, except that it may not increase the number of shares available thereunder, decrease the price at which options may be granted, change the class of employees eligible to participate, or extend the term of the Program or options granted thereunder without the approval of the holders of a majority of the outstanding shares of CCL Common Stock. CCL believes that the federal income tax consequences of the Program are as follows. An optionee who exercises a non-qualified option granted under the CCL Stock Option Plan will recognize compensation taxable as ordinary income (subject to withholding) in an amount equal to the difference between the option price and the fair market value of the shares on the date of exercise and CCL or the subsidiary employing the optionee will be entitled to a deduction from income in the same amount. The optionee's basis in such shares will be increased by the amount taxable as compensation, and his capital gain or loss when he disposes of the shares will be calculated using such increased basis. If all applicable requirements of the Code with respect to incentive stock options are met, no income to the optionee will be recognized and no deduction will be allowable to CCL at the time of the grant or exercise of an incentive stock option. The excess of the fair market value of the shares at the time of exercise of an incentive stock option over the amount paid is an item of tax preference which may be subject to the alternative minimum tax. In general, if an incentive stock option is exercised three months after termination of employment, the optionee will recognize ordinary income in an amount equal to the difference between the option price and the fair market value of the shares on the date of exercise and CCL or the subsidiary employing the optionee will be entitled to a deduction in the same amount. If the shares acquired subject to the option are sold within one year of the date of exercise or two years from the date of grant, the optionee will recognize ordinary income in an amount equal to the difference between the option price and the lesser of the fair market value of the shares on the date of exercise or the sale price and CCL or the employing subsidiary will be entitled to a deduction from income in the same amount. Any excess of the sale price over the fair market value on the date of exercise will be taxed as a capital gain. Shares of CCL Common Stock which are not subject to restrictions and possibility of forfeiture and which are awarded to an employee under the CCL Incentive Stock Plan will be treated as ordinary income, subject to withholding, to an employee at the time of the transfer of the shares to him and the value of such awards will be deductible by CCL or by the subsidiary employing the employee at the same time in the same amount. Shares granted subject to restrictions and possibility of forfeiture will not be subject to tax nor will such grant result in a tax deduction for CCL at the time of award. However, when such shares become free of restrictions and possibility 88 of forfeiture, the fair market value of such shares at that time (i) will be treated as ordinary income to the employee and (ii) will be deductible by CCL or by the subsidiary employing the employee. The tax treatment upon disposition of shares acquired under the Program will depend upon how long the shares have been held and on whether or not the shares were acquired by exercising an incentive stock option. There are no tax consequences to CCL upon a participant's disposition of shares acquired under the Program, except that CCL may take a deduction equal to the amount the participant must recognize as ordinary income in the case of the disposition of shares acquired under incentive stock options before the applicable holding period has been satisfied. Pension Plans. None of the executive officers of CCL are currently active participants in a qualified defined benefit plan of CCL. Prior to June 1, 1995 and January 1, 1995, respectively, Messrs. Freeman and VanOort were eligible to participate in, and accrue benefits under, Corning's Salaried Pension Plan (the "Corning Salaried Pension Plan"), a defined benefit plan, contributions to which are determined by Corning's actuaries and are not made on an individual basis. Benefits paid under this plan are based upon career earnings (regular salary and cash awards paid under Corning's variable compensation plans) and years of credited service. The Corning Salaried Pension Plan provides that salaried employees of Corning who retire on or after December 31, 1993 will receive pension benefits equal to the greater of (a) benefits provided by a formula pursuant to which they shall receive for each year of credited service an amount equal to 1.5% of annual earnings up to the social security wage base and 2% of annual earnings in excess of such base or (b) benefits calculated pursuant to a formula which provides that retirees will receive for each year of credited service prior to January 1, 1994 an amount equal to 1% of the first $24,000 of average earnings for the highest five consecutive years of annual earnings in the ten years of credited service immediately prior to 1994 and 1.5% of such average earnings in excess of $24,000. Effective upon commencement of employment, salaried employees may contribute to the Corning Salaried Pension Plan 2% of their annual earnings up to the social security wage base. Such employees will receive for each year of credited service after December 31, 1990, in lieu of the amount described in (a) above, an amount equal to 2% of annual earnings. The benefit formula is reviewed and adjusted periodically for inflationary and other factors. Corning maintains a non-qualified Executive Supplemental Pension Plan (the "Executive Supplemental Plan") pursuant to which it will pay to certain executives amounts approximately equal to the difference between the benefits provided for under the Corning Salaried Pension Plan and benefits which would have been payable thereunder but for the provisions of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). It is anticipated that, prior to the Distribution Date, the Compensation Committee of the Corning Board will adopt a transferee supplemental pension plan (the "Transferee Supplemental Plan"), a nonqualified, unfunded defined benefit plan for the benefit of approximately 15 key employees and executive officers of CCL who are former employees of Corning, including Messrs. Freeman and VanOort, effective immediately after the Distribution Date. The Transferee Supplemental Plan will provide benefits approximately equal to the difference between the benefits provided for under the Corning Salaried Pension Plan and the Executive Supplemental Plan and benefits which would have been payable thereunder but for the termination of employment with Corning of such employees. Maximum annual benefits calculated under the straight life annuity option form of pension payable to participants at age 65, the normal retirement age specified in the Corning Salaried Pension Plan, are illustrated in the table set forth below. The table below does not reflect any limitations on benefits imposed by ERISA. It is estimated that Messrs. Freeman and VanOort, who have ____ and ____ years of credited service, respectively, would receive each year if they worked to age 65, the normal retirement age specified in the Corning Salaried Pension Plan, $_____ and $_____, respectively, under the Corning Salaried Pension Plan, the Executive Supplemental Plan and the Transferee Supplemental Plan. 89
- ----------------------------------------------------------------------------------------------------------------------- Years of Service - ----------------------------------------------------------------------------------------------------------------------- 15 20 25 30 35 40 - ----------------------------------------------------------------------------------------------------------------------- Remuneration - ----------------------------------------------------------------------------------------------------------------------- $ 100,000 - ----------------------------------------------------------------------------------------------------------------------- 200,000 - ----------------------------------------------------------------------------------------------------------------------- 300,000 - ----------------------------------------------------------------------------------------------------------------------- 400,000 - ----------------------------------------------------------------------------------------------------------------------- 500,000 - ----------------------------------------------------------------------------------------------------------------------- 600,000 - ----------------------------------------------------------------------------------------------------------------------- 700,000 - ----------------------------------------------------------------------------------------------------------------------- 800,000 - ----------------------------------------------------------------------------------------------------------------------- 900,000 - ----------------------------------------------------------------------------------------------------------------------- 1,000,000 - ----------------------------------------------------------------------------------------------------------------------- 1,100,000 - ----------------------------------------------------------------------------------------------------------------------- 1,200,000 - -----------------------------------------------------------------------------------------------------------------------
CCL Profit Sharing Plan. Most of the employees of CCL and its subsidiaries have been eligible to participate in a tax-qualified, defined contribution plan known as the CCL Profit Sharing Plan (the "CCL Profit Sharing Plan"), which provides for investment of employee contributions, including tax-deferred contributions under Section 401(k) of the Code, and matching contributions made by their employers, in several investment funds, including Corning Common Stock, at the employees' discretion. Effective as of the Distribution Date, CCL Common Stock will be added as an investment fund and a portion of the employer matching contributions will automatically be invested in CCL Common Stock. Corning Common Stock will no longer be available as an investment fund except with respect to amounts already so invested under the CCL Profit Sharing Plan. Effective as of the Distribution Date, the CCL Profit Sharing Plan will be amended to permit participating employees' employers to make discretionary contributions, other than matching contributions, to the CCL Profit Sharing Plan for the benefit of such employees, which contributions may be invested in CCL Common Stock. CCL Employee Stock Ownership Plan. CCL has adopted, as of ________, an employee stock ownership plan, as defined in Section 4975(e)(7) of the Code and related regulations and intended to qualify as a retirement plan under Section 401(a) of the Code, to be known as the CCL Employee Stock Ownership Plan (the "CCL ESOP"). Most employees of CCL and its subsidiaries will become participants in the CCL ESOP after accruing six months of service. To the extent permitted under the CCL ESOP, CCL will contribute as of the Distribution Date an amount equal to a portion of each participating employee's annual compensation. CCL may in its discretion from time to time make additional contributions to the CCL ESOP for the benefit of participating employees. The assets of the CCL ESOP will be invested primarily in shares of CCL Common Stock. 90 Amounts contributed to the CCL ESOP for the benefit of participating employees will be 100% vested at age 65, the normal retirement age specified in the CCL ESOP, or at death, disability or termination of employment following completion of two years of credited service. Contributions to the CCL ESOP will not currently be taxable income to the participating employees and will not generally be available to them until termination of employment. Employee Stock Purchase Plan. CCL has adopted, as of the Distribution Date, the Employee Stock Purchase Plan (the "CCL Stock Purchase Plan"), intended to qualify as an "employee stock purchase plan" under Section 423 of the Code, pursuant to which CCL may make available for sale to employees shares of its Common Stock at a price equal to 85% of the market value on the first or last day of each calendar quarter, whichever is lower. The CCL Stock Purchase Plan, which will be administered by the CCL Compensation Committee, is designed to give eligible employees (generally, employees of CCL and its subsidiaries) the opportunity to purchase shares of CCL Common Stock through payroll deductions up to 10% of compensation in a series of quarterly offerings commencing ________, 1997, and ending no later than ___________. Any eligible employee may elect to participate in the CCL Stock Purchase Plan on a quarterly basis and may terminate his payroll deduction at any time or increase or reduce prospectively the amount of his deduction at the beginning of any calendar quarter. At the end of each calendar quarter, a participating employee will purchase shares of CCL Common Stock with the funds deducted. The number of shares purchased will be a number determined by dividing the amount withheld by the lower of 85% of the closing price of a share of CCL Common Stock as reported in The Wall Street Journal on the first or last business day of the particular calendar quarter. An employee will have no interest in any shares of CCL Common Stock until such shares are actually purchased by him. Under the CCL Stock Purchase Plan, the maximum number of shares of CCL Common Stock which may be purchased by eligible employees will be __________, subject to adjustment in the case of changes in the capital stock of CCL resulting from any recapitalization, stock dividend, stock split or any other increase or decrease effected without receipt of consideration by CCL or a merger or consolidation in which CCL is the surviving corporation. The CCL Stock Purchase Plan has a term of _____ years and no shares of CCL Common Stock may be offered for sale or sold under the CCL Stock Purchase Plan after the _____ anniversary of the effective date. The CCL Board is authorized to terminate or amend the CCL Stock Purchase Plan, except that it may not increase the number of shares of CCL Common Stock available thereunder, decrease the price at which such shares may be offered for sale or extend the term of the CCL Stock Purchase Plan without the approval of the holders of a majority of the shares of the capital stock of CCL cast at a meeting at which such matter is considered. 91 SECURITY OWNERSHIP BY CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF CCL All of the outstanding shares of CCL Common Stock are currently held by CLSI, which is wholly owned by Corning. The following table sets forth the number of shares of CCL Common Stock that are projected to be beneficially owned after the CCL Spin-Off Distribution by the directors, by the named executive officers and by all directors and executive officers of CCL as a group. The projections are based on the number of shares of Corning Common Stock held by such persons and such group as of ______, 1996 (excluding shares of restricted stock that will be forfeited prior to the Distribution Date and Corning Common Stock held in the CCL Profit Sharing Plan) and on the number of options to acquire Corning Common Stock held as of such date and exercisable within 60 days thereof. With respect to the shares of CCL Common Stock, the number reflects the distribution ratio of one share of CCL Common Stock for every eight shares of Corning Common Stock and with respect to options the number reflects the actual number of shares of Corning Common Stock subject to options. Number of Shares Number of Name Beneficially Owned Exercisable Options - ---- ------------------ ------------------- Van C. Campbell Gregory C. Critchfield David A. Duke Kenneth W. Freeman Donald M. Hardison, Jr. Douglas M. VanOort All Directors and Executive Officers as a Group 92 DESCRIPTION OF CCL CAPITAL STOCK General The following is a brief summary of certain provisions of the CCL Certificate, as the restated certificate of incorporation will be amended immediately prior to the CCL Spin-Off Distribution, and does not relate to or give effect to provisions of statutory or other law except as specifically stated. The CCL Certificate authorizes the issuance of 100,000,000 shares of CCL Common Stock. Approximately 28,762,161 shares of CCL Common Stock are expected to be outstanding immediately following the CCL Spin-Off Distribution. The rights of holders of shares of CCL Common Stock are governed by the CCL Certificate, the CCL By-Laws and by the DGCL. Voting Rights Subject to the voting of any shares of CCL Series Preferred Stock (as defined below) that may be outstanding, voting power is vested in the CCL Common Stock, each share having one vote. Preemptive Rights The CCL Certificate provides that no holder of shares of CCL Common Stock or CCL Series Preferred Stock shall have any preemptive rights except as the CCL Board may determine from time to time. No such rights have been granted by the CCL Board. CCL Common Stock Liquidation Rights. Subject to the preferential rights of any outstanding CCL Series Preferred Stock, in the event of any liquidation of CCL, holders of shares of CCL Common Stock then outstanding are entitled to share ratably in the assets of CCL available for distribution to such holders. Dividend Policy. Subject to any preferential rights of any outstanding CCL Series Preferred Stock, such dividends as may be determined by the CCL Board may be declared and paid on the shares of CCL Common Stock from time to time out of any funds legally available therefor. It is currently contemplated that, following the Distributions, CCL will not pay cash dividends in the foreseeable future, but will retain earnings to provide funds for the operation and expansion of its business. Dividend decisions will be based upon a number of factors, including the operating results and financial requirements of CCL and such other considerations as the CCL Board deems relevant. In addition, the CCL Credit Facility and the Indenture governing the Notes will contain covenants that will limit the ability of CCL to pay dividends on the CCL Common Stock. See "Risk Factors--Risks Relating to CCL--Absence of Dividends" and "Description of Certain Indebtedness of CCL." Other Provisions. The shares of CCL Common Stock have no redemption, sinking fund or conversion privileges applicable thereto and holders of shares of CCL Common Stock are not liable to assessments or to further call. Listing and Trading. Prior to the Distributions, there has been no public trading market for the CCL Common Stock although a "when issued" market is expected to develop prior to the Distribution Date. Application has been made to list the CCL Common Stock on the NYSE, subject to official notice of the Distributions, under the trading symbol "__." Prices at which CCL Common Stock may trade prior to the Distributions on a "when-issued" basis or after the Distributions cannot be predicted. Until shares of the CCL Common Stock are fully distributed and an orderly market develops, the prices at which trading in such stock occurs may fluctuate significantly. The prices at which CCL Common Stock will trade will be determined by the marketplace and may be influenced by many factors, including, among others, the depth and liquidity of the market for CCL Common Stock, investor perceptions of CCL, the clinical laboratory testing business, and general economic and market 93 conditions. CCL initially will have approximately __ stockholders of record, based on the number of holders of record of Corning Common Stock at the date of this Information Statement. The Transfer Agent and Registrar for the CCL Common Stock will be Harris Trust and Savings Bank. For certain information regarding options to purchase CCL Common Stock that may become outstanding after the Distributions, see "Management of CCL." CCL Series Preferred Stock The CCL Certificate authorizes the issuance of up to 10,000,000 shares of CCL Series Preferred Stock, par value $___ per share (the "CCL Series Preferred Stock"). The CCL Board has the authority to issue such shares from time to time, without stockholder approval, and to determine the designations, preferences, rights, including voting rights, and restrictions of such shares, subject to the DGCL. Pursuant to this authority, the CCL Board has designated __ shares of CCL Series Preferred Stock as CCL Series A Preferred Stock. No other class of CCL Series Preferred Stock has been designated by the CCL Board. Preferred Share Purchase Rights Attached to each share of CCL Common Stock is one right ("CCL Right"), which entitles the registered holder to purchase from CCL one one-hundredth of a share of CCL Series A Preferred Stock at a price of $[50] per one-hundredth of a share of CCL Series A Preferred Stock (the "Exercise Price"), subject to adjustment. The CCL Rights expire on December 31, 2006 (the "Final Expiration Date"), unless the Final Expiration Date is extended or unless the CCL Rights are earlier exercised. The CCL Rights represented by the certificates for shares of CCL Common Stock are not exercisable, and are not transferable apart from the shares of CCL Common Stock, until the earlier of (1) ten days following the public announcement by CCL or an Acquiring Person (as defined below) that a person or group has acquired beneficial ownership of 20% or more of the shares of CCL Common Stock (an "Acquiring Person") or (2) ten business days (or such later date as the CCL Board may determine prior to such time as any person or group of affiliated persons becomes an Acquiring Person) after the commencement or first public announcement of an intention to make a tender or exchange offer that would result in a person or group beneficially owning 20% or more of the shares of CCL Common Stock (the earlier of such dates being called the "Rights Distribution Date"). The CCL Board has the authority to determine that a person that has inadvertently acquired beneficial ownership of 20% of the shares of CCL Common Stock is not an Acquiring Person if such person promptly reduces its ownership interest to below 20%. Separate certificates for the CCL Rights will be mailed to holders of record of the shares of CCL Common Stock as of such date. The CCL Rights could then begin trading separately from the shares of CCL Common Stock. Generally, in the event that a person or group becomes an Acquiring Person, each CCL Right (other than the CCL Rights owned by the Acquiring Person and certain affiliated persons) will thereafter entitle the holder to receive, upon exercise of the CCL Right, shares of CCL Common Stock having a value equal to two times the Exercise Price of the CCL Right. In the event that a person or group becomes an Acquiring Person (but prior to such time as such person or group beneficially owns 50% or more of the outstanding shares of CCL Common Stock), the CCL Board may exchange each CCL Right and each one one-hundredth of a share of CCL Series A Preferred Stock (other than CCL Rights and CCL Series A Preferred Stock owned by the Acquiring Person and certain affiliated persons) for one share of CCL Common Stock. In the event that CCL is acquired in a merger, consolidation, or other business combination transaction or more than 50% of CCL's assets, cash flow or earning power is sold or transferred, each CCL Right (other than the CCL Rights owned by an Acquiring Person and certain affiliated persons) will thereafter entitle the holder thereof to receive, upon the exercise of the CCL Right, common stock of the acquiring corporation having a value equal to two times the Exercise Price of the CCL Right. The CCL Rights are redeemable in whole, but not in part, at $.01 per CCL Right at any time prior to any person or group becoming an Acquiring Person. The right to exercise the CCL Rights terminates at the time that the CCL Board elects to redeem the CCL Rights. Notice of redemption shall be given by mailing such notice to 94 the registered holders of the CCL Rights. At no time will the CCL Rights have any voting rights. The CCL Rights Agent is Harris Trust and Savings Bank (the "CCL Rights Agent"). The exercise price payable, and the number of shares of CCL Series A Preferred Stock or other securities or property issuable, upon exercise of the CCL Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of, the shares of CCL Series A Preferred Stock, (ii) upon the grant to holders of the shares of CCL Series A Preferred Stock of certain rights or warrants to subscribe for or purchase shares of CCL Series A Preferred Stock at a price, or securities convertible into shares of CCL Series A Preferred Stock with a conversion price, less than the then current market price of the shares of CCL Series A Preferred Stock or (iii) upon the distribution to holders of the shares of CCL Series A Preferred Stock of evidences of indebtedness or assets (excluding regular periodic cash dividends paid out of earnings or retained earnings or dividends payable in shares of CCL Series A Preferred Stock) or of subscription rights or warrants (other than those referred to above). The number of outstanding CCL Rights and the number of one one-hundredths of a share of CCL Series A Preferred Stock issuable upon exercise of each CCL Right are also subject to adjustment in the event of a stock split of, or stock dividend on, or subdivision, consolidation or combination of, the shares of CCL Common Stock prior to the CCL Rights Distribution Date. With certain exceptions, no adjustment in the exercise price will be required until cumulative adjustments require an adjustment of at least 1% in such exercise price. Upon exercise of the CCL Rights, no fractional shares of CCL Series A Preferred Stock will be issued (other than fractions which are integral multiples of one one-hundredth of a share, which may, at the election of CCL, be evidenced by depository receipts) and in lieu thereof an adjustment in cash will be made. The CCL Rights have certain antitakeover effects. The CCL Rights may cause substantial dilution for a person or group that attempts to acquire CCL on terms not approved by the CCL Board, except pursuant to an offer conditioned on a substantial number of CCL Rights being acquired. The CCL Rights should not interfere with any merger or other business combination approved by the CCL Board since the CCL Rights may be redeemed by CCL at $.01 per CCL Right prior to the acquisition by a person or group of beneficial ownership of 20% or more of the shares of CCL Common Stock. The shares of CCL Series A Preferred Stock purchasable upon exercise of the CCL Rights will rank junior to all other series of CCL's preferred stock or any similar stock that specifically provides that they shall rank prior to the shares of CCL Series A Preferred Stock. The shares of CCL Series A Preferred Stock will be nonredeemable. Each share of CCL Series A Preferred Stock will be entitled to a minimum preferential quarterly dividend of $1 per share, but will be entitled to an aggregate dividend of 100 times the dividend declared per share of CCL Common Stock. In the event of liquidation, the holders of the shares of CCL Series A Preferred Stock will be entitled to a minimum preferential liquidation payment of $1 per share, but will be entitled to an aggregate payment of 100 times the payment made per share of CCL Common Stock. Each share of CCL Series A Preferred Stock will have 100 votes, voting together with the shares of CCL Common Stock. In the event of any merger, consolidation or other transaction in which shares of CCL Common Stock are exchanged, each share of CCL Series A Preferred Stock will be entitled to receive 100 times the amount and type of consideration received per share of CCL Common Stock. These rights are protected by customary antidilution provisions. Because of the nature of the CCL Series A Preferred Stock's dividend, liquidation and voting rights, the value of the interest in a share of CCL Series A Preferred Stock purchasable upon the exercise of each CCL Right approximates the value of one share of CCL Common Stock. The foregoing description of the CCL Rights does not purport to be complete and is qualified in its entirety by reference to the description of the CCL Rights contained in the CCL Rights Agreement, dated as of ____, 1996 between CCL and the CCL Rights Agent. Prior to the CCL Rights Distribution Date, the CCL Rights Agreement may be amended in any respect. After the CCL Rights Distribution Date, the CCL Rights Agreement may be amended in any respect that does not adversely affect the CCL Rights holders. 95 Restrictions on Transfer Shares of the CCL Common Stock distributed to Corning shareholders will be freely transferable, except for shares received by any persons who may be deemed to be "affiliates" of CCL as that term is defined in Rule 144 promulgated under the Securities Act, which shares will remain subject to the resale limitations of Rule 144. Persons who may be deemed to be affiliates of CCL after the CCL Spin-off Distribution generally include individuals or entities that control, are controlled by, or are under common control with CCL and may include certain officers and directors of CCL as well as principal stockholders of CCL. Persons who are affiliates of CCL will be permitted to sell their shares of CCL only pursuant to an effective registration statement under the Securities Act or an exemption from the registration requirements of the Securities Act, such as the exemption provided by Section 4(1) of the Securities Act or Rule 144 thereunder. The Section 4(1) exemption allows the sale of unregistered shares by a person who is not an issuer, an underwriter or a dealer. Rule 144 provides persons who are not issuers with objective standards for selling restricted securities and securities held by affiliates without registration. The rule requires (1) current public information be available concerning the issuer; (2) volume limitations be placed on sales during any three-month period; and (3) compliance with certain manner of sale restrictions. The amount of the CCL Common Stock which could be sold under Rule 144 during a three-month period cannot exceed the greater of (1) 1% of the outstanding shares of CCL Common Stock, or (2) the average weekly trading volume for the shares for a four-week period prior to the date that notice of the sale is filed with the Commission. 96 ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE CCL CERTIFICATE OF INCORPORATION AND BY-LAWS General In addition to the CCL Rights, the CCL Certificate and the CCL By-Laws contain other provisions that may discourage a third party from seeking to acquire CCL, or to commence a proxy contest or other takeover-related action. These provisions, which are in all material respects identical to the provisions contained in the certificate of incorporation and By-Laws of Corning, are intended to enhance the likelihood of continuity and stability in the composition of the CCL Board and in the policies formulated by the CCL Board and to discourage certain types of transactions that may involve an actual or threatened change of control of CCL. These provisions are designed to reduce the vulnerability of CCL to an unsolicited acquisition proposal and also to discourage certain tactics that may be used in proxy fights. Because such provisions could have the effect of discouraging potential acquisition proposals, they may consequently inhibit fluctuations in the market price of CCL Common Stock which could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in the management of CCL. See "Risk Factors--Risks Relating to CCL--Certain Provisions Relating to Change in Control." Board of Directors The CCL Certificate provides that, effective as of the CCL Spin-Off Distribution, the CCL Board is divided into three classes, with the classes to be nearly as equal as possible. One class has a term expiring at the 1998 annual meeting of stockholders of CCL; the second class has a term expiring at the 1999 annual meeting of stockholders of CCL; and the third class has a term expiring at the 2000 annual meeting of stockholders of CCL. At each annual meeting of stockholders, one class of the CCL Board will be elected for a three-year term. The classification of directors has the effect of making it more difficult to change the composition of the CCL Board. At least two annual meetings of stockholders, instead of one, generally will be required to effect a change in the majority of the CCL Board. The CCL Board believes that the longer time required to elect a majority of a classified board will help ensure the continuity and stability of CCL's management and policies, because in most cases a majority of the directors at any given time will have had prior experience as directors of CCL. Under the DGCL, unless the certificate of incorporation otherwise provides, a director on a classified board may only be removed by the stockholders for cause. The CCL Certificate provides that a director of CCL is only removable by the stockholders for cause. The CCL Certificate limits the number of directors to twelve and requires that any vacancies on the CCL Board be filled only by a majority of the entire CCL Board. The provisions of the DGCL and the CCL Certificate relating to the removal of directors and the filling of vacancies on the CCL Board preclude a third party from removing incumbent directors without cause and simultaneously gaining control of the CCL Board by filling, with its own nominees, the vacancies created by removal. These provisions also reduce the power of stockholders generally, even those with a majority voting power in CCL, to remove incumbent directors and to fill vacancies on the CCL Board without the support of the incumbent directors. Stockholder Action and Special Meetings The CCL Certificate provides that all stockholder actions to be effected by written consent and not a duly called meeting must be effected by the unanimous written consent of all stockholders entitled to consent thereto. This provision reduces the power of the CCL stockholders and precludes a stockholder of CCL from conducting any form of consent solicitation. The CCL Certificate also does not permit stockholders of CCL to call special meetings of stockholders. 97 Advance Notice Requirements for Stockholder Proposals and Director Nominations The CCL By-Laws contain an advance notice procedure with respect to the nomination, other than by or at the direction of the CCL Board or a committee thereof, of candidates for election as directors as well as for other stockholder proposals to be considered at annual meetings of stockholders. Delivery of a notice with the required information must be delivered to the Secretary of CCL not later than 60 days nor more than 90 days prior to the date of the stockholders' meeting at which the nomination or other proposal is to be considered. No matters can be considered at special meetings of the stockholders other than such matters as are set forth in the notice of meeting. Although the notice provisions do not give the CCL Board any power to approve or disapprove stockholder nominations or proposals for action by CCL, they may have the effect of (i) precluding a contest for the election of directors or the consideration of stockholder proposals if the procedures established by the CCL By-Laws are not followed and (ii) discouraging or deterring any third party from conducting a solicitation of proxies to elect its own slate of directors or to approve its proposals, without regard to whether consideration of such nominees or proposals might be harmful or beneficial to CCL and its stockholders. The purpose of requiring advance notice is to afford the CCL Board an opportunity to consider the qualifications of the proposed nominees or the merits of other stockholder proposals and, to the extent deemed necessary or desirable by the CCL Board, to inform stockholders about those matters. Business Combinations with Interested Stockholders Paragraph 6 of the CCL Certificate (the "Fair Price Amendment") requires the approval by the holders of at least 80% of the voting power of the outstanding capital stock of CCL entitled to vote generally in the election of directors (the "CCL Voting Stock") as a condition for mergers and certain other Business Combinations (as defined below) with any beneficial owner of more than 10% of such voting power (an "Interested Stockholder") unless (i) the transaction is approved by at least a majority of the Continuing Directors (as defined below) or (ii) certain minimum price, form of consideration and procedural requirements are met. An Interested Stockholder, in general, is defined as any person or group who is, or was at any time within the two-year period immediately prior to the date in question, the beneficial owner of more than 10% of the voting power of the CCL Voting Stock. The term "beneficial owner" includes persons directly or indirectly owning or having the right to acquire or vote the shares. In certain circumstances, an Interested Stockholder could include persons or entities affiliated or associated with the Interested Stockholder. A Business Combination generally includes the following transactions: (i) a merger or consolidation of CCL or any subsidiary with an Interested Stockholder; (ii) the sale or other disposition by CCL or a subsidiary of assets having an aggregate fair market value of $20,000,000 or more if an Interested Stockholder is a party to the transaction; (iii) the issuance or transfer of stock or other securities of CCL or of a subsidiary to an Interested Stockholder in exchange for cash or property (including stock or other securities) having an aggregate fair market value of $20,000,000 or more; (iv) the adoption of any plan or proposal for the liquidation or dissolution of CCL proposed by or on behalf of an Interested Stockholder; (v) any reclassification of securities, recapitalization, merger or consolidation with a subsidiary or other transaction which has the effect, directly or indirectly, of increasing the percentage of the outstanding stock of any class of CCL or a subsidiary owned by an Interested Stockholder; or (vi) any agreement, contract or other arrangement providing for any one or more of the foregoing actions. A Continuing Director is in general (i) any member of the CCL Board who is not an Interested Stockholder or affiliated or associated with an Interested Stockholder and was a director of CCL prior to the time the Interested Stockholder became an Interested Stockholder, and any successor to such a Continuing Director who is not affiliated or associated with an Interested Stockholder and was recommended or elected by a majority of the Continuing Directors then on the CCL Board, or (ii) any person who was a director of CCL as of the Distribution Date and any successor thereto who was recommended or elected by a majority of the Continuing Directors then on the CCL Board. It is possible that the approval of a majority of the Continuing Directors could be required in circumstances where the Continuing Directors constitute less than a quorum of the entire CCL Board. 98 The 80% affirmative stockholder vote would not be required if the Business Combination in question had been approved by a majority of the Continuing Directors or if all the minimum price, form of consideration and procedural requirements described below are satisfied. Minimum Price and Form of Consideration Requirements. In a Business Combination involving cash or other consideration being paid to CCL's stockholders, the consideration required, in the case of each class of CCL Voting Stock, would be either cash or the same type of consideration used by the Interested Stockholder in acquiring the largest portion of its share of that class of CCL Voting Stock prior to the first public announcement of the proposed Business Combination. In addition, such consideration would be required to meet the minimum price requirements described below. In the case of payments to holders of CCL Common Stock, the fair market value per share of such payments would be at least equal in value to the higher of (i) the highest per share price paid by the Interested Stockholder in acquiring any shares of CCL Common Stock during the two years prior to the first public announcement of the proposed Business Combination (the "Announcement Date") or in the transaction in which it became an Interested Stockholder, whichever is higher, and (ii) the fair market value per share of CCL Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder, whichever is higher. In the case of payments to holders of any series of CCL's voting Series Preferred Stock, if any, the fair market value per share of such payments would have to be at least equal to the higher of (i) the price per share determined with respect to shares of such series in the same manner as described in the preceding paragraph with respect to shares of Common Stock and (ii) the highest preferential amount per share to which the holders of such series of CCL Series Preferred Stock are entitled in the event of a voluntary or involuntary liquidation of CCL. If the transaction does not involve any cash or other property being received by any of the other stockholders, such as a sale of assets or an issuance of CCL's securities to an Interested Stockholder, then the minimum price, form of consideration and procedural requirements would not apply, but an 80% vote of stockholders would still be required unless the transaction was approved by a majority of the Continuing Directors. Procedural Requirements. An 80% stockholder vote would be required to authorize a Business Combination with an Interested Stockholder if CCL, after the interested stockholder became an Interested Stockholder, had failed to pay full quarterly dividends on its Preferred Stock, if any, or reduced the rate of dividends paid on its Common Stock, unless such failure or reduction was approved by a majority of the Continuing Directors. An 80% stockholder vote to authorize a Business Combination with an Interested Stockholder would also be required if the Interested Stockholder had acquired any additional shares of the CCL Voting Stock, directly from CCL or otherwise, in any transaction subsequent to the transaction pursuant to which it became an Interested Stockholder. The receipt by the Interested Stockholder at any time after it became an Interested Stockholder, whether in connection with the proposed Business Combination or otherwise, of the benefit of any loans or other financial assistance or tax advantages provided by CCL (other than proportionately as a stockholder) would also trigger the 80% stockholder vote requirement to authorize a Business Combination with an Interested Stockholder (unless the Business Combination was approved by a majority of the Continuing Directors). In summary, none of the minimum price, form of consideration or procedural requirements described above would apply in the case of a Business Combination approved by a majority of the Continuing Directors. In the absence of such approval, all of such requirements would have to be satisfied to avoid the 80% stockholder vote requirements. 99 Amendment of the CCL Certificate Amendment or repeal of the provisions of the CCL Certificate described above or the adoption of any provision inconsistent therewith would require the affirmative vote of at least 80% of the CCL Voting Stock unless the proposed amendment or repeal or the adoption of the inconsistent provisions are approved by two-thirds of the entire CCL Board and a majority of the Continuing Directors. Antitakeover Statutes Section 203 of the DGCL prohibits transactions between a Delaware corporation and an "interested stockholder," which is defined therein as a person who, together with any affiliates and/or associates of such person, beneficially owns, directly or indirectly, 15% or more of the outstanding voting shares of a Delaware corporation. This provision prohibits certain business combinations (defined broadly to include mergers, consolidations, sales or other dispositions of assets having an aggregate value in excess of 10% of the consolidated assets of the corporation, and certain transactions that would increase the interested stockholder's proportionate share ownership in the corporation) between an interested stockholder and a corporation for a period of three years after the date the interested stockholder acquired its stock unless (i) the business combination is approved by the corporation's board of directors prior to the date the interested stockholder acquired shares, (ii) the interested stockholder acquired at least 85% of the voting stock of the corporation in the transaction in which it becomes an interested stockholder, or (iii) the business combination is approved by a majority of the board of directors and by the affirmative vote of 66 2/3% of the votes entitled to be cast by disinterested stockholders at an annual or special meeting. The CCL Certificate and the CCL By-Laws do not exclude CCL from the restrictions imposed under Section 203 of the DGCL. Tax Sharing and Indemnification Agreements The corporate tax liability which potentially could arise from an acquisition of shares of CCL capital stock or assets of CCL for a period of time following the CCL Spin-Off Distribution, together with the related indemnification arrangements contained in the Tax Sharing and Spin-Off Tax Indemnification Agreements, could have an antitakeover effect on the acquisition of control of CCL. See "The Relationship Among Corning, CCL and CPS After the Distributions--Tax Sharing Agreement" and "The Relationship Among Corning, CCL and CPS After the Distributions--Spin-Off Tax Indemnification Agreements." 100 DESCRIPTION OF CERTAIN INDEBTEDNESS OF CCL Description of Notes Prior to the Distributions, CCL will offer (the "CCL Notes Offering") $200 million aggregate principal amount of senior subordinated notes (the "Notes"). It is anticipated that the Notes will be subordinated to senior indebtedness and will be guaranteed, on a subordinated basis, by certain of CCL's subsidiaries. The net proceeds of the CCL Notes Offering will be used to repay certain intercompany indebtedness owed to Corning. The Notes will be issued under an indenture to be entered into between CCL and ___________, as Trustee (the "Indenture"). The Notes will mature on a date and bear interest at a rate determined prior to the Distributions. It is anticipated that the Indenture will include customary covenants, including limitations on the incurrence of debt and liens; dividends and distributions on, and repurchases of, capital stock; repurchases of subordinated debt; and mergers, consolidations, and sales of assets. It is also contemplated that the Indenture will also include customary events of default. The Distributions are conditioned on the consummation of the CCL Notes Offering. Description of CCL Credit Facility Prior to the Distributions, CCL expects to enter into a $___million credit facility with a syndicate of financial institutions consisting of a $____ million revolving credit facility and a $____ million term loan facility (together, the "CCL Credit Facility"). The proceeds from the CCL Credit Facility are expected to be used to partially finance the repayment of $500 million of intercompany debt owed to Corning and for general corporate purposes. The CCL Credit Facility is expected to mature in November 2002. The Distributions are conditioned on the receipt by CCL of a commitment letter with respect to the CCL Credit Facility. Depending on market conditions at the time of the CCL Notes Offering and the consummation of the CCL Credit Facility, the total combined debt amount, the interest rates, and the amounts of each of the CCL Credit Facility and the Notes may vary from that indicated herein. 101 LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS OF CCL Limitation on Liability of Directors Pursuant to authority conferred by Section 102 of the DGCL, Paragraph 11 of the CCL Certificate ("Paragraph 11") eliminates the personal liability of CCL's directors to CCL or its stockholders for monetary damages for breach of fiduciary duty, including without limitation, directors serving on committees of the CCL Board. Directors remain liable for (1) any breach of the duty of loyalty to CCL or its stockholders, (2) any act or omission not in good faith or which involves intentional misconduct or a knowing violation of law, (3) any violation of Section 174 of the DGCL, which proscribes the payment of dividends and stock purchases or redemptions under certain circumstances, and (4) any transaction from which directors derive an improper personal benefit. Indemnification and Insurance In accordance with Section 145 of the DGCL, which provides for the indemnification of directors, officers and employees under certain circumstances, Paragraph 11 grants CCL's directors and officers a right to indemnification for all expenses, liabilities and losses relating to civil, criminal, administrative or investigative proceedings to which they are a party (1) by reason of the fact that they are or were directors or officers of CCL or (2) by reason of the fact that, while they are or were directors or officers of CCL, they are or were serving at the request of CCL as directors or officers of another corporation, partnership, joint venture, trust or enterprise. Paragraph 11 further provides for the mandatory advancement of expenses incurred by officers and directors in defending such proceedings in advance of their final disposition upon delivery to CCL by the indemnitee of an undertaking to repay all amounts so advanced if it is ultimately determined that such indemnitee is not entitled to be indemnified under Paragraph 11. CCL may not indemnify or make advance payments to any person in connection with proceedings initiated against CCL by such person without the authorization of the CCL Board. In addition, Paragraph 11 provides that directors and officers therein described shall be indemnified to the fullest extent permitted by Section 145 of DGCL, or any successor provisions or amendments thereunder. In the event that any such successor provisions or amendments provide indemnification rights broader than permitted prior thereto, Paragraph 11 allows such broader indemnification rights to apply retroactively with respect to any predating alleged action or inaction and also allows the indemnification to continue after an indemnitee has ceased to be a director or officer of CCL and to inure to the benefit of the indemnitee's heirs, executors and administrators. Paragraph 11 further provides that the right to indemnification is not exclusive of any other right which any indemnitee may have or thereafter acquire under any statute, the CCL Certificate, any agreement or vote of stockholders or disinterested directors or otherwise, and allows CCL to indemnify and advance expenses to any person whom the corporation has the power to indemnify under the DGCL or otherwise. Insofar as indemnification for liabilities arising under the Securities Act may be permitted for directors and officers and controlling persons pursuant to the foregoing provisions, CCL has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. The CCL Certificate authorizes CCL to purchase insurance for directors and officers of CCL and persons who serve at the request of CCL as directors, officers, employees or agents of another corporation, partnership, joint venture, trust or enterprise, against any expense, liability or loss incurred in such capacity, whether or not CCL would have the power to indemnify such persons against such expense or liability under the DGCL. CCL intends to maintain insurance coverage of its officers and directors as well as insurance coverage to reimburse CCL for potential costs of its corporate indemnification of directors and officers. 102 INDEX TO FINANCIAL STATEMENTS
Page ---- FINANCIAL STATEMENTS OF CORNING CLINICAL LABORATORIES INC. Report of Price Waterhouse LLP -- Independent Accountants.......................................................F-2 Report of Deloitte and Touch LLP -- Independent Auditors........................................................F-3 Report of Ernst & Young LLP -- Independent Auditors.............................................................F-4 Report of Leverone and Company -- Independent Auditors..........................................................F-5 Combined Financial Statements: Combined Balance Sheets--December 31, 1995 and 1994........................................................F-6 Combined Statements of Operations--Years ended December 31, 1995, 1994 and 1993............................F-7 Combined Statements of Cash Flows--Years ended December 31, 1995, 1994 and 1993............................F-8 Combined Statements of Stockholder's Equity--Years ended December 31, 1995, 1994 and 1993...............................................................................................F-9 Notes to Combined Financial Statements....................................................................F-10 Financial Statement Schedule II -- Valuation Accounts and Reserves........................................F-22 Quarterly Operating Results (unaudited)...................................................................F-23 Interim Combined Financial Statements (unaudited): Combined Balance Sheets--June 30, 1996 and December 31, 1995..............................................F-24 Combined Statements of Operations--Three and Six Months ended June 30, 1996 and 1995......................F-25 Combined Statements of Cash Flows--Six Months ended June 30, 1996 and 1995................................F-26 Notes to Interim Combined Financial Statements............................................................F-27 FINANCIAL STATEMENTS OF CORNING PHARMACEUTICAL SERVICES INC. Report of Price Waterhouse LLP -- Independent Accountants......................................................F-30 Combined Financial Statements: Combined Balance Sheets--December 31, 1995 and 1994.......................................................F-31 Combined Statements of Income--Years ended December 31, 1995, 1994 and 1993...............................F-32 Combined Statements of Cash Flows--Years ended December 31, 1995, 1994 and 1993...........................F-33 Combined Statements of Stockholder's Equity--Years ended December 31, 1995, 1994 and 1993..........................................................................................F-34 Notes to Combined Financial Statements....................................................................F-35 Quarterly Operating Results (unaudited)...................................................................F-44 Interim Combined Financial Statements (unaudited): Combined Balance Sheets--June 30, 1996 and December 31, 1995..............................................F-45 Combined Statements of Income--Three and Six Months ended June 30, 1996 and 1995..........................F-46 Combined Statements of Cash Flows--Six Months ended June 30, 1996 and 1995................................F-47 Notes to Combined Interim Financial Statements............................................................F-48
F-1 Report of Independent Accountants To the Boards of Directors and Stockholders of Corning Incorporated and Corning Clinical Laboratories Inc. In our opinion, based upon our audits and the reports of other auditors, the accompanying combined balance sheets and the related combined statements of operations and of cash flows and of stockholder's equity appearing on pages F-6 through F-22 present fairly, in all material respects, the financial position of Corning Clinical Laboratories Inc. and the combined companies as discussed in Note 1 (collectively, the "Company"), a wholly-owned business of Corning Incorporated, at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1993 financial statements of Maryland Medical Laboratory, Inc., Nichols Institute and Bioran Medical Laboratory, which were acquired by the Company in 1994 in separate transactions accounted for as poolings of interests and which collectively reflect total revenues of $438 million for the year ended December 31, 1993. Those statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for Maryland Medical Laboratory, Inc., Nichols Institute and Bioran Medical Laboratory, is based solely on the reports of the other auditors. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for the opinion expressed above. As discussed in Note 2 to the combined financial statements, in 1993 the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." /s/ Price Waterhouse - -------------------- Price Waterhouse LLP New York, New York September 20, 1996 F-2 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Nichols Institute: We have audited the consolidated statements of operations, stockholders' equity and cash flows for the year ended December 31, 1993 of Nichols Institute and its subsidiaries (the Company) (not presented separately herein). These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Nichols Institute and its subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles. As discussed in Note 11 to the consolidated financial statements, the Company has received a subpoena from the Office of the Inspector General of the Department of Health and Human Services (OIG) requesting documents in connection with an investigation and internal review concerning the possible submission of false or improper claims to the Medicare and Medicaid programs. No claim or charges have been made against the Company relating to this investigation. The ultimate outcome of this investigation cannot presently be determined. Accordingly, no provision for any loss that may result from this investigation has been made in the accompanying consolidated financial statements. As discussed in Notes 1 and 3 to the consolidated financial statements, at December 31, 1993, the Company was not in compliance with certain covenants of its senior note agreements and the senior lenders have not waived those covenants. The senior note agreements provide that, as a result of failure to comply with the covenants, the note holders have the right to declare the entire unpaid balance immediately due and payable, and if that were to occur, the Company would not have the funds required to retire the debt unless alternative financing is obtained. Management's plans in regard to these matters are described in Notes 1 and 3. The note holders' right to declare the entire unpaid balance under the note agreements immediately due and payable raises substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty, except for the classification of amounts due under the senior note agreements as current. /s/Deloitte & Touche - -------------------- Deloitte & Touche LLP Costa Mesa, California February 28, 1994 F-3 REPORT OF INDEPENDENT AUDITORS Board of Directors Maryland Medical Laboratory, Inc. We have audited the combined balance sheet of Maryland Medical Laboratory, Inc. and affiliates as of March 31, 1994, and the related combined statements of income, changes in equity and cash flows for the year then ended (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Maryland Medical Laboratory, Inc. and affiliates at March 31, 1994, and the combined results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Ernst & Young - ----------------- Ernst & Young LLP Baltimore, Maryland May 19, 1994 F-4 REPORT OF INDEPENDENT AUDITORS To the Board of Directors Moran Research Labs 415 Massachusetts Avenue Cambridge, MA 02139 We have audited the accompanying balance sheet of Moran Research Labs (d/b/a Bioran Medical Laboratory, a Massachusetts Business Trust) as of December 31, 1993, and the related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Moran Research Labs (d/b/a Bioran Medical Laboratory, a Massachusetts Business Trust) at December 31, 1993 and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Leverone & Company - ---------------------- Leverone & Company Billerica, Massachusetts November 10, 1994 F-5 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (in thousands)
1995 1994 ---- ---- ASSETS Current Assets: Cash and cash equivalents $ 36,446 $ 38,719 Accounts receivable, net of allowance of $147,947 and $74,829 for 1995 and 1994, respectively 318,252 360,410 Inventories 26,601 28,248 Deferred taxes on income 98,845 53,696 Prepaid expenses and other assets 22,014 19,241 ----------- ----------- Total current assets 502,158 500,314 Property, plant and equipment, net 296,116 287,562 Intangible assets, net 1,030,633 1,053,194 Deferred taxes on income 6,062 19,593 Other assets 18,416 22,000 ----------- ----------- TOTAL ASSETS $1,853,385 $1,882,663 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Accounts payable and accrued expenses $ 240,525 $ 236,887 Current portion of long-term debt 12,148 12,572 Income taxes payable 39,766 30,454 Due to Corning Incorporated and affiliates 8,979 6,043 ----------- ------------ Total current liabilities 301,418 285,956 Long-term debt (principally due to Corning Incorporated) 1,195,566 1,153,054 Other liabilities 60,600 56,841 ----------- ----------- Total liabilities 1,557,584 1,495,851 ----------- ----------- Commitments and Contingencies Stockholder's Equity: Contributed capital 297,823 297,823 Retained earnings (accumulated deficit) (3,118) 85,893 Cumulative translation adjustment 2,325 3,096 Market valuation adjustment (1,229) -- ----------- ----------- Total stockholder's equity 295,801 386,812 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $1,853,385 $1,882,663 ========== ==========
The accompanying notes are an integral part of these statements. F-6 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)
1995 1994 1993 ---- ---- ---- Net revenues $1,629,388 $1,633,699 $1,416,338 Costs and expenses: Cost of services 980,232 969,844 805,729 Selling, general and administrative 523,271 411,939 363,579 Provision for restructuring and other special charges 50,560 79,814 99,600 Interest expense, net 82,016 63,295 41,898 Amortization of intangible assets 44,656 42,588 28,421 Other, net 6,221 3,464 6,423 ----------- ---------- ------ Total 1,686,956 1,570,944 1,345,650 ----------- --------- --------- Income (loss) before taxes (57,568) 62,755 70,688 Income tax expense (benefit) (5,516) 34,410 25,929 ----------- ---------- ---------- Income (loss) before cumulative effect of change in accounting principle (52,052) 28,345 44,759 Cumulative effect of change in accounting principle -- -- (10,562) ----------- ---------- ---------- Net income (loss) $ (52,052) $ 28,345 $ 34,197 =========== ========== ==========
The accompanying notes are an integral part of these statements. F-7 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)
1995 1994 1993 ---- ---- ---- Cash flows from operating activities: Net income (loss) $ (52,052) $ 28,345 $ 34,197 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 101,513 89,517 66,479 Provision for doubtful accounts 152,590 59,480 47,240 Provision for restructuring and other special charges 50,560 79,814 99,600 Deferred income tax provision (32,384) (4,742) (23,841) Cumulative effect of change in accounting principle -- -- 10,562 Other, net 8,303 14,600 1,765 Changes in operating assets and liabilities: Accounts receivable (109,500) (103,402) (61,828) Accounts payable and accrued expenses 14,604 (32,756) (33,903) Restructuring, integration and other special charges (57,768) (88,093) (46,917) Due from/to Corning Incorporated and affiliates 2,934 14,783 (2,581) Other assets and liabilities, net 7,028 (19,583) 8,841 ----- --------- ---------- Net cash provided by operating activities 85,828 37,963 99,614 --------- --------- ---------- Cash flows from investing activities: Capital expenditures (74,045) (93,354) (65,317) Proceeds from disposition of assets 2,880 55,762 -- Acquisition of businesses, net of cash acquired (22,907) (12,154) (401,428) Decrease (increase) in investments 985 3,560 (6,942) --------- --------- --------- Net cash used in investing activities (93,087) (46,186) (473,687) ------- ------- --------- Cash flows from financing activities: Proceeds from borrowings, primarily with Corning Incorporated 55,729 186,046 709,630 Repayment of long-term debt (13,784) (118,046) (265,196) Dividends paid (36,959) (60,468) (51,478) --------- ------- ------- Net cash provided by financing activities 4,986 7,532 392,956 --------- -------- ------- Net change in cash and cash equivalents (2,273) (691) 18,883 Cash and cash equivalents, beginning of year 38,719 39,410 20,527 ------ -------- ------- Cash and cash equivalents, end of year $ 36,446 $ 38,719 $ 39,410 ========= ========= =========
The accompanying notes are an integral part of these statements. F-8 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED STATEMENTS OF STOCKHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)
Cumulative Market Total Retained Translation Valuation Stockholder's Contributed Capital Earnings Adjustment Adjustment Equity ------------------- -------- ---------- ---------- ------------- Balance, December 31, 1992 $ 261,499 $ 146,938 $ (288) $ -- $ 408,149 Net income 34,197 34,197 Dividends to CLSI (28,088) (28,088) Dividends to S-Corporation shareholders (23,390) (23,390) Equity of pooled entity 4,150 (4,096) 54 Translation adjustment 4,587 4,587 -------- --------- --------- ---------- --------- Balance, December 31, 1993 265,649 125,561 4,299 -- 395,509 Net income 28,345 28,345 Dividends to CLSI (33,275) (33,275) Dividends to S-Corporation shareholders (27,193) (27,193) Dividends in-kind to S-Corporation shareholders (7,545) (7,545) Capital contribution 32,174 32,174 Translation adjustment (1,203) (1,203) -------- --------- --------- ---------- -------- Balance, December 31, 1994 297,823 85,893 3,096 -- 386,812 Net loss (52,052) (52,052) Dividends to CLSI (36,959) (36,959) Translation adjustment (771) (771) Market valuation adjustment (1,229) (1,229) --------- --------- --------- ---------- -------- Balance, December 31, 1995 $ 297,823 $ (3,118) $ 2,325 $ (1,229) $ 295,801 ========= ========== ========= ========== =========
The accompanying notes are an integral part of these statements. F-9 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) NOTES TO COMBINED FINANCIAL STATEMENTS (dollars in thousands, unless otherwise indicated) 1. BASIS OF PRESENTATION Corning Clinical Laboratories Inc. and Corning Nichols Institute Inc. (collectively referred to as "CCL" or the "Company") are wholly-owned subsidiaries of Corning Life Sciences Inc. ("CLSI") which in turn is a wholly-owned subsidiary of Corning Incorporated ("Corning"). The Company is one of the largest clinical laboratory testing businesses in the United States. The accompanying financial statements present the carved-out results of operations, cash flows and financial position of Corning's clinical laboratory testing business. Corning Pharmaceutical Services Inc., a subsidiary of CCL, and its related entities ("CPS") as well as environmental testing services formerly provided by CCL are excluded. In 1994, Corning acquired three clinical laboratory testing businesses on the behalf of CCL in separate transactions accounted for as poolings of interests (see Note 3). Results presented for 1994 and 1993 include the results of CCL and the pooled entities on a combined basis. In May 1996, Corning's Board of Directors approved a plan to distribute to its shareholders on a pro rata basis all of the shares of CCL and CPS (the "CCL and CPS Spin-Off Distributions"). The result of the plan will be the creation of two independent, publicly-owned (but as yet unnamed) companies. As a result of the Spin-Off Distributions, CCL will operate Corning's clinical laboratory testing business as an independent public company and CPS will own and operate Corning's contract research business as an independent public company. The Spin-Off Distributions will be effected by the distribution of a dividend to holders of Corning Common Stock of all of the outstanding CCL Common Stock, followed immediately by the distribution of a dividend to the holders of CCL Common Stock of all of the CPS Common Stock. Corning has submitted to the Internal Revenue Service a request for a ruling that the Spin-Off Distributions qualify as tax-free distributions under the Internal Revenue Code of 1986. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The combined financial statements include the accounts of all laboratory entities controlled by the Company. The equity method of accounting is used for investments in affiliates which are not Company controlled and in which the Company's interest is generally between 20 and 50 percent. All significant intercompany accounts and transactions are eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-10 Revenue Recognition The Company generally recognizes revenue as services are rendered upon completion of the testing process. Billings for services under third-party payor programs, including Medicare and Medicaid, are recorded as revenues net of allowances for differences between amounts billed and the estimated receipts under such programs. Adjustments to the estimated receipts, based on final settlement with the third-party payors, are recorded upon settlement. In 1995, 1994 and 1993, approximately 23%, 28% and 25%, respectively, of net revenues were generated by Medicare and Medicaid programs. Concentrations of Credit Risk Concentrations of credit risk with respect to accounts receivable are limited due to the diversity of the Company's clients as well as their dispersion across many different geographic regions. Taxes on Income The Company uses the asset and liability approach to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the change is enacted. In 1993 the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). The adoption of SFAS 109 resulted in a charge to net income of $10.6 million, principally representing a reduction in the Company's deferred tax assets to reflect the then enacted statutory tax rate. Cash and Cash Equivalents Cash and cash equivalents include all highly-liquid investments with original maturities at the time acquired by the Company of three months or less, and consist principally of amounts temporarily invested in a U.S. government money market fund. Inventories Inventories, which consist principally of supplies, are valued at the lower of cost (first in, first out method) or market. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation and amortization are provided on the straight-line method at rates adequate to allocate the cost of the applicable assets over their expected useful lives, which range from three to forty years. Intangible Assets Acquisition costs in excess of the fair value of net tangible assets acquired are capitalized and amortized over appropriate periods not exceeding forty years. Other intangible assets are recorded at cost and amortized over periods not exceeding fifteen years. F-11 Impairment Accounting The Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121) in 1995. The Company reviews the recoverability of its long-lived assets, including related goodwill and intangible assets, when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. Evaluation of possible impairment is based on the Company's ability to recover the asset from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations. If the expected undiscounted pre-tax cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. This assessment of impairment requires management to make estimates of expected future cash flows. It is at least reasonably possible that future events or circumstances could cause these estimates to change. In addition, the carrying value of intangible assets has historically been subject to a separate evaluation based on estimating expected future undiscounted cash flows from operating activities. If these estimated cash flows are less than the carrying amount of the intangible assets, the Company would recognize an impairment loss in an amount necessary to write down the intangible assets to fair value. Earnings Per Share Earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. Historical earnings per share data is not meaningful as the Company's historical capital structure is not comparable to periods subsequent to the CCL Spin-Off Distribution. 3. BUSINESS COMBINATIONS AND DIVESTITURES Acquisitions During 1995, the Company acquired several laboratories in separate transactions accounted for under the purchase method. The total cost of the acquired businesses aggregated approximately $23 million and was financed through borrowings from Corning. Intangible assets of approximately $21.6 million resulted from the transactions and are being amortized over periods not to exceed forty years. During 1994, Corning acquired three clinical laboratory testing companies on behalf of the Company in separate transactions accounted for as poolings of interests. In June 1994, Corning acquired the stock of Maryland Medical Laboratory, Inc. ("MML") in exchange for approximately 4.5 million shares of Corning common stock; in August 1994, Corning acquired the stock of Nichols Institute ("Nichols") in exchange for approximately 7.5 million shares of Corning common stock and reserved an additional 1.1 million shares for future issuance upon the exercise of stock options; and, in October 1994, Corning acquired the stock of Bioran Medical Laboratory ("Bioran") in exchange for approximately 6.0 million shares of Corning common stock. Results presented for 1994 and 1993 include the results of the Company, MML, Nichols and Bioran on a combined basis. In 1994, the Company also acquired several other laboratories in separate transactions accounted for under the purchase method. The total cost of the acquired businesses aggregated approximately $26 million and was financed through the issuance of Corning stock and borrowings from Corning. Intangible assets of approximately $24 million resulted from these transactions and are being amortized over periods not to exceed forty years. F-12 In the third quarter of 1993, Corning acquired on behalf of the Company the outstanding shares of common stock of Damon Corporation ("Damon"), a clinical-testing business, for $405 million, including acquisition costs, financed through borrowings from Corning. In addition, approximately $167 million of Damon's indebtedness was refinanced. Goodwill of approximately $600 million resulted from the transaction and is being amortized over forty years. Reserves aggregating $79 million were established for the costs of closing Damon facilities as a result of the integration of Damon operations. In the fourth quarter of 1993, the Company acquired the clinical-testing laboratories of Unilab Corporation ("Unilab") in Denver, Dallas and Phoenix in exchange for its ownership interest in Unilab operations, the assumption of approximately $70 million of Unilab debt, and the Company's investment in J.S. Pathology PLC. Goodwill of approximately $200 million resulted from this transaction and is being amortized over forty years. As a result of this transaction, the Company received a small equity investment in Unilab. The Company previously owned 43% of Unilab. The operations of the businesses, subsequent to the dates they were acquired, are included in the combined financial statements. The pro forma effect of the 1995 acquisitions on periods prior to the acquisitions is not material. In 1993, Corning also acquired and contributed to the Company DeYor Laboratory, Inc., in a transaction accounted for as a pooling of interests, by issuing 840,000 shares of Corning common stock. The Company's combined financial statements for periods prior to this acquisition have not been restated, since this acquisition was not material to the Company's financial position or the results of its operations for such periods. Divestitures In the second quarter of 1994, the Company sold the California clinical laboratory testing operations acquired in the Damon transaction to Physicians Clinical Laboratory, Inc. for cash proceeds of $51 million. 4. TAXES ON INCOME The Company is included in the consolidated Federal income tax return filed by Corning. CLSI and its subsidiaries, including the Company, have a tax sharing agreement with Corning, pursuant to which they are required to compute their provision for income taxes on a separate return basis and pay to Corning the separate Federal income tax return liability so computed. The components of the provision (benefit) for income taxes for 1995, 1994 and 1993 are as follows: 1995 1994 1993 ---- ---- ---- Current: Federal $ 22,786 $31,598 $46,215 State and local 3,556 7,019 2,815 Foreign 526 535 740 Deferred (benefit): Federal (28,109) (1,339) (23,818) State and local (4,275) (3,403) (23) -------- ------ ------ Income tax expense (benefit) $ (5,516) $34,410 $25,929 ======== ======= ======= F-13 Prior to acquisition by Corning, Bioran and certain MML operations were S-Corporations; accordingly, no federal provision for income taxes has been reflected relative to these operations. A reconciliation of the Federal statutory rate to the Company's effective tax rate for 1995, 1994 and 1993 is as follows: 1995 1994 1993 ---- ---- ---- Taxes at statutory rate (35.0%) 35.0% 35.0% State and local income taxes, net of federal (0.8%) 3.8% 2.6% tax benefit Income from partnership and S-Corporations not subject to federal and state income tax 1.7% (10.3%) (11.1%) Goodwill 17.6% 14.3% 4.8% Non-deductible items 6.0% 8.6% 3.4% Other, net 0.9% 3.4% 2.0% --------- ----------- ----------- Effective tax rate (9.6%) 54.8% 36.7% ========= =========== =========== The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 1995 and 1994 are as follows: 1995 1994 ---- ---- Current deferred tax asset: Accounts receivable reserve $ 48,584 $ 16,692 Liabilities not currently deductible 49,222 34,422 Other 1,039 2,582 -------- -------- Current deferred tax asset $ 98,845 $ 53,696 ======== ======== Non-current deferred tax asset (liability): Liabilities not currently deductible $21,152 $33,572 Depreciation and amortization (15,090) (13,979) -------- -------- Non-current deferred tax asset $ 6,062 $ 19,593 ======== ======== Income taxes payable at December 31, 1995 and 1994 consist of Federal income taxes payable of $34.2 million and $28.7 million, respectively, state income taxes payable of $5.0 million and $1.5 million, respectively, and foreign income taxes payable of $0.6 million and $0.3 million, respectively. The Company paid income taxes of $21.7 million, $58.5 million and $52.0 million during 1995, 1994 and 1993, respectively. F-14 5. PROVISION FOR RESTRUCTURING AND OTHER SPECIAL CHARGES In the second quarter of 1995, the Company recorded a provision for restructuring totaling $33.0 million primarily for workforce reduction programs and the costs of exiting a number of leased facilities. Additionally, in the first quarter of 1995, the Company recorded a special charge of $12.8 million for the settlement of claims related to inadvertent billing errors of certain laboratory tests that were not completely and/or successfully performed or reported due to insufficient samples and/or invalid results. Additionally, in the fourth quarter of 1995, the Company recorded a charge of $4.8 million related to claims by the Civil Division of the U.S. Department of Justice ("DOJ") of alleged billing errors related to a laboratory test performed by Bioran prior to its acquisition by the Company. In the third quarter of 1994, the Company recorded a provision for restructuring and other special charges totaling $79.8 million which included $48.2 million of integration costs, $21.6 million of transaction expenses, and $10 million of other reserves primarily related to the Nichols, MML and Bioran acquisitions. The integration costs represent the expected costs for closing clinical laboratories in certain markets where duplicate Company, Nichols, MML or Bioran facilities existed at the time of the acquisitions. In the third quarter of 1993, the Company recorded a provision for restructuring costs and other special charges totaling $99.6 million. The restructuring component of this special charge aggregated $56.6 million and consisted primarily of asset write-offs, facility related costs and costs for workforce reduction programs related principally to the integration of the Company's operations with those acquired in the Damon acquisition. The special charge consisted primarily of a $36.5 million charge to reflect the settlement and related legal expenses associated with a compromise agreement with the DOJ to settle claims brought on behalf of the Inspector General, U.S. Department of Health and Human Services. The claims related to the marketing, sale, pricing and billing of certain blood-test series provided to Medicare patients. The settlement does not constitute an admission with respect to any issue arising from subsequent civil actions. In making the settlement, the Company did not admit any wrongdoing in connection with its marketing or business practices. The following summarizes the Company's restructuring activity (in millions):
1993 and 1994 Amounts Balance at 1995 Amounts Balance at Restructuring Utilized December 31, Restructuring Utilized December 31, Provisions Through 1994 1994 Provision in 1995 1995 ---------- ------------ ---- --------- ------- ---- Employee termination costs $ 32.5 $14.8 $17.7 $23.4 $27.0 $14.1 Write-off of fixed assets 35.6 19.1 16.5 3.7 9.2 11.0 Costs of exiting leased facilities 21.7 9.3 12.4 3.1 6.8 8.7 Other 15.0 13.4 1.6 2.8 .5 3.9 ------ ------ ----- ----- ----- ----- Total $104.8 $56.6 $48.2 $33.0 $43.5 $37.7 ====== ===== ===== ===== ===== =====
The substantial portion of the balance at December 31, 1995 is expected to be expended in 1996. Employee termination costs include severance benefits related to approximately 3,300 employees (700, 2,000 and 600 in 1995, 1994 and 1993, respectively), of which 2,355 have been terminated or notified of their termination at December 31, 1995. Management expects that approximately 300 terminations and the remaining business or facility exits will occur by the end of 1996. The decrease in the number of actual versus anticipated employee terminations is primarily attributable to higher than expected attrition and higher average termination costs. Certain severance and facility exit costs have payment terms extending beyond 1997. F-15 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31, 1995 and 1994 consist of the following: 1995 1994 ---- ---- Land $ 18,568 $ 18,969 Buildings and improvements 186,192 173,546 Laboratory equipment, furniture and fixtures 286,326 247,200 Leasehold improvements 39,078 30,050 Construction-in-progress 19,490 33,508 -------- -------- Property and equipment, at cost 549,654 503,273 Less: accumulated depreciation and amortization (253,538) (215,711) -------- -------- Property and equipment, net $296,116 $287,562 ======== ======== Depreciation and amortization expense aggregated $56.8 million, $46.9 million and $38.1 million for 1995, 1994 and 1993, respectively. 7. INTANGIBLE ASSETS Intangible assets at December 31, 1995 and 1994 consist of the following: 1995 1994 ---- ---- Goodwill $1,056,073 $1,043,089 Customer lists 84,558 100,428 Other (principally non-compete covenants) 50,626 61,401 ---------- ---------- Intangible assets, at cost 1,191,257 1,204,918 Less: accumulated amortization (160,624) (151,724) ---------- ---------- Intangible assets, net $1,030,633 $1,053,194 ========== ========== Amortization expense aggregated $44.7 million, $42.6 million and $28.4 million for 1995, 1994 and 1993, respectively. 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses at December 31, 1995 and 1994 consist of the following:
1995 1994 ---- ---- Accrued wages and benefits $ 81,985 $ 74,519 Restructuring, integration and other special charges 61,878 69,812 Accrued expenses 57,338 34,851 Trade accounts payable 31,129 36,169 Accrued acquisition commitments 8,195 21,536 --------- --------- Accounts payable and accrued expenses $ 240,525 $ 236,887 ========= ==========
F-16 9. LONG-TERM DEBT Long-term debt, exclusive of current maturities, at December 31, 1995 and 1994, respectively, consists of the following:
1995 1994 ---- ---- Notes payable to Corning: Revolving credit notes - interest at the London Interbank offered rate ("LIBOR") plus 1/8% to 1/4%, maturing 1997 $ 605,636 $ 551,982 Installment note with interest at 9%, maturing 2001 90,000 100,000 Term note with interest at 6.24%, maturing 2003 100,000 100,000 Term note with interest at 6.93%, maturing 2013 100,000 100,000 Term note with interest at 7.17%, maturing 2004 150,000 150,000 Term note with interest at 7.77%, maturing 2024 100,000 100,000 Note payable denominated in pounds Sterling, interest at the London Interbank Sterling Rate minus 1%, due 2002 8,049 8,516 Mortgage note payable through 2011, interest at 9.25% 6,138 6,355 Capital lease obligations expiring through 2031 32,518 32,538 Other 3,225 3,663 ---------- ---------- Total $1,195,566 $1,153,054 ========== ==========
Current maturities on long-term debt totaled $12.1 million and $12.6 million at December 31, 1995 and 1994, respectively. Long-term debt, including capital leases, maturing in each of the years subsequent to December 31, 1996 is as follows: Fiscal year ending December 31, 1997......................... $ 261,131 1998......................... 10,493 1999......................... 10,530 2000......................... 10,576 2001 and thereafter.......... 902,836 ---------- Total long-term debt $1,195,566 ========== F-17 Future minimum payments under capital leases and the present value thereof are as follows: Fiscal year ending December 31, 1997......................... $ 4,061 1998......................... 3,846 1999......................... 3,840 2000......................... 3,948 2001 and thereafter.......... 116,102 -------- Total future minimum payments under capital leases 131,797 Less amount representing interest (99,279) -------- Present value of minimum payments under capital leases $ 32,518 ======== The Company paid interest of $74.2 million, $60.2 million and $41.2 million during 1995, 1994 and 1993, respectively. Based on borrowing rates currently available to the Company for loans with similar terms and maturities, the fair value of loans payable to third parties (carrying amount of approximately $50.0 million) was approximately $62.0 million at December 31, 1995. 10. EMPLOYEE RETIREMENT PLANS Defined Benefit Plans An acquired entity had a defined benefit pension plan which in 1990 was frozen as to the further accrual of benefits. At December 31, 1995 the present value of the projected benefit obligation using a discount rate of 7.5% was $22.6 million and the fair value of the plan assets (publicly traded corporate debt and equity securities, government obligations and money market funds) was $17.4 million. The difference between the projected benefit obligation and the fair value of plan assets is included in other long-term liabilities in the accompanying combined balance sheet. Defined Contribution Plans The Company has several defined contribution plans covering substantially all of its full-time employees. Company contributions to these plans aggregated $18.5 million, $15.9 million and $7.3 million for 1995, 1994 and 1993, respectively. F-18 11. RELATED PARTY TRANSACTIONS The Company, in the ordinary course of business, conducts a number of transactions with Corning and its affiliates. The significant transactions occurring during the years ended December 31, 1995, 1994 and 1993 are as follows: 1995 1994 1993 ---- ---- ---- Interest expense on borrowings $78,930 $55,835 $28,400 Purchase of laboratory supplies 11,261 11,607 7,338 Corporate fees 2,800 2,800 2,450 Certain executives of the Company are included in various stock compensation programs of Corning. Expenses related to these programs have been included in the Company's combined financial statements. In 1994, Corning contributed capital of $25.2 million through the reduction of revolving credit notes and former S-Corporation shareholders contributed capital of a building approximating $4.4 million. 12. COMMITMENTS AND CONTINGENCIES Minimum rental commitments under noncancellable operating leases, primarily real estate, in effect at December 31, 1995 are as follows: Year ending December 31, 1996................................ $ 40,459 1997................................ 30,481 1998................................ 20,527 1999................................ 14,877 2000................................ 12,532 2001 and thereafter................. 65,920 -------- Net minimum lease payments $184,796 ======== Operating lease rental expense for 1995, 1994 and 1993 aggregated $46.9 million, $49.4 million and $46.9 million, respectively. The Company is self-insured for substantially all casualty losses. The basis for the insurance reserve at December 31, 1995 and 1994 is the actuarially determined projected losses for each program (within the self-insured retention) based upon the Company's loss experience. The Company has entered into several settlement agreements with various governmental and private payors during recent years. At present, government investigations of certain practices by clinical laboratories acquired in recent years are ongoing. In addition, certain payors are reviewing their reimbursement practices for laboratory tests. The results of these investigations and reviews may result in additional settlement payments or reductions in reimbursements for certain tests. The recorded reserves represent management's best estimate at December 31, 1995; however, it is possible that claims could arise that could be materially in excess of amounts reserved. F-19 13. SUBSEQUENT EVENTS (unaudited) In the first quarter of 1996, the Company entered into a settlement agreement with the DOJ pursuant to which the Company paid to the United States a total of $6.7 million, which had been accrued in 1995, in settlement of civil claims by the DOJ of alleged billing errors related to a laboratory test performed by Bioran prior to its acquisition by the Company. In the second quarter of 1996, the DOJ notified the Company that it has taken issue with payments related to certain tests received by Damon from federally funded health care programs prior to its acquisition by the Company. Company management has met with the DOJ several times to evaluate the substance of the government's allegations. The Company established $46.0 million of additional reserves equal to management's estimate of the low end of the range of potential amounts which could be required to satisfy the government's claims. It is possible that the aggregate claim (which might include restitution, treble damages, other civil penalties or criminal fines) could be in excess of established reserves by an amount which could be material to the Company's results of operations in the period in which such claim is settled. However, because Corning has agreed to fund any settlement prior to the CCL Spin-Off Distribution and has agreed to indemnify the Company (Note 14) for the settlement of any material DOJ claims pending at the Distribution date, the settlement of the claim will not have a material adverse impact on the Company's overall financial condition or cash flows. 14. SPIN-OFF DISTRIBUTION (unaudited) Coincident with the CCL Spin-Off Distribution, the Company plans to record a non-recurring charge of approximately $20 million ($13 million after tax) associated with the CCL Spin-Off Distribution. The largest component of the charge will be the cost of establishing an employee stock ownership plan ($11 million). The remainder of the charge will consist principally of the costs for advisors and other fees associated with establishing the Company as a separate publicly-traded entity. The amount of the charge is subject to change based on the price of the CCL stock on the Distribution Date. Prior to the CCL Spin-Off Distribution, the Company will borrow approximately $500 million in long-term debt to repay Corning for certain intercompany borrowings. The debt is assumed to consist of $300 million of bank borrowings and $200 million of publicly-traded high-yield notes. Corning will contribute the remaining debt to the Company's equity prior to the CCL Spin-Off Distribution. In conjunction with the CCL Spin-Off Distribution, Corning and the Company will enter into an indemnification agreement whereby Corning agrees to indemnify CCL for any losses arising out of any federal, criminal, civil or administrative investigations or claims that are pending as of the Distribution Date to the extent that such investigations or claims arise out of or are related to alleged violations of federal laws by reason of CCL, its affiliates, officers or directors billing any federal program or agency for services rendered to beneficiaries of such program or agency. Corning, CCL and CPS will enter into tax indemnification agreements that will prohibit CCL and CPS for a period of two years after the Spin-Off Distributions from taking certain actions that might jeopardize the favorable tax treatment of the Distributions under section 355 of the Internal Revenue Code of 1986, as amended and will provide Corning and CCL with certain rights of indemnification against CCL and CPS. The tax indemnification agreements will also require CCL and CPS to take such actions as Corning may request to preserve the favorable tax treatment provided for in any rulings obtained from the Internal Revenue Service in respect of the Distributions. F-20 Corning, CCL and CPS will also enter into a tax sharing agreement which will allocate among Corning, CCL and CPS responsibility for federal, state and local taxes relating to taxable periods before and after the Spin-Off Distributions and provide for computing and apportioning tax liabilities and tax benefits for such periods among the parties. 15. PLANNED CHANGE IN ACCOUNTING POLICY (unaudited) Coincident with the CCL Spin-Off Distribution, CCL management will adopt a new accounting policy for evaluating the recoverability of intangible assets and measuring possible impairment under Statement of the Accounting Principles Board No. 17. Most of CCL's intangible assets resulted from purchase business combinations in 1993. Significant changes in the clinical laboratory and health care industries subsequent to 1993, including increased government regulation and movement from traditional fee-for-service care to managed cost health care, have caused the fair value of CCL's intangible assets to be significantly less than carrying value. CCL management believes that a valuation of intangible assets based on the amount for which each regional laboratory could be sold in an arms-length transaction is preferable to using projected undiscounted pre-tax cash flows. CCL believes fair value is a better indicator of the extent to which the intangible assets may be recoverable and therefore, may be impaired. This change in method of evaluating the recoverability of intangible assets will result in CCL recording a charge of between $400 million and $450 million coincident with the CCL Spin-Off Distribution to reflect the other than temporary impairment of intangible assets. This will result in a reduction of amortization expense of approximately $10 million to $11.3 million annually and $2.5 million to $2.8 million quarterly. The fair value method will be applied to each of CCL's regional laboratories. In developing management's estimate of fair value, CCL management will consider, among other things, (i) the financial projections of each regional laboratory, (ii) the future of each regional laboratory, including growth opportunities, managed care concentration and planned actions, (iii) publicly-available information regarding comparable publicly-traded companies in the industry, (iv) comparable sales prices, if available, and (v) other information deemed relevant. F-21 Corning Clinical Laboratories Inc. Schedule II - Valuation Accounts and Reserves (amounts in thousands) Balance at Net Deductions Balance at Year ended December 31, 1995 1-1-95 Additions and Other 12-31-95 ------ --------- --------- -------- Doubtful accounts and allowances $ 74,829 $152,590 $ 79,472 $147,947 Balance at Net Deductions Balance at Year ended December 31, 1994 1-1-94 Additions and Other 12-31-94 ------ --------- --------- -------- Doubtful accounts and allowances $ 71,991 $ 59,480 $ 56,642 $ 74,829 Balance at Net Deductions Balance at Year ended December 31, 1993 1-1-93 Additions and Other 12-31-93 ------ --------- --------- -------- Doubtful accounts and allowances $ 65,859 $ 47,240 $ 41,108 $ 71,991
F-22 QUARTERLY OPERATING RESULTS (unaudited)
First Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------- ------- ------- ------- ----- 1996 Net revenues $401,395 $424,543 Gross profit 154,277 158,242 Loss before taxes (1,642) (37,518)(1) Net loss (1,511) (37,922) 1995 Net revenues $417,662 $421,853 $399,959 $389,914 $1,629,388 Gross profit 168,606 175,793 159,091 145,666 649,156 Income (loss) before taxes 19,827(1) (5,088)(1) (56,405)(2) (15,902)(1) (57,568) Net income (loss) 4,423 (3,852) (38,595) (14,028) (52,052) 1994 Net revenues $399,063 $422,942 $408,478 $403,216 $1,633,699 Gross profit 159,050 182,050 163,391 159,364 663,855 Income (loss) before taxes 40,624 45,109 (51,250)(1) 28,272 62,755 Net income (loss) 24,152 24,148 (36,535) 16,580 28,345 (1) Includes impact of restructuring and other special charges of $46.0 million, $12.8 million, $33.0 million, $4.8 million and $79.8 million in second quarter 1996, first quarter 1995, second quarter 1995, fourth quarter 1995 and third quarter 1994, respectively, which are discussed in Note 5 to the CCL Combined Financial Statements. (2) Includes a $62.0 million charge to increase the reserve for doubtful accounts and allowances resulting from billing systems implementation and integration problems at certain laboratories and increased regulatory requirements.
F-23 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED BALANCE SHEETS JUNE 30, 1996 AND DECEMBER 31, 1995 (in thousands) June 30, December 31, 1996 1995 -------- ------------ (unaudited) ASSETS Current Assets: Cash and cash equivalents $ 37,605 $ 36,446 Accounts receivable, net of allowance of $125,446 and $147,947 for June 30, 1996 and December 31, 1995, respectively 321,212 318,252 Inventories 25,855 26,601 Deferred taxes on income 91,829 98,845 Prepaid expenses and other assets 18,883 22,014 ---------- ---------- Total current assets 495,384 502,158 Property and equipment, net 306,497 296,116 Intangible assets, net 1,011,507 1,030,633 Other assets 29,868 24,478 ---------- ---------- TOTAL ASSETS $1,843,256 $1,853,385 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Accounts payable and accrued expenses $ 252,483 $ 240,525 Current portion of long-term debt 12,421 12,148 Income taxes payable 28,503 39,766 Due to Corning Incorporated and affiliates 12,186 8,979 ---------- ---------- Total current liabilities 305,593 301,418 Long-term debt (principally due to Corning Incorporated) 1,226,030 1,195,566 Other liabilities 58,510 60,600 ---------- ---------- Total liabilities 1,590,133 1,557,584 ---------- ---------- Stockholder's Equity: Contributed capital 297,823 297,823 Accumulated deficit (43,722) (3,118) Cumulative translation adjustment 1,741 2,325 Market valuation adjustment (2,719) (1,229) ---------- ---------- Total stockholder's equity 253,123 295,801 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $1,843,256 $1,853,385 ========== ========== The accompanying notes are an integral part of these statements. F-24 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1996 AND 1995 (in thousands) (unaudited)
Three Months Ended Six Months Ended June 30, 1996 June 30, 1995 June 30, 1996 June 30, 1995 ------------- ------------- ------------- ------------- Net revenues $ 424,543 $ 421,853 $ 825,938 $ 839,515 Costs and expenses: Cost of services 266,301 246,060 513,419 495,116 Selling, general and administrative 120,205 114,289 246,249 218,289 Provision for restructuring and other special charges 46,000 33,035 46,000 45,885 Interest expense, net 19,879 20,743 40,021 40,550 Amortization of intangible assets 10,655 11,411 21,444 22,385 Other, net (979) 1,403 (2,035) 2,551 --------- --------- --------- --------- Total 462,061 426,941 865,098 824,776 Income (loss) before taxes (37,518) (5,088) (39,160) 14,739 Income tax expense (benefit) 404 (1,236) 273 14,168 --------- --------- --------- --------- Net income (loss) $ (37,922) $ (3,852) $ (39,433) $ 571 ========= ========= ========= =========
The accompanying notes are an integral part of these statements. F-25 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) COMBINED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995 (in thousands) (unaudited)
1996 1995 ---- ---- Cash flows from operating activities: Net income (loss) $ (39,433) $ 571 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 50,232 50,468 Provision for doubtful accounts 51,352 41,466 Provision for restructuring and other special charges 46,000 45,885 Deferred income tax provision 7,016 (13,788) Other, net (651) 6,057 Changes in operating assets and liabilities: Accounts receivable (54,311) (90,615) Accounts payable and accrued expenses (15,906) 5,071 Restructuring, integration and other special charges (14,114) (45,577) Due from/to Corning Incorporated and affiliates 3,208 4,347 Changes in other assets and liabilities (16,692) 11,702 --------- --------- Net cash provided by operating activities 16,701 15,587 --------- --------- Cash flows from investing activities: Capital expenditures (46,890) (39,621) Acquisition of businesses, net of cash acquired -- (22,907) (Decrease)/increase in investments (7,582) 1,661 Proceeds from sale of assets 9,279 -- --------- --------- Net cash used in investing activities (45,193) (60,867) --------- --------- Cash flows from financing activities: Proceeds from borrowings, primarily with Corning Incorporated 64,619 71,581 Repayment of long-term debt (33,796) (2,785) Dividends paid (1,172) (18,479) --------- --------- Net cash provided by financing activities 29,651 50,317 --------- --------- Net change in cash and cash equivalents 1,159 5,037 Cash and cash equivalents, beginning of year 36,446 38,719 --------- --------- Cash and cash equivalents, end of period $ 37,605 $ 43,756 ========= =========
The accompanying notes are an integral part of these statements. F-26 CORNING CLINICAL LABORATORIES INC. (a wholly-owned business of Corning Incorporated) NOTES TO INTERIM COMBINED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION Corning Clinical Laboratories Inc. and Corning Nichols Institute Inc. (collectively referred to as "CCL" or the "Company") are wholly-owned subsidiaries of Corning Life Sciences Inc. ("CLSI") which in turn is a wholly-owned subsidiary of Corning Incorporated ("Corning"). The Company is one of the largest clinical laboratory testing businesses in the United States. These financial statements present the carved-out results of operations, cash flows and financial position of Corning's clinical laboratory testing business. Corning Pharmaceutical Services Inc., a subsidiary of CCL, and its related entities ("CPS") as well as environmental testing services formerly provided by CCL are excluded. In May 1996, Corning's Board of Directors approved a plan to distribute to its shareholders on a pro rata basis all of the shares of CCL and CPS (the "CCL and CPS Spin-Off Distributions"). The result of the plan will be the creation of two independent, publicly-owned (but as yet unnamed) companies. As a result of the Spin-Off Distributions, CCL will operate Corning's clinical laboratory testing business as an independent public company and CPS will own and operate Corning's contract research business as an independent public company. The Spin-Off Distributions will be effected by the distribution of a dividend to holders of Corning Common Stock of all of the outstanding CCL Common Stock, followed immediately by the distribution of a dividend to the holders of CCL Common Stock of all of the CPS Common Stock. Corning has submitted to the Internal Revenue Service a request for a ruling that the Spin-Off Distributions qualify as tax-free distributions under the Internal Revenue Code of 1986. The interim combined 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 combined financial statements have been compiled without audit and are subject to year-end adjustments. These interim combined financial statements should be read in conjunction with the historical combined financial statements of CCL for the years ended December 31, 1995, 1994 and 1993 included elsewhere herein. 2. COMMITMENTS AND CONTINGENCIES As disclosed in the Company's 1995 combined financial statements, federal government investigations of certain practices by clinical laboratories acquired in recent years are ongoing. In the second quarter of 1996, the U.S. Department of Justice notified the Company that it has taken issue with a number of payments received by Damon Corporation from federally funded healthcare programs prior to its acquisition. CCL management has met with the government several times to evaluate the substance of the government's allegations. Discussions with the government are in a preliminary state and consequently, it is not possible to predict the outcome of this matter with any certainty. In the second quarter of 1996, the Company recorded a special charge of $46 million to establish additional reserves equal to management's estimate of the low end of the range of potential amounts which could be required to satisfy the government's claims. It is possible that the aggregate claim (which might include restitution, treble damages, other civil penalties or criminal fines) could be in excess of established reserves by an amount which could be material to the Company's results of operations in the period in which such claim is settled. However, because Corning has agreed to fund any settlement prior to the CCL Spin-Off Distribution and has agreed to indemnify the Company (Note 4) for the settlement of any material DOJ claims pending at the Distribution date, the settlement of the claim will not have a material adverse impact on the Company's overall financial condition or cash flows. F-27 3. RESTRUCTURING RESERVES As described in Note 5 to the CCL Combined Financial statements, CCL has recorded charges for restructuring plans in previous years. Reserves relating to these programs totaled approximately $37.7 million and $25.6 million at December 31, 1995 and June 30, 1996, 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. SPIN-OFF DISTRIBUTION Coincident with the CCL Spin-Off Distribution, the Company plans to record a non-recurring charge of approximately $20 million ($13 million after tax) associated with the CCL Spin-Off Distribution. The largest component of the charge will be the cost of establishing an employee stock ownership plan ($11 million). The remainder of the charge will consist principally of the costs for advisors and other fees associated with establishing the Company as a separate publicly-traded entity. The amount of the charge is subject to change based on the price of the CCL stock on the Distribution Date. Prior to the CCL Spin-Off Distribution, the Company will borrow approximately $500 million in long-term debt to repay Corning for certain intercompany borrowings. The debt is assumed to consist of $300 million of bank borrowings and $200 million of publicly-traded high-yield notes. Corning will contribute the remaining debt to the Company's equity prior to the CCL Spin-Off Distribution. In conjunction with the CCL Spin-Off Distribution, Corning and the Company will enter into an indemnification agreement whereby Corning agrees to indemnify CCL for any losses arising out of any federal, criminal, civil or administrative investigations or claims that are pending as of the Distribution Date to the extent that such investigations or claims arise out of or are related to alleged violations of federal laws by reason of CCL, its affiliates, officers or directors billing any federal program or agency for services rendered to beneficiaries of such program or agency. Corning, CCL and CPS will enter into tax indemnification agreements that will prohibit CCL and CPS for a period of two years after the Spin-Off Distributions from taking certain actions that might jeopardize the favorable tax treatment of the Distributions under section 355 of the Internal Revenue Code of 1986, as amended and will provide Corning and CCL with certain rights of indemnification against CCL and CPS. The tax indemnification agreements will also require CCL and CPS to take such actions as Corning may request to preserve the favorable tax treatment provided for in any rulings obtained from the Internal Revenue Service in respect of the Distributions. Corning, CCL and CPS will also enter into a tax sharing agreement which will allocate among Corning, CCL and CPS responsibility for federal, state and local taxes relating to taxable periods before and after the Spin-Off Distributions and provide for computing and apportioning tax liabilities and tax benefits for such periods among the parties. F-28 5. PLANNED CHANGE IN ACCOUNTING POLICY Coincident with the CCL Spin-Off Distribution, CCL management will adopt a new accounting policy for evaluating the recoverability of intangible assets and measuring possible impairment under Statement of the Accounting Principles Board No. 17. Most of CCL's intangible assets resulted from purchase business combinations in 1993. Significant changes in the clinical laboratory and health care industries subsequent to 1993, including increased government regulation and movement from traditional fee-for-service care to managed cost health care, have caused the fair value of CCL's intangible assets to be significantly less than carrying value. CCL management believes that a valuation of intangible assets based on the amount for which each regional laboratory could be sold in an arms-length transaction is preferable to using projected undiscounted pre-tax cash flows. CCL believes fair value is a better indicator of the extent to which the intangible assets may be recoverable and therefore, may be impaired. This change in method of evaluating the recoverability of intangible assets will result in CCL recording a charge of between $400 million and $450 million coincident with the CCL Spin-Off Distribution to reflect the other than temporary impairment of intangible assets. This will result in a reduction of amortization expense of approximately $10 million to $11.3 million annually and $2.5 million to $2.8 million quarterly. The fair value method will be applied to each of CCL's regional laboratories. In developing management's estimate of fair value, CCL management will consider, among other things, (i) the financial projections of each regional laboratory, (ii) the future of each regional laboratory, including growth opportunities, managed care concentration and planned actions, (iii) publicly-available information regarding comparable publicly-traded companies in the industry, (iv) comparable sales prices, if available, and (v) other information deemed relevant. F-29 -----END PRIVACY-ENHANCED MESSAGE-----