10-Q 1 a38099.txt QUEST DIAGNOSTICS INCORPORATED 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, 2004 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 [_] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_] As of July 23, 2004, there were 101,884,157 outstanding shares of the registrant's common stock, $.01 par value. PART I - FINANCIAL INFORMATION
Page ---- Item 1. Financial Statements Index to consolidated financial statements filed as part of this report: Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003 2 Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations" 24 Item 4. Controls and Procedures Controls and Procedures 24
1 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (in thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended June 30, June 30, ----------------------- ----------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- Net revenues .............................. $1,297,674 $1,219,935 $2,553,416 $2,312,732 ---------- ---------- ---------- ---------- Operating costs and expenses: Cost of services .......................... 747,577 703,124 1,484,858 1,351,221 Selling, general and administrative ....... 307,402 296,062 614,947 575,261 Amortization of intangible assets ......... 2,058 2,068 4,122 4,091 Other operating expense, net .............. 10,618 10 10,591 233 ---------- ---------- ---------- ---------- Total operating costs and expenses ..... 1,067,655 1,001,264 2,114,518 1,930,806 ---------- ---------- ---------- ---------- Operating income .......................... 230,019 218,671 438,898 381,926 Other income (expense): Interest expense, net ..................... (16,346) (16,866) (30,990) (30,775) Minority share of income .................. (5,019) (4,415) (9,473) (8,218) Equity earnings in unconsolidated joint ventures ............................... 5,397 4,554 9,954 8,610 Other income (expense), net ............... (1,223) 1,461 (24) 656 ---------- ---------- ---------- ---------- Total non-operating expenses, net ...... (17,191) (15,266) (30,533) (29,727) ---------- ---------- ---------- ---------- Income before taxes ....................... 212,828 203,405 408,365 352,199 Income tax expense ........................ 85,999 82,993 165,387 143,751 ---------- ---------- ---------- ---------- Net income ................................ $ 126,829 $ 120,412 $ 242,978 $ 208,448 ========== ========== ========== ========== Basic earnings per common share: Net income ................................ $ 1.23 $ 1.15 $ 2.36 $ 2.03 Weighted average common shares outstanding - basic ................................ 103,009 105,049 103,075 102,543 Diluted earnings per common share: Net income ................................ $ 1.20 $ 1.12 $ 2.30 $ 1.98 Weighted average common shares outstanding - diluted .............................. 105,397 107,677 105,569 105,066
The accompanying notes are an integral part of these statements. 2 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 2004 AND DECEMBER 31, 2003 (in thousands, except per share data) (unaudited)
June 30, December 31, 2004 2003 ---------- ------------ Assets Current assets: Cash and cash equivalents ................................................ $ 137,802 $ 154,958 Accounts receivable, net of allowance of $202,894 and $211,739 at June 30, 2004 and December 31, 2003, respectively ..................... 677,710 609,187 Inventories .............................................................. 72,848 72,484 Deferred income taxes .................................................... 97,764 108,975 Prepaid expenses and other current assets ................................ 57,996 50,182 ---------- ---------- Total current assets .................................................. 1,044,120 995,786 Property, plant and equipment, net ....................................... 615,301 607,305 Goodwill, net ............................................................ 2,517,338 2,518,875 Intangible assets, net ................................................... 12,760 16,978 Deferred income taxes .................................................... 54,675 49,635 Other assets ............................................................. 102,657 112,839 ---------- ---------- Total assets ............................................................. $4,346,851 $4,301,418 ========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses .................................... $ 639,633 $ 649,850 Short-term borrowings and current portion of long-term debt .............. 130,409 73,950 ---------- ---------- Total current liabilities ............................................. 770,042 723,800 Long-term debt ........................................................... 971,717 1,028,707 Other liabilities ........................................................ 165,719 154,217 Commitments and contingencies Common stockholders' equity: Common stock, par value $0.01 per share; 300,000 shares authorized; 106,797 and 106,804 shares issued at June 30, 2004 and December 31, 2003, respectively .................................................... 1,068 1,068 Additional paid-in capital ............................................... 2,231,752 2,267,014 Retained earnings ........................................................ 592,708 380,559 Unearned compensation .................................................... (419) (2,346) Accumulated other comprehensive income ................................... 1,009 5,947 Treasury stock, at cost; 5,083 and 3,990 shares at June 30, 2004 and December 31, 2003, respectively ....................................... (386,745) (257,548) ---------- ---------- Total common stockholders' equity ..................................... 2,439,373 2,394,694 ---------- ---------- Total liabilities and stockholders' equity ............................... $4,346,851 $4,301,418 ========== ==========
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, 2004 AND 2003 (in thousands) (unaudited)
2004 2003 --------- --------- Cash flows from operating activities: Net income.............................................................. $ 242,978 $ 208,448 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization........................................... 83,917 74,972 Provision for doubtful accounts......................................... 112,338 113,543 Deferred income tax provision........................................... 9,748 5,891 Minority share of income................................................ 9,473 8,218 Stock compensation expense.............................................. 965 2,876 Tax benefits associated with stock-based compensation plans............. 39,983 9,541 Other, net.............................................................. 2,592 1,442 Changes in operating assets and liabilities: Accounts receivable.................................................. (180,861) (157,996) Accounts payable and accrued expenses................................ (461) (63,821) Integration, settlement and other special charges.................... (16,341) (9,283) Income taxes payable................................................. 4,920 29,769 Other assets and liabilities, net.................................... 8,873 4,078 --------- --------- Net cash provided by operating activities............................... 318,124 227,678 --------- --------- Cash flows from investing activities: Business acquisitions, net of cash acquired............................. -- (237,411) Capital expenditures.................................................... (90,847) (75,806) Proceeds from disposition of assets..................................... 4,741 3,402 Increase in investments and other assets................................ (2,876) (11,114) --------- --------- Net cash used in investing activities................................... (88,982) (320,929) --------- --------- Cash flows from financing activities: Proceeds from borrowings................................................ 304,921 450,000 Repayments of debt...................................................... (305,637) (354,539) Purchases of treasury stock............................................. (271,103) (10,065) Exercise of stock options............................................... 66,839 9,207 Dividends paid.......................................................... (30,943) -- Distributions to minority partners...................................... (8,314) (6,262) Financing costs paid.................................................... (2,061) (4,227) Other................................................................... -- 429 --------- --------- Net cash (used in) provided by financing activities..................... (246,298) 84,543 --------- --------- Net change in cash and cash equivalents................................. (17,156) (8,708) Cash and cash equivalents, beginning of period.......................... 154,958 96,777 --------- --------- Cash and cash equivalents, end of period................................ $ 137,802 $ 88,069 ========= =========
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 commercial clinical laboratories. Quest Diagnostics is the leading provider of esoteric testing, including gene-based testing, and testing for drugs of abuse. The Company is also a leading provider of anatomic pathology services and testing to support clinical trials of new pharmaceuticals worldwide. Through the Company's national network of laboratories and patient service centers, and its esoteric testing laboratories 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. On an annual basis, Quest Diagnostics processes over 130 million requisitions for testing 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 2003 Annual Report on Form 10-K. Certain amounts reported in the Company's consolidated statements of operations for the three and six months ended June 30, 2003 have been reclassified to conform to the 2004 presentation, which reports operating income on the face of the consolidated statements of operations. Earnings Per Share Basic earnings per common share is calculated by dividing net income by the weighted average common shares outstanding. Diluted earnings per common share is calculated by dividing net income by the weighted average 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 (the "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 Employee Equity Participation Program. These dilutive securities increased the weighted average common shares outstanding by 2.4 million shares and 2.5 million shares for the three and six months ended June 30, 2004, respectively. For the three and six months ended June 30, 2003, these dilutive securities increased the weighted average common shares outstanding by 2.6 million and 2.5 million shares, respectively. Stock-Based Compensation The Company has chosen to adopt the disclosure only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123" ("SFAS 148"), and continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations. 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 $0.5 million and $1.3 million for the three months ended June 30, 2004 and 2003, respectively, and $1.0 million and $2.9 million for the six months ended June 30, 2004 and 2003, 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, as amended by SFAS 148 (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Net income: Net income, as reported........................... $126,829 $120,412 $242,978 $208,448 Add: Stock-based compensation under APB 25........ 417 1,340 965 2,876 Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects............. (10,796) (13,124) (21,760) (27,929) -------- ------- -------- -------- Pro forma net income.............................. $116,450 $108,628 $222,183 $183,395 ======== ======== ======== ======== Earnings per common share: Basic - as reported............................... $ 1.23 $ 1.15 $ 2.36 $ 2.03 -------- -------- -------- -------- Basic - pro forma................................. $ 1.13 $ 1.03 $ 2.16 $ 1.79 -------- -------- -------- -------- Diluted - as reported............................. $ 1.20 $ 1.12 $ 2.30 $ 1.98 -------- -------- -------- -------- Diluted - pro forma............................... $ 1.11 $ 1.02 $ 2.12 $ 1.77 -------- -------- -------- --------
The fair value of each option grant was estimated on the date of grant currently calculated using the Black-Scholes option-pricing model with the following weighted average assumptions:
Three Months Ended Six Months Ended June 30, June 30, ------------------ ---------------- 2004 2003 2004 2003 -------- -------- ------- ------- Dividend yield...................... 0.7% 0.0% 0.7% 0.0% Risk-free interest rate............. 3.7% 2.6% 3.1% 2.8% Expected volatility................. 47.1% 48.5% 47.2% 48.1% Expected holding period, in years... 5 5 5 5
New Accounting Standards In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, "Consolidation of Variable Interest Entities", as revised in December 2003 ("FIN 46"). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. Historically, entities generally were not consolidated unless the entity was controlled through voting interests. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate but in which it has a significant variable interest. The adoption of FIN 46 did not have an impact on the Company's consolidated financial statements. In March 2004, the Emerging Issues Task Force ("EITF") reached a final consensus on Issue 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share", ("Issue 03-6"), effective June 30, 2004. Issue 03-6 requires the use of the two-class method to compute earnings per share for companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The contingent interest feature of the Debentures represents a participation right, thereby qualifying the Debentures as a participating security and requiring the use of the two-class method for purposes of calculating earnings per share when holders of the security are entitled to receive contingent interest. 6 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) The holders of the Debentures will receive contingent interest, and the Company would be required to utilize the two-class method, if the Debentures trade at a price greater than or equal to 120% of the principal amount of the Debentures (or $1,200 per Debenture) for periods specified under the indenture. For the periods presented, the holders of the Debentures were not entitled to contingent interest and as such, the two-class method has not been utilized to compute earnings per common share. For purposes of presenting diluted earnings per common share, a company would reflect the more dilutive effect of either the if-converted or the two-class methods. Had utilization of the two-class method been required, basic and diluted earnings per common share for the three and six months ended June 30, 2004, as presented, would have been reduced by approximately 3%. 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. For the periods presented, the holders of the Debentures did not have the ability to exercise their conversion rights. Had the use of the if-converted method been required to give effect to the conversion of the Debentures, diluted earnings per common share for the the three and six months ended June 30, 2004 would have been reduced by approximately 2%. As such, the use of the two-class method would have resulted in an additional 1% dilution beyond the 2% dilution calculated using the if-converted method. 2. BUSINESS ACQUISITION On February 28, 2003, the Company completed the acquisition of Unilab Corporation ("Unilab"), the leading commercial clinical laboratory in California. In connection with the acquisition of Unilab, the Company entered into an agreement to sell to Laboratory Corporation of America Holdings, Inc., certain assets in northern California (the "Divestiture"). During the fourth quarter of 2003, the Company finalized its plan related to the integration of Unilab into the Company's laboratory network. As part of the plan, and following the Divestiture, the Company closed its previously owned clinical laboratory in the San Francisco Bay area and completed the integration of remaining customers in the northern California area to Unilab's laboratories in San Jose and Sacramento. The Company currently operates two laboratories in the Los Angeles metropolitan area. The Company plans to open a new regional laboratory in the Los Angeles metropolitan area and then integrate its business in the Los Angeles metropolitan area into the new facility. As of June 30, 2004 and December 31, 2003, accruals related to the Unilab integration plan totaled approximately $5 million and $7 million, respectively. While the majority of the accrued costs at June 30, 2004 are expected to be paid during the remainder of 2004, there are certain severance costs that have payment terms extending into 2005. The following unaudited pro forma combined financial information for the three and six months ended June 30, 2003, assumes that the acquisition of Unilab and the related Divestiture were completed on January 1, 2003 (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, 2003 June 30, 2003 ------------------ ---------------- Pro forma Pro forma ------------------ ---------------- Net revenues........................................... $1,215,626 $2,378,649 Net income............................................. 119,959 216,675 Basic earnings per common share: Net income............................................. $ 1.14 $ 2.07 Weighted average common shares outstanding - basic..... 105,049 104,816 Diluted earnings per common share: Net income............................................. $ 1.11 $ 2.02 Weighted average common shares outstanding - diluted... 107,677 107,360
The unaudited pro forma combined financial information presented above reflects certain reclassifications to the historical financial statements of Unilab to conform the acquired company's accounting policies and classification of certain costs and expenses to that of Quest Diagnostics. These adjustments had no impact on pro forma net income. Pro forma results for the six months ended June 30, 2003 exclude $14.5 million of direct transaction costs, which were incurred and expensed by Unilab immediately prior to the closing of the Unilab acquisition. 7 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 3. GOODWILL AND INTANGIBLE ASSETS Goodwill at June 30, 2004 and December 31, 2003 consisted of the following:
June 30, December 31, 2004 2003 ---------- ------------ Goodwill................................................................... $2,705,391 $2,706,928 Less: accumulated amortization ............................................ (188,053) (188,053) ---------- ---------- Goodwill, net.............................................................. $2,517,338 $2,518,875 ========== ==========
The changes in the gross carrying amount of goodwill for the six month period ended June 30, 2004 and for the year ended December 31, 2003 are as follows:
June 30, December 31, 2004 2003 ---------- ------------ Balance at beginning of period............................................. $2,706,928 $1,976,903 Goodwill acquired during the period........................................ -- 730,025 Other...................................................................... (1,537) -- ---------- ---------- Balance at end of period................................................... $2,705,391 $2,706,928 ========== ==========
Intangible assets at June 30, 2004 and December 31, 2003 consisted of the following:
June 30, 2004 December 31, 2003 --------------------------------- -------------------------------- Weighted Average Amortization Accumulated Accumulated Period Cost Amortization Net Cost Amortization Net ------------ -------- ------------ ------- ------- ----------- ------- Non-compete agreements.... 5 years $44,942 $(40,811) $ 4,131 $44,942 $(37,947) $ 6,995 Customer lists... 15 years 42,225 (36,477) 5,748 42,225 (35,568) 6,657 Other............ 10 years 5,600 (2,719) 2,881 5,895 (2,569) 3,326 ------- ------ ------- ------- -------- ------- Total......... 10 years $92,767 $(80,007) $12,760 $93,062 $(76,084) $16,978 ======= ======== ======= ======= ======== =======
Amortization expense related to intangible assets was $2,058 and $2,068 for the three months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 and 2003, amortization expense related to intangible assets was $4,122 and $4,091, respectively. 8 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) The estimated amortization expense related to intangible assets for each of the five succeeding fiscal years and thereafter as of June 30, 2004 is as follows:
Fiscal Year Ending December 31, -------------------- Remainder of 2004... $ 2,478 2005................ 3,148 2006................ 1,872 2007................ 1,037 2008................ 847 2009................ 750 Thereafter.......... 2,628 ------- Total............. $12,760 =======
4. DEBT Term Loan due December 2008 On December 19, 2003, the Company entered into a new $75 million amortizing term loan facility (the "term loan due December 2008"), which was funded on January 12, 2004 and the proceeds of which were used to repay $75 million of outstanding principal under the Company's term loan due June 2007. Interest is based on LIBOR plus an applicable margin that can fluctuate over a range of up to 119 basis points, based on changes in the Company's public debt rating. As of June 30, 2004, the Company's borrowing rate for LIBOR-based loans was LIBOR plus 0.55%. The term loan due December 2008 requires principal repayments of the initial amount borrowed equal to 20% on each of the third and fourth anniversary dates of the funding and the remainder of the outstanding balance on December 31, 2008. The term loan due December 2008 is guaranteed by the Company's wholly owned subsidiaries that operate clinical laboratories in the United States (the "Subsidiary Guarantors"). 2004 Debt Refinancings On April 20, 2004, the Company entered into a new $500 million senior unsecured revolving credit facility which replaced a $325 million unsecured revolving credit facility. Under the new $500 million senior unsecured revolving credit facility (the "Credit Facility"), which matures in April 2009, interest is based on certain published rates plus an applicable margin that will vary over an approximate range of 90 basis points based on changes in the Company's credit ratings. At the option of the Company, it may elect to enter into LIBOR-based interest rate contracts for periods up to 180 days. Interest on any outstanding amounts not covered under the LIBOR-based interest rate contracts is based on an alternate base rate, which is calculated by reference to the prime rate or federal funds rate. As of June 30, 2004, the Company's borrowing rate for LIBOR-based loans was LIBOR plus 0.625%. The Credit Facility is guaranteed by the Subsidiary Guarantors. The Credit Facility contains various covenants, including the maintenance of certain financial ratios, which could impact the Company's ability to, among other things, incur additional indebtedness. In addition, on April 20, 2004, the Company entered into a new $300 million receivables securitization facility which replaced a $250 million receivables securitization facility that matured in April 2004. The new $300 million receivables securitization facility (the "secured receivables credit facility") matures in April 2007. Interest on the secured receivables credit facility is based on rates that are intended to approximate commercial paper rates for highly rated issuers. The secured receivables credit facility is supported by one-year back-up facilities provided by two banks on a committed basis. Borrowings outstanding under the secured receivables credit facility, if any, are classified as a current liability on the Company's consolidated balance sheet since the lenders fund the borrowings through the issuance of commercial paper which matures at various dates within one year from the date of issuance and the term of the one-year back-up facilities described above. 9 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) On April 30, 2004, the Company repaid the remaining $230 million of principal outstanding under its term loan due June 2007 with $100 million of borrowings under the Credit Facility and $130 million of borrowings under the secured receivables credit facility. In conjunction with the debt refinancings, the Company recorded a $2.9 million charge to earnings in the second quarter of 2004 representing the write-off of deferred financing costs associated with the debt that was refinanced. The $2.9 million charge was included in interest expense, net within the consolidated statements of operations for the three and six months ended June 30, 2004. 5. COMMITMENTS AND CONTINGENCIES The Company has standby letters of credit issued under its $68 million letter of credit lines to ensure its performance or payment to third parties, which amounted to $61 million at June 30, 2004. The letters of credit, which are renewed annually, primarily represent collateral for current and future automobile liability and workers' compensation loss payments. The Company has entered into several settlement agreements with various government and private payers during recent years relating to industry-wide billing and marketing practices that had been substantially discontinued by the mid-1990s. The Company is aware of certain pending lawsuits filed under the qui tam provisions of the civil False Claims Act. Some of the proceedings against the Company involve claims that are substantial in amount. Although management believes that established reserves for billing-related claims are sufficient, including qui tam cases of which management is aware, 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 position. However, the Company understands that there may be pending qui tam claims brought by former employees or other "whistle blowers" as to which it has not been provided with a copy of the complaint and accordingly cannot determine the extent of any potential liability. 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. 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 proceedings or claims are resolved. As a general matter, providers of clinical laboratory testing services may be subject to lawsuits alleging negligence or other similar legal claims. These suits could involve claims for substantial damages. Any professional liability litigation could also have an adverse impact on the Company's client base and reputation. The Company maintains various liability insurance programs for claims that could result from providing or failing to provide clinical laboratory testing services, including inaccurate testing results and other exposures. The Company's insurance coverage limits its maximum exposure on individual claims; however, the Company is essentially self-insured for a significant portion of these claims. The basis for claims reserves incorporates actuarially determined losses based upon the Company's historical and projected loss experience. Management believes that present insurance coverage and reserves are sufficient to cover currently estimated exposures. Although management cannot predict the outcome of any claims made against the Company, management does not anticipate that the ultimate outcome of any such 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. 10 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 6. STOCKHOLDERS' EQUITY Changes in stockholders' equity for the six months ended June 30, 2004 were as follows:
Accumulated Shares of Other Common Additional Compre- Treasury Compre- Stock Common Paid-In Retained Unearned hensive Stock, at hensive Outstanding Stock Capital Earnings Compensation Income Cost Income ----------- ------ ---------- -------- ------------ ----------- --------- -------- Balance, December 31, 2003.......... 102,814 $1,068 $2,267,014 $380,559 $(2,346) $ 5,947 $(257,548) Net income.................... 242,978 $242,978 Other comprehensive loss...... (4,938) (4,938) -------- Comprehensive income....... $238,040 ======== Dividends declared ........... (30,829) Issuance of common stock under benefit plans........ 93 1 1,777 962 4,310 Exercise of stock options..... 2,081 (70,757) 137,596 Shares to cover employee payroll tax withholdings on stock issued under benefit plans...................... (76) (1) (6,265) Tax benefits associated with stock-based compensation plans......... 39,983 Amortization of unearned compensation............... 965 Purchases of treasury stock .. (3,198) (271,103) ------- ------ ---------- -------- ------- ------- --------- Balance, June 30, 2004.............. 101,714 $1,068 $2,231,752 $592,708 $ (419) $ 1,009 $(386,745) ======= ====== ========== ======== ======= ======= =========
In 2003, the Company's Board of Directors authorized a share repurchase program, which permits the Company to purchase up to $600 million of its common stock. For the three months ended June 30, 2004, the Company repurchased approximately 2.7 million shares of its common stock at an average price of $85.34 per share for a total of $226 million. For the six months ended June 30, 2004, the Company repurchased approximately 3.2 million shares of its common stock at an average price of $84.76 per share for a total of $271 million. Through June 30, 2004, the Company has repurchased approximately 7.2 million shares of its common stock at an average price of $73.54 for a total of $529 million. At June 30, 2004, $71 million of the share repurchase authorization remained available. In July 2004, the Company's Board of Directors authorized the Company to purchase up to an additional $300 million of its common stock, bringing the total available for repurchases under the combined authorizations to $371 million as of July 22, 2004. For the three and six months ended June 30, 2004, the Company reissued approximately 1.0 million shares and 2.1 million shares, respectively, in connection with employee benefit plans. During the first quarter of 2004, the Company's Board of Directors declared a quarterly cash dividend of $0.15 per common share payable on April 21, 2004 to shareholders of record on April 7, 2004. The quarterly dividend was paid on April 21, 2004 and totaled approximately $15.5 million. During the second quarter of 2004, the Company's Board of Directors declared a quarterly cash dividend of $0.15 per common share payable on July 21, 2004 to shareholders of record on July 7, 2004 and totaled approximately $15.3 million. 11 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Changes in stockholders' equity for the six months ended June 30, 2003 were as follows:
Accumulated Other Shares of Retained Compre- Common Additional Earnings hensive Treasury Compre- Stock Common Paid-In (Accumulated Unearned Income Stock, at hensive Outstanding Stock Capital Deficit) Compensation (Loss) Cost Income ----------- ------ ---------- ------------ ------------ ----------- --------- -------- Balance, December 31, 2002.......... 97,963 $ 980 $1,817,511 $(40,772) $(3,332) $(5,524) $ -- Net income.................... 208,448 $208,448 Other comprehensive income.... 3,190 3,190 -------- Comprehensive income....... $211,638 ======== Shares issued to acquire Unilab..................... 7,055 71 372,393 Fair value of Unilab converted options.......... 8,452 Issuance of common stock under benefit plans........ 274 3 11,630 (5,041) Exercise of stock options..... 453 4 9,203 Shares to cover employee payroll tax withholdings on stock issued under benefit plans...................... (170) (2) (9,099) Tax benefits associated with stock-based compensation plans......... 9,541 Amortization of unearned compensation............... 3,301 Purchases of treasury stock... (162) (10,065) ------- ------ ---------- -------- ------- ------- -------- Balance, June 30, 2003.............. 105,413 $1,056 $2,219,631 $167,676 $(5,072) $(2,334) $(10,065) ======= ====== ========== ======== ======= ======= ========
12 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 7. SUPPLEMENTAL CASH FLOW & OTHER DATA
Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Depreciation expense........................... $ 40,789 $ 36,203 $ 79,795 $ 70,881 Interest expense............................... (16,768) (16,993) (31,818) (31,178) Interest income................................ 422 127 828 403 -------- -------- -------- -------- Interest expense, net.......................... (16,346) (16,866) (30,990) (30,775) Interest paid.................................. 4,012 5,434 25,915 32,545 Income taxes paid.............................. 108,820 93,432 112,391 100,630 Businesses acquired: Fair value of assets acquired.................. $ -- $ 5,102 $ -- $977,866 Fair value of liabilities assumed.............. -- 4,161 -- 279,510 Non-cash financing activities: Fair value of common stock issued to acquire Unilab...................................... $ -- $ -- $ -- $372,464 Fair value of converted options issued in conjunction with the Unilab acquisition..... -- -- -- 8,452
8. 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 due 2021 are guaranteed by the Subsidiary Guarantors. With the exception of Quest Diagnostics Receivables Incorporated (see paragraph below), the non-guarantor subsidiaries are primarily foreign subsidiaries and less than wholly owned subsidiaries. In conjunction with the receivables securitization, the Company formed a new wholly owned non-guarantor subsidiary, Quest Diagnostics Receivables Incorporated ("QDRI"). Through March 31, 2004, the Company and the Subsidiary Guarantors, with the exception of American Medical Laboratories, Incorporated ("AML") and Unilab, transferred all private domestic receivables (principally excluding receivables due from Medicare, Medicaid and other federal programs, and receivables due from customers of its joint ventures) to QDRI. In conjunction with the Company's new $300 million secured receivables credit facility, effective in the second quarter of 2004, the Company and the Subsidiary Guarantors, including AML and Unilab, transfer all private domestic receivables 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 February 28, 2003, Quest Diagnostics acquired Unilab, which has been included in the accompanying condensed consolidating financial data, subsequent to the closing of the acquisition, as a Subsidiary Guarantor. 13 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Statement of Operations Three Months Ended June 30, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................... $209,548 $1,021,661 $133,259 $(66,794) $1,297,674 Operating costs and expenses: Cost of services............................ 115,462 586,962 45,153 -- 747,577 Selling, general and administrative......... 27,528 220,894 63,927 (4,947) 307,402 Amortization of intangible assets........... 503 1,546 9 -- 2,058 Royalty (income) expense.................... (82,968) 82,968 -- -- -- Other operating (income) expense, net....... 10,622 3 (7) -- 10,618 -------- ---------- -------- -------- ----------- Total operating costs and expenses....... 71,147 892,373 109,082 (4,947) 1,067,655 -------- ---------- -------- -------- ----------- Operating income............................... 138,401 129,288 24,177 (61,847) 230,019 Non-operating expenses, net.................... (20,832) (57,301) (905) 61,847 (17,191) -------- ---------- -------- -------- ---------- Income before taxes............................ 117,569 71,987 23,272 -- 212,828 Income tax expense............................. 47,280 28,795 9,924 -- 85,999 -------- ---------- -------- -------- ---------- Income before equity earnings.................. 70,289 43,192 13,348 -- 126,829 Equity earnings from subsidiaries.............. 56,540 -- -- (56,540) -- -------- ---------- -------- -------- ---------- Net income..................................... $126,829 $ 43,192 $ 13,348 $(56,540) $ 126,829 ======== ========== ======== ======== ==========
Condensed Consolidating Statement of Operations Three Months Ended June 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................... $203,649 $956,955 $122,729 $(63,398) $1,219,935 Operating costs and expenses: Cost of services............................ 113,864 548,495 40,765 -- 703,124 Selling, general and administrative......... 18,045 225,769 56,210 (3,962) 296,062 Amortization of intangible assets........... 821 1,247 -- -- 2,068 Royalty (income) expense.................... (70,661) 70,661 -- -- -- Other operating (income) expense, net....... -- (4) 14 -- 10 -------- -------- -------- -------- ---------- Total operating costs and expenses....... 62,069 846,168 96,989 (3,962) 1,001,264 -------- -------- -------- -------- ---------- Operating income............................... 141,580 110,787 25,740 (59,436) 218,671 Non-operating expenses, net.................... (17,539) (55,761) (1,402) 59,436 (15,266) -------- -------- -------- -------- ---------- Income before taxes............................ 124,041 55,026 24,338 -- 203,405 Income tax expense............................. 50,928 22,009 10,056 -- 82,993 -------- -------- -------- -------- ---------- Income before equity earnings.................. 73,113 33,017 14,282 -- 120,412 Equity earnings from subsidiaries.............. 47,299 -- -- (47,299) -- -------- -------- -------- --------- ---------- Net income..................................... $120,412 $ 33,017 $ 14,282 $(47,299) $ 120,412 ======== ======== ======== ========= ==========
14 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, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................... $ 409,773 $2,013,982 $254,917 $(125,256) $2,553,416 Operating costs and expenses: Cost of services............................ 236,282 1,160,797 87,779 -- 1,484,858 Selling, general and administrative......... 55,444 446,519 122,262 (9,278) 614,947 Amortization of intangible assets........... 1,026 3,078 18 -- 4,122 Royalty (income) expense.................... (163,967) 163,967 -- -- -- Other operating expense, net................ 9,886 22 683 -- 10,591 --------- ---------- -------- --------- ---------- Total operating costs and expenses....... 138,671 1,774,383 210,742 (9,278) 2,114,518 --------- ---------- -------- --------- ----------- Operating income............................... 271,102 239,599 44,175 (115,978) 438,898 Non-operating expenses, net.................... (35,528) (109,020) (1,963) 115,978 (30,533) --------- ---------- -------- --------- ---------- Income before taxes............................ 235,574 130,579 42,212 -- 408,365 Income tax expense............................. 96,985 52,232 16,170 -- 165,387 --------- ---------- -------- --------- ---------- Income before equity earnings.................. 138,589 78,347 26,042 -- 242,978 Equity earnings from subsidiaries.............. 104,389 -- -- (104,389) -- --------- ---------- -------- --------- ---------- Net income..................................... $ 242,978 $ 78,347 $ 26,042 $(104,389) $ 242,978 ========= ========== ======== ========= ==========
Condensed Consolidating Statement of Operations Six Months Ended June 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................... $ 395,280 $1,806,325 $235,709 $(124,582) $2,312,732 Operating costs and expenses: Cost of services............................ 229,370 1,044,281 77,570 -- 1,351,221 Selling, general and administrative......... 37,272 432,808 112,967 (7,786) 575,261 Amortization of intangible assets........... 1,110 2,981 -- -- 4,091 Royalty (income) expense.................... (139,965) 139,965 -- -- -- Other operating (income) expense, net....... -- (7) 240 -- 233 --------- ---------- -------- --------- ---------- Total operating costs and expenses....... 127,787 1,620,028 190,777 (7,786) 1,930,806 --------- ---------- -------- --------- ---------- Operating income............................... 267,493 186,297 44,932 (116,796) 381,926 Non-operating expenses, net.................... (34,839) (108,865) (2,819) 116,796 (29,727) --------- ---------- -------- --------- ---------- Income before taxes............................ 232,654 77,432 42,113 -- 352,199 Income tax expense............................. 95,119 30,972 17,660 -- 143,751 --------- ---------- -------- --------- ---------- Income before equity earnings.................. 137,535 46,460 24,453 -- 208,448 Equity earnings from subsidiaries.............. 70,913 -- -- (70,913) -- --------- ---------- -------- --------- ---------- Net income..................................... $ 208,448 $ 46,460 $ 24,453 $ (70,913) $ 208,448 ========= ========== ======== ========= ==========
15 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Balance Sheet June 30, 2004
Non- Subsidiary Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ---------- ---------- ------------ ------------ ------------ Assets Current assets: Cash and cash equivalents................ $ 123,002 $ 2,869 $ 11,931 $ -- $ 137,802 Accounts receivable, net................. 21,965 85,097 570,648 -- 677,710 Other current assets..................... 33,324 107,655 87,629 -- 228,608 ---------- ---------- --------- ----------- ---------- Total current assets.................. 178,291 195,621 670,208 -- 1,044,120 Property, plant and equipment, net....... 222,820 365,745 26,736 -- 615,301 Goodwill and intangible assets, net ..... 157,355 2,327,350 45,393 -- 2,530,098 Intercompany receivable (payable)........ 637,737 (228,221) (409,516) -- -- Investment in subsidiaries............... 2,022,950 -- -- (2,022,950) -- Other assets............................. 50,207 69,036 38,089 - 157,332 ---------- ---------- --------- ----------- ---------- Total assets.......................... $3,269,360 $2,729,531 $ 370,910 $(2,022,950) $4,346,851 ========== ========== ========= =========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses.... $ 355,033 $ 256,690 $ 27,910 $ -- $ 639,633 Short-term borrowings and current portion of long-term debt.............. -- 488 129,921 -- 130,409 ---------- ---------- --------- ----------- ---------- Total current liabilities............. 355,033 257,178 157,831 -- 770,042 Long-term debt........................... 416,004 553,757 1,956 -- 971,717 Other liabilities........................ 58,950 83,327 23,442 -- 165,719 Common stockholders' equity.............. 2,439,373 1,835,269 187,681 (2,022,950) 2,439,373 ---------- ---------- --------- ----------- ---------- Total liabilities and stockholders' equity............................. $3,269,360 $2,729,531 $ 370,910 $(2,022,950) $4,346,851 ========== ========== ========= =========== ==========
Condensed Consolidating Balance Sheet December 31, 2003
Non- Subsidiary Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ---------- ---------- ------------ ------------ ------------ Assets Current assets: Cash and cash equivalents................ $ 141,588 $ 1,991 $ 11,379 $ -- $ 154,958 Accounts receivable, net................. 17,919 164,247 427,021 -- 609,187 Other current assets..................... 36,576 114,758 80,307 -- 231,641 ---------- ---------- --------- ----------- ---------- Total current assets.................. 196,083 280,996 518,707 -- 995,786 Property, plant and equipment, net....... 228,109 350,196 29,000 -- 607,305 Goodwill and intangible assets, net...... 158,295 2,332,147 45,411 -- 2,535,853 Intercompany receivable (payable)........ 510,958 (106,078) (404,880) -- -- Investment in subsidiaries............... 1,929,235 -- -- (1,929,235) -- Other assets............................. 73,398 50,053 39,023 -- 162,474 ---------- ---------- --------- ----------- ---------- Total assets.......................... $3,096,078 $2,907,314 $ 227,261 $(1,929,235) $4,301,418 ========== ========== ========= =========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses.... $ 337,635 $ 281,753 $ 30,462 $ -- $ 649,850 Current portion of long-term debt........ -- 73,950 -- -- 73,950 ---------- ---------- --------- ----------- ---------- Total current liabilities............. 337,635 355,703 30,462 -- 723,800 Long-term debt........................... 315,844 710,908 1,955 -- 1,028,707 Other liabilities........................ 47,905 83,781 22,531 -- 154,217 Common stockholders' equity.............. 2,394,694 1,756,922 172,313 (1,929,235) 2,394,694 ---------- ---------- --------- ----------- ---------- Total liabilities and stockholders' equity............................. $3,096,078 $2,907,314 $ 227,261 $(1,929,235) $4,301,418 ========== ========== ========= =========== ==========
16 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, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Cash flows from operating activities: Net income .............................. $ 242,978 $ 78,347 $ 26,042 $(104,389) $ 242,978 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization ........ 28,519 50,474 4,924 -- 83,917 Provision for doubtful accounts ...... 2,409 25,143 84,786 -- 112,338 Other, net ........................... (29,288) (17,501) 5,161 104,389 62,761 Changes in operating assets and liabilities ...................... (4,162) 24,705 (204,413) -- (183,870) --------- --------- --------- --------- --------- Net cash provided by (used in) operating activities ........................... 240,456 161,168 (83,500) -- 318,124 Net cash provided by (used in) investing activities ........................... 107,719 (52,066) (3,957) (140,678) (88,982) Net cash (used in) provided by financing activities ........................... (366,761) (108,224) 88,009 140,678 (246,298) --------- --------- --------- --------- --------- Net change in cash and cash equivalents .......................... (18,586) 878 552 -- (17,156) Cash and cash equivalents, beginning of period ............................... 141,588 1,991 11,379 -- 154,958 --------- --------- --------- --------- --------- Cash and cash equivalents, end of period ............................... $ 123,002 $ 2,869 $ 11,931 $ -- $ 137,802 ========= ========= ========= ========= =========
Condensed Consolidating Statement of Cash Flows Six Months Ended June 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Cash flows from operating activities: Net income .............................. $ 208,448 $ 46,460 $ 24,453 $(70,913) $ 208,448 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ........ 27,165 43,502 4,305 -- 74,972 Provision for doubtful accounts ...... 2,943 29,917 80,683 -- 113,543 Other, net ........................... (44,043) (12,476) 13,574 70,913 27,968 Changes in operating assets and liabilities ....................... (33,699) (78,008) (85,546) -- (197,253) --------- -------- -------- -------- --------- Net cash provided by operating activities ........................... 160,814 29,395 37,469 -- 227,678 Net cash used in investing activities ........................... (260,004) (39,305) (6,306) (15,314) (320,929) Net cash provided by (used in) financing activities ........................... 90,845 10,942 (32,558) 15,314 84,543 --------- -------- -------- -------- --------- Net change in cash and cash equivalents .......................... (8,345) 1,032 (1,395) -- (8,708) Cash and cash equivalents, beginning of period ............................... 79,015 7,377 10,385 -- 96,777 --------- -------- -------- -------- --------- Cash and cash equivalents, end of period ............................... $ 70,670 $ 8,409 $ 8,990 $ -- $ 88,069 ========= ======== ======== ======== =========
17 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, as well as 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 it is generally straightforward 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 one-half of total operating 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 2003 Annual Report on Form 10-K. Integration of Unilab Corporation On February 28, 2003, we completed the acquisition of Unilab Corporation, or Unilab, the leading commercial clinical laboratory in California. In connection with the acquisition of Unilab, we entered into an agreement to sell to Laboratory Corporation of America Holdings, Inc., certain assets in northern California, or the Divestiture. During the fourth quarter of 2003, we finalized our plan related to the integration of Unilab into our laboratory network. As part of the plan, and following the Divestiture, we closed our previously owned clinical laboratory in the San Francisco Bay area and completed the integration of remaining customers in the northern California area to Unilab's laboratories in San Jose and Sacramento. We currently operate two laboratories in the Los Angeles metropolitan area. We plan to open a new regional laboratory in the Los Angeles metropolitan area and then integrate our business in the Los Angeles metropolitan area into the new facility. As of June 30, 2004 and December 31, 2003, accruals related to the Unilab integration plan totaled approximately $5 million and $7 million, respectively. While the majority of the accrued costs at June 30, 2004 are expected to be paid during the remainder of 2004, there are certain severance costs that have payment terms extending into 2005. Results of Operations Three and Six Months Ended June 30, 2004 Compared with Three and Six Months Ended June 30, 2003 Net income for the three months ended June 30, 2004 increased to $127 million from $120 million for the prior year period. For the six months ended June 30, 2004, net income increased to $243 million from $208 million for the prior year period. These increases in earnings were primarily attributable to revenue growth and efficiencies generated from our Six Sigma and standardization initiatives, partially offset by investments in our operations and the impact of $13.2 million in pre-tax charges recorded in the second quarter of 2004. Of the $13.2 million of charges incurred in the second quarter of 2004, $10.3 million related to the acceleration of certain pension obligations in connection with the recently completed CEO succession process with the remaining $2.9 million representing the write-off of deferred financing costs associated with the refinancing of our bank debt and credit facility. These charges served to reduce reported net income for both the three and six months ended June 30, 2004 by $7.9 million. Net Revenues Net revenues for the three months ended June 30, 2004 grew by 6.4% over the prior year level, driven by increases in average revenue per requisition and improvements in testing volumes. Net revenues for the six months ended June 30, 2004 grew by 10.4% over the prior year level and include six months of Unilab's results, which was acquired on February 28, 2003, compared to four months of Unilab's results in the prior year. Pro forma revenue growth, assuming that the Unilab acquisition and the related Divestiture had been completed on January 1, 2003, was 7.3% for the six months ended June 30, 2004. For the three and six months ended June 30, 2004, clinical testing volume, measured by the number of requisitions, increased 2.1% and 6.4%, respectively, compared to the prior year periods. On a pro forma basis, assuming that the Unilab acquisition and the Divestiture had been completed on January 1, 2003, testing volume increased 2.6% for 18 the six months ended June 30, 2004. Average revenue per requisition improved 3.7% and 3.4% for the three and six months ended June 30, 2004, respectively, compared to the prior year periods, primarily attributable to a continuing shift in test mix to higher value testing, including gene-based testing, which continued to grow at approximately 15% over the prior year level, and increases in the number of tests ordered per requisition. The inclusion of Unilab's results subsequent to February 28, 2003 served to reduce average revenue per requisition by approximately 0.7% for the six months ended June 30, 2004, reflecting Unilab's lower revenue per requisition. Drugs of abuse testing, which is among our lowest priced services and accounts for approximately 6% of our volume and 3% of our consolidated net revenues, grew for the second consecutive quarter after several years of decline. The growth in drugs of abuse testing had an insignificant impact on our overall volume growth and revenue per requisition for the three and six months ended June 30, 2004. Our businesses, other than clinical laboratory testing, which represent approximately 4% of our consolidated net revenues, grew over 15% and 20% during the three and six months ended June 30, 2004, respectively, compared to the prior year periods and contributed approximately one-half of a percent to reported net revenue growth in both periods. Operating Costs and Expenses Total operating costs and expenses for the three and six months ended June 30, 2004 increased $66 million and $184 million, respectively, from the prior year periods primarily due to increases in our clinical testing volume. The increased costs were primarily in the areas of employee compensation and benefits and testing supplies. While our cost structure has been favorably impacted by efficiencies generated from our Six Sigma and standardization initiatives, we continue to make investments to further improve customer service levels and pursue our overall business strategy. Cost of services, which includes the costs of obtaining, transporting and testing specimens, was 57.6% of net revenues for the three months ended June 30, 2004, unchanged from the prior year period. For the six months ended June 30, 2004, cost of services, as a percentage of net revenues, decreased to 58.2% from 58.4% in the prior year period. This improvement was primarily the result of the increase in average revenue per requisition and efficiency gains resulting from our Six Sigma and standardization initiatives. This improvement was partially offset by initial installation costs associated with deploying our Internet-based orders and results systems in physicians' offices and an increase in the number of phlebotomists in our patient service centers to support an increasing percentage of our volume generated from these sites. At June 30, 2004, greater than 30% of our orders and greater than 40% of our test results were being transmitted via the Internet, approximately double the level of a year ago. The increase in the number of orders and test results reported via our Internet-based systems is improving the initial collection of billing information which is reducing the cost of billing and bad debt expense, both of which are components of selling, general and administrative expenses. Additionally, we believe that the number of physicians who no longer draw blood in their office continues to increase, which is resulting in an increase in the number of blood draws in our patient service centers or by our phlebotomists placed in physicians' offices. This shift has increased our operating costs associated with our blood draws, but is reducing costs in accessioning and other parts of our operations due to improved billing information and a reduction in the number of inadequate patient samples obtained by our trained phlebotomists compared to samples collected by physician employed phlebotomists. Selling, general and administrative expenses, which include the costs of the sales force, billing operations, bad debt expense and general management and administrative support, decreased during the three months ended June 30, 2004, as a percentage of net revenues, to 23.7% from 24.3% in the prior year period. For the six months ended June 30, 2004, selling, general and administrative expenses, as a percentage of net revenues, decreased to 24.1% from 24.9% in the prior year period. The improvements were primarily due to efficiencies from our Six Sigma and standardization initiatives and the improvement in average revenue per requisition. Partially offsetting these improvements are additional costs for expanding our sales force and enhancing their training. During the second quarter of 2004, bad debt expense improved to 4.3% of net revenues, compared to 4.8% in the prior year period. For the six months ended June 30, 2004, bad debt expense was 4.4% of net revenues, compared to 4.9% of net revenues in the prior year period. This improvement primarily relates to the collection of diagnosis, patient and insurance information necessary to more effectively bill for services performed. We believe that our Six Sigma and standardization initiatives and the increased use of electronic ordering by our customers will provide additional opportunities to further improve our overall collection experience and cost structure. 19 Other operating expense, net represents miscellaneous income and expense items related to operating activities including gains and losses associated with the disposal of operating assets. For the three and six months ended June 30, 2004, other operating expense, net includes a $10.3 million charge associated with the acceleration of certain pension obligations in connection with the recently completed CEO succession process. Operating Income Operating income for the three months ended June 30, 2004 improved to $230 million, or 17.7% of net revenues, from $219 million, or 17.9% of net revenues, in the prior year period. For the six months ended June 30, 2004, operating income improved to $439 million, or 17.2% of net revenues, from $382 million, or 16.5% of net revenues, in the prior year period. The increases in operating income for the three and six months ended June 30, 2004 were principally driven by revenue growth and efficiencies generated from our Six Sigma and standardization initiatives, which have reduced both the cost of services and selling, general and administrative expenses as a percentage of net revenues. Offsetting these improvements were investments in our operations and a charge in the second quarter of 2004 of $10.3 million related to the acceleration of certain pension obligations associated with the recently completed CEO succession process. This charge reduced operating income, as a percentage of net revenues, by 0.8% and 0.4%, respectively, for the three and six months ended June 30, 2004. Other Income (Expense) Interest expense, net for both the three and six months ended June 30, 2004 included a $2.9 million charge representing the write-off of deferred financing costs associated with the second quarter 2004 refinancing of our bank debt and credit facility. Our 2004 debt refinancing, which was done to take advantage of the improved lending environment and our improved credit profile, is discussed further in Note 4 to the interim consolidated financial statements. Serving to reduce interest expense, net for the three and six months ended June 30, 2004 was a reduction in the amount of debt outstanding during the periods, compared to the prior year, as well as a reduction in borrowing costs associated with our 2004 refinancing. Other income (expense), net represents miscellaneous income and expense items related to non-operating activities such as gains and losses associated with investments and other non-operating assets. Impact of Contingent Convertible Debentures on Earnings per Common Share The if-converted method is used in determining the dilutive effect of our 1 3/4% contingent convertible debentures due 2021, or 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, 2004, the holders of the 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 earnings per common share would have been reduced by approximately 2% during the three and six months ended June 30, 2004. See Note 1 to the interim consolidated financial statements for a discussion of the potential impact of the Debentures on earnings per common share calculations as a result of a new accounting standard. Also, see Note 11 to the Consolidated Financial Statements contained in our 2003 Annual Report on Form 10-K for a further discussion of the Debentures. 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. See Note 2 to the Consolidated Financial Statements contained in our 2003 Annual Report on Form 10-K for additional discussion of our financial instruments and hedging activities. At both June 30, 2004 and December 31, 2003, the fair value of our debt was estimated at approximately $1.2 billion, using quoted market prices and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. At June 30, 2004 and December 31, 2003, the estimated fair value exceeded the carrying value of the debt by approximately $70 million and $86 million, respectively. An assumed 10% increase in interest rates (representing approximately 45 and 50 basis points at June 30, 2004 and December 31, 2003, respectively) would potentially reduce the estimated fair value of our debt by approximately $16 million and $17 million at June 30, 2004 and December 31, 2003, respectively. 20 The Debentures have a contingent interest component that will require us to pay contingent interest based on certain thresholds, as outlined in the indenture governing the Debentures. The contingent interest component is considered to be a derivative instrument subject to Statement of Financial Accounting Standards 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, 2004 and December 31, 2003. Borrowings under our senior unsecured revolving credit facility, our secured receivables credit facility and our term loan due December 2008 are subject to variable interest rates. Interest rates on our senior unsecured revolving credit facility and term loan are subject to a pricing schedule that can fluctuate based on changes in our credit rating. As such, our borrowing cost under these credit arrangements will be subject to both fluctuations in interest rates and changes in our credit rating. As of June 30, 2004, our borrowing rates for our LIBOR-based loans ranged from LIBOR plus 0.55% to LIBOR plus 0.625%. At June 30, 2004, there was $130 million of borrowings outstanding under our $300 million secured receivables credit facility, $100 million of borrowings outstanding under our $500 million senior unsecured revolving credit facility and $75 million outstanding under our term loan due December 2008. See Note 4 to the interim consolidated financial statements for details regarding the 2004 debt refinancings. Based on our net exposure to interest rate changes, an assumed 10% change in interest rates on our variable rate indebtedness (representing approximately 12 basis points) would impact annual net interest expense by approximately $0.4 million, assuming no changes to the debt outstanding at June 30, 2004. Liquidity and Capital Resources Cash and Cash Equivalents Cash and cash equivalents at June 30, 2004 totaled $138 million, compared to $155 million at December 31, 2003. Cash flows from operating activities in 2004 provided cash of $318 million, which together with cash on-hand were used to fund investing and financing activities, which required cash of $89 million and $246 million, respectively. Cash and cash equivalents at June 30, 2003 totaled $88 million, compared to $97 million at December 31, 2002. Cash flows from operating activities in 2003 provided cash of $228 million, which along with cash flows from financing activities of $85 million and cash on-hand, were used to fund investing activities, which required cash of $321 million. Cash Flows From Operating Activities Net cash provided by operating activities for the six months ended June 30, 2004 was $318 million compared to $228 million in the prior year period. This increase was primarily due to improved operating performance and increased tax benefits associated with stock-based compensation plans, partially offset by an increase in accounts receivable associated with growth in net revenues. Days sales outstanding, a measure of billing and collection efficiency, improved to 47 days at June 30, 2004 from 48 days at December 31, 2003. Cash Flows From Investing Activities Net cash used in investing activities for the six months ended June 30, 2004 was $89 million, consisting primarily of capital expenditures of $91 million. Net cash used in investing activities for the six months ended June 30, 2003 was $321 million, consisting primarily of acquisition and related transaction costs of $237 million to acquire the outstanding capital stock of Unilab, and capital expenditures of $76 million. The acquisition and related transaction costs included the cash portion of the Unilab purchase price of $297 million and approximately $12 million of transaction costs paid in 2003, partially offset by $72 million of cash acquired from Unilab. 21 Cash Flows From Financing Activities Net cash used in financing activities in the six months ended June 30, 2004 was $246 million, consisting primarily of purchases of treasury stock totaling $271 million, and dividend payments totaling $31 million, partially offset by $67 million received from the exercise of stock options. In addition, we repaid the remaining $305 million of principal outstanding under our term loan due June 2007 with $100 million of borrowings under our senior unsecured revolving credit facility, $130 million of borrowings under our secured receivables credit facility and $75 million of borrowings under our term loan due December 2008. The $271 million in treasury stock purchases represents 3.2 million shares of our common stock repurchased at an average price of $84.76 per share. Net cash provided by financing activities for the six months ended June 30, 2003 was $85 million, consisting primarily of $450 million of borrowings under our term loan due June 2007, partially offset by debt repayments totaling $355 million. Borrowings under our term loan facility due June 2007 were used to finance the cash portion of the purchase price and related transaction costs associated with the acquisition of Unilab, and to repay $220 million of debt, representing substantially all of Unilab's then existing outstanding debt, and related accrued interest. Of the $220 million, $124 million represents payments related to our cash tender offer which was completed on March 7, 2003, for all of the outstanding $100.8 million principal amount of Unilab's 12 3/4% senior subordinated notes due 2009 and $23 million of related tender premium and associated tender offer costs. The remaining debt repayments in 2003 consisted primarily of $127 million of repayments under our term loan facility due June 2007 and a $6 million capital lease repayment. During the six months ended June 30, 2003, we repurchased $10 million of our common stock. Dividend Policy On October 21, 2003, our Board of Directors declared our first payment of a quarterly cash dividend of $0.15 per common share, which was paid on January 23, 2004. We have paid a $0.15 per share dividend each quarter since the first quarter's payment. We expect to fund future dividend payments with cash flows from operations, and do not expect the dividend to have a material impact on our ability to finance future growth. Share Repurchase Plan In 2003, our Board of Directors authorized a share repurchase program, which permitted us to purchase up to $600 million of our common stock. For the three months ended June 30, 2004, we repurchased approximately 2.7 million shares of our common stock at an average price of $85.34 per share for a total of $226 million. For the six months ended June 30, 2004, we repurchased approximately 3.2 million shares of our common stock at an average price of $84.76 per share for a total of $271 million. Through June 30, 2004, we have repurchased approximately 7.2 million shares of our common stock at an average price of $73.54 for a total of $529 million under our share repurchase program. In July 2004, our Board of Directors authorized us to purchase up to an additional $300 million of our common stock, bringing the total available for repurchases under the combined authorizations to $371 million as of July 22, 2004. Contractual Obligations and Commitments A 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 11 to the Consolidated Financial Statements in our 2003 Annual Report on Form 10-K. A discussion of our debt refinancings in April 2004 is contained in Note 4 to the interim consolidated financial statements. A discussion and analysis regarding our minimum rental commitments under noncancelable operating leases and noncancelable commitments to purchase products or services at December 31, 2003 is contained in Note 15 to the Consolidated Financial Statements in our 2003 Annual Report on Form 10-K. See Note 5 to the interim consolidated financial statements for information regarding the status of our remaining contractual obligations and commitments. Our credit agreements relating to our senior unsecured revolving credit facility and our term loan due December 2008 contain various covenants and conditions, including the maintenance of certain financial ratios, that could impact our ability to, among other things, incur additional indebtedness. We do not expect these covenants to adversely impact our ability to execute our growth strategy or conduct normal business operations. Unconsolidated Joint Ventures We have investments in unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and Dayton, Ohio, which are accounted for under the equity method of accounting. We believe that our transactions with our joint ventures are 22 conducted at arm's length, reflecting current market conditions and pricing. Total net revenues of our unconsolidated joint ventures, on a combined basis, are less than 6% of our consolidated net revenues. Total assets associated with our unconsolidated joint ventures are less than 3% of our consolidated total assets. We have no material unconditional 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 $180 million to $190 million during 2004 for capital expenditures to support and expand our existing operations, principally related to investments in information technology, equipment, and facility upgrades. In April 2004, we entered into a new $500 million senior unsecured revolving credit facility which replaced a $325 million unsecured revolving credit facility. In addition, we entered into a new $300 million secured receivables credit facility which replaced a $250 million secured receivables credit facility that matured in April 2004. On April 30, 2004, we repaid the remaining $230 million of principal outstanding under our term loan due June 2007 with $100 million of borrowings under the $500 million senior unsecured revolving credit facility and $130 million of borrowings under the $300 million secured receivables credit facility. See Note 4 to the interim consolidated financial statements for further details regarding the refinancings. As of June 30, 2004, $400 million of the $500 million senior unsecured revolving credit facility and $170 million of the $300 million secured receivables credit facility remained available to us for future borrowing. We believe that cash from operations and our borrowing capacity under our credit facilities will provide sufficient financial flexibility to meet seasonal working capital requirements and to fund capital expenditures, debt service requirements, cash dividends on common shares, share repurchases and additional growth opportunities for the foreseeable future. Our investment grade credit ratings have had a favorable impact on our cost of and access to capital, and we believe that our strong financial performance should provide us with access to additional financing, if necessary, to fund growth opportunities that cannot be funded from existing sources. Impact of New Accounting Standards In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, "Consolidation of Variable Interest Entities", as revised in December 2003. In March 2004, the Emerging Issues Task Force reached a final consensus on Issue 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share". The impacts of these accounting standards are discussed in Note 1 to the interim consolidated financial statements. 23 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 (the "Litigation Reform Act") 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 may include, but are not limited to, unanticipated expenditures, changing relationships with customers, payers, suppliers and strategic partners, competitive environment, changes in government regulations, conditions of the economy and other factors described in our 2003 Annual Report on Form 10-K and subsequent filings. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations". Item 4. Controls and Procedures (a) Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are adequate and effective. (b) During the quarterly period covered by this report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 24 PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note 5 to the interim consolidated financial statements for information regarding the status of government investigations and private claims. Item 2. Changes in Securities and Use of Proceeds ISSUER PURCHASES OF EQUITY SECURITIES
----------------------------------------------------------------------------------------------------------- (d) Approximate Dollar Value (a) Total (c) Total Number of Shares of Shares that May Yet Be Number of Purchased as Part of Purchased Under the Plans or Shares (b) Average Price Publicly Announced Programs Period Purchased Paid per Share Plans or Programs (in thousands) ----------------------------------------------------------------------------------------------------------- April 1, 2004 - April 30, 2004 270,500 $84.96 270,500 $274,600 ----------------------------------------------------------------------------------------------------------- May 1, 2004 - May 31, 2004 892,900 $86.15 892,900 $197,672 ----------------------------------------------------------------------------------------------------------- June 1, 2004 - June 30, 2004 1,487,518 $84.92 1,487,518 $ 71,348 ----------------------------------------------------------------------------------------------------------- Total 2,650,918 $85.34 2,650,918 $ 71,348 -----------------------------------------------------------------------------------------------------------
In 2003, our Board of Directors authorized a share repurchase program, which permits us to purchase up to $600 million of our common stock. In July 2004, our Board of Directors authorized us to purchase up to an additional $300 million of our common stock, bringing the total available for repurchases under the combined authorizations to $371 million as of July 22, 2004. Item 4. Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Stockholders of the Company was held on May 4, 2004. 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 2007 Annual Meeting of Stockholders, by the following votes:
For Withheld ---------- --------- Dr. John C. Baldwin 84,250,137 7,416,589 Mr. William R. Grant 84,054,787 7,611,939 Dr. Surya N. Mohapatra 84,030,540 4,636,186
The following persons continue as directors: Mr. William F. Buehler Mr. James F. Flaherty III Mr. Kenneth W. Freeman Ms. Rosanne Haggerty Dr. Dan C. Stanzione Dr. Gail R. Wilensky Mr. John B. Ziegler 25 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, 2004, was approved by the following number of stockholder votes for, against, and abstained: For: 89,787,655 Against: 1,349,558 Abstained: 528,713 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 10.1 First Amendment to Term Loan Credit Agreement dated as April 20, 2004 among Quest Diagnostics Incorporated, certain subsidiary guarantors of the Company, the lenders party thereto, and Sumitomo Mitsui Banking Corporation 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K filed during the second quarter of 2004: On April 22, 2004, the Company furnished a current report on Form 8-K reporting its press release of April 22, 2004 announcing, among other things, its results for the quarter ended March 31, 2004. On April 22, 2004, the Company filed a current report on Form 8-K announcing that Surya N. Mohapatra, Ph.D., will be appointed President and Chief Executive Officer on May 4, 2004, the date of its 2004 Annual Meeting of Stockholders, completing the CEO succession plan announced in November 2003. 26 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. July 30, 2004 Quest Diagnostics Incorporated By /s/ Surya N. Mohapatra ----------------------------------------- Surya N. Mohapatra, Ph.D. President and Chief Executive Officer By /s/ Robert A. Hagemann ----------------------------------------- Robert A. Hagemann Senior Vice President and Chief Financial Officer 27 STATEMENT OF DIFFERENCES ------------------------ The section symbol shall be expressed as................................ 'SS'