-----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, EteJdrwDxxzsAdszm1z3c/4j81Ay8dP+6vraXv41o7oyDE49iokZKkiW3pzE/hpi a780EP639GbnSQeV93LFvw== 0000950117-02-001837.txt : 20020813 0000950117-02-001837.hdr.sgml : 20020813 20020812214952 ACCESSION NUMBER: 0000950117-02-001837 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST DIAGNOSTICS INC CENTRAL INDEX KEY: 0001022079 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MEDICAL LABORATORIES [8071] IRS NUMBER: 161387862 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12215 FILM NUMBER: 02727926 BUSINESS ADDRESS: STREET 1: ONE MALCOLM AVE CITY: TETERBORO STATE: NJ ZIP: 07608 BUSINESS PHONE: 2013935000 MAIL ADDRESS: STREET 1: ONE MALCOLM AVE CITY: TETERBORO STATE: NJ ZIP: 07601 FORMER COMPANY: FORMER CONFORMED NAME: CORNING CLINICAL LABORATORIES INC DATE OF NAME CHANGE: 19960903 10-Q 1 a33151.txt QUEST DIAGNOSTICS, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 - -------------------------------------------------------------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended June 30, 2002 Commission file number 1-12215 Quest Diagnostics Incorporated One Malcolm Avenue Teterboro, NJ 07608 (201) 393-5000 Delaware (State of Incorporation) 16-1387862 (I.R.S. Employer Identification Number) - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- As of August 2, 2002, there were outstanding 97,424,717 shares of Common Stock, $.01 par value. PART I - FINANCIAL INFORMATION Item 1. Financial Statements Index to consolidated financial statements filed as part of this report:
Page Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2001 2 Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations"
1 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (in thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended June 30, June 30, ---------------------- ------------------------ 2002 2001 2002 2001 ---------- -------- ---------- ---------- Net revenues ................................... $1,068,810 $931,589 $2,015,572 $1,814,142 ---------- -------- ---------- ---------- Costs and expenses: Cost of services ............................ 630,258 549,391 1,187,996 1,078,456 Selling, general and administrative ......... 276,821 256,474 535,224 509,276 Interest expense, net ....................... 14,916 20,458 27,591 43,158 Amortization of goodwill and other intangible assets .................................... 2,065 12,139 4,220 23,239 Provision for special charge ................ - 5,997 - 5,997 Minority share of income .................... 3,938 2,851 7,820 3,967 Other, net .................................. (5,660) (1,432) (6,274) (1,134) ---------- -------- ---------- ---------- Total ..................................... 922,338 845,878 1,756,577 1,662,959 ---------- -------- ---------- ---------- Income before taxes and extraordinary loss ..... 146,472 85,711 258,995 151,183 Income tax expense ............................. 59,321 38,607 105,155 68,331 ---------- -------- ---------- ---------- Income before extraordinary loss ............... 87,151 47,104 153,840 82,852 Extraordinary loss, net of taxes ............... - (21,609) - (21,609) ---------- -------- ---------- ---------- Net income ..................................... $ 87,151 $ 25,495 $ 153,840 $ 61,243 ========== ======== ========== ========== Basic net income per common share: Income before extraordinary loss ............... $ 0.90 $ 0.51 $ 1.60 $ 0.90 Extraordinary loss, net of taxes ............... - (0.23) - (0.24) ---------- -------- ---------- ---------- Net income ..................................... $ 0.90 $ 0.28 $ 1.60 $ 0.66 ========== ======== ========== ========== Diluted net income per common share: Income before extraordinary loss ............... $ 0.87 $ 0.48 $ 1.54 $ 0.85 Extraordinary loss, net of taxes .............. - (0.22) - (0.22) ---------- -------- ---------- ---------- Net income .................................... $ 0.87 $ 0.26 $ 1.54 $ 0.63 ========== ======== ========== ========== Weighted average common shares outstanding - basic ......................... 96,393 92,566 95,907 92,228 Weighted average common shares outstanding - diluted ....................... 100,297 97,304 99,802 96,962
The accompanying notes are an integral part of these statements. 2 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 2002 AND DECEMBER 31, 2001 (in thousands, except per share data) (unaudited)
June 30, December 31, 2002 2001 ----------- ----------- Assets Current assets: Cash and cash equivalents ......................................... $ 89,840 $ 122,332 Accounts receivable, net of allowance of $207,392 and $216,203 at June 30, 2002 and December 31, 2001, respectively .............. 597,667 508,340 Inventories ....................................................... 57,930 49,906 Deferred taxes on income .......................................... 146,782 157,649 Prepaid expenses and other current assets ......................... 41,595 38,287 ---------- ---------- Total current assets ............................................ 933,814 876,514 Property, plant and equipment, net ................................... 568,994 508,619 Goodwill, net ........................................................ 1,778,297 1,351,123 Intangible assets, net ............................................... 24,184 28,020 Deferred taxes on income ............................................. 46,444 52,678 Other assets ......................................................... 99,752 113,601 ---------- ---------- Total assets ......................................................... $3,451,485 $2,930,555 ========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses ............................. $ 644,813 $ 657,219 Short-term borrowings and current portion of long-term debt ....... 301,768 1,404 ---------- ---------- Total current liabilities ....................................... 946,581 658,623 Long-term debt ....................................................... 820,819 820,337 Other liabilities .................................................... 114,091 115,608 Commitments and contingencies Common stockholders' equity: Common stock, par value $0.01 per share; 300,000 shares authorized; 97,424 and 96,024 shares issued at June 30, 2002 and December 31, 2001, respectively .............................................. 974 960 Additional paid-in capital ........................................ 1,788,479 1,714,676 Accumulated deficit ............................................... (209,086) (362,926) Unearned compensation ............................................. (8,118) (13,253) Accumulated other comprehensive loss .............................. (2,255) (3,470) ---------- ---------- Total common stockholders' equity ............................... 1,569,994 1,335,987 ---------- ---------- Total liabilities and stockholders' equity ........................... $3,451,485 $2,930,555 ========== ==========
The accompanying notes are an integral part of these statements. 3 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (in thousands) (unaudited)
2002 2001 ---------- ---------- Cash flows from operating activities: Net income................................................................... $ 153,840 $ 61,243 Extraordinary loss, net of taxes........................................... - 21,609 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................. 63,815 70,903 Provision for doubtful accounts........................................... 110,477 110,854 Provision for special charge.............................................. - 5,997 Deferred income tax provision............................................. 17,563 1,247 Minority share of income.................................................. 7,820 3,967 Stock compensation expense................................................ 4,953 11,814 Tax benefits associated with stock-based compensation plans............... 38,189 22,898 Other, net................................................................ (2,056) 2,962 Changes in operating assets and liabilities: Accounts receivable..................................................... (136,837) (146,154) Accounts payable and accrued expenses................................... (38,040) (20,253) Integration, settlement and other special charges....................... (12,668) (33,439) Other assets and liabilities, net....................................... 10,890 37,987 --------- --------- Net cash provided by operating activities.................................... 217,946 151,635 --------- --------- Cash flows from investing activities: Business acquisitions, net of cash acquired.................................. (333,512) (55,746) Capital expenditures......................................................... (83,390) (78,432) Collection of note receivable ............................................... 10,660 2,000 Proceeds from disposition of assets.......................................... 1,043 21,492 Increase in investments and other assets..................................... (2,917) (9,901) --------- --------- Net cash used in investing activities........................................ (408,116) (120,587) --------- --------- Cash flows from financing activities: Repayments of long-term debt................................................. (333,265) (734,025) Proceeds from borrowings..................................................... 475,237 722,333 Costs paid in connection with debt refinancing............................... - (23,684) Exercise of stock options.................................................... 22,103 10,132 Distributions to minority partners........................................... (6,268) (2,969) Preferred stock dividends paid............................................... - (147) Other........................................................................ (129) - --------- --------- Net cash provided by (used in) financing activities.......................... 157,678 (28,360) --------- --------- Net change in cash and cash equivalents...................................... (32,492) 2,688 Cash and cash equivalents, beginning of year................................. 122,332 171,477 --------- --------- Cash and cash equivalents, end of period..................................... $ 89,840 $ 174,165 ========= ========= Cash paid during the period for: Interest..................................................................... $ 30,504 $ 50,704 Income taxes................................................................. 38,760 20,442 Businesses acquired: Fair value of assets acquired.............................................. $ 549,947 $ 55,746 Fair value of liabilities acquired......................................... 204,490 -
The accompanying notes are an integral part of these statements. 4 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, unless otherwise indicated) (unaudited) 1. BASIS OF PRESENTATION Background Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or the "Company") is the largest clinical laboratory testing business in the United States. As the nation's leading provider of diagnostic testing and related services for the healthcare industry, Quest Diagnostics offers a broad range of clinical laboratory testing services to physicians, hospitals, managed care organizations, employers, governmental institutions and other independent clinical laboratories. Quest Diagnostics has the leading market share in clinical laboratory testing and esoteric testing, including molecular diagnostics, as well as non-hospital based anatomic pathology services and testing for drugs of abuse. Through the Company's national network of laboratories and patient service centers, and its esoteric testing laboratory and development facilities, Quest Diagnostics offers comprehensive and innovative diagnostic testing, information and related services used by physicians and other healthcare customers to diagnose, treat and monitor diseases and other medical conditions. Quest Diagnostics also offers clinical testing and services to support clinical trials of new pharmaceuticals worldwide. On an annualized basis, Quest Diagnostics processes over 115 million requisitions through its extensive network of laboratories and patient service centers in virtually every major metropolitan area throughout the United States. Basis of Presentation The interim consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature. The interim consolidated financial statements have been compiled without audit. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's 2001 Annual Report on Form 10-K. Earnings Per Share Basic net income per common share is calculated by dividing net income, less preferred stock dividends (approximately $30 thousand per quarter in 2001), by the weighted average number of common shares outstanding. Diluted net income per common share is calculated by dividing net income, less preferred stock dividends, by the weighted average number of common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. The if-converted method is used in determining the dilutive effect of the Company's 1 3/4% contingent convertible debentures in periods when the holders of such securities are permitted to exercise their conversion rights. Potentially dilutive common shares include outstanding stock options and restricted common shares granted under the Company's Employees Equity Participation Program. These dilutive securities increased the weighted average number of common shares outstanding by 3.9 million shares and 4.7 million shares, respectively, for both the three and six months ended June 30, 2002 and 2001. During the fourth quarter of 2001, the Company redeemed all of its then issued and outstanding shares of preferred stock. Stock-Based Compensation Quest Diagnostics has adopted the disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), and follows Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations to account for its stock-based compensation plans. Under this approach, the cost of restricted stock awards is expensed over their vesting period, while the imputed cost of stock option grants and discounts offered under the Company's Employee Stock Purchase Plan ("ESPP") is disclosed, based on the vesting provisions of the individual grants, but not charged to expense. Stock-based compensation expense recorded in accordance with APB 25, related to restricted stock awards, was $2.5 million and $4.9 million for the three months ended June 30, 2002 and 2001, respectively, and $5.0 million and $11.8 million for the six months ended June 30, 2002 and 2001, respectively. 5 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) The following table presents net income and basic and diluted earnings per common share, had the Company elected to recognize compensation cost based on the fair value at the grant dates for stock option awards and discounts granted for stock purchases under the Company's ESPP, consistent with the method prescribed by SFAS 123:
Three Months Ended Six Months Ended June 30, June 30, --------------------- ----------------------- 2002 2001 2002 2001 ------- ------- -------- -------- Net income Net income ..................................... $87,151 $25,495 $153,840 $ 61,243 Impact of recognizing compensation cost pursuant to provisions of SFAS 123 ................... (9,909) (6,759) (17,953) (10,010) ------- ------- -------- -------- Net income, adjusted for impact of SFAS 123 .... $77,242 $18,736 $135,887 $ 51,233 ======= ======= ======== ======== Basic net income per common share Net income ..................................... $ 0.90 $ 0.28 $ 1.60 $ 0.66 Impact of recognizing compensation cost pursuant to provisions of SFAS 123 ................... (0.10) (0.08) (0.18) (0.11) ------- ------- -------- -------- Net income, adjusted for impact of SFAS 123 .... $ 0.80 $ 0.20 $ 1.42 $ 0.55 ======= ======= ======== ======== Diluted net income per common share Net income ..................................... $ 0.87 $ 0.26 $ 1.54 $ 0.63 Impact of recognizing compensation cost pursuant to provisions of SFAS 123 ................... (0.10) (0.07) (0.18) (0.10) ------- ------- -------- -------- Net income, adjusted for impact of SFAS 123 .... $ 0.77 $ 0.19 $ 1.36 $ 0.53 ======= ======= ======== ========
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Three Months Ended Six Months Ended June 30, June 30, --------------------- ----------------------- 2002 2001 2002 2001 ------- ------- -------- -------- Dividend yield..................................... 0.0% 0.0% 0.0% 0.0% Risk-free interest rate............................ 4.3% 5.3% 4.2% 5.2% Expected volatility................................ 45.2% 47.7% 45.2% 47.7% Expected holding period, in years.................. 5 5 5 5
New Accounting Standards In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). SFAS 144 further refines SFAS 121's requirement that companies recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable based on its undiscounted future cash flows and measure an impairment loss as the difference between the carrying amount and fair value of the asset. In addition, SFAS 144 provides guidance on accounting and disclosure issues surrounding long-lived assets to be disposed of by sale. SFAS 144 also extends the presentation of discontinued operations to include more disposal transactions. SFAS 144 is effective for all fiscal quarters of all fiscal years beginning after December 15, 2001 (January 1, 2002 for the Company). The Company's adoption of SFAS 144 did not result in any impairment loss being recorded. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt" ("SFAS 4"), SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers" 6 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) ("SFAS 44") and SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements" ("SFAS 64") and amends SFAS No. 13, "Accounting for Leases" ("SFAS 13"). This statement updates, clarifies and simplifies existing accounting pronouncements. As a result of rescinding SFAS 4 and SFAS 64, the criteria in APB No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", will be used to classify gains and losses from extinguishment of debt. SFAS 44 was no longer necessary because the transitions under the Motor Carrier Act of 1980 were completed. SFAS 13 was amended to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions and makes technical corrections to existing pronouncements. The provisions of SFAS 145 are effective for fiscal years beginning after May 15, 2002, with earlier application encouraged. The Company expects to adopt SFAS 145 effective January 1, 2003 and reflect any necessary reclassifications in its consolidated statements of operations. The adoption of SFAS 145 will not have a material impact on the Company's financial position. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses the recognition, measurement, and reporting of costs associated with exit or disposal activities, and supercedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). The principal difference between SFAS 146 and EITF 94-3 relates to the requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity, including those related to employee termination benefits and obligations under operating leases and other contracts, be recognized when the liability is incurred, and not necessarily the date of an entity's commitment to an exit plan, as under EITF 94-3. SFAS 146 also establishes that the initial measurement of a liability recognized under SFAS 146 be based on fair value. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company expects to adopt SFAS 146, effective January 1, 2003. For exit or disposal activities initiated prior to January 1, 2003, the Company plans to follow the accounting guidance outlined in EITF 94-3. 2. ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which broadens the criteria for recording intangible assets separate from goodwill. SFAS 142 requires the use of a nonamortization approach to account for purchased goodwill and certain intangibles. Under a nonamortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed for impairment and an impairment charge is recorded in the periods in which the recorded carrying value of goodwill and certain intangibles is more than its estimated fair value. The Company adopted SFAS 142 effective January 1, 2002. The provisions of SFAS 142 require that a transitional impairment test be performed as of the beginning of the year the statement is adopted. The provisions of SFAS 142 also require that a goodwill impairment test be performed annually or in the case of other events that indicate a potential impairment. The new criteria for recording intangible assets separate from goodwill did not require the Company to reclassify any of its intangible assets. The Company's transitional impairment test indicated that there was no impairment of goodwill upon adoption of SFAS 142. The annual impairment test of goodwill will be performed at the end of the Company's fiscal year on December 31st. Effective January 1, 2002, the Company evaluates the recoverability and measures the possible impairment of its goodwill under SFAS 142. The impairment test is a two-step process that begins with the estimation of the fair value of the reporting unit. The first step screens for potential impairment and the second step measures the amount of the impairment, if any. Management's estimate of fair value considers publicly available information regarding the market capitalization of the Company as well as (i) publicly available information regarding comparable publicly-traded companies in the clinical laboratory testing industry, (ii) the financial projections and future prospects of the Company's business, including its growth opportunities and likely operational improvements, and (iii) comparable sales prices, if available. As part of the first step to assess potential impairment, management compares the estimate of fair value for the Company to the book value of the Company's consolidated net assets. If the book value of the consolidated net assets is greater than the estimate of fair value, the Company would then proceed to the second step to measure the impairment, if any. The second step compares the implied fair value of goodwill with its carrying value. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and 7 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit's goodwill is greater than its implied fair value, an impairment loss will be recognized in the amount of the excess. Management believes its estimation methods are reasonable and reflective of common valuation practices. On a quarterly basis, management performs a review of the Company's business to determine if events or changes in circumstances have occurred which could have a material adverse effect on the fair value of the Company and its goodwill. If such events or changes in circumstances were deemed to have occurred, the Company would perform an impairment test of goodwill as of the end of the quarter, consistent with the annual impairment test, and record any noted impairment loss. The following table presents net income and basic and diluted earnings per common share, adjusted to reflect results as if the nonamortization provisions of SFAS 142 had been in effect for the periods presented:
Three Months Ended Six Months Ended June 30, June 30, -------------------- ---------------------- 2002 2001 2002 2001 ------- ------- -------- -------- Net income Reported net income ............................. $87,151 $25,495 $153,840 $ 61,243 Add back: Amortization of goodwill, net of taxes - 9,543 - 18,190 ------- ------- -------- -------- Adjusted net income ............................. $87,151 $35,038 $153,840 $ 79,433 ======= ======= ======== ======== Income before extraordinary loss, adjusted to exclude amortization of goodwill, net of taxes $87,151 $56,647 $153,840 $101,042 Basic net income per common share Reported net income ............................. $ 0.90 $ 0.28 $ 1.60 $ 0.66 Amortization of goodwill ........................ - 0.10 - 0.20 ------- ------- -------- -------- Adjusted net income ............................. $ 0.90 $ 0.38 $ 1.60 $ 0.86 ======= ======= ======== ======== Income before extraordinary loss, adjusted to exclude amortization of goodwill, net of taxes $ 0.90 $ 0.61 $ 1.60 $ 1.09 Diluted net income per common share Reported net income ............................. $ 0.87 $ 0.26 $ 1.54 $ 0.63 Amortization of goodwill ........................ - 0.10 - 0.19 ------- ------- -------- -------- Adjusted net income ............................. $ 0.87 $ 0.36 $ 1.54 $ 0.82 ======= ======= ======== ======== Income before extraordinary loss, adjusted to exclude amortization of goodwill, net of taxes $ 0.87 $ 0.58 $ 1.54 $ 1.04
8 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Other intangible assets consist of the following:
Weighted Average Amortization Period June 30, 2002 December 31, 2001 ---------------- ------------------------------------ ----------------------------------- Accumulated Accumulated Cost Amortization Net Cost Amortization Net -------- ------------ ------- -------- ------------ ------- Non-compete agreements.......... 5 years $43,943 $(29,391) $14,552 $43,943 $(26,566) $17,377 Customer lists........ 15 years 41,301 (32,822) 8,479 41,331 (31,787) 9,544 Other................. 12 years 3,267 (2,114) 1,153 3,067 (1,968) 1,099 ------- -------- ------- ------- -------- ------- Total.............. 8 years $88,511 $(64,327) $24,184 $88,341 $(60,321) $28,020 ======= ======== ======= ======= ======== =======
For the three months ended June 30, 2002 and 2001, amortization expense related to other intangible assets was $2,065 and $1,989, respectively. For the six months ended June 30, 2002 and 2001, amortization expense related to other intangible assets was $4,220 and $3,852, respectively. The estimated amortization expense related to other intangible assets for each of the five succeeding fiscal years as of June 30, 2002 is as follows:
Fiscal year ending December 31, ------------------- Remainder of 2002 ......... $ 3,725 2003....................... 7,355 2004....................... 5,830 2005....................... 2,503 2006....................... 1,389 2007....................... 639 Thereafter................. 2,743 ------- Total.................... $24,184 =======
3. BUSINESS ACQUISITION Acquisition of American Medical Laboratories, Incorporated On April 1, 2002, the Company completed its previously announced acquisition of all of the outstanding voting stock of American Medical Laboratories, Incorporated, ("AML") and an affiliated company of AML, LabPortal, Inc. ("LabPortal"), a provider of electronic connectivity products, in an all-cash transaction with a combined value of approximately $500 million, which included the assumption of approximately $160 million in debt. Through the acquisition of AML, Quest Diagnostics acquired all of AML's operations, including two full-service laboratories, 51 patient service centers, and hospital sales, service and logistics capabilities. The all-cash purchase price of approximately $335 million and related transaction costs, together with the repayment of approximately $150 million of principal and related accrued interest, representing substantially all of AML's debt, was financed by Quest Diagnostics with cash on-hand, $300 million of borrowings under its secured receivables credit facility and $175 million of borrowings under its unsecured revolving credit facility. During the second quarter of 2002, Quest Diagnostics repaid all of the $175 million borrowed under the Company's unsecured revolving credit facility. 9 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) The acquisition of AML was accounted for under the purchase method of accounting. As such, the cost to acquire AML has been allocated on a preliminary basis to the assets and liabilities acquired based on estimated fair values as of the closing date. The consolidated financial statements include the results of operations of AML subsequent to the closing of the acquisition. The following table summarizes the Company's preliminary purchase price allocation related to the acquisition of AML based on the estimated fair value of the assets acquired and liabilities assumed on the acquisition date. The purchase price allocation will be finalized after completion of the valuation of certain assets and liabilities, including costs to integrate AML's operations.
Estimated Fair Values as of April 1, 2002 ------------- Current assets........................................ $ 83,517 Property, plant and equipment......................... 32,207 Goodwill.............................................. 419,871 Other assets.......................................... 3,134 -------- Total assets acquired............................... 538,729 -------- Current portion of long-term debt..................... 11,834 Other current liabilities............................. 43,461 Long-term debt........................................ 139,465 Other liabilities..................................... 2,193 -------- Total liabilities assumed........................... 196,953 -------- Net assets acquired................................. $341,776 ========
Based on management's review of the net assets acquired and consultations with valuation specialists, no intangible assets meeting the criteria under SFAS No. 141, "Business Combinations", were identified. Of the $420 million allocated to goodwill, approximately $17 million is expected to be deductible for tax purposes. 10 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) The following unaudited pro forma combined financial information for the six months ended June 30, 2002 and the three and six months ended June 30, 2001 assumes that the AML acquisition was effected on January 1, 2001 (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, 2002 2001 2001 ---------- ---------- ---------- Net revenues........................................... $2,093,987 $1,958,962 $1,006,049 Income before extraordinary loss....................... 153,437 89,423 49,269 Net income............................................. 153,437 67,815 27,661 Basic earnings per common share: Income before extraordinary loss....................... $ 1.60 $ 0.97 $ 0.53 Net income............................................. 1.60 0.74 0.30 Weighted average common shares outstanding - basic..... 95,907 92,228 92,566 Diluted earnings per common share: Income before extraordinary loss....................... $ 1.54 $ 0.92 $ 0.51 Net income............................................. 1.54 0.70 0.28 Weighted average common shares outstanding - diluted... 99,802 96,962 97,304
Proforma results for the six months ended June 30, 2002 exclude $14.5 million of non-recurring merger costs which were incurred and expensed by AML immediately prior to the closing of the AML acquistion. The all-cash purchase price for LabPortal of approximately $4 million and related transaction costs, together with the repayment of all of LabPortal's outstanding debt of approximately $7 million and related accrued interest, was financed by Quest Diagnostics with cash on-hand. The acquisition of LabPortal was accounted for under the purchase method of accounting. As such, the cost to acquire LabPortal has been allocated on a preliminary basis to the assets and liabilities acquired based on estimated fair values as of the closing date, including approximately $7 million of goodwill. The consolidated financial statements include the results of operations of LabPortal subsequent to the closing of the acquisition. 4. PROVISION FOR SPECIAL CHARGE During the second quarter of 2001, the Company recorded a special charge of $6.0 million in connection with the refinancing of its debt and settlement of the Company's interest rate swap agreements. Prior to the Company's debt refinancing in June 2001, the Company's secured credit agreement required the Company to maintain interest rate swap agreements to mitigate the risk of changes in interest rates associated with a portion of its variable interest rate indebtedness. These interest rate swap agreements were considered a hedge against changes in the amount of future cash flows associated with the interest payments of the Company's variable rate debt obligations. Accordingly, the interest rate swap agreements were recorded at their estimated fair value in the Company's consolidated balance sheet and the related losses on these contracts were deferred in shareholders' equity as a component of comprehensive income. In conjunction with the debt refinancing, the interest rate swap agreements were terminated and the losses which were included in shareholders' equity as a component of comprehensive income were reflected as a special charge in the consolidated statement of operations for the three and six months ended June 30, 2001. 5. EXTRAORDINARY LOSS In conjunction with the Company's debt refinancing in the second quarter of 2001, the Company recorded an extraordinary loss of $36.0 million, ($21.6 million, net of taxes). The loss represented the write-off of deferred financing costs of $23.2 million, associated with the Company's debt which was refinanced, and $12.8 million of payments related primarily to the tender premium incurred in connection with the Company's cash tender offer of the Company's 10 3/4% Senior Subordinated Notes. See Note 1,"New Accounting Standards", for a discussion regarding the impact of SFAS 145. 11 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 6. COMMITMENTS AND CONTINGENCIES The Company has entered into several settlement agreements with various governmental and private payers during recent years relating to industry-wide billing and marketing practices that had been substantially discontinued by early 1993. In addition, the Company is aware of several pending lawsuits filed under the qui tam provisions of the civil False Claims Act and has received notices of private claims relating to billing issues similar to those that were the subject of prior settlements with various governmental payers. Some of the proceedings against the Company involve claims that are substantial in amount. Some of the cases involve the operations of SmithKline Beecham Clinical Laboratories, Inc. ("SBCL") prior to the closing of the SBCL acquisition. SmithKline Beecham plc ("SmithKline Beecham") has agreed to indemnify Quest Diagnostics, on an after-tax basis, against monetary payments for governmental claims or investigations relating to the billing practices of SBCL that had been settled before or were pending as of the closing date of the SBCL acquisition. SmithKline Beecham has also agreed to indemnify Quest Diagnostics, on an after-tax basis, against monetary payments to private payers, relating to or arising out of the governmental claims. The indemnification with respect to governmental claims is for 100% of those claims. SmithKline Beecham will indemnify Quest Diagnostics, in respect of private claims for: 100% of those claims, up to an aggregate amount of $80 million; 50% of those claims to the extent the aggregate amount exceeds $80 million but is less than $130 million; and 100% of such claims to the extent the aggregate amount exceeds $130 million. The indemnification also covers 80% of out-of-pocket costs and expenses relating to investigations of the claims indemnified against by SmithKline Beecham. SmithKline Beecham has also agreed to indemnify the Company with respect to pending actions relating to a former SBCL employee that at times reused certain needles when drawing blood from patients. In addition, SmithKline Beecham has agreed to indemnify the Company against all monetary payments relating to professional liability claims of SBCL for services provided prior to the closing of the SBCL acquisition. Amounts due from SmithKline Beecham at June 30, 2002, related principally to indemnified professional liability claims discussed above, totaled approximately $11 million. The estimated reserves and related amounts due from SmithKline Beecham are subject to change as additional information regarding the outstanding claims is gathered and evaluated. At June 30, 2002, recorded reserves relating to billing claims approximated $10 million. Although management believes that established reserves for both indemnified and non-indemnified claims are sufficient, it is possible that additional information (such as the indication by the government of criminal activity, additional tests being questioned or other changes in the government's or private claimants' theories of wrongdoing) may become available which may cause the final resolution of these matters to exceed established reserves by an amount which could be material to the Company's results of operations and cash flows in the period in which such claims are settled. The Company does not believe that these issues will have a material adverse effect on its overall financial condition. In addition to the billing-related settlement reserves discussed above, the Company is involved in various legal proceedings arising in the ordinary course of business. Some of the proceedings against the Company involve claims that are substantial in amount. Some of these claims involve contracts of SBCL that were terminated following the Company's acquisition of SBCL. During the second quarter of 2002, the Company paid approximately $5 million to settle a claim related to a contract of SBCL that was terminated following the Company's acquisition of SBCL. The settlement had been fully reserved for. Although management cannot predict the outcome of such proceedings or any claims made against the Company, management does not anticipate that the ultimate outcome of the various proceedings or claims will have a material adverse effect on the Company's financial position but may be material to the Company's results of operations and cash flows in the period in which such claims are resolved. 12 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 7. COMMON STOCKHOLDERS' EQUITY Changes in common stockholders' equity for the six months ended June 30, 2002 were as follows:
Accumulated Additional Other Common Paid-In Accumulated Unearned Comprehensive Comprehensive Stock Capital Deficit Compensation (Loss) Income --------------------------------------------------------------------------------------- Balance, December 31, 2001 $960 $1,714,676 $(362,926) $(13,253) $(3,470) Net income.................... 153,840 $153,840 Other comprehensive income.... 1,215 1,215 -------- Comprehensive income........ $155,055 ======== Issuance of common stock under benefit plans (214 common shares)..................... 2 13,523 Exercise of options (1,186 common shares).............. 12 22,091 Tax benefits associated with stock-based compensation plans....................... 38,189 Amortization of unearned compensation................ 5,135 - ---------------------------------------------------------------------------------------------------- Balance, June 30, 2002 $974 $1,788,479 $(209,086) $ (8,118) $(2,255) ================================================================
13 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Changes in common stockholders' equity for the six months ended June 30, 2001 were as follows:
Accumulated Additional Other Common Paid-In Accumulated Unearned Comprehensive Comprehensive Stock Capital Deficit Compensation (Loss) Income --------------------------------------------------------------------------------------- Balance, December 31, 2000 $465 $1,591,976 $(525,111) $(31,077) $(5,458) Net income.................... 61,243 $61,243 Other comprehensive income.... 1,859 1,859 ------- Comprehensive income........ $63,102 ======= Two-for-one stock split (47,149 common shares).............. 472 (472) Preferred dividends declared (59) Issuance of common stock under benefit plans (193 common shares)..................... 2 24,764 (4,053) Exercise of options (606 common shares)..................... 6 10,126 Shares to cover employee payroll tax withholdings on exercised options (2 common shares)..................... (189) Tax benefits associated with stock-based compensation plans....................... 22,898 Amortization of unearned compensation................ 12,481 - ----------------------------------------------------------------------------------------------------- Balance, June 30, 2001 $945 $1,649,103 $(463,927) $(22,649) $(3,599) ==== ========== ========== ========= ========
During the six months ended June 30, 2001, two thousand common shares were surrendered to cover employee payroll tax withholdings related to the exercise of stock options. For reporting purposes, these shares were accounted for as treasury purchases which were immediately retired. For the six months ended June 30, 2001, other comprehensive income included the cumulative effect of the change in accounting for derivative financial instruments upon adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, which reduced comprehensive income by approximately $1 million. In addition, in conjunction with the Company's debt refinancing, the interest rate swap agreements were terminated and the losses which were included in shareholders' equity as a component of comprehensive income were reflected as a special charge in the consolidated statements of operations for the three and six months ended June 30, 2001 (See Note 4). 8. PENDING ACQUISITION Acquisition of Unilab Corporation On April 2, 2002, the Company entered into a definitive agreement with Unilab Corporation ("Unilab"), which provides that Quest Diagnostics will acquire all of the outstanding shares of Unilab common stock and assume Unilab's existing debt of approximately $200 million. In exchange for their Unilab shares, Unilab stockholders may elect to receive $26.50 in cash, 0.3256 shares of Quest Diagnostics common stock or a combination of cash and stock. The aggregate amount of cash available to Unilab stockholders will be limited to 30% of the total consideration available for the Unilab shares. Unilab has approximately 37.4 million shares of common stock outstanding on a fully diluted basis. If Unilab stockholders elect to receive 30% of the consideration in cash and if all options are exercised, Quest Diagnostics 14 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) would issue approximately 8.5 million shares and pay $297 million in cash to the stockholders of Unilab. If Unilab stockholders elect to receive 100% of the consideration in Quest Diagnostics common stock and all Unilab options were exercised, Quest Diagnostics would issue approximately 12.2 million common shares to the stockholders of Unilab. The transaction, which has been approved by the Boards of Directors of both companies, is subject to the satisfaction of customary conditions, including the tender of a majority of Unilab's common stock on a fully diluted basis, and regulatory review. During the second quarter of 2002, the Company and Unilab received a request for additional information (commonly referred to as a "second request") from the Federal Trade Commission ("FTC") under the Hart-Scott-Rodino Antitrust Improvements Act (the "HSR Act") in connection with the Company's pending acquisition of Unilab. Subject to completion of the HSR process and satisfaction of the other conditions to the cash election exchange offer and the agreement and plan of merger, the Company hopes to close the transaction in the third quarter of 2002. The Company and Unilab are continuing their discussions with the FTC regarding the proposed transaction and the process is taking longer than anticipated. The Company continues to believe that the transaction is not anti-competitive. As part of the acquisition, Quest Diagnostics would acquire all of Unilab's operations, including its primary testing facilities in Los Angeles, San Jose and Sacramento, California, its more than 400 regional service and testing facilities located throughout California and its operations in Arizona. The Company expects to finance the cash portion of the purchase price and any retirements of Unilab's existing debt with the proceeds from a new $450 million five-year amortizing term loan commitment, which is available for the acquisition of Unilab, available borrowings under its unsecured revolving credit facility and cash on hand. The term loan, which is contingent upon the completion of the Unilab transaction, will carry interest at LIBOR plus 1.3125% and require principal repayments of the initial amount borrowed equal to 15%, 20%, 20%, 20% and 25% in years one through five, respectively. Since the transaction has yet to close, a preliminary purchase price allocation is not practical at this time. 9. SUMMARIZED FINANCIAL INFORMATION The Company's 6 3/4% senior notes due 2006, 7 1/2% senior notes due 2011 and 1 3/4% contingent convertible debentures are guaranteed by each of the Company's wholly owned subsidiaries that operate clinical laboratories in the United States (the "Subsidiary Guarantors"). With the exception of Quest Diagnostics Receivables Incorporated (see paragraph below), the non-guarantor subsidiaries are primarily foreign and less than wholly owned subsidiaries. In conjunction with the Company's receivables financing in 2000, the Company formed a new wholly owned non-guarantor subsidiary, Quest Diagnostics Receivables Incorporated ("QDRI"). The Company and the Subsidiary Guarantors, with the exception of AML, transfer all private domestic receivables (principally excluding receivables due from Medicare, Medicaid and other federal programs and receivables due from customers of its joint ventures) to QDRI. QDRI utilizes the transferred receivables to collateralize the Company's secured receivables credit facility. The Company and the Subsidiary Guarantors provide collection services to QDRI. QDRI uses cash collections principally to purchase new receivables from the Company and the Subsidiary Guarantors. The following condensed consolidating financial data illustrates the composition of the combined guarantors. Investments in subsidiaries are accounted for by the parent using the equity method for purposes of the supplemental consolidating presentation. Earnings (losses) of subsidiaries are therefore reflected in the parent's investment accounts and earnings. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions. On April 1, 2002, Quest Diagnostics acquired AML (see Note 3) which has been included in the accompanying condensed consolidating financial data, subsequent to the closing of the acquisition, as a Subsidiary Guarantor. 15 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Statement of Operations Six Months Ended June 30, 2002
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................ $ 363,269 $1,545,617 $254,858 $(148,172) $2,015,572 Costs and expenses: Cost of services.......................... 244,113 867,811 76,072 - 1,187,996 Selling, general and administrative....... 84,571 327,658 130,633 (7,638) 535,224 Interest, net............................. 40,409 122,626 5,090 (140,534) 27,591 Amortization of intangible assets......... 996 3,224 - - 4,220 Royalty (income) expense.................. (124,157) 124,157 - - - Other, net................................ 1,687 (693) 552 - 1,546 --------- ----------- -------- --------- ---------- Total.................................... 247,619 1,444,783 212,347 (148,172) 1,756,577 --------- ----------- -------- --------- ---------- Income before taxes and extraordinary loss.. 115,650 100,834 42,511 - 258,995 Income tax expense.......................... 45,094 40,511 19,550 - 105,155 --------- ----------- -------- --------- ---------- Income before equity earnings............... 70,556 60,323 22,961 - 153,840 Equity earnings from subsidiaries........... 83,284 - - (83,284) - --------- ----------- -------- --------- ---------- Net income.................................. $ 153,840 $ 60,323 $ 22,961 $ (83,284) $ 153,840 ========= =========== ======== ========= ========== Condensed Consolidating Statement of Operations Six Months Ended June 30, 2001 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................ $ 301,626 $1,437,653 $217,717 $(142,854) $1,814,142 Costs and expenses: Cost of services.......................... 219,952 808,689 49,815 - 1,078,456 Selling, general and administrative....... 78,758 312,868 125,014 (7,364) 509,276 Interest, net............................. 33,461 131,882 13,305 (135,490) 43,158 Amortization of goodwill and other intangible assets....................... 2,324 20,616 299 - 23,239 Provision for special charge.............. 5,997 - - - 5,997 Royalty (income) expense.................. (122,054) 122,054 - - - Other, net................................ 685 (877) 3,025 - 2,833 --------- ---------- -------- --------- ---------- Total.................................... 219,123 1,395,232 191,458 (142,854) 1,662,959 --------- ---------- -------- --------- ---------- Income before taxes and extraordinary loss.. 82,503 42,421 26,259 - 151,183 Income tax expense.......................... 36,922 20,517 10,892 - 68,331 --------- ---------- -------- --------- ---------- Income before equity earnings and extraordinary loss.......................... 45,581 21,904 15,367 - 82,852 Equity earnings from subsidiaries........... 19,542 - - (19,542) - --------- ---------- -------- --------- ---------- Income before extraordinary loss............ 65,123 21,904 15,367 (19,542) 82,852 Extraordinary loss, net of taxes............ (3,880) (15,567) (2,162) - (21,609) --------- ---------- -------- --------- ---------- Net income.................................. $ 61,243 $ 6,337 $ 13,205 $ (19,542) $ 61,243 ========= ========== ======== ========= ==========
16 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Balance Sheet June 30, 2002
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Assets Current assets: Cash and cash equivalents................... $ - $ 82,958 $ 6,882 $ - $ 89,840 Accounts receivable, net.................... 15,072 106,775 475,820 - 597,667 Other current assets........................ 85,893 64,511 95,903 - 246,307 ----------- ---------- ---------- ----------- ---------- Total current assets..................... 100,965 254,244 578,605 - 933,814 Property, plant and equipment, net.......... 200,684 342,595 25,715 - 568,994 Intangible assets, net ..................... 153,765 1,605,326 43,390 - 1,802,481 Intercompany receivable (payable)........... 13,791 181,441 (195,232) - - Investment in subsidiaries.................. 1,709,595 - - (1,709,595) - Other assets................................ 67,095 39,454 39,647 - 146,196 ----------- ---------- ---------- ----------- ---------- Total assets............................. $ 2,245,895 $2,423,060 $ 492,125 $(1,709,595) $3,451,485 =========== ========== ========== =========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses....... $ 318,592 $ 292,008 $ 34,213 $ - $ 644,813 Short-term borrowings and current portion of long-term debt............................ - 1,425 300,343 - 301,768 ----------- ---------- ---------- ----------- ---------- Total current liabilities................ 318,592 293,433 334,556 - 946,581 Long-term debt.............................. 313,930 503,729 3,160 - 820,819 Other liabilities........................... 43,379 54,494 16,218 - 114,091 Common stockholders' equity................. 1,569,994 1,571,404 138,191 (1,709,595) 1,569,994 ----------- ---------- ---------- ----------- ---------- Total liabilities and stockholders' equity $ 2,245,895 $2,423,060 $ 492,125 $(1,709,595) $3,451,485 =========== ========== ========== =========== ========== Condensed Consolidating Balance Sheet December 31, 2001 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Assets Current assets: Cash and cash equivalents................... $ - $ 110,571 $ 11,761 $ - $ 122,332 Accounts receivable, net.................... 9,083 52,232 447,025 - 508,340 Other current assets........................ 93,144 52,755 99,943 - 245,842 ----------- ---------- ---------- ----------- ---------- Total current assets..................... 102,227 215,558 558,729 - 876,514 Property, plant and equipment, net.......... 170,494 320,244 17,881 - 508,619 Intangible assets, net ..................... 154,809 1,188,031 36,303 - 1,379,143 Intercompany receivable (payable)........... 425,735 92,378 (518,113) - - Investment in subsidiaries.................. 1,096,647 - - (1,096,647) - Other assets................................ 75,633 54,998 35,648 - 166,279 ----------- ---------- ---------- ----------- ---------- Total assets............................. $ 2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555 =========== ========== ========== =========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses....... $ 334,666 $ 290,039 $ 32,514 $ - $ 657,219 Short-term borrowings and current portion of long-term debt............................ 21 1,040 343 - 1,404 ----------- ---------- ---------- ----------- ---------- Total current liabilities................ 334,687 291,079 32,857 - 658,623 Long-term debt.............................. 310,690 502,519 7,128 - 820,337 Other liabilities........................... 44,181 57,469 13,958 - 115,608 Common stockholders' equity................. 1,335,987 1,020,142 76,505 (1,096,647) 1,335,987 ----------- ---------- ---------- ----------- ---------- Total liabilities and stockholders' equity $ 2,025,545 $1,871,209 $ 130,448 $(1,096,647) $2,930,555 =========== ========== ========== =========== ==========
17 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Statement of Cash Flows Six Months Ended June 30, 2002
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Cash flows from operating activities: Net income.................................. $ 153,840 $ 60,323 $ 22,961 $ (83,284) $ 153,840 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............. 22,605 37,647 3,563 - 63,815 Provision for doubtful accounts........... 2,460 15,679 92,338 - 110,477 Other, net................................ (29,804) (2,787) 15,776 83,284 66,469 Changes in operating assets and liabilities 31,859 (89,358) (119,156) - (176,655) ----------- ---------- ---------- ---------- --------- Net cash provided by operating activities... 180,960 21,504 15,482 - 217,946 Net cash used in investing activities....... (205,897) (54,056) (1,930) (146,233) (408,116) Net cash provided by (used in) financing activities................................ 24,937 4,939 (18,431) 146,233 157,678 ----------- ---------- ---------- ---------- --------- Net change in cash and cash equivalents..... - (27,613) (4,879) - (32,492) Cash and cash equivalents, beginning of year - 110,571 11,761 - 122,332 ----------- ---------- ---------- ---------- --------- Cash and cash equivalents, end of period.... $ - $ 82,958 $ 6,882 $ - $ 89,840 =========== ========== ========== ========== ========= Condensed Consolidating Statement of Cash Flows Six Months Ended June 30, 2001 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Cash flows from operating activities: Net income.................................. $ 61,243 $ 6,337 $ 13,205 $ (19,542) $ 61,243 Extraordinary loss, net of taxes 3,880 15,567 2,162 - 21,609 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............. 19,443 49,106 2,354 - 70,903 Provision for doubtful accounts........... 715 10,047 100,092 - 110,854 Provision for special charge.............. 5,997 - - - 5,997 Other, net................................ 27,480 30,349 (34,483) 19,542 42,888 Changes in operating assets and liabilities (101,123) (4,194) (56,542) - (161,859) ----------- ---------- ---------- ---------- --------- Net cash provided by operating activities... 17,635 107,212 26,788 - 151,635 Net cash used in investing activities....... (23,888) (91,941) (194) (4,564) (120,587) Net cash provided by (used in) financing activities................................ 6,253 (14,318) (24,859) 4,564 (28,360) ----------- ---------- ---------- ---------- --------- Net change in cash and cash equivalents..... - 953 1,735 - 2,688 Cash and cash equivalents, beginning of year - 163,863 7,614 - 171,477 ----------- ---------- ---------- ---------- --------- Cash and cash equivalents, end of period.... $ - $ 164,816 $ 9,349 $ - $ 174,165 =========== ========== ========== ========== =========
18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. While many operational aspects of our business are subject to complex federal, state and local regulations, the accounting for our business is generally straight-forward with net revenues primarily recognized upon completion of the testing process. Our revenues are primarily comprised of a high volume of relatively low dollar transactions, and about half of all our costs and expenses consist of employee compensation and benefits. Due to the nature of our business, several of our accounting policies involve significant estimates and judgments. These accounting policies have been described in our 2001 Annual Report on Form 10-K, with the following accounting policy adopted effective January 1, 2002: Accounting for and recoverability of goodwill In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The impact of adopting SFAS 142 is summarized in Note 2 to the interim consolidated financial statements. Effective January 1, 2002, we evaluate the recoverability and measure the possible impairment of our goodwill under SFAS 142. The impairment test is a two-step process that begins with the estimation of the fair value of the reporting unit. The first step screens for potential impairment and the second step measures the amount of the impairment, if any. Our estimate of fair value considers publicly available information regarding the market capitalization of our Company, as well as (i) publicly available information regarding comparable publicly-traded companies in the clinical laboratory testing industry, (ii) the financial projections and future prospects of our business, including its growth opportunities and likely operational improvements, and (iii) comparable sales prices, if available. As part of the first step to assess potential impairment, we compare our estimate of fair value for the Company to the book value of our consolidated net assets. If the book value of our consolidated net assets is greater than our estimate of fair value, we would then proceed to the second step to measure the impairment, if any. The second step compares the implied fair value of goodwill with its carrying value. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit goodwill is greater than its implied fair value, an impairment loss will be recognized in the amount of the excess. We believe our estimation methods are reasonable and reflective of common valuation practices. On a quarterly basis, we perform a review of our business to determine if events or changes in circumstances have occurred which could have a material adverse effect on the fair value of the Company and its goodwill. If such events or changes in circumstances were deemed to have occurred, we would perform an impairment test of goodwill as of the end of the quarter, consistent with the annual impairment test, and record any noted impairment loss. Integration of Acquired Businesses American Medical Laboratories, Incorporated On April 1, 2002, we completed our previously announced acquisition of all of the outstanding voting stock of American Medical Laboratories, Incorporated, ("AML"). See Note 3 to the interim consolidated financial statements for a full discussion of this transaction. We estimate that we will incur between $10 million and $15 million of costs to integrate Quest Diagnostics and AML. The majority of these costs are expected to require cash outlays and are expected to primarily relate to severance and other integration-related costs during 2002 and 2003, including the elimination of excess capacity and workforce reductions. Of the total costs indicated above, estimated costs related to actions that impact the employees and operations of AML, which will be accounted for as a cost of the AML acquisition and included in goodwill, are expected to total between $7 million and $10 million. Of the total costs indicated above, estimated costs related to actions that impact Quest Diagnostics' employees 19 and operations, which will be accounted for as a charge to earnings in the period that the integration plans are approved and communicated, are expected to total between $3 million and $5 million. We expect to finalize and record these costs during the third quarter of 2002. We expect that the AML integration will result in approximately $15 million of annual synergies and that we will achieve this annual rate of synergies by the end of 2003. Unilab Corporation On April 2, 2002, we entered into a definitive agreement with Unilab Corporation ("Unilab") which provides that we will acquire all of the outstanding shares of Unilab common stock. See Note 8 to the interim consolidated financial statements for a full discussion of this transaction. We estimate that we will incur up to $20 million of costs to integrate Quest Diagnostics and Unilab. A significant portion of these costs is expected to require cash outlays and are expected to primarily relate to severance and other integration-related costs during 2002 and 2003, including the elimination of excess capacity and workforce reductions. These estimates are preliminary and will be subject to revisions as integration plans are developed and finalized. To the extent that the costs relate to actions that impact the employees and operations of Unilab, such costs will be accounted for as a cost of the Unilab acquisition and included in goodwill. To the extent that the costs relate to actions that impact Quest Diagnostics' employees and operations, such costs will be accounted for as a charge to earnings in the period that the integration plans are approved and communicated. We expect to finalize and record these costs during the fourth quarter of 2002. Results of Operations Three and Six Months Ended June 30, 2002 Compared with Three and Six Months Ended June 30, 2001 Reported net income for the three months ended June 30, 2002 increased to $87 million from $25 million for the three months ended June 30, 2001. For the six months ended June 30, 2002, reported net income increased to $154 million from $61 million for the prior year period. Assuming the nonamortization provisions of SFAS 142 had been in effect in 2001, net income for the three and six months ended June 30, 2001 would have been $35 million and $79 million, respectively. In addition, results for the three and six months ended June 30, 2001 included an extraordinary loss of $36 million ($22 million, net of tax) and a special charge of $6.0 million ($3.6 million, net of tax), both of which were incurred in conjunction with our debt refinancing in the second quarter of 2001. After considering the impact of SFAS 142 and excluding the extraordinary loss and special charge in 2001, income for the three months ended June 30, 2002 increased by $27 million, compared to the prior year period, an increase of 45%. After considering the impact of SFAS 142 and excluding the extraordinary loss and special charge in 2001, income for the six months ended June 30, 2002 increased by $49 million, compared to the prior year period, an increase of 47%. These increases in earnings were primarily attributable to revenue growth, driven by improvements in average revenue per requisition and clinical testing volume, improved efficiencies generated from our Six Sigma and Standardization initiatives, and a reduction in net interest expense, partially offset by increases in employee compensation and supply costs, depreciation expense and investments in our information technology strategy and strategic growth opportunities. Net Revenues Net revenues for the three and six months ended June 30, 2002 grew by 14.7% and 11.1%, respectively, compared to the prior year period. The acquisition of AML, which was completed on April 1, 2002, contributed approximately 60% and 40% to the increase in net revenues for the three and six months ended June 30, 2002. For the three and six months ended June 30, 2002, clinical testing volume, measured by the number of requisitions, increased 12% and 7.3%, respectively, compared to the prior year period. Assuming AML had been part of Quest Diagnostics in 2001, clinical testing volume would have increased 3.7% and 3.5%, respectively, on a pro forma basis, for the three and six months ended June 30, 2002, compared to the prior year period. Average revenue per requisition increased 2.4% and 3.2%, respectively, for the three and six months ended June 30, 2002. Our drugs-of-abuse testing business continued to negatively impact total company volume comparisons, reducing volume growth by approximately 1% for the three and six months ended June 30, 2002. The improvement in average revenue per requisition was primarily attributable to a continuing shift in test mix to higher value testing, contributing more than half of the improvement in average revenue per requisition, and a shift in payer mix to higher priced fee-for-service reimbursement. 20 Operating Costs and Expenses Total operating costs for the three and six months ended June 30, 2002 increased $101 million and $135 million, respectively, from the year earlier period primarily due to increases in our clinical testing volume, largely as a result of the AML acquisition, employee compensation and supply costs and depreciation expense; partially offset by a reduction in bad debt expense. While our cost structure has been favorably impacted by the synergies realized as a result of the integration of SmithKline Beecham Clinical Laboratories, Inc. ("SBCL") and the improved efficiencies generated from our Six Sigma and Standardization initiatives, we continue to make investments to enhance our infrastructure to pursue our overall business strategy. These investments include those related to: o Skills training for all employees, which together with our competitive pay and benefits, helps to increase employee satisfaction and performance, which we believe will result in better service to our customers; o Our information technology strategy, which is designed to result in better service to our customers; and o Our strategic growth opportunities. Cost of services, which includes the costs of obtaining, transporting and testing specimens was 59.0% of net revenues for the three months ended June 30, 2002 and remained unchanged from the prior year period. For the six months ended June 30, 2002, costs of services, as a percentage of net revenues, decreased to 58.9% from 59.4% a year ago. The positive net impact of increased average revenue per requisition and our Six Sigma and Standardization efforts on reducing cost of services as a percentage of net revenues was offset by the addition of AML's cost structure as of April 1, 2002. Selling, general and administrative expenses, which includes the costs of the sales force, billing operations, bad debt expense and general management and administrative support, decreased during the three months ended June 30, 2002 as a percentage of net revenues to 25.9% from 27.5% in the prior year period. For the six months ended June 30, 2002, selling, general and administrative expenses decreased as a percentage of net revenues to 26.6% from 28.1% in the prior year period. These decreases were primarily due to improvements in average revenue per requisition, efficiencies from our Six Sigma and Standardization efforts, in particular bad debt expense, and the addition of AML's cost structure as of April 1, 2002. During the second quarter of 2002, bad debt expense was reduced to 5.2% of net revenues, compared to 6.0% of net revenues a year ago. For the six months ended June 30, 2002, bad debt expense was 5.5% of net revenues, compared to 6.1% of net revenues in the prior year. The improvements in bad debt expense were principally attributable to the continued progress that we have made in our overall collection experience through process improvements, driven by our Six Sigma and Standardization initiatives, primarily related to the collection of diagnosis, patient and insurance information necessary to effectively bill for services performed. Based on prior experience, as well as the continued sharing of internal best practices in the billing functions, we believe that additional opportunities exist to further improve our overall collection experience. Interest, Net Net interest expense for the three and six months ended June 30, 2002 decreased from the prior year periods by $5.5 million and $15.6 million, respectively. These reductions were primarily due to the favorable impact of our debt refinancings in 2001 and a favorable interest rate environment. Amortization of Goodwill and Other Intangible Assets Amortization of goodwill and other intangible assets for the three and six months ended June 30, 2002 decreased from the prior year period by $10.1 million and $19.0 million, respectively, principally as the result of adopting SFAS 142, effective January 1, 2002. See Note 2 to the interim consolidated financial statements for further details regarding the impact of SFAS 142. Provision for Special Charge During the second quarter of 2001, we recorded a special charge of $6.0 million in connection with the refinancing of our debt and settlement of our interest rate swap agreements. Prior to our debt refinancing in June 2001, our secured credit agreement required us to maintain interest rate swap agreements to mitigate the risk of changes in interest rates associated with a portion of our variable interest rate indebtedness. These interest rate swap agreements were considered a hedge against changes in the amount of future cash flows associated with the interest payments of our variable rate debt 21 obligations. Accordingly, the interest rate swap agreements were recorded at their estimated fair value in our consolidated balance sheet and the related losses on these contracts were deferred in shareholders' equity as a component of comprehensive income. In conjunction with the debt refinancing, the interest rate swap agreements were terminated and the losses which were reflected in shareholders' equity as a component of comprehensive income were reflected as a special charge in the consolidated statement of operations for the three and six months ended June 30, 2001. Minority Share of Income Minority share of income for the three and six months ended June 30, 2002 increased from the prior year level, primarily due to the improved performance of our consolidated joint ventures. Other, Net Other, net, which represents income for each of the periods presented, increased $4.2 million and $5.1 million, for the three and six months ended June 30, 2002, respectively. The increases are primarily due to improved operating performance at our unconsolidated joint ventures, which resulted in an increase in equity earnings of $2.5 million and $3.9 million for the three and six months ended June 30, 2002. The second quarter of 2001 reflects the net impact of writing-off $7.0 million of impaired assets, partially offset by a $6.3 million gain on the sale of an investment. The remainder of the increases for both periods is primarily due to miscellaneous real estate and investment gains and losses in both 2002 and 2001. Income Taxes During 2001, our effective tax rate was significantly impacted by goodwill amortization, the majority of which was not deductible for tax purposes, and had the effect of increasing the overall tax rate. The reduction in the effective tax rate for the three and six months ended June 30, 2002 was primarily due to the reduction in amortization of goodwill (as a result of adopting SFAS 142, effective January 1, 2002) the majority of which was not deductible for tax purposes. Extraordinary Loss In conjunction with our debt refinancing in the second quarter of 2001, we recorded an extraordinary loss of $36 million, ($22 million, net of taxes). The loss represented the write-off of deferred financing costs of $23 million, associated with our debt which was refinanced, and $12.8 million of payments related primarily to the tender premium incurred in connection with our cash tender offer of our 10 3/4% senior subordinated notes due 2006 (the "Subordinated Notes"). EBITDA EBITDA represents income before net interest expense, income taxes, depreciation and amortization, and special items in 2001. The specials items represented the extraordinary loss and the special charge associated with our debt refinancing in the second quarter of 2001. EBITDA is presented and discussed because management believes it is a useful adjunct to net income and other measurements under accounting principles generally accepted in the United States since it is a meaningful measure of a company's performance and ability to meet its future debt service requirements, fund capital expenditures and meet working capital requirements. EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States and should not be considered as an alternative to (i) net income (or any other measure of performance under accounting principles generally accepted in the United States) as a measure of performance or (ii) cash flows from operating, investing or financing activities as an indicator of cash flows or as a measure of liquidity. EBITDA for the three months ended June 30, 2002 improved to $195 million, or 18.2% of net revenues, from $149 million, or 16.0% of net revenues, in 2001. For the six months ended June 30, 2002, EBITDA improved to $350 million, or 17.4% of net revenues, from $271 million, or 15.0% of net revenues, in 2001. The increases in EBITDA were primarily due to revenue growth, driven by improvements in average revenue per requisition and clinical testing volume and improved efficiencies generated from our Six Sigma and Standardization initiatives, partially offset by increases in employee compensation and supply costs, and investments in our information technology strategy and strategic growth opportunities. The improvements in EBITDA as a percentage of net revenues were also driven by these same factors and were partially offset by the acquisition of AML, which had EBITDA percentages lower than those of Quest Diagnostics. 22 Impact of Contingent Convertible Debentures on Earnings per Common Share On November 26, 2001, we completed our $250 million offering of 1 3/4% contingent convertible debentures due 2021 (the "Debentures"). Each one thousand dollar principal amount of Debentures is convertible into 11.429 shares of our common stock, which represents an initial conversion price of $87.50 per share. Holders may surrender the Debentures for conversion into shares of our common stock under any of the following circumstances: (i) if the sales price of our common stock is above 120% of the conversion price (or $105 per share) for specified periods; (ii) if we call the Debentures or (iii) if specified corporate transactions have occurred. See Note 12 to the Consolidated Financial Statements contained in our 2001 Annual Report on Form 10-K for a further discussion of the Debentures. The if-converted method is used in determining the dilutive effect of the Debentures in periods when the holders of such securities are permitted to exercise their conversion rights. As of and for the three and six months ended June 30, 2002, the holders of our Debentures did not have the ability to exercise their conversion rights. Had the requirements to allow the holders to exercise their conversion rights been met and the Debentures remained outstanding for the entire period, diluted net income per common share would have been reduced by approximately 2% during the quarter and six months ended June 30, 2002. Quantitative and Qualitative Disclosures About Market Risk We address our exposure to market risks, principally the market risk of changes in interest rates, through a controlled program of risk management that may include the use of derivative financial instruments. We do not hold or issue derivative financial instruments for trading purposes. We do not believe that our foreign exchange exposure is material to our financial position or results of operations taken as a whole. See Note 2 to the Consolidated Financial Statements contained in our 2001 Annual Report on Form 10-K for additional discussion of our financial instruments and hedging activities. At June 30, 2002 and December 31, 2001, the fair value of our debt was estimated at approximately $1.2 billion and $857 million, respectively, using quoted market prices and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. At June 30, 2002 and December 31, 2001, the estimated fair value exceeded the carrying value of the debt by approximately $70 million and $35 million, respectively. An assumed 10% increase in interest rates (representing approximately 50 basis points) would potentially reduce the estimated fair value of our debt by approximately $23 million and $26 million at June 30, 2002 and December 31, 2001, respectively. Our Debentures have a contingent interest component that will require us to pay contingent interest based on certain thresholds, as outlined in the Indenture. The contingent interest component which is more fully described in Note 12 to the Consolidated Financial Statements contained in our 2001 Annual Report on Form 10-K, is considered to be a derivative instrument subject to SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended. As such, the derivative was recorded at its fair value in the consolidated balance sheet and was not material at June 30, 2002 and December 31, 2001. Borrowings under our unsecured revolving credit facility under our Credit Agreement and our secured receivables credit facility are subject to variable interest rates. Interest rates on our unsecured revolving credit facility are also subject to a pricing schedule that fluctuates over an approximate range of 50 basis points, based on changes in our credit rating. As such, our borrowing cost under these credit facilities will be subject to both fluctuations in interest rates and changes in our credit rating. As of June 30, 2002, our borrowing rate for LIBOR-based loans was LIBOR plus 1.3125%. At June 30, 2002 and December 31, 2001, we had approximately $307 million and $7 million, respectively, of variable interest rate debt outstanding, which included $300 million outstanding under our secured receivables credit facility at June 30, 2002. Based on our net exposure to interest rate changes, an assumed 10% change in interest rates on our variable rate indebtedness (representing approximately 20 basis points) would impact net interest expense by approximately $0.6 million on an annual basis, assuming no changes to the debt outstanding at June 30, 2002. 23 Liquidity and Capital Resources Cash and Cash Equivalents Cash and cash equivalents at June 30, 2002 totaled $90 million, a decrease of $32 million from December 31, 2001. Cash flows from operating activities in 2002 provided cash of $218 million, which along with cash flows from financing activities of $158 million, were used to fund investing activities, which required cash of $408 million. Cash and cash equivalents at June 30, 2001 totaled $174 million, an increase of $2.7 million from December 31, 2000. Cash flows from operating activities in 2001 provided cash of $152 million, which was used to fund investing and financing activities, which required cash of $149 million. Cash From Operating Activities Net cash from operating activities for 2002 was $66 million higher than the 2001 level. This increase was primarily due to improved operating performance. Days sales outstanding, a measure of billing and collection efficiency, was 52 days at both June 30, 2002 and March 31, 2002, compared to 54 days at December 31, 2001. Cash From Investing Activities Net cash used in investing activities in 2002 was $408 million, consisting primarily of acquisition and related costs of $334 million, primarily to acquire the outstanding voting stock of AML, and capital expenditures of $83 million. Net cash used in investing activities in 2001 was $121 million, consisting primarily of capital expenditures of $78 million, acquisition and related costs of $56 million, including $47 million to acquire the assets of Clinical Laboratories of Colorado, Inc., and $21 million in proceeds from the disposition of assets, principally related to the sale of an investment in the second quarter of 2001. Cash From Financing Activities Net cash provided by financing activities in 2002 was $158 million, consisting primarily of the net cash activity associated with our acquisition of AML and proceeds from the exercise of stock options. AML's all-cash purchase price of approximately $335 million and related transaction costs, together with the repayment of approximately $150 million of acquired AML debt and accrued interest was financed by us with cash on-hand and $300 million of borrowings under our existing secured receivables credit facility and $175 million of borrowings under our existing unsecured revolving credit facility. During the second quarter of 2002, we repaid all of the $175 million borrowed under our unsecured revolving credit facility. Net cash used in financing activities for 2001 was $28 million, consisting primarily of the net cash activity associated with our debt refinancing in the second quarter of 2001, partially offset by proceeds from the exercise of stock options. During the second quarter of 2001, we refinanced the majority of our long-term debt. The gross proceeds of $722 million from our senior notes offering and the new term loan under our unsecured credit agreement, together with cash on-hand, was used to repay the entire outstanding principal under our then existing secured credit agreement and to consummate the cash tender offer and consent solicitation for our Subordinated Notes. Of the $734 million in debt repayments for the six months ended June 30, 2001, $584 million related to the repayment of the entire outstanding principal under our then existing secured credit agreement and $147 million represented the aggregate principal amount of outstanding Subordinated Notes which were tendered. During the remainder of 2001, we redeemed all of the remaining $3 million of our outstanding Subordinated Notes. During 2001, we incurred approximately $30 million of costs associated with the debt refinancing. Of that amount, $24 million was included in financing activities and principally represented $11 million of costs associated with placing the new debt, and a $13 million tender premium incurred in conjunction with our cash tender offer of the Subordinated Notes, which was included in the extraordinary loss recorded in the second quarter of 2001. The remaining $6 million was reflected in cash from operations and represented the cost to settle the interest rate swap agreements on the debt which was refinanced. Dividend Policy We have never declared or paid cash dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future. We currently intend to retain all available funds and any future earnings to retire debt and fund the growth of our business. 24 Contractual Obligations and Commitments A full description of the terms of our indebtedness, related debt service requirements and our future payments under certain of our contractual obligations is contained in Note 12 to the Consolidated Financial Statements in our 2001 Annual Report on Form 10-K. A full discussion and analysis regarding our minimum rental commitments under noncancelable operating leases, noncancelable commitments to purchase products or services, and reserves with respect to insurance claims is contained in Note 17 to the Consolidated Financial Statements in our 2001 Annual Report on Form 10-K. See Note 6 to the interim consolidated financial statements for information regarding the status of billing-related claims. See Note 3 to the interim consolidated financial statements for a full discussion and analysis regarding our acquisition of AML. As more fully described in Note 12 to the Consolidated Financial Statements in our 2001 Annual Report on Form 10-K, the borrowings outstanding under our secured receivables credit facility are classified as a current liability. However, it is our current intention to roll-over this facility annually, as we have done since 2001. If we are not able to roll-over all or a part of this facility, we will need to refinance the secured receivables credit facility with cash on-hand, our unsecured revolving credit facility or a new financing agreement. Our Credit Agreement relating to our unsecured revolving credit facility contains various covenants and conditions, including the maintenance of certain financial ratios, that could impact our ability to, among other things, incur additional indebtedness, repurchase shares of our outstanding common stock, make additional investments and consummate acquisitions. We do not expect these covenants to adversely impact our ability to execute our growth strategy or conduct normal business operations. On April 2, 2002, we entered into a definitive agreement with Unilab to acquire all of the outstanding shares of Unilab common stock and assume Unilab's debt of approximately $200 million. See Note 8 to the interim consolidated financial statements for a full discussion and analysis regarding the transaction. Unconsolidated Joint Ventures At June 30, 2002 and December 31, 2001, we had investments in unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and Dayton, Ohio. At June 30, 2002, as a result of the AML acquisition, we also had an investment in an unconsolidated joint venture in Chesapeake, Virginia. Our investments in unconsolidated joint ventures are accounted for under the equity method of accounting. We believe that our transactions with our joint ventures are conducted at arm's length, reflecting current market conditions and pricing. Total annual net revenues of our unconsolidated joint ventures, on a combined basis, are less than 6% of our consolidated net revenues. As of June 30, 2002 and December 31, 2001, total assets associated with our unconsolidated joint ventures are less than 3% of our consolidated total assets. We have no material obligations or guarantees to, or in support of, our unconsolidated joint ventures and their operations. Requirements and Capital Resources We estimate that we will invest approximately $160 million to $170 million during 2002 for capital expenditures, principally related to investments in information technology, equipment, and facility upgrades and expansions. Other than the reduction for outstanding letters of credit under our unsecured revolving credit facility, which approximated $33 million at July 25, 2002, all of our $325 million unsecured revolving credit facility remains available to us for future borrowing. We believe that cash from operations and our borrowing capacity under our revolving credit facilities, together with the indemnification by SmithKline Beecham plc against monetary fines, penalties or losses from outstanding government and other related claims, will provide sufficient financial flexibility to meet seasonal working capital requirements and to fund capital expenditures, debt service requirements and additional growth opportunities for the foreseeable future. Improvements in our industry and in particular our financial performance have resulted in improvements to our credit ratings from both Standard & Poor's and Moody's Investor Services. Our investment grade credit ratings have had a favorable impact on our cost of and access to capital. We believe that our improved financial performance should provide us with access to additional financing, if necessary, to fund growth opportunities which cannot be funded from existing sources. As discussed above in "Contractual Obligations and Commitments", on April 2, 2002, we entered into a definitive agreement with Unilab to acquire all of the outstanding shares of Unilab common stock and assume Unilab's debt of approximately $200 million. We have obtained a commitment, which is contingent upon the completion of the Unilab acquisition, for a $450 million five-year amortizing term loan to be used to finance the transaction. See Note 8 to the interim consolidated financial statements for a full discussion and analysis regarding the transaction. 25 Impact of New Accounting Standards In August 2001, the FASB issued SFAS No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets". In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". The impact of the above referenced accounting standards is discussed in Note 1 to the interim consolidated financial statements. Forward Looking Statements Some statements and disclosures in this document are forward-looking statements. Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as "may", "believe", "will", "expect", "project", "estimate", "anticipate", "plan" or "continue". These forward-looking statements are based on our current plans and expectations and are subject to a number of risks and uncertainties that could significantly cause our plans and expectations, including actual results, to differ materially from the forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation. We would like to take advantage of the "safe harbor" provisions of the Litigation Reform Act in connection with the forward-looking statements included in this document. The risks and other factors that could cause our actual financial results to differ materially from those projected, forecasted or estimated by us in forward-looking statements are detailed in our 2001 Annual Report on Form 10-K. 26 PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note 6 to the interim consolidated financial statements for information regarding the status of government investigations and private claims, including those related to SBCL. Item 4. Submission of Matters to a Vote of Security Holders (a) The annual meeting of stockholders of the Company was held on May 7, 2002. At the meeting the matters described below were approved by the stockholders. (b-c) The following nominees for the office of director were elected for terms expiring at the 2005 annual meeting of stockholders, with the following number of votes for and withheld:
For Withheld William F. Buehler 89,212,102 576,729 Van C. Campbell 88,573,611 1,215,220 Rosanne Haggerty 89,189,648 599,183 Dan C. Stanzione 88,715,994 1,072,837
The following persons continue as directors: Kenneth D. Brody Mary A. Cirillo Kenneth W. Freeman William R. Grant Gail R. Wilensky John B. Ziegler The appointment of PricewaterhouseCoopers LLP as independent accountants to audit the financial statements of the Company and its subsidiaries for the fiscal year ending December 31, 2002, was approved, with the following number of votes for, against, and abstained: For: 86,776,549 Against: 2,893,155 Abstained: 119,127 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 2.1 Agreement and Plan of Merger, dated as of April 2, 2002, among the Company, Quest Diagnostics Newco Incorporated and Unilab Corporation (incorporated by reference to Exhibit 2.1 to the current report on Form 8-K (Date of Report: April 2, 2002)). 2.2 Amendment to the Agreement and Plan of Merger, dated as of May 13, 2002 among the Company, Quest Diagnostics Newco Incorporated and Unilab Corporation (incorporated by reference to Annex to the prospectus forming a part of the Company's registration statement on Form S-4 (No. 333-88330)). 2.3 Amendment No. 2 to the Agreement and Plan of Merger, dated as of June 20, 2002 among the Company, Quest Diagnostics Newco Incorporated and Unilab Corporation (incorporated by reference to Annex to the prospectus forming a part of the Company's registration statement on Form S-4 (No. 333-88330)). 27 10.1 Term Loan Credit Agreement dated as of June 21, 2002 among Quest Diagnostics Incorporated, certain subsidiary guarantors of the Company, the lenders party thereto, and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 99.12 of the Company's Registration Statement on Form S-4 (No. 333-88330)). 10.2 Amendment No. 3 to the Amended and Restated Credit and Security Agreement dated as of July 24, 2002 among Quest Diagnostics Receivables Inc., as Borrower, the Company, as Initial Servicer, each of the lenders party thereto and Wachovia Bank, National Association, as Administrative Agent. 10.3 The Quest Diagnostics Incorporated 1996 Employee Equity Participation Program, as amended. 10.4 The Quest Diagnostics Incorporated 1999 Employee Equity Participation Program, as amended. (b) Reports on Form 8-K: On April 12, 2002, the Company filed a current report on Form 8-K (Date of Report: April 1, 2002) reporting under Item 5 on the acquisition of American Medical Laboratories, Incorporated and the guarantee of certain indebtedness of the Company by certain of the Company's subsidiaries. On April 2, 2002, the Company filed a current report on Form 8-K (Date of Report: April 2, 2002) reporting under Item 5 on the execution of a definitive agreement and plan of merger with Unilab Corporation and the execution of a stockholders agreement with certain stockholders of Unilab Corporation. 28 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. August 12, 2002 Quest Diagnostics Incorporated By /s/ Kenneth W. Freeman ---------------------------- Kenneth W. Freeman Chairman of the Board and Chief Executive Officer By /s/Robert A. Hagemann ---------------------------- Robert A. Hagemann Vice President and Chief Financial Officer 29 EX-10 3 ex10-2.txt EXHIBIT 10.2 Exhibit 10.2 AMENDMENT NO. 3 TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT THIS AMENDMENT NO. 3 TO AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT (this "Amendment") is entered into as of July 24, 2002, by and among: (1) QUEST DIAGNOSTICS RECEIVABLES INC., a Delaware corporation (the "Borrower"), (2) QUEST DIAGNOSTICS INCORPORATED, a Delaware corporation as initial servicer (together with the Borrower, the "Loan Parties"), (3) BLUE RIDGE ASSET FUNDING CORPORATION, a Delaware corporation, WACHOVIA BANK, NATIONAL ASSOCIATION, in its capacity as a Liquidity Bank to Blue Ridge, and Lloyds TSB Bank plc, in its capacity as a Liquidity Bank to Blue Ridge, (4) La Fayette Asset Securitization LLC, a Delaware limited liability company (together with its successors, "La Fayette"), ATLANTIC ASSET SECURITIZATION CORP., a Delaware corporation, and Credit Lyonnais New York Branch, in its capacity as a Liquidity Bank to Atlantic and hereafter, to La Fayette, (5) WACHOVIA BANK, NATIONAL ASSOCIATION, in its capacity as agent for the Blue Ridge Group, and Credit Lyonnais New York Branch, in its capacity as agent for the Atlantic Group and as agent for the La Fayette Group (in such latter capacity, together with its successors in such latter capacity, the "La Fayette Agent" or a "Co-Agent"), and (6) WACHOVIA BANK, NATIONAL ASSOCIATION, as administrative agent for the Blue Ridge Group, the Atlantic Group and the Co-Agents (in such capacity, together with any successors thereto in such capacity, the "Administrative Agent" and together with each of the Co-Agents, the "Agents"), with respect to that certain Amended and Restated Credit and Security Agreement dated as of September 28, 2001, by and among the parties hereto other than La Fayette and the La Fayette Agent (as heretofore amended, the "Existing Agreement" which, as amended hereby, is hereinafter referred to as the "Agreement"). Unless otherwise indicated, capitalized terms used in this Amendment are used with the meanings attributed thereto in the Existing Agreement. W I T N E S S E T H : WHEREAS, simultaneously herewith, Atlantic is assigning all of its rights and obligations under the Existing Agreement to La Fayette; and WHEREAS, to reflect such assignment, the parties hereto desire to amend the Existing Agreement as hereinafter set forth; NOW, THEREFORE, in consideration of the premises and the mutual agreements herein contained, the parties hereto hereby agree as follows: 1. Amendments to Existing Agreement. Subject to the terms and conditions hereinafter set forth, the parties hereby agree to amend the Existing Agreement as follows: 1.1. The definition of "Atlantic Liquidity Agreement" is hereby deleted in its entirety from Annex A to the Existing Agreement and the following new definition is hereby added to such Annex A in its appropriate alphabetical order: "La Fayette Liquidity Agreement" means the Liquidity Asset Purchase Agreement dated as of July 24, 2002 among La Fayette, the La Fayette Agent, and the La Fayette Liquidity Banks from time to time party thereto, as the same may be amended, restated, supplemented, replaced or otherwise modified from time to time. 1.2. Replace all references in the Existing Agreement (and in all Annexes, Exhibits and Schedules thereto) to the term in the left-hand column in the table below with the term opposite such term in the right-hand column:
- -------------------------------------------------------------------------------------- Term to be Replaced Replacement Term - -------------------------------------------------------------------------------------- "Atlantic Asset Securitization Corp." "La Fayette Asset Securitization LLC" - -------------------------------------------------------------------------------------- "Atlantic Agent" "La Fayette Agent" - -------------------------------------------------------------------------------------- "Atlantic Group" "La Fayette Group" - -------------------------------------------------------------------------------------- "Atlantic" "La Fayette" - -------------------------------------------------------------------------------------- "Atlantic Allocation Limit" "La Fayette Allocation Limit" - -------------------------------------------------------------------------------------- "Atlantic Fee Letter" "La Fayette Fee Letter" - -------------------------------------------------------------------------------------- "Atlantic Liquidity Agreement" "La Fayette Liquidity Agreement" - -------------------------------------------------------------------------------------- "Atlantic Liquidity Bank" "La Fayette Liquidity Bank" - -------------------------------------------------------------------------------------- "Wachovia Bank, N.A." "Wachovia Bank, National Association" - --------------------------------------------------------------------------------------
2 1.3. Section 4.1 of the Existing Agreement is hereby amended to provide that from and after the date of this Amendment, all fees that would otherwise be payable to Atlantic under what was formerly called the Atlantic Fee Letter and is now called the La Fayette Fee Letter shall henceforth be payable to La Fayette. 1.4. Part E of Schedule 14.2 to the Existing Agreement is hereby amended to delete "Account #____________" where it appears and to substitute in lieu thereof "Account # __________". 1.5. Upon effectiveness of this Amendment in accordance with Section 3 below, Atlantic shall cease to be a party to the Existing Agreement and all of Atlantic's rights and obligations under the Transaction Documents shall be automatically assumed by La Fayette. 2. Representations. ---------------- 2.1. Each of the Loan Parties represents and warrants to the Lenders and the Agents that it has duly authorized, executed and delivered this Amendment and that the Agreement constitutes, a legal, valid and binding obligation of such Loan Party, enforceable in accordance with its terms (except as enforceability may be limited by applicable bankruptcy, insolvency, or similar laws affecting the enforcement of creditors' rights generally or by equitable principles relating to enforceability). 2.2. Each of the Loan Parties further represents and warrants to the Lenders and the Agents that each of its representations and warranties set forth in Section 6.1 of the Agreement is true and correct as of the date hereof and that no Event of Default or Unmatured Default exists as of the date hereof and is continuing. 3. Conditions Precedent. This Amendment shall become effective as of the date first above written upon receipt by the Administrative Agent (a) of a counterpart hereof duly executed by each of the parties hereto, and (b) confirmation from the La Fayette Agent that it has received the La Fayette Liquidity Agreement and that such agreement is in full force and effect. 4. Miscellaneous. -------------- 4.1. Except as expressly amended hereby, the Existing Agreement and shall remain unaltered and in full force and effect, and each of the parties hereby ratifies and confirms the Agreement and each of the other Transaction Documents to which it is a party. 4.2. THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO PRINCIPLES OF CONFLICTS OF LAW. 4.3. EACH LOAN PARTY HEREBY ACKNOWLEDGES AND AGREES THAT: 3 4.3.1. IT IRREVOCABLY (i) SUBMITS TO THE NON-EXCLUSIVE JURISDICTION, FIRST, OF ANY UNITED STATES FEDERAL COURT, AND SECOND, IF FEDERAL JURISDICTION IS NOT AVAILABLE, OF ANY NEW YORK STATE COURT, IN EITHER CASE SITTING IN NEW YORK COUNTY, NEW YORK, IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THE AGREEMENT, AND (ii) WAIVES, TO THE FULLEST EXTENT IT MAY EFFECTIVELY DO SO, THE DEFENSE OF AN INCONVENIENT FORUM TO THE MAINTENANCE OF AN ACTION OR PROCEEDING IN SUCH COURTS. 4.3.2. TO THE EXTENT THAT IT HAS OR HEREAFTER MAY ACQUIRE ANY IMMUNITY FROM THE JURISDICTION OF ANY COURT OR FROM ANY LEGAL PROCESS (WHETHER THROUGH SERVICE OR NOTICE, ATTACHMENT PRIOR TO JUDGMENT, ATTACHMENT IN AID TO EXECUTION, EXECUTION OR OTHERWISE) WITH RESPECT TO ITSELF OR ITS PROPERTY, IT HEREBY IRREVOCABLY WAIVES SUCH IMMUNITY IN RESPECT OF ITS OBLIGATIONS UNDER OR IN CONNECTION WITH THE AGREEMENT. 4.4. This Amendment may be executed in any number of counterparts and by the different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same Amendment. [Signature pages follow] 4 IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. QUEST DIAGNOSTICS RECEIVABLES INC. By: __________________________________ Name: Title: QUEST DIAGNOSTICS INCORPORATED By: __________________________________ Name: Title: 5 WACHOVIA BANK, NATIONAL ASSOCIATION, individually, as Administrative Agent and as Blue Ridge Agent By: __________________________________ Name: Title: BLUE RIDGE ASSET FUNDING CORPORATION BY: WACHOVIA BANK, NATIONAL ASSOCIATION, its attorney-in-fact By: __________________________________ Name: Title: 6 ATLANTIC ASSET SECURITIZATION CORP. By: Credit Lyonnais New York Branch., its attorney-in-fact By: _________________________________ Name: Konstantina Kourmpetis Title: Director LA FAYETTE ASSET SECURITIZATION LLC By: La Fayette Member, Inc., as its sole member By: _________________________________ Name: Konstantina Kourmpetis Title: Director Credit Lyonnais New York Branch, individually and as Atlantic Agent and La Fayette Agent By: _________________________________ Name: Konstantina Kourmpetis Title: Director 7 LLOYDS TSB BANK PLC By: __________________________________ Name: Title: By: __________________________________ Name: Title: 8 EX-10 4 ex10-3.txt EXHIBIT 10.3 Exhibit 10.3 As Amended as of May 7, 2002 QUEST DIAGNOSTICS INCORPORATED EMPLOYEE EQUITY PARTICIPATION PROGRAM QUEST DIAGNOSTICS INCORPORATED EMPLOYEE EQUITY PARTICIPATION PROGRAM 1. Purpose ------- The Employee Equity Participation Program (the "Program") is intended to encourage executive, managerial, technical and other employees of (i) Quest Diagnostics Incorporated (the "Corporation"), (ii) any "subsidiary corporation" of the Corporation within the meaning of Section 424 of the Internal Revenue Code of 1986, as amended (the "Code") or of any successor section, or (iii) any other entity in which the Corporation holds beneficially at least one-half of the ownership interest (such entity or "subsidiary corporation" being referred to herein as a "Subsidiary") to become owners of stock of the Corporation in order to increase their proprietary interest in the Corporation's success; to stimulate the efforts of certain key executive, managerial, technical and other employees by giving suitable recognition to services which contribute materially to the Corporation's success; and to provide such employees with additional incentive and reward opportunity based, in part, upon the attainment of predetermined goals over specified periods. The Program shall consist of two plans: (a) the Stock Option Plan and (b) the Incentive Stock Plan. 2. Administration -------------- The Program shall be administered by a committee appointed by the Board of Directors of the Corporation, to be known as the "Compensation Committee" (the "Committee"), consisting of not less than two members of the Corporation's Board of Directors, each member of which shall be a "non-employee director" within the meaning of Rule 16b-3(b)(3)(i) promulgated under the Securities Exchange Act of 1934 (the "1934 Act") or any successor thereto and an "outside director" within the meaning set forth in regulations promulgated under Section 162(m) of the Code. Without limiting the foregoing, unless and to the extent those definitions are amended, no member of the Committee shall be an officer or employee of the Corporation or a subsidiary thereof, a former officer of the Corporation, a former employee of the Corporation who receives compensation for prior services (other than benefits under a tax-qualified retirement plan) during the taxable year, any other person who receives directly or indirectly in any capacity (other than as a director) remuneration in excess of the lesser of $60,000 or 5 percent of the gross income realized by the entity employing such member during such entity's taxable year ending with or within the Corporation's taxable year or any person who is a member of a law firm retained by, or a partner or executive officer of an investment banking firm that performs services for, the Corporation. No member of the Committee shall have been eligible to participate in the Program in the preceding year nor be eligible to participate in the Program while serving on the 1 Committee. The Committee shall select periodically the executive, managerial, technical and other employees who shall participate in the Program and the extent of their participation in any particular Plan under the Program and shall report such selections and levels of participation to the Board of Directors. 2 The Committee's interpretation and construction of any provisions of this Program or any Plan or any right, option or award granted or contract executed under it shall be final unless otherwise determined by the Board of Directors, which determination shall be final. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith. 3. Eligibility ----------- The Committee shall from time to time select the executive, managerial, technical and other employees (including officers and employees who are directors) of the Corporation and of any Subsidiary who shall be eligible to participate in any Plan under the Program. 4. Stock ----- The shares subject to options, grants or incentive stock rights under the Program shall be shares of the Corporation's Common Stock par value $.01 per share, either authorized but unissued or issued and held in treasury or such other securities as may be issued by the Corporation in substitution therefor. The total amount of the Common Stock of the Corporation which may be (i) sold pursuant to options granted under the Stock Option Plan and (ii) granted, or issued pursuant to incentive stock rights awarded, under the Incentive Stock Plan shall not exceed 3,000,000 shares. There may be awarded under the Incentive Stock Plan in lieu of shares the cash equivalent thereof valued at the date that the Committee determines whether, or to what extent, performance objectives have been met. In each case, the number of shares shall be subject to adjustment in accordance with the provisions of Section 5. Shares from the unexercised portion of the options which expire or of the options which are terminated during the period when options may be granted and shares forfeited or not earned under the Incentive Stock Plan may again either (i) be the subject of an option under the Stock Option Plan or (ii) be awarded or be the subject of rights granted under the Incentive Stock Plan. Shares of the Common Stock of the Corporation used by an optionee as full or partial payment to the Corporation for the purchase price of shares subject to an option agreement, the terms of which explicitly provide for the grant of an additional option as contemplated by Section 6(a)(i) hereof, shall again be made available for use under the Program. Shares otherwise surrendered upon the exercise of stock options may not again be the subject of options or awards granted under the Program. Shares surrendered under the Program in payment of taxes due upon the exercise of stock options or upon the recognition of income for shares issued under the Incentive Stock Plan may not be issued again under the Program. No single eligible employee under the Stock Option Plan may receive grants of stock options covering in excess of 600,000, or 20% of the total, shares authorized under the Program. 5. Recapitalization ---------------- The number of shares of Common Stock which may be granted, awarded or earned under the Incentive Stock Plan or made subject to options granted under the Stock Option Plan in the 3 aggregate and to any single eligible employee, the number of shares covered by each outstanding option, and the price per share thereunder, and the number of shares granted or subject to incentive stock rights under the Incentive Stock Plan shall all be proportionally adjusted for any increase or decrease in the number of issued shares of Common Stock of the Corporation resulting from a subdivision or consolidation of shares or other capital adjustment, the distribution of shares of capital stock to stockholders of the Corporation, the payment of a stock dividend or other increase or decrease in such shares effected without receipt of consideration by the Corporation, or any distribution or spin-off of assets (other than a normal cash dividend) to the stockholders of the Corporation. Subject to any required action by the stockholders, if the Corporation shall be the surviving corporation in any merger or consolidation, any option granted under the Stock Option Plan and any incentive stock right granted under the Incentive Stock Plan shall apply to the securities to which a holder of the number of shares of Common Stock subject to the option or such right, as the case may be, would have been entitled before the occurrence of such event. A dissolution or liquidation of the Corporation, or a merger or consolidation in which the Corporation is not the surviving corporation, shall cause every option outstanding under the Stock Option Plan to terminate, except that the surviving corporation may, in its absolute and uncontrolled discretion, tender an option or options to purchase its shares on terms and conditions, both as to number of shares and otherwise, which will substantially preserve the rights and benefits of any option then outstanding under the Stock Option Plan. Upon the dissolution or liquidation of the Corporation, or upon the effective date of any merger or consolidation in which the Corporation is not the survivor and in which the survivor has not tendered options as provided in the preceding sentence, the Corporation shall deliver to each optionee whose incentive stock options are being terminated an amount in cash equal to the difference between the option price and the fair market value of a share of the Corporation's Common Stock determined in good faith by the Committee. In the case of such a merger or consolidation in which the Corporation is not the survivor, the Corporation shall also deliver to each person whose incentive stock options are being terminated and to each person who had exercised an incentive stock option and who was holding the shares so purchased for long-term capital gains treatment an amount equal to the difference between the federal income tax which the person would be required to pay as a result of being unable to hold such shares for long-term capital gains purposes (assuming a sale price equal to the fair market value as provided above) and the tax such person is required to pay as a result of having to dispose of shares on account of such merger or consolidation. In the event of a change in the Corporation's presently authorized Common Stock which is limited to a change of authorized shares with par value into the same number of shares with a different par value or into the same number of shares without par value, the shares resulting from any such change shall be deemed to be Common Stock within the meaning of the Program. 6. Stock Option Plan ----------------- (a) The Committee may from time to time grant options, including but not limited to performance-based stock options and to incentive stock options permitted by Section 422 of the Code, to purchase shares of Common Stock, evidenced by agreements in such form 4 as the Committee may, from time to time, approve, containing in substance the following terms and conditions: (i) The option price shall be payable in full upon the exercise of the option and may be paid either in United States dollars, or under rules established and maintained from time to time by the Committee, in shares of the Common Stock of the Corporation owned by the optionee, or a combination of cash and shares. Under such rules, an optionee paying the purchase price of an option in already-owned, freely transferable, unencumbered shares of Common Stock of the Corporation may receive new options to purchase shares of Common Stock of the Corporation at the then current market price (being the mean between the high and low selling prices of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions list on the date of exercise; provided, however, that if on the date of exercise, an optionee sells through a broker designated by the Corporation any of the shares purchased as a result of the exercise of the option, then the shares shall be valued at the average sales price of such shares sold on such date as reported to the Corporation by such broker) for the same number of shares surrendered upon exercise of the original option. In no circumstance will the total number of shares subject to the new option granted exceed the number of shares surrendered upon exercise of the original option, will the new option be exercisable within twelve months of the date of exercise or will the new option have a life beyond that of the original option. Shares of the Corporation's Common Stock tendered for payment (either actually or by attestation) shall be valued at the mean between the high and low selling prices of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions list on the date of exercise; provided, however, that if on the date of exercise, an optionee sells through a broker designated by the Corporation any of the shares purchased as a result of the exercise of the option, then the shares shall be valued at the average sales price of such shares sold on such date as reported to the Corporation by such broker). (ii) The option shall state the total number of shares to which it pertains. (iii) The option price shall be not less than 100% of the fair market value of the shares on the date of the granting of the option. (iv) Each option granted under the Stock Option Plan shall expire on the date designated by the Committee but in no event more than ten years from the date the option is granted. (v) The Committee may in its discretion provide that an option may not be exercised in whole or in part for any period or periods of time specified by the Committee. Except as may be so provided by the Committee and except as otherwise provided 5 herein, any option may be exercised in whole at any time or in part from time to time after the option has vested in accordance with the terms of the applicable agreement and during its term; provided, however, that, except in the event of a change of control (as determined by the Committee) in no circumstance will an option under the Stock Option Plan become exercisable in less than twelve months from the date of grant. (vi) The aggregate fair market value (determined as of the time the option is granted) of the stock for which any employee may be granted incentive stock options under this Plan or any other plans of the Corporation or any subsidiary of the Corporation shall not exceed $100,000 (or such other limit as may be in effect from time to time under Section 422 of the Code or any statutory successor thereto) in any calendar year in which such option or any portion thereof first becomes exercisable pursuant to the terms of the agreement between such employee and the Corporation. (vii) If, in the opinion of counsel for the Corporation, the listing, registration or qualification of the shares subject to option under any securities exchange or under any state or Federal law, or the consent or approval of any governmental regulatory body, or an exemption from registration, is necessary or desirable, each option shall be subject to the requirement that such option may not be exercised in whole or in part unless such listing, registration, qualification, consent, approval or exemption shall have been effected or obtained free of any conditions not acceptable to the Committee. (viii) An optionee shall have no rights as a stockholder with respect to shares covered by his option to purchase until the date of the issuance or transfer of the shares to him and only after such shares are fully paid. No adjustment will be made for dividends or other rights for which the record date is prior to the date of such issuance or transfer, except as provided in Section 5. (ix) The option agreements authorized under the Stock Option Plan shall contain such other provisions not inconsistent with this Program as the Committee may deem advisable. (b) Options may be granted under the Stock Option Plan from time to time in substitution for (i) stock options held by consultants to or directors or employees of other corporations who are about to become and who do concurrently with the grant of such options become consultants to or directors or employees of the Corporation or a Subsidiary as the result of a merger or consolidation of the employing corporation with the Corporation or a Subsidiary, or the acquisition by the Corporation or a Subsidiary of the assets of the employing corporation, or the acquisition by the Corporation or a Subsidiary of stock of the employing corporation as the result of which it becomes a Subsidiary or (ii) in substitution stock options to acquire common stock of Corning Incorporated ("Corning"), which options are held by employees of the Corporation and are canceled as a result of the spinoff distribution by Corning of all of the Corporation's outstanding common stock to the 6 stockholders of Corning. The terms and conditions of the substitute options so granted may vary from the terms and conditions set forth in Section 6 of this Program to such extent as the Committee at the time of grant may deem appropriate to conform, in whole or in part, to the provisions of the stock options in substitution for which they are granted. Options granted under this paragraph (b) or pursuant to the terms of the agreements contemplated by Section 6(a)(i) hereof shall not reduce the shares available for options, grants or incentive stock rights under the Program as set forth in Section 4 hereof. (c) If the optionee's employment by the Corporation or a Subsidiary shall terminate, his option shall terminate unless otherwise determined by the Committee, or specific provision has been otherwise made as evidenced by the terms of the option agreement approved by the Committee. The Committee shall have full power and authority to determine whether, to what extent and under what circumstances any option shall be exercisable, suspended or canceled in the event of an optionee's termination of employment. If an optionee dies while in the employ of the Corporation or a Subsidiary, or within three months after termination of employment with options exercisable pursuant to action taken by the Committee or otherwise in accordance with the preceding sentences, the optionee's estate, personal representative or beneficiary shall have the right to exercise such option in accordance with the terms of the option agreement with respect to all shares subject to option on the date of death. If an optionee shall be transferred from the Corporation to a Subsidiary or from a Subsidiary to the Corporation or from a Subsidiary to another Subsidiary, his employment shall not be deemed to have terminated. If an optionee shall be employed by a corporation or an entity which ceases to be a Subsidiary, the Committee may, subject to the provisions of clauses (iv) and (v) of Paragraph (a) of this Section 6, permit the participant to exercise options held for such period of time as it determines with respect to all shares which were available for purchase by the optionee on the date the corporation or entity ceased to be a Subsidiary. 7. Incentive Stock Plan -------------------- The Committee may from time to time award shares of Incentive Stock and grant incentive stock rights, or either, to eligible employees on the terms set forth herein. (a) "Incentive Stock" shall be shares of the Corporation's Common Stock awarded pursuant to the terms of the Incentive Stock Plan. (b) An "incentive stock right" shall, subject to the terms, conditions and limitations of this Section 7, give the holder thereof the right to receive in consideration of services performed for, but without payment of cash to, the Corporation such shares of Common Stock, cash or a combination of the two as the Committee may determine. 7 (c) Subject to the limitations of Section 4, the Committee shall from time to time select, and report to the Board of Directors, (i) the individual employees who are to receive shares of Incentive Stock or incentive stock rights, or a combination thereof, (ii) the number of shares of Incentive Stock a designated employee is to receive, either directly or upon maturation of an incentive stock right, (iii) whether ownership of, or any portion of, such shares of Incentive Stock is to be vested in the designated employee without the possibility of forfeiture or other restrictions at the time of the Committee's action or at one or more specified dates in the future, (iv) whether ownership of such, or any portion of such, shares of Incentive Stock is to be vested in the designated employee at the time of the Committee's action, but subject to the possibility of forfeiture or other restrictions, and (v) the specific dates from the date of the Committee's award over which the possibility of forfeiture or other restrictions are to lapse. Shares of Incentive Stock shall be issued in the name of, and distributed to, those employees from time to time designated by the Board as recipients of Incentive Stock as follows: (1) Each employee designated as a recipient of shares of Incentive Stock shall receive, promptly after the date or dates the Committee determines the number of such shares which such employee is to receive not subject to the possibility of forfeiture and other restrictions, one or more stock certificates registered in the name of the designated employee for such number of shares, the ownership of which is vested non-forfeitably and without restriction in such employee; and (2) Certificates covering shares of Incentive Stock subject to the possibility of forfeiture and other restrictions shall be issued promptly after the date or dates the Committee determines the number of such shares to be issued in the name of the designated employee but held by the Corporation as provided in clause (e) below. (d) The shares which are granted subject to restrictions and the possibility of forfeiture (and all shares issued or distributed by means of dividends, splits, combinations, reclassifications, or other capital changes thereon) (i) may not be sold, assigned, transferred, pledged or otherwise encumbered, except (a) for gifts to a spouse, ancestors, or descendants, or to trusts for their benefit and (b) pursuant to the qualified domestic relations orders referred to in Section 9 hereof, subject, however, in each such case to the restrictions and possibility of forfeiture applicable to such shares and (ii) except as otherwise provided in an agreement approved by the Committee are to be forfeitable to the Corporation upon termination of employment for any reason other than death, disability approved by the Corporation or retirement with the consent of the Corporation. The restrictions and possibility of forfeiture imposed by this clause (d) shall lapse at such time and in such proportions as the Committee shall, subject to limitations of clause (c) above, determine. (e) Each certificate issued in respect of shares granted under the Incentive Stock Plan subject to restrictions on transfer and the possibility of forfeiture shall be registered in the name of the employee but shall be held by the Corporation in safekeeping for the employee and until 8 such restrictions and the possibility of forfeiture shall lapse. Such certificates shall bear a legend substantially as follows: "The transferability of this certificate and the shares of stock represented hereby are restricted and the shares are subject to the further terms and conditions (including forfeiture) contained in the Incentive Stock Plan of Quest Diagnostics Incorporated and an agreement executed pursuant thereto. A copy of such Plan and such agreement are on file in the office of the Secretary of Quest Diagnostics Incorporated, Teterboro, New Jersey." (f) An employee who is to receive shares of Incentive Stock only upon the expiration of certain specified periods or who is the holder of an incentive stock right shall have no rights as a stockholder with respect to any shares which may become vested in, or be awarded to, him, as the case may be, until such shares have been actually issued. (g) The value of shares of the Incentive Stock or the value of the shares of Common Stock granted by the Corporation to the holder of an incentive stock right shall be the mean between the high and low selling prices of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions list on the date the Committee determines that the applicable performance objectives were met or the date the possibility of forfeiture shall terminate, as the case may be. (h) At the time an incentive stock right is granted, the Committee shall establish with respect to each holder one or more performance periods and performance objectives. If the objectives have been met and are being maintained at the end of the applicable performance period to the satisfaction of the Committee, the holder of the incentive stock right shall receive promptly the shares and/or cash which are subject to the agreement referred to below. (i) Any provisions hereof the contrary notwithstanding, the Committee shall have the authority and the power to adjust performance periods, performance objectives and the number of shares which may be awarded pursuant to an incentive stock right if it determines that conditions so warrant. Such conditions may include, but need not be limited to, changes in functional responsibilities of a holder of an incentive stock right, changes in laws or government regulations, changes in accounting treatment or in generally accepted accounting principles, acquisitions, dispositions or distributions deemed to be material, or extraordinary events which significantly impact consolidated financial performance. (j) Incentive stock rights shall be evidenced by agreements in such form and not inconsistent with the Incentive Stock Plan as the Committee shall approve from time to time, which agreements shall, among other things, contain in substance the following terms, conditions and provisions: (i) The number of shares to which the incentive stock right relates and whether such rights are to be paid in shares, in cash or in a combination or the two; (ii) The length of the performance period or periods; 9 (iii) The performance objectives applicable to an individual granted an incentive stock right, which objectives may relate, but shall not be limited, to overall corporate performance measures, such as earnings per share, return on stockholders' equity and return on capital, or to divisional, subsidiary or other business unit performance measures, or to a combination of each; and (iv) Such other rules, as determined by the Committee, governing the continuation of an incentive stock right after the holder terminates, either voluntarily or involuntarily, his employment with the Corporation. (k) Unless otherwise determined by the Committee or set forth in the agreement contemplated by subsection (j) above, if the holder of an incentive stock right shall cease to be employed by the Corporation or a Subsidiary, his incentive stock right shall terminate immediately. However, if employment is terminated on account of death, retirement or termination of employment with the consent of the Corporation (including termination by reason of retirement, disability or a Subsidiary ceasing to be such), the Committee may award to such employee such shares or cash at such time and under such conditions as it shall in its sole discretion determine. 8. Amendment and Administration of the Program ------------------------------------------- The Board of Directors may, upon the recommendation of the Committee, from time to time alter, amend, suspend, or discontinue the Program or either Plan thereunder, except that no alteration or amendment shall, without the approval of the holders of a majority of the outstanding shares entitled to vote thereon, increase the total number of shares which may be sold or awarded under the Program, decrease the price at which options may be granted, change the standards of eligibility of employees eligible to participate, materially increase the benefits of the Program or either Plan thereunder to participants, or extend the term of the Program or of options granted thereunder. Adjustments in the total number of shares purchasable or awardable under the Program or optioned to any individual and adjustments of the option price may be made, however, without stockholder approval pursuant to the adjustment provisions described under the provisions of Section 5 hereof. No amendment or modification shall apply to affect adversely any employee with respect to incentive stock or incentive stock rights already awarded to him or an option already granted. Anything to the contrary in this Section 8 notwithstanding, should the provisions of Rule 16b-3, or any successor rule, under the 1934 Act be amended, the Board may amend the Program in accordance with any modifications to such Rule. With respect to persons subject to Section 16 of the 1934 Act, transactions under the Program are intended to comply with all applicable conditions of Rule 16b-3, or any successor rule, under the 1934 Act. To the extent any provision of the Program or action by the Committee, the Board of Directors or any administrator fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee or the Board of Directors. 10 9. Assignability ------------- No option or right granted under the Program shall be assignable or transferable except by Will, by the laws of descent and distribution, or except for an incentive stock option pursuant to domestic relations orders as defined in or meeting the requirements of the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended. During the lifetime of an optionee, an option shall be exercisable only by him and any shares purchased upon the exercise of an option shall be issued in the name of the optionee alone. 10. Effective Date and Term of Program. ----------------------------------- The Program shall become effective when approved by a majority of the votes cast at a meeting of the Corporation's stockholders by stockholders entitled to vote thereon. No shares may be optioned or awarded (except upon the attainment of performance goals contemplated by Section 7(h) hereof) and no incentive stock rights may be granted under the Program after the fifth anniversary, plus 60 calendar days, of the Program's effective date. 11. Use of Proceeds --------------- Proceeds from the sale of stock under the Program shall constitute general funds of the Corporation. 12. Withholding ----------- Whenever under the Program shares are to be issued in satisfaction of options, awards or rights granted thereunder, the Corporation shall have the right to require the employee to remit to it an amount in cash, in shares of the Corporation's Common Stock, or though the reduction of options, awards or rights to be issued thereof, necessary to satisfy federal, state and local withholding tax requirements prior to the delivery of any certificate or certificates for shares. Whenever under the Program payments are to be made in cash, such payment shall be net of an amount necessary to satisfy federal, state and local withholding tax requirements. 11 EX-10 5 ex10-4.txt EXHIBIT 10.4 Exhibit 10.4 Quest Diagnostics Incorporated 1999 Employee Equity Participation Program As amended as of May 7, 2002 1. THE PROGRAM a) Purpose. This Quest Diagnostics Incorporated 1999 Employee Equity Participation Program (the "Program") is intended to benefit the stockholders of Quest Diagnostics Incorporated (the "Company") by providing a means to attract, retain and reward individuals who can and do contribute to the longer term financial success of the Company. Further, the recipients of stock-based awards under the Program should identify their success with that of the Company's stockholders and therefore will be encouraged to increase their proprietary interest in the Company. b) Effective Date. To serve this purpose, the Program will become effective upon its approval by the holders of stock entitled to vote at the Company's 1999 Annual Meeting of Stockholders. 2. ADMINISTRATION a) Committee. The Program shall be administered by a Committee, appointed by the Board of Directors of the Company (the "Board"), which shall consist of no less than two of its members, all of whom shall not be (or formerly have been) employees of the Company (the "Committee"); provided, however, that from time to time the Board may assume, at its sole discretion, administration of the Program. Except with regard to awards to employees subject to Section 16 of the Securities Exchange Act of 1934, the Committee may delegate certain responsibilities and powers to any executive officer or officers selected by it. Any such delegation may be revoked by the Committee at any time. b) Powers and authority. The Committee's powers and authority include, but are not limited to: selecting individuals, who are employees of the Company and any subsidiary of the Company or other entity in which the Company has a significant equity or other interest as determined by the Committee, to receive awards; determining the types and terms and conditions of all awards granted, including performance and other earnout and/or vesting contingencies; permitting transferability of awards to eligible third parties; interpreting the Program's provisions; and administering the Program in a manner that is consistent with its purpose. The Committee's decision in carrying out the Program and its interpretation and construction of any provisions of the Program or any award granted or agreement or other instrument executed under it shall be final and binding upon all persons. No members of the Board shall be liable for any action or determination made in good faith in administering the Program. c) Award Prices. All awards denominated or made in Shares shall use as the per Share price the mean between the high and low selling prices of a share of the Common Stock of the Company ("Share") on the applicable date as reported in The New York Times l, or if Shares are not traded on such date, the mean between the high and low selling prices on the next preceding day on which such Shares are traded provided, however, that where a "reload" option is issued to an optionee who exercises an option by tendering (either actually or by attestation) Shares previously owned by the optionee, then the per Share exercise price of the reload option (which shall be for the same number of shares tendered for payment) shall be the market price at which the Shares tendered are valued in accordance with Section 4(b). The applicable date shall be the day on which the award is granted or, another Program transaction occurs, except that in the case of a stock option or stock appreciation right granted retroactively in tandem with or as a substitution for another previously granted stock option or stock appreciation right, the applicable date shall be grant date for such prior award. Except as provided for in Section 3(d), the per Share exercise price of any stock option or stock appreciation right may not be decreased after the grant of the award, and a stock option or stock appreciation right may not be surrendered as consideration in exchange for the grant of a new award with a lower per Share exercise price. 3. SHARES SUBJECT TO THE PROGRAM AND ADJUSTMENTS a) Maximum Shares Available for Delivery. Subject to adjustments under Section 3(d), the maximum number of Shares that may be delivered to participants and their beneficiaries under the Program shall be equal to (i) 9,000,000 Shares; (ii) any Shares available for future awards under the Company's 1996 Employee Equity Participation Program (the "Prior Program") as of the effective date of this Program; and (iii) any Shares that are represented by awards granted under the Prior Program of the Company, which are forfeited, expire or are canceled without the delivery of Shares or which result in the forfeiture of Shares back to the Company. In addition, any Shares delivered under the Program or the Prior Program of the Company which are forfeited back to the Company because of the failure to meet an award 1 contingency or condition shall again be available for delivery pursuant to new awards granted under the Program. Any Shares covered by an award (or portion of an award) granted under the Program or the Prior Program of the Company, which is forfeited or canceled, expires or is settled in cash, including the settlement of tax withholding obligations using Shares, shall be deemed not to have been delivered for purposes of determining the maximum number of Shares available for delivery under the Program. Likewise, if any stock option is exercised by tendering Shares, either actually or by attestation, to the Company as full or partial payment for such exercise under this Program or the Prior Program of the Company, only the number of Shares issued net of the Shares tendered shall be deemed delivered for purposes of determining the maximum number of Shares available for delivery under the Program. Further, Shares issued under the Program through the settlement, assumption or substitution of outstanding awards or obligations to grant future awards as a condition of the Company acquiring another entity shall not reduce the maximum number of Shares available for delivery under the Program. b) Other Program Limits. Subject to adjustment under Section 3(d), the following additional maximums are imposed under the Program. The maximum number of Shares that may be issued in conjunction with awards granted pursuant to Section 4(d) shall be 1,800,000. The maximum aggregate number of Shares that may be covered by awards granted to any one individual pursuant to Sections 4(b) and 4(c) shall not exceed 1,000,000 Shares. The aggregate maximum payments that can be made for awards granted to any one individual pursuant to Section 4(d) shall not exceed 300,000 Shares. c) Payment Shares. Subject to the overall limitation on the number of Shares that may be delivered under the Program, the Committee may, in addition to granting awards under Section 4, use available Shares as the form of payment for compensation, grants or rights earned or due under any other compensation plans or arrangements of the Company, including those of any entity acquired by the Company. d) Adjustments for Corporate Transactions. (i) The Committee may determine that a corporate transaction has affected the price per Share such that an adjustment or adjustments to outstanding awards are required to preserve (or prevent enlargement of) the benefits or potential benefits intended at time of grant. For this purpose a corporate transaction will include, but is not limited to, any stock dividend, stock split, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination or exchange of shares, or other similar occurrence. In the event of such a corporate transaction, the Committee may, in such manner as the Committee deems equitable, adjust (i) the number and kind of shares which may be delivered under the Program pursuant to Sections 3(a) and 3(b); (ii) the number and kind of shares subject to outstanding awards; and (iii) the exercise price of outstanding stock options and stock appreciation rights. Similar adjustments may be made in situations where the Company assumes or substitutes for outstanding awards held by employees and other persons of an entity acquired by the Company. (ii) In the event that the Company is not the surviving company of a merger, consolidation or amalgamation with another company, or in the event of a liquidation or reorganization of the Company, and in the absence of the surviving corporation's assumption of outstanding awards made under the Program, the Committee may provide for appropriate adjustments and/or settlements of such grants either at the time of grant or at a subsequent date. The Committee may also provide for adjustments and/or settlements of outstanding awards as it deems appropriate and consistent with the Program's purpose in the event of any other change-in-control of the Company. 4. TYPES OF AWARDS a) General. An award may be granted singularly, in combination with another award(s) or in tandem whereby exercise or vesting of one award held by a participant cancels another award held by the participant. Subject to the limitations of Section 2(c), an award may be granted as an alternative or successor to or replacement of an existing award under the Program or under any other compensation plan or arrangement of the Company, including the plan of any entity acquired by the Company. The types of awards that may be granted under the Program include: b) Stock Option. A stock option represents a right to purchase a specified number of Shares during a specified period at a price per Share which is no less than one hundred percent (100%) of the per Share amount stipulated by Section 2(c). A stock option may be in a form intended to comply with Section 422 or any other similar provision of the Internal 2 Revenue Code (the "Code") or in another form which may or may not qualify for favorable federal income tax treatment. Each stock option shall expire on the applicable date designated by the Committee but in no event may such date be more than eleven years from the date the stock option is granted. The Shares covered by a stock option may be purchased by means of a cash payment or such other means as the Committee may from time-to-time permit, including (i) tendering (either actually or by attestation) Shares valued using the market price at the time of exercise (which, where on the date of exercise, the optionee sells through a broker designated by the Corporation any of the shares purchased as a result of the exercise of the stock option, shall be the average sales price of the price of such shares sold on such date as reported to the Corporation by the broker), (ii) authorizing a third party to sell Shares (or a sufficient portion thereof) acquired upon exercise of a stock option and to remit to the Company a sufficient portion of the sale proceeds to pay for all the Shares acquired through such exercise and any tax withholding obligations resulting from such exercise; or (iii) any combination of the above. c) Stock Appreciation Right. A stock appreciation right is a right to receive a payment in cash, Shares or a combination, equal to the excess of the aggregate market price at time of exercise of a specified number of Shares over the aggregate exercise price of the stock appreciation right being exercised. The longest term a stock appreciation right may be outstanding shall be eleven years. Such exercise price shall be no less than one hundred percent (100%) of the per Share amount stipulated by Section 2(c). d) Stock Award. A stock award is a grant of Shares or of a right to receive Shares (or their cash equivalent or a combination of both) in the future. Except in cases of certain terminations of employment or an extraordinary event, each stock award shall be earned and vest over at least three years and shall be governed by such conditions, restrictions and contingencies as the Committee shall determine. These may include continuous service and/or the achievement of performance goals. The performance goals that may be used by the Committee for such awards granted to persons who may become subject to Code Section 162(m) shall consist of operating profits (including EBITDA), net profits, earnings per share, profit returns and margins, revenues, shareholder return and/or value, stock price and working capital. Performance goals may be measured solely on a corporate, subsidiary or business unit basis, or a combination thereof. Further, performance criteria may reflect absolute entity performance or a relative comparison of entity performance to the performance of a peer group of entities or other external measure of the selected performance criteria. Profit, earnings and revenues used for any performance goal measurement shall exclude: gains or looses on operating asset sales or dispositions; asset write-downs; litigation or claim judgments or settlements; accruals for historic environmental obligations; effect of changes in tax law or rate on deferred tax liabilities; accruals for reorganization and restructuring programs; uninsured catastrophic property losses; the cumulative effect of changes in accounting principles; and any extraordinary non-recurring items as described in Accounting Principles Board Opinion No. 30 and/or in management's discussion and analysis of financial performance appearing in the Company's annual report to stockholders for the applicable year. 5. AWARD SETTLEMENTS AND PAYMENTS a) Dividends and Dividend Equivalents. An award may contain the right to receive dividends or dividend equivalent payments which may be paid either currently or credited to a participant's account. Any such crediting of dividends or dividend equivalents may be subject to such conditions, restrictions and contingencies as the Committee shall establish, including the reinvestment of such credited amounts in Share equivalents. b) Payments. Awards may be settled through cash payments, the delivery of Shares, the granting of awards or combination thereof as the Committee shall determine. Any award settlement, including payment deferrals, may be subject to such conditions, restrictions and contingencies as the Committee shall determine. The Committee may permit or require the deferral of any award payment, subject to such rules and procedures as it may establish, which may include provisions for the payment or crediting of interest, or dividend equivalents, including converting such credits into deferred Share equivalents. 6. PROGRAM AMENDMENT AND TERMINATION a) Amendments. The Board may amend this Program as it deems necessary and appropriate to better achieve the Program's purpose provided, however, that: (i) the Share and other award limitations set forth in Sections 3(a) and 3(b) cannot be increased and (ii) the minimum stock option and stock appreciation right exercise prices set forth in Sections 2(c) and 4(b) and (c) cannot be changed unless such a plan amendment is properly approved by the Company's stockholders. b) Program Suspension and Termination. The Board may suspend or terminate this Program at any time. However, in no event may any awards be granted under the Program after the tenth anniversary of its approval by stockholders of the Company. Any such suspension or termination shall not of itself impair any outstanding award granted under the Program or the applicable participant's rights regarding such award. 3 7. MISCELLANEOUS a) Assignability. Except by will or by the laws of descent and distribution and, if permitted by the Committee, as a gift to a family member or a trust or similar entity for the benefit of one or more family members, no award granted under the Program shall be assignable or transferable. b) No Individual Rights. No person shall have any claim or right to be granted an award under the Program. Neither the Program nor any action taken hereunder shall be construed as giving any employee or other person any right to continue to be employed by or to perform services for the Company, any subsidiary or related entity. The right to terminate the employment of or performance of services by any Program participant at any time and for any reason is specifically reserved to the employing entity. c) Unfunded Program. The Program shall be unfunded and shall not create (or be construed to create) a trust or a separate fund or funds. The Program shall not establish any fiduciary relationship between the Company and any participant or beneficiary of a participant. To the extent any person holds any obligation of the Company by virtue of an award granted under the Program, such obligation shall merely constitute a general unsecured liability of the Company and accordingly shall not confer upon such person any right, title or interest in any assets of the Company. d) Use of Proceeds. Any proceeds from the sale of shares under the Program shall constitute general funds of the Company. e) Other Benefit and Compensation Programs. Unless otherwise specifically determined by the Committee, settlements of awards received by participants under the Program shall not be deemed a part of a participant's regular, recurring compensation for purposes of calculating payments or benefits from any Company benefit plan or severance program. Further, the Company may adopt any other compensation programs, plans or arrangements as it deems appropriate. f) No Fractional Shares. No fractional Shares shall be issued or delivered pursuant to the Program or any award, and the Committee shall determine whether cash shall be paid or transferred in lieu of any fractional Shares, or whether such fractional Shares or any rights thereto shall be canceled. g) Governing Law. The validity, construction and effect of the Program and any award, agreement or other instrument issued under it shall be determined in accordance with the laws of the state of New Jersey without reference to principles of conflict of law. 4 -----END PRIVACY-ENHANCED MESSAGE-----