-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R1jLNW32A57dYAUiJ8QXNZ0aGVgtLKArw/i1yy23YHNQZWbeboASG/uexJ6rjEJd k+aqWG8M8OSi/GUTU2T+gA== 0000950117-04-003722.txt : 20041029 0000950117-04-003722.hdr.sgml : 20041029 20041029080138 ACCESSION NUMBER: 0000950117-04-003722 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041029 DATE AS OF CHANGE: 20041029 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST DIAGNOSTICS INC CENTRAL INDEX KEY: 0001022079 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MEDICAL LABORATORIES [8071] IRS NUMBER: 161387862 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12215 FILM NUMBER: 041104248 BUSINESS ADDRESS: STREET 1: ONE MALCOLM AVE CITY: TETERBORO STATE: NJ ZIP: 07608 BUSINESS PHONE: 2013935000 MAIL ADDRESS: STREET 1: ONE MALCOLM AVE CITY: TETERBORO STATE: NJ ZIP: 07601 FORMER COMPANY: FORMER CONFORMED NAME: CORNING CLINICAL LABORATORIES INC DATE OF NAME CHANGE: 19960903 10-Q 1 a38595.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 September 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 October 26, 2004, there were 101,199,780 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 Nine Months Ended September 30, 2004 and 2003 2 Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 3 Consolidated Statements of Cash Flows for the Nine Months Ended September 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 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (in thousands, except per share data) (unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- Net revenues ............................ $1,289,897 $1,221,221 $3,843,313 $3,533,953 ---------- ---------- ---------- ---------- Operating costs and expenses: Cost of services ........................ 748,424 711,180 2,233,282 2,062,401 Selling, general and administrative ..... 308,248 292,413 923,195 867,674 Amortization of intangible assets ....... 1,664 2,055 5,786 6,146 Other operating (income) expense, net ... (142) (1,950) 10,449 (1,717) ---------- ---------- ---------- ---------- Total operating costs and expenses ... 1,058,194 1,003,698 3,172,712 2,934,504 ---------- ---------- ---------- ---------- Operating income ........................ 231,703 217,523 670,601 599,449 Other income (expense): Interest expense, net ................... (13,630) (14,472) (44,620) (45,247) Minority share of income ................ (4,893) (4,607) (14,366) (12,825) Equity earnings in unconsolidated joint ventures ....................... 5,548 4,371 15,502 12,981 Other income (expense), net ............. 3 (62) (21) 594 ---------- ---------- ---------- ---------- Total non-operating expenses, net .... (12,972) (14,770) (43,505) (44,497) ---------- ---------- ---------- ---------- Income before taxes ..................... 218,731 202,753 627,096 554,952 Income tax expense ...................... 88,587 82,729 253,974 226,480 ---------- ---------- ---------- ---------- Net income .............................. $ 130,144 $ 120,024 $ 373,122 $ 328,472 ========== ========== ========== ========== Basic earnings per common share: Net income .............................. $ 1.29 $ 1.15 $ 3.64 $ 3.18 Weighted average common shares outstanding - basic .................. 101,244 104,787 102,465 103,291 Diluted earnings per common share: Net income .............................. $ 1.26 $ 1.12 $ 3.56 $ 3.10 Weighted average common shares outstanding - diluted ................ 103,272 107,278 104,799 105,804
The accompanying notes are an integral part of these statements. 2 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 (in thousands, except per share data) (unaudited)
September 30, December 31, 2004 2003 ------------- ------------ Assets Current assets: Cash and cash equivalents ....................... $ 201,036 $ 154,958 Accounts receivable, net of allowance of $205,584 and $211,739 at September 30, 2004 and December 31, 2003, respectively ..... 686,045 609,187 Inventories ..................................... 73,219 72,484 Deferred income taxes ........................... 98,242 108,975 Prepaid expenses and other current assets ....... 54,293 50,182 ---------- ---------- Total current assets ........................ 1,112,835 995,786 Property, plant and equipment, net .............. 618,001 607,305 Goodwill, net ................................... 2,517,338 2,518,875 Intangible assets, net .......................... 12,378 16,978 Deferred income taxes ........................... 33,031 49,635 Other assets .................................... 101,375 112,839 ---------- ---------- Total assets .................................... $4,394,958 $4,301,418 ========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses ........... $ 649,710 $ 649,850 Short-term borrowings and current portion of long-term debt ............................ 130,182 73,950 ---------- ---------- Total current liabilities ................... 779,892 723,800 Long-term debt .................................. 971,810 1,028,707 Other liabilities ............................... 165,572 154,217 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 September 30, 2004 and December 31, 2003, respectively ..... 1,068 1,068 Additional paid-in capital ...................... 2,214,259 2,267,014 Retained earnings ............................... 707,684 380,559 Unearned compensation ........................... (205) (2,346) Accumulated other comprehensive income .......... 190 5,947 Treasury stock, at cost; 5,760 and 3,990 shares at September 30, 2004 and December 31, 2003, respectively .............. (445,312) (257,548) ---------- ---------- Total common stockholders' equity ........... 2,477,684 2,394,694 ---------- ---------- Total liabilities and stockholders' equity ...... $4,394,958 $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 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (in thousands) (unaudited)
2004 2003 --------- --------- Cash flows from operating activities: Net income ............................................. $ 373,122 $ 328,472 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .......................... 126,455 113,500 Provision for doubtful accounts ........................ 172,027 172,102 Deferred income tax provision .......................... 31,391 16,589 Minority share of income ............................... 14,366 12,825 Stock compensation expense ............................. 1,179 4,093 Tax benefits associated with stock-based compensation plans .................................. 54,156 17,880 Other, net ............................................. 2,526 (1,791) Changes in operating assets and liabilities: Accounts receivable ................................. (248,885) (231,991) Accounts payable and accrued expenses ............... (10,251) (67,359) Integration, settlement and other special charges ... (17,426) (13,769) Income taxes payable ................................ 27,161 43,707 Other assets and liabilities, net ................... 9,386 6,255 --------- --------- Net cash provided by operating activities .............. 535,207 400,513 --------- --------- Cash flows from investing activities: Business acquisitions, net of cash acquired ............ -- (237,538) Capital expenditures ................................... (134,146) (121,690) Proceeds from disposition of assets .................... 7,551 9,034 Increase in investments and other assets ............... (3,177) (11,450) --------- --------- Net cash used in investing activities .................. (129,772) (361,644) --------- --------- Cash flows from financing activities: Proceeds from borrowings ............................... 304,921 450,000 Repayments of debt ..................................... (305,908) (372,806) Purchases of treasury stock ............................ (381,145) (124,081) Exercise of stock options .............................. 83,085 16,773 Dividends paid ......................................... (46,214) -- Distributions to minority partners ..................... (11,982) (10,580) Financing costs paid ................................... (2,114) (4,227) Other .................................................. -- 343 --------- --------- Net cash used in financing activities .................. (359,357) (44,578) --------- --------- Net change in cash and cash equivalents ................ 46,078 (5,709) Cash and cash equivalents, beginning of period ......... 154,958 96,777 --------- --------- Cash and cash equivalents, end of period ............... $ 201,036 $ 91,068 ========= =========
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. 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. Other potentially dilutive securities include outstanding stock options and restricted common shares granted under the Company's Employee Equity Participation Program. These securities increased the weighted average common shares outstanding by 2.0 million shares and 2.3 million shares for the three and nine months ended September 30, 2004, respectively. For both the three and nine months ended September 30, 2003, these securities increased the weighted average common shares outstanding by 2.5 million shares. 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 $0.2 million and $1.2 million for the three months ended September 30, 2004 and 2003, respectively, and $1.2 million and $4.1 million for the nine months ended September 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 Nine Months Ended September 30, September 30, ------------------- ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Net income: Net income, as reported .............. $130,144 $120,024 $373,122 $328,472 Add: Stock-based compensation under APB 25 ............................ 214 1,217 1,179 4,093 Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects ............... (11,770) (12,215) (33,531) (40,144) -------- -------- -------- -------- Pro forma net income ................. $118,588 $109,026 $340,770 $292,421 ======== ======== ======== ======== Earnings per common share: Basic - as reported .................. $ 1.29 $ 1.15 $ 3.64 $ 3.18 -------- -------- -------- -------- Basic - pro forma .................... $ 1.17 $ 1.04 $ 3.33 $ 2.83 -------- -------- -------- -------- Diluted - as reported ................ $ 1.26 $ 1.12 $ 3.56 $ 3.10 -------- -------- -------- -------- Diluted - pro forma .................. $ 1.15 $ 1.03 $ 3.27 $ 2.80 -------- -------- -------- --------
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 Nine Months Ended September 30, September 30, ------------------ ------------------ 2004 2003 2004 2003 -------- -------- -------- -------- Dividend yield ....................... 0.7% 0.0% 0.7% 0.0% Risk-free interest rate .............. 3.7% 3.3% 3.1% 2.8% Expected volatility .................. 46.6% 48.1% 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 common share when holders of the security are entitled to receive contingent interest. 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 6 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) 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 nine months ended September 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 three and nine months ended September 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. In September 2004, the EITF reached a final consensus on Issue 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share", ("Issue 04-8"), effective December 31, 2004. Issue 04-8 requires that the Debentures be included in the dilutive earnings per common share calculation (if dilutive) using the if-converted method, regardless of whether the holders of these securities are permitted to exercise their conversion rights, and be applied by retroactively restating previously reported diluted earnings per common share. As noted above, the use of the if-converted method to account for the impact of the Debentures would have reduced diluted earnings per common share by approximately 2%. The Company expects that this change in accounting will reduce diluted earnings per common share for the three and twelve months ended December 31, 2004 by approximately $0.03 and $0.10, respectively, and for the three and twelve months ended December 31, 2003 by $0.02 and $0.08, respectively. 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. The following unaudited pro forma combined financial information for the nine months ended September 30, 2003, assumes that the acquisition of Unilab and the related Divestiture were completed on January 1, 2003 (in thousands, except per share data):
Nine Months Ended September 30, 2003 ------------------ Pro forma ------------------ Net revenues ......................... $3,599,870 Net income ........................... 336,698 Basic earnings per common share: Net income ........................... $ 3.21 Weighted average common shares outstanding - basic ............... 104,807 Diluted earnings per common share: Net income ........................... $ 3.14 Weighted average common shares outstanding - diluted ............. 107,333
7 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED (in thousands, unless otherwise indicated) (unaudited) 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 nine months ended September 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. 3. GOODWILL AND INTANGIBLE ASSETS Goodwill at September 30, 2004 and December 31, 2003 consisted of the following:
September 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 nine month period ended September 30, 2004 and for the year ended December 31, 2003 are as follows:
September 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 September 30, 2004 and December 31, 2003 consisted of the following:
Weighted September 30, 2004 December 31, 2003 Average -------------------------------- -------------------------------- Amortization Accumulated Accumulated Period Cost Amortization Net Cost Amortization Net ------------ ------- ------------ ------- ------- ------------ ------- Non-compete agreements ............... 5 years $44,942 $(41,910) $ 3,032 $44,942 $(37,947) $ 6,995 Customer lists ....................... 15 years 42,225 (36,931) 5,294 42,225 (35,568) 6,657 Other ................................ 10 years 6,850 (2,798) 4,052 5,895 (2,569) 3,326 ------- -------- ------- ------- -------- ------- Total ............................. 10 years $94,017 $(81,639) $12,378 $93,062 $(76,084) $16,978 ======= ======== ======= ======= ======== =======
Amortization expense related to intangible assets was $1,664 and $2,055 for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, amortization expense related to intangible assets was $5,786 and $6,146, 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 September 30, 2004 is as follows:
Fiscal Year Ending December 31, - --------------------------- Remainder of 2004.......... $ 986 2005....................... 3,704 2006....................... 2,428 2007....................... 1,038 2008....................... 847 2009....................... 750 Thereafter................. 2,625 ------- Total................... $12,378 =======
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 ratings. As of September 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 public debt 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 September 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 nine months ended September 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 $55 million at September 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 relating to billing practices filed under the qui tam provisions of the civil False Claims Act and other state and local statutes. Some of the proceedings against the Company involve claims that are substantial in amount. On October 25, 2004, the Company and its test kit manufacturing subsidiary, Nichols Institute Diagnostics, each received a subpoena from the United States Attorney's office for the Eastern District of New York. The subpoenas seek the production of various business records, including documents related to tests cleared by the Food and Drug Administration for parathyroid hormone, or PTH, levels. The Company intends to cooperate with the government's investigation. Nichols Institute Diagnostics manufactures and markets diagnostic test kits and systems primarily for esoteric testing. These tests are sold principally to hospitals, clinical laboratories and dialysis centers. Quest Diagnostics' net revenues from sales of the PTH test kits and related PTH laboratory testing are estimated to be less than 1% of consolidated net revenues. In addition, 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 believes that established reserves for legal matters are sufficient, it is possible that additional information (such as the indication by the government of criminal activity, additional tests being questioned or other changes in the government's or private claimants' theories of wrongdoing) may become available which may cause the final resolution of these matters to exceed established reserves by an amount which could be material to the Company's results of operations and cash flows in the period in which such claims are settled. The Company does not believe that these issues will have a material adverse effect on its overall financial position. However, the Company understands that there may be pending qui tam claims brought by former employees or other "whistle blowers", or other pending claims as to which the Company has not been provided with a copy of the complaint and accordingly cannot determine the extent of any potential liability. 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 nine months ended September 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 .................... 373,122 $373,122 Other comprehensive loss ...... (5,757) (5,757) -------- Comprehensive income ....... $367,365 ======== Dividends declared ............ (45,997) Issuance of common stock under benefit plans ........ 144 1 1,524 962 8,126 Exercise of stock options ..... 2,701 (102,170) 185,255 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 ......... 54,156 Amortization of unearned compensation ............... 1,179 Purchases of treasury stock ... (4,546) (381,145) ------------------------------------------------------------------------------- Balance, September 30, 2004 ......... 101,037 $1,068 $2,214,259 $707,684 $ (205) $ 190 $(445,312) ===============================================================================
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. In July 2004, the Company's Board of Directors authorized the Company to purchase up to an additional $300 million of its common stock. For the three months ended September 30, 2004, the Company repurchased approximately 1.3 million shares of its common stock at an average price of $81.64 per share for a total of $110 million. For the nine months ended September 30, 2004, the Company repurchased approximately 4.5 million shares of its common stock at an average price of $83.84 per share for a total of $381 million. Through September 30, 2004, the Company has repurchased approximately 8.5 million shares of its common stock at an average price of $74.82 for a total of $639 million. At September 30, 2004, $261 million of the share repurchase authorization remained available. For the three and nine months ended September 30, 2004, the Company reissued approximately 0.7 million shares and 2.8 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 $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 $15.3 million. During the third quarter of 2004, the Company's Board of Directors declared a quarterly cash dividend of $0.15 per common share payable on October 22, 2004 to shareholders of record on October 8, 2004 and totaled $15.2 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 nine months ended September 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 .................... 328,472 $328,472 Other comprehensive income ..................... 4,862 4,862 -------- Comprehensive income ....... $333,334 ======== 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 ........ 329 3 14,527 (4,365) Exercise of stock options ..... 928 9 16,764 Shares to cover employee payroll tax withholdings on stock issued under benefit plans .............. (174) (2) (9,328) Tax benefits associated with stock-based compensation plans ...................... 17,880 Amortization of unearned compensation ............... 4,093 Purchases of treasury stock ... (2,355) (141,334) ----------------------------------------------------------------------------------- Balance, September 30, 2003 ......... 103,746 $1,061 $2,238,199 $287,700 $(3,604) $ (662) $(141,334) ===================================================================================
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 Nine Months Ended September 30, September 30, ------------------- ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Depreciation expense ................ $ 40,874 $ 36,473 $120,669 $107,354 Interest expense .................... (14,067) (14,580) (45,885) (45,758) Interest income ..................... 437 108 1,265 511 -------- -------- -------- -------- Interest expense, net ............... (13,630) (14,472) (44,620) (45,247) Interest paid ....................... 21,505 22,455 47,420 55,000 Income taxes paid ................... 30,952 49,637 143,343 150,267 Businesses acquired: Fair value of assets acquired ....... $ -- $ 1,129 $ -- $978,995 Fair value of liabilities assumed ... -- 1,129 -- 280,639 Non-cash financing activities: Treasury stock purchases not settled .......................... $ -- $ 17,253 $ -- $ 17,253 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 September 30, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated -------- ---------- ------------- ------------ ------------ Net revenues .............................. $208,270 $1,016,843 $ 131,491 $(66,707) $ 1,289,897 Operating costs and expenses: Cost of services ....................... 111,829 592,352 44,243 -- 748,424 Selling, general and administrative .... 22,871 221,531 68,788 (4,942) 308,248 Amortization of intangible assets ...... 381 1,274 9 -- 1,664 Royalty (income) expense ............... (83,418) 83,418 -- -- -- Other operating income, net ............ (3) (3) (136) -- (142) -------- ---------- --------- -------- ----------- Total operating costs and expenses .. 51,660 898,572 112,904 (4,942) 1,058,194 -------- ---------- --------- -------- ----------- Operating income .......................... 156,610 118,271 18,587 (61,765) 231,703 Non-operating expenses, net ............... (18,611) (55,217) (909) 61,765 (12,972) -------- ---------- --------- -------- ----------- Income before taxes ....................... 137,999 63,054 17,678 -- 218,731 Income tax expense ........................ 56,127 25,221 7,239 -- 88,587 -------- ---------- --------- -------- ----------- Income before equity earnings ............. 81,872 37,833 10,439 -- 130,144 Equity earnings from subsidiaries ......... 48,272 -- -- (48,272) -- -------- ---------- --------- -------- ----------- Net income ................................ $130,144 $ 37,833 $ 10,439 $(48,272) $ 130,144 ======== ========== ========= ======== ===========
Condensed Consolidating Statement of Operations Three Months Ended September 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated -------- ---------- ------------- ------------ ------------ Net revenues .............................. $199,163 $962,175 $113,763 $(53,880) $1,221,221 Operating costs and expenses: Cost of services ....................... 118,426 551,450 41,304 -- 711,180 Selling, general and administrative .... 17,602 223,405 55,398 (3,992) 292,413 Amortization of intangible assets ...... 218 1,828 9 -- 2,055 Royalty (income) expense ............... (73,098) 73,098 -- -- -- Other operating (income) expense, net .. -- (2,217) 267 -- (1,950) -------- -------- -------- -------- ---------- Total operating costs and expenses .. 63,148 847,564 96,978 (3,992) 1,003,698 -------- -------- -------- -------- ---------- Operating income .......................... 136,015 114,611 16,785 (49,888) 217,523 Non-operating expenses, net ............... (15,953) (47,250) (1,455) 49,888 (14,770) -------- -------- -------- -------- ---------- Income before taxes ....................... 120,062 67,361 15,330 -- 202,753 Income tax expense ........................ 49,813 26,945 5,971 -- 82,729 -------- -------- -------- -------- ---------- Income before equity earnings ............. 70,249 40,416 9,359 -- 120,024 Equity earnings from subsidiaries ......... 49,775 -- -- (49,775) -- -------- -------- -------- -------- ---------- Net income ................................ $120,024 $ 40,416 $ 9,359 $(49,775) $ 120,024 ======== ======== ======== ======== ==========
14 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Statement of Operations Nine Months Ended September 30, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Net revenues ............................... $ 618,043 $3,030,825 $386,408 $(191,963) $3,843,313 Operating costs and expenses: Cost of services ........................ 348,111 1,753,149 132,022 -- 2,233,282 Selling, general and administrative ..... 78,315 668,050 191,050 (14,220) 923,195 Amortization of intangible assets ....... 1,407 4,352 27 -- 5,786 Royalty (income) expense ................ (247,385) 247,385 -- -- -- Other operating expense, net ............ 9,883 19 547 -- 10,449 --------- ---------- -------- --------- ---------- Total operating costs and expenses ... 190,331 2,672,955 323,646 (14,220) 3,172,712 --------- ---------- -------- --------- ---------- Operating income ........................... 427,712 357,870 62,762 (177,743) 670,601 Non-operating expenses, net ................ (54,139) (164,237) (2,872) 177,743 (43,505) --------- ---------- -------- --------- ---------- Income before taxes ........................ 373,573 193,633 59,890 -- 627,096 Income tax expense ......................... 153,112 77,453 23,409 -- 253,974 --------- ---------- -------- --------- ---------- Income before equity earnings .............. 220,461 116,180 36,481 -- 373,122 Equity earnings from subsidiaries .......... 152,661 -- -- (152,661) -- --------- ---------- -------- --------- ---------- Net income ................................. $ 373,122 $ 116,180 $ 36,481 $(152,661) $ 373,122 ========= ========== ======== ========= ==========
Condensed Consolidating Statement of Operations Nine Months Ended September 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Net revenues ............................... $ 594,443 $2,768,500 $349,472 $(178,462) $3,533,953 Operating costs and expenses: Cost of services ........................ 347,796 1,595,731 118,874 -- 2,062,401 Selling, general and administrative ..... 54,874 656,213 168,365 (11,778) 867,674 Amortization of intangible assets ....... 1,328 4,809 9 -- 6,146 Royalty (income) expense ................ (213,063) 213,063 -- -- -- Other operating (income) expense, net ... -- (2,224) 507 -- (1,717) --------- ---------- -------- --------- ---------- Total operating costs and expenses ... 190,935 2,467,592 287,755 (11,778) 2,934,504 --------- ---------- -------- --------- ---------- Operating income ........................... 403,508 300,908 61,717 (166,684) 599,449 Non-operating expenses, net ................ (50,792) (156,115) (4,274) 166,684 (44,497) --------- ---------- -------- --------- ---------- Income before taxes ........................ 352,716 144,793 57,443 -- 554,952 Income tax expense ......................... 144,932 57,917 23,631 -- 226,480 --------- ---------- -------- --------- ---------- Income before equity earnings .............. 207,784 86,876 33,812 -- 328,472 Equity earnings from subsidiaries .......... 120,688 -- -- (120,688) -- --------- ---------- -------- --------- ---------- Net income ................................. $ 328,472 $ 86,876 $ 33,812 $(120,688) $ 328,472 ========= ========== ======== ========= ==========
15 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED (in thousands, unless otherwise indicated) (unaudited) Condensed Consolidating Balance Sheet September 30, 2004
Non- Subsidiary Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ---------- ---------- ------------ ------------ ------------ Assets Current assets: Cash and cash equivalents ................. $ 185,315 $ 3,237 $ 12,484 $ -- $ 201,036 Accounts receivable, net .................. 25,504 92,070 568,471 -- 686,045 Other current assets ...................... 30,802 106,955 87,997 -- 225,754 ---------- ---------- --------- ----------- ---------- Total current assets ................... 241,621 202,262 668,952 -- 1,112,835 Property, plant and equipment, net ........ 218,687 373,889 25,425 -- 618,001 Goodwill and intangible assets, net ....... 158,289 2,326,043 45,384 -- 2,529,716 Intercompany receivable (payable) ......... 606,013 (205,733) (400,280) -- -- Investment in subsidiaries ................ 2,065,716 -- -- (2,065,716) -- Other assets .............................. 42,421 54,011 37,974 -- 134,406 ---------- ---------- --------- ----------- ---------- Total assets ........................... $3,332,747 $2,750,472 $ 377,455 $(2,065,716) $4,394,958 ========== ========== ========= =========== ========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses ..... $ 379,253 $ 241,987 $ 28,470 $ -- $ 649,710 Short-term borrowings and current portion of long-term debt ....................... -- 261 129,921 -- 130,182 ---------- ---------- --------- ----------- ---------- Total current liabilities .............. 379,253 242,248 158,391 -- 779,892 Long-term debt ............................ 416,092 553,762 1,956 -- 971,810 Other liabilities ......................... 59,718 81,360 24,494 -- 165,572 Common stockholders' equity ............... 2,477,684 1,873,102 192,614 (2,065,716) 2,477,684 ---------- ---------- --------- ----------- ---------- Total liabilities and stockholders' equity .............................. $3,332,747 $2,750,472 $ 377,455 $(2,065,716) $4,394,958 ========== ========== ========= =========== ==========
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 Nine Months Ended September 30, 2004
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Cash flows from operating activities: Net income ................................. $ 373,122 $116,180 $ 36,481 $(152,661) $ 373,122 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization ........... 42,786 76,047 7,622 -- 126,455 Provision for doubtful accounts ......... 3,662 34,724 133,641 -- 172,027 Other, net .............................. (59,065) 406 9,616 152,661 103,618 Changes in operating assets and liabilities .......................... 69,567 (50,924) (258,658) -- (240,015) --------- -------- --------- --------- --------- Net cash provided by (used in) operating activities .............................. 430,072 176,433 (71,298) -- 535,207 Net cash used in investing activities ...... (140,390) (78,038) (5,466) 94,122 (129,772) Net cash (used in) provided by financing activities .............................. (245,955) (97,149) 77,869 (94,122) (359,357) --------- -------- --------- --------- --------- Net change in cash and cash equivalents .... 43,727 1,246 1,105 -- 46,078 Cash and cash equivalents, beginning of period ............................... 141,588 1,991 11,379 -- 154,958 --------- -------- --------- --------- --------- Cash and cash equivalents, end of period ... $ 185,315 $ 3,237 $ 12,484 $ -- $ 201,036 ========= ======== ========= ========= =========
Condensed Consolidating Statement of Cash Flows Nine Months Ended September 30, 2003
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated --------- ---------- ------------- ------------ ------------ Cash flows from operating activities: Net income ................................. $ 328,472 $ 86,876 $ 33,812 $(120,688) $ 328,472 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ........... 39,945 67,017 6,538 -- 113,500 Provision for doubtful accounts ......... 4,468 47,867 119,767 -- 172,102 Other, net .............................. (76,240) (6,874) 12,022 120,688 49,596 Changes in operating assets and liabilities .......................... (15,149) (140,340) (107,668) -- (263,157) --------- --------- --------- --------- --------- Net cash provided by operating activities .............................. 281,496 54,546 64,471 -- 400,513 Net cash used in investing activities ...... (265,518) (62,282) (13,202) (20,642) (361,644) Net cash (used in) provided by financing activities .............................. (15,692) 3,526 (53,054) 20,642 (44,578) --------- --------- --------- --------- --------- Net change in cash and cash equivalents .... 286 (4,210) (1,785) -- (5,709) Cash and cash equivalents, beginning of period ............................... 79,015 7,377 10,385 -- 96,777 --------- --------- --------- --------- --------- Cash and cash equivalents, end of period ... $ 79,301 $ 3,167 $ 8,600 $ -- $ 91,068 ========= ========= ========= ========= =========
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. Results of Operations Three and Nine Months Ended September 30, 2004 Compared with Three and Nine Months Ended September 30, 2003 Net income for the three months ended September 30, 2004 increased to $130 million from $120 million for the prior year period. For the nine months ended September 30, 2004, net income increased to $373 million from $328 million for the prior year period. These increases in earnings were primarily attributable to revenue growth and efficiencies generated from our Six Sixma and standardization initiatives, partially offset by investments in our operations. During the quarter ended September 30, 2004, we estimate the impact of hurricanes on our business in the southeastern part of the United States reduced revenue growth by slightly more than one-half of a percent and reduced earnings per common share by $0.03. In addition, for the nine-month period ended September 30, 2004, the increase in earnings was partially offset by 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 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 the nine months ended September 30, 2004 by $7.9 million. Net Revenues Net revenues for the three months ended September 30, 2004 grew by 5.6% over the prior year level. This increase was driven by improvements in testing volumes and increases in average revenue per requisition, partially offset by the impact of hurricanes, which we estimate reduced revenue growth by slightly more than one-half of a percent. Net revenues for the nine months ended September 30, 2004 grew by 8.8% over the prior year level and include nine months of Unilab's results, which was acquired on February 28, 2003, compared to seven 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 6.8% for the nine months ended September 30, 2004. For the three and nine months ended September 30, 2004, clinical testing volume, measured by the number of requisitions, increased 3.3% and 5.3%, respectively, compared to the prior year periods. The improvement in testing 18 volume for the three months ended September 30, 2004 reflects an estimated reduction of just over one-half of a percent due to hurricanes. On a pro forma basis, assuming that the Unilab acquisition and the Divestiture had been completed on January 1, 2003, testing volume increased 2.8% for the nine months ended September 30, 2004. Average revenue per requisition improved 1.9% and 2.9% for the three and nine months ended September 30, 2004, respectively, compared to the prior year periods. These improvements are primarily attributable to a continuing shift in test mix to higher value testing, including gene-based testing, and increases in the number of tests ordered per requisition. The improvement for the third quarter reflects a slower rate of growth than reported in the first half of 2004, and reflects about one-half of a percent reduction from a shift in payer mix associated with certain new business. The inclusion of Unilab's results subsequent to February 28, 2003 served to reduce average revenue per requisition by approximately 0.5% for the nine months ended September 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 third consecutive quarter after several years of decline. The growth in drugs of abuse testing contributed to the shift in payer mix referenced above. Our businesses, other than clinical laboratory testing, which represent approximately 4% of our consolidated net revenues, grew approximately 15% and 20% during the three and nine months ended September 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 nine months ended September 30, 2004 increased $54 million and $238 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 58.0% of net revenues for the three months ended September 30, 2004, decreasing from 58.2% of net revenues in the prior year period. For the nine months ended September 30, 2004, cost of services, as a percentage of net revenues, decreased to 58.1% 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 September 30, 2004, nearly 40% of our orders and more than 50% of our test results were being transmitted via the Internet. 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 physician employed phlebotomists compared to samples collected by our 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, was 23.9% of net revenues during the three months ended September 30, 2004, unchanged from the prior year period. For the nine months ended September 30, 2004, selling, general and administrative expenses, as a percentage of net revenues, decreased to 24.0% from 24.6% in the prior year period. The improvement for the nine-month period was 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 third quarter of 2004, bad debt expense improved to 4.6% of net revenues, compared to 4.8% in the prior year period. For the nine months ended September 30, 2004, bad debt expense was 4.5% of net revenues, compared to 4.9% of net revenues in the prior year period. This decrease primarily relates to the improved collection of diagnosis, patient and insurance information necessary to more effectively bill for services performed. We believe that our Six Sigma and standardization initiatives 19 and the increased use of electronic ordering by our customers will provide additional opportunities to further improve our overall collection experience and cost structure. Other operating (income) 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 nine months ended September 30, 2004, other operating (income) expense, net includes a $10.3 million charge associated with the acceleration of certain pension obligations in connection with the CEO succession process. For the three and nine months ended September 30, 2003, other operating (income) expense, net includes $3.3 million of gains on the sale of certain operating assets, partially offset by a $1.1 million charge associated with the integration of Unilab. Operating Income Operating income for the three months ended September 30, 2004 improved to $232 million, or 18.0% of net revenues, from $218 million, or 17.8% of net revenues, in the prior year period. The percentage for the third quarter of 2004 reflects a reduction of approximately 0.6%, contributed equally by the estimated impact of hurricanes and an increase in bad debt expense compared to the second quarter of 2004. For the nine months ended September 30, 2004, operating income improved to $671 million, or 17.4% of net revenues, from $599 million, or 17.0% of net revenues, in the prior year period. The increases in operating income for the three and nine months ended September 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, for the nine-month period, selling, general and administrative expenses as a percentage of net revenues. Offsetting these improvements were investments in our operations and, for the nine-month period, a charge in the second quarter of 2004 of $10.3 million related to the acceleration of certain pension obligations associated with the CEO succession process. This charge reduced operating income, as a percentage of net revenues, by 0.3% for the nine months ended September 30, 2004. Other Income (Expense) Interest expense, net for the three and nine months ended September 30, 2004 decreased from the prior year periods primarily due to a reduction in borrowing costs associated with our 2004 refinancing as well as a reduction in the amount of debt outstanding, compared to the prior year. In addition, interest expense, net for the nine months ended September 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. 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 nine months ended September 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 nine months ended September 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 new accounting standards. 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. 20 At both September 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 September 30, 2004 and December 31, 2003, the estimated fair value exceeded the carrying value of the debt by approximately $74 million and $86 million, respectively. An assumed 10% increase in interest rates (representing approximately 45 and 50 basis points at September 30, 2004 and December 31, 2003, respectively) would reduce the estimated fair value of our debt by approximately $15 million and $17 million at September 30, 2004 and December 31, 2003, respectively. 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 September 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 on the secured receivables credit facility is based on rates that are intended to approximate commercial paper rates for highly rated issuers. 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 September 30, 2004, our borrowing rates for our LIBOR-based loans ranged from LIBOR plus 0.55% to LIBOR plus 0.625%. At September 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 $0.6 million, assuming no changes to the debt outstanding at September 30, 2004. Liquidity and Capital Resources Cash and Cash Equivalents Cash and cash equivalents at September 30, 2004 totaled $201 million, compared to $155 million at December 31, 2003. Cash flows from operating activities in 2004 were $535 million which were used to fund investing and financing activities, which required cash of $130 million and $359 million, respectively. Cash and cash equivalents at September 30, 2003 totaled $91 million, compared to $97 million at December 31, 2002. Cash flows from operating activities in 2003 provided cash of $401 million which, together with cash on-hand, were used to fund investing and financing activities, which required cash of $362 million and $45 million, respectively. Cash Flows From Operating Activities Net cash provided by operating activities for the nine months ended September 30, 2004 was $535 million compared to $401 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, was 48 days at September 30, 2004 unchanged from December 31, 2003. Cash Flows From Investing Activities Net cash used in investing activities for the nine months ended September 30, 2004 was $130 million, consisting primarily of capital expenditures of $134 million. Net cash used in investing activities for the nine months ended September 30, 2003 was $362 million, consisting primarily of acquisition and related transaction costs of $238 million to acquire the outstanding capital stock of Unilab, and capital expenditures of $122 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 for the nine months ended September 30, 2004 was $359 million, consisting primarily of purchases of treasury stock totaling $381 million and dividend payments totaling $46 million, partially offset by $83 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 $381 million in treasury stock purchases represents 4.5 million shares of our common stock repurchased at an average price of $83.84 per share. Net cash used in financing activities for the nine months ended September 30, 2003 was $45 million, consisting primarily of $450 million of borrowings under our term loan due June 2007, partially offset by debt repayments totaling $373 million. Borrowings under our term loan 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 due June 2007 and $24 million of capital lease repayments. In addition during the nine months ended September 30, 2003, we repurchased 2.4 million shares of our common stock at an average price of $60.00 per share for a total of $141 million. At September 30, 2003, $17 million of the purchases had not been settled and as such are not included in "cash flows from financing activities" on the consolidated statement of cash flows. 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 common 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. In July 2004, our Board of Directors authorized us to purchase up to an additional $300 million of our common stock. For the three months ended September 30, 2004, we repurchased approximately 1.3 million shares of our common stock at an average price of $81.64 per share for a total of $110 million. For the nine months ended September 30, 2004, we repurchased approximately 4.5 million shares of our common stock at an average price of $83.84 per share for a total of $381 million. Through September 30, 2004, we have repurchased approximately 8.5 million shares of our common stock at an average price of $74.82 for a total of $639 million under our share repurchase program. At September 30, 2004, the total available for repurchases under the remaining authorizations was $261 million. 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 22 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 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. See Note 4 to the interim consolidated financial statements for further details regarding the refinancings. As of September 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, or EITF, reached a final consensus on Issue 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share". In September 2004, the EITF reached a final consensus on Issue 04-8, "The Effect of Contingently Convertible Instruments on Diluted 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 legal proceedings involving the Company. Item 2. Unregistered Sales of Equity 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 Plans Programs Period Purchased Paid per Share or Programs (in thousands) - --------------------------------------------------------------------------------------------------------------- July 1, 2004 - July 31, 2004 409,000 $81.33 409,000 $338,083 - --------------------------------------------------------------------------------------------------------------- August 1, 2004 - August 31, 2004 938,900 $81.77 938,900 $261,306 - --------------------------------------------------------------------------------------------------------------- September 1, 2004 - September 30, 2004 -- -- -- $261,306 - --------------------------------------------------------------------------------------------------------------- Total 1,347,900 $81.64 1,347,900 $261,306 - ---------------------------------------------------------------------------------------------------------------
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. Item 6. Exhibits
Exhibits: 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
25 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. October 29, 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 26 STATEMENT OF DIFFERENCES ------------------------ The section symbol shall be expressed as................................ 'SS' EX-31 2 ex31-1.txt EXHIBIT 31.1 Exhibit 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Surya N. Mohapatra certify that: 1. I have reviewed this quarterly report on Form 10-Q of Quest Diagnostics Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. October 29, 2004 By /s/ Surya N. Mohapatra ------------------------------------- Surya N. Mohapatra, Ph.D. President and Chief Executive Officer EX-31 3 ex31-2.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Robert A. Hagemann, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Quest Diagnostics Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. October 29, 2004 By /s/ Robert A. Hagemann ------------------------------------- Robert A. Hagemann Senior Vice President and Chief Financial Officer EX-32 4 ex32-1.txt EXHIBIT 32.1 Exhibit 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 Pursuant to 18 U.S.C. 'SS' 1350, the undersigned certifies that, to the best of my knowledge, the Quarterly Report on Form 10-Q for the period ended September 30, 2004 of Quest Diagnostics Incorporated, as being filed with the Securities and Exchange Commission concurrently herewith, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 'SS' 78m or 78o(d)) and that the information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of Quest Diagnostics Incorporated. Dated: October 29, 2004 /s/ Surya N. Mohapatra ---------------------------------------- Surya N. Mohapatra, Ph.D. President and Chief Executive Officer EX-32 5 ex32-2.txt EXHIBIT 32.2 Exhibit 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 Pursuant to 18 U.S.C. 'SS' 1350, the undersigned certifies that, to the best of my knowledge, the Quarterly Report on Form 10-Q for the period ended September 30, 2004 of Quest Diagnostics Incorporated, as being filed with the Securities and Exchange Commission concurrently herewith, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 'SS' 78m or 78o(d)) and that the information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of Quest Diagnostics Incorporated. Dated: October 29, 2004 /s/ Robert A. Hagemann ---------------------------------------- Robert A. Hagemann Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----