-----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, TELcRTr3eqtwX2MUC0vSKIcsIRnWf1MAkLqgFw8nm6i6z46FVGhoLOJJwR5Z9aB7 mICHJc5GRyTomVC2ZiGp8g== 0001047469-99-032015.txt : 19990816 0001047469-99-032015.hdr.sgml : 19990816 ACCESSION NUMBER: 0001047469-99-032015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 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: SEC FILE NUMBER: 001-12215 FILM NUMBER: 99689643 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 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 - -------------------------------------------------------------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended June 30, 1999 Commission file number 1-12215 QUEST DIAGNOSTICS INCORPORATED One Malcolm Avenue Teterboro, NJ 07608 (201) 393-5000 DELAWARE (State of Incorporation) 16-1387862 (I.R.S. Employer Identification Number) - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ------ As of July 30, 1999, there were outstanding 30,430,689 shares of Common Stock, $.01 par value. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Index to consolidated financial statements filed as part of this report: Page Consolidated Statements of Operations for the Three and Six Months Ended June 30, 1999 and 1998 2 Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1999 and 1998 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 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations"
1 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- ------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1999 1998 1999 1998 ----------- ----------- ----------- ----------- NET REVENUES....................................... $ 394,034 $ 366,739 $ 775,875 $ 734,614 COSTS AND EXPENSES: Cost of services................................ 225,659 217,806 452,654 435,846 Selling, general and administrative............. 131,642 116,133 258,655 236,579 Interest expense, net........................... 5,008 9,036 12,367 18,150 Amortization of intangible assets............... 5,219 5,366 10,313 10,746 Other, net...................................... 1,999 139 3,301 1,364 ----------- ----------- ----------- ----------- Total......................................... 369,527 348,480 737,290 702,685 ----------- ----------- ----------- ----------- INCOME BEFORE TAXES................................ 24,507 18,259 38,585 31,929 INCOME TAX EXPENSE ................................ 11,420 9,405 18,065 16,444 ----------- ----------- ----------- ----------- NET INCOME ........................................ $ 13,087 $ 8,854 $ 20,520 $ 15,485 =========== =========== =========== =========== Basic net income per common share.................. $ 0.44 $ 0.30 $ 0.69 $ 0.52 Diluted net income per common share................ $ 0.43 $ 0.29 $ 0.67 $ 0.51 Basic weighted average common shares outstanding... 29,920 29,783 29,819 29,736 Diluted weighted average common shares outstanding. 30,729 30,579 30,505 30,290
The accompanying notes are an integral part of these statements. 2 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 1999 AND DECEMBER 31, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA)
June 30, December 31, 1999 1998 ------------ ------------ (unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents............................................. $ 148,478 $ 202,908 Accounts receivable, net of allowance of $68,766 and $70,701 at June 30, 1999 and December 31, 1998, respectively.............. 224,920 220,861 Inventories........................................................... 32,923 31,164 Deferred taxes on income.............................................. 92,521 94,441 Due from Corning Incorporated......................................... 14,015 16,000 Prepaid expenses and other assets..................................... 14,950 12,813 ------------ ------------ Total current assets.............................................. 527,807 578,187 PROPERTY, PLANT AND EQUIPMENT, NET......................................... 243,107 240,389 INTANGIBLE ASSETS, NET..................................................... 482,813 494,721 OTHER ASSETS............................................................... 59,080 46,943 ------------ ------------ TOTAL ASSETS............................................................... $ 1,312,807 $ 1,360,240 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses................................. $ 239,224 $ 242,285 Current portion of long-term debt..................................... 61,452 51,444 Income taxes payable.................................................. 12,679 15,736 ------------ ------------ Total current liabilities......................................... 313,355 309,465 LONG-TERM DEBT............................................................. 338,391 413,426 OTHER LIABILITIES.......................................................... 63,243 69,419 COMMITMENTS AND CONTINGENCIES PREFERRED STOCK............................................................ 1,000 1,000 COMMON STOCKHOLDERS' EQUITY: Common stock, par value $0.01 per share; 100,000 shares authorized; 30,359 and 30,241 shares issued at June 30, 1999 and December 31, 1998, respectively........................................ 304 302 Additional paid-in capital............................................ 1,201,883 1,201,006 Accumulated deficit................................................... (603,051) (623,514) Unearned compensation................................................. (2,751) (3,895) Accumulated other comprehensive income (loss)......................... 433 (3,038) Common stock in treasury, at cost; 214 shares at December 31, 1998................................................. -- (3,931) ------------ ------------ Total common stockholders' equity................................. 596,818 566,930 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 1,312,807 $ 1,360,240 ============ ============
The accompanying notes are an integral part of these statements. 3 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (IN THOUSANDS) (UNAUDITED)
1999 1998 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................................. $ 20,520 $ 15,485 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......................................... 33,146 34,497 Provision for doubtful accounts....................................... 40,242 44,999 Deferred income tax provision......................................... 6,300 13,096 Other, net............................................................ 4,636 3,735 Changes in operating assets and liabilities: Accounts receivable............................................... (44,481) (49,868) Accounts payable and accrued expenses............................. 8,042 2,791 Restructuring, integration and other special charges.............. (9,775) (15,719) Due from Corning Incorporated and affiliates...................... -- 5,815 Other assets and liabilities, net................................. (6,024) (13,645) ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES.................................. 52,606 41,186 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures.................................................. (25,938) (19,457) Transaction costs..................................................... (5,176) -- Proceeds from disposition of assets................................... 848 460 Increase in investments............................................... (5,687) (482) ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES...................................... (35,953) (19,479) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of long-term debt........................................... (64,991) (25,730) Financing costs paid.................................................. (4,947) -- Purchase of treasury stock............................................ (1,103) (4,994) Distributions to minority partners.................................... (975) -- Dividends paid........................................................ (58) (58) Exercise of stock options............................................. 991 100 ---------- ---------- NET CASH USED IN FINANCING ACTIVITIES...................................... (71,083) (30,682) ---------- ---------- NET CHANGE IN CASH AND CASH EQUIVALENTS.................................... (54,430) (8,975) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................... 202,908 161,661 ---------- ---------- CASH AND CASH EQUIVALENTS, END OF PERIOD................................... $ 148,478 $ 152,686 ========== ========== CASH PAID DURING THE PERIOD FOR: Interest.............................................................. $ 19,259 $ 21,960 Income taxes.......................................................... $ 11,148 $ 11,699
The accompanying notes are an integral part of these statements. 4 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) 1. BASIS OF PRESENTATION BACKGROUND Prior to January 1, 1997, Quest Diagnostics Incorporated and its subsidiaries (the "Company" or "Quest Diagnostics") was a wholly-owned subsidiary of Corning Incorporated ("Corning"). On December 31, 1996, Corning distributed all of the outstanding shares of common stock of the Company to the stockholders of Corning, with one share of common stock of the Company being distributed for each eight shares of outstanding common stock of Corning (the "Spin-Off Distribution"). BASIS OF PRESENTATION The interim consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of operations for the periods presented. All such adjustments are of a normal recurring nature. The interim consolidated financial statements have been compiled without audit and are subject to year-end adjustments. Operating results for the interim period are not necessarily indicative of the results that may 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 Form 10-K for the year ended December 31, 1998. COMPREHENSIVE INCOME Comprehensive income encompasses all changes in stockholders' equity (except those arising from transactions with stockholders) and includes net income, net unrealized capital gains or losses on available-for-sale securities and foreign currency translation adjustments. Comprehensive income was $24.0 million and $15.8 million for the six months ended June 30, 1999 and 1998, respectively. Comprehensive income was $15.2 million and $8.7 million for the quarter ended June 30, 1999 and 1998, respectively. EARNINGS PER SHARE Basic net income per common share is calculated by dividing net income, less preferred stock dividends (approximately $30 per quarter), by the weighted average number of common shares outstanding. Diluted net income per common share is calculated by dividing net income, less preferred stock dividends, by the weighted average number of common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include outstanding stock options and restricted common shares granted under the Company's Employee Equity Participation Program. 5 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) 2. ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS On February 9, 1999, the Company signed a definitive agreement to acquire the clinical laboratory business of SmithKline Beecham plc ("SmithKline Beecham") for approximately $1.3 billion. The purchase price will be paid through the issuance of approximately 12.6 million shares of common stock of Quest Diagnostics and the payment of $1.025 billion of cash. The acquisition will be accounted for under the purchase method of accounting. Quest Diagnostics expects to close the transaction in August 1999. As a result, SmithKline Beecham will own approximately 29.5% of Quest Diagnostics' outstanding common stock. Under the terms of a stockholder agreement, SmithKline Beecham will initially have the right to designate two nominees to Quest Diagnostics' Board of Directors as long as SmithKline Beecham owns at least 20% of the outstanding common stock. (As long as SmithKline Beecham owns at least 10% but less than 20% of the outstanding common stock, it will have the right to designate one nominee.) Quest Diagnostics' Board of Directors will expand to nine directors immediately following the close. The stockholder agreement will also impose limitations on the right of SmithKline Beecham to sell or vote its shares and prohibit SmithKline Beecham from purchasing in excess of 29.5% of the outstanding common stock of Quest Diagnostics. The transaction was approved by Quest Diagnostics' shareholders on June 29, 1999. In conjunction with this transaction, the Board of Directors of Quest Diagnostics approved an amendment to the preferred share purchase rights of the Quest Diagnostics common stock. Under the amendment, stockholders would not have the right to purchase shares of common stock at a predefined price as a result of SmithKline Beecham owning the shares of common stock to be issued in the transaction or SmithKline Beecham's purchase of additional shares provided that SmithKline Beecham does not own more than 29.5% of the Company's outstanding common stock. 3. COMMITMENTS AND CONTINGENCIES The Company has entered into several settlement agreements with various governmental and private payers during recent years relating primarily to industry-wide billing and marketing practices that had been substantially discontinued by early 1993. At present, government investigations of certain practices by Nichols Institute, a clinical laboratory company acquired in 1994, are ongoing. The Company has received notices of private claims relating to billing issues similar to those that were the subject of prior settlements with various governmental payers. In March 1997, a former subsidiary of Damon Corporation ("Damon"), an independent clinical laboratory acquired by Corning and contributed to Quest Diagnostics in 1993, was served a complaint in a purported class action. The complaint asserts claims relating to private reimbursement of billings by Damon that are similar to those that were part of a prior government settlement. While the ultimate outcome of these claims cannot be predicted, based on information currently available to the Company, management does not believe that exposure related to these claims or the remaining government investigations in excess of recorded reserves is material. Corning has agreed to indemnify the Company against all monetary settlements for any governmental claims relating to the billing practices of the Company and its predecessors based on investigations that were pending on December 31, 1996. Corning also agreed to indemnify the Company in respect of private claims relating to indemnified or previously settled government claims that alleged overbillings by Quest Diagnostics or any of its existing subsidiaries for services provided before January 1, 1997. Corning will indemnify Quest Diagnostics in respect of private claims for 50% of the aggregate of all judgment or settlement payments made by December 31, 2001 that exceed $42 million. The 50% share will be limited to 6 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) a total amount of $25 million and will be reduced to take into account any deductions or tax benefits realized by Quest Diagnostics. At June 30, 1999, the receivable from Corning totaled $14 million, which is management's best estimate of amounts which are probable of being received from Corning to satisfy the remaining indemnified governmental claims on an after-tax basis. At June 30, 1999, recorded reserves approximated $49.8 million, including $18.8 million in other long-term liabilities. Although management believes that established reserves for both indemnified and non-indemnified claims are sufficient, it is possible that additional information (such as the indication by the government of criminal activity, additional tests being questioned or other changes in the government's or private claimants' theories of wrongdoing) may become available which may cause the final resolution of these matters to exceed established reserves by an amount which could be material to the Company's results of operations and cash flows in the period in which such claims are settled. The Company does not believe that these issues will have a material adverse effect on its overall financial condition. In April 1998, the Company entered into a settlement agreement with the U.S. Attorney's office in Baltimore for approximately $6.9 million related to the billing of certain tests performed for which the Company had incomplete or missing order forms from the physician. The occurrence of this practice was relatively rare and was engaged in primarily to preserve the integrity of test results from specimens subject to rapid deterioration. This settlement is covered by the indemnification from Corning discussed above and was fully reserved for. 4. RESTRUCTURING RESERVES The Company has recorded charges for restructuring plans in previous years. Reserves relating to these programs totaled $9.1 million and $13.6 million at June 30, 1999 and December 31, 1998, respectively. Management believes that the costs of the restructuring plans will be financed through cash from operations and does not anticipate any significant impact on its liquidity as a result of the restructuring plans. 5. COMMON STOCKHOLDERS' EQUITY COMMON STOCK PURCHASE PROGRAM During February 1998, Quest Diagnostics' Board of Directors authorized a limited share purchase program which permits the Company to purchase up to $27 million of its outstanding common stock through 1999. Shares purchased under the program are expected to be reissued in connection with certain employee benefit plans. Cumulative purchases under the program through June 30, 1999 total $14.1 million. The Company suspended purchases of its shares when it reached a preliminary understanding of the transaction with SmithKline Beecham on January 15, 1999. UNEARNED COMPENSATION Under the Company's Employee Equity Participation Program, approximately 300 thousand shares of restricted stock were granted in 1998, primarily to executive employees. These shares were earned on achievement of financial performance goals and are subject to forfeiture if employment terminates prior to the end of the prescribed vesting period, which ranges primarily from three to four years. The market value of the shares awarded under the plan is recorded as unearned compensation and is amortized to compensation expense over the prescribed vesting period. Due to change in control provisions included in the restricted stock grant agreements, the remaining restricted shares will immediately vest upon the close of the transaction with SmithKline Beecham. 7 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) 6. SUMMARIZED FINANCIAL INFORMATION The Company's 10 3/4% senior subordinated notes due 2006 are guaranteed, fully, jointly and severally, and unconditionally, on a senior subordinated basis by substantially all of the Company's wholly-owned, domestic subsidiaries ("Subsidiary Guarantors"). The non-guarantor subsidiaries are foreign and less than wholly-owned subsidiaries. The following condensed consolidating financial data illustrates the composition of the combined guarantors. The Company believes that separate complete financial statements of the respective guarantors would not provide additional material information which would be useful in assessing the financial composition of the Subsidiary Guarantors. 8 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1999
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................ $ 316,205 $ 415,899 $ 43,771 $ -- $ 775,875 Costs and expenses: Cost of services......................... 195,665 231,908 25,081 -- 452,654 Selling, general and administrative...... 125,820 116,790 16,045 -- 258,655 Interest expense, net.................... 2,543 9,387 437 -- 12,367 Amortization of intangible assets........ 3,821 6,292 200 -- 10,313 Royalty (income) expense................. (35,480) 35,480 -- -- -- Other, net............................... (372) 49 3,624 -- 3,301 ----------- ----------- ----------- ----------- ----------- Total.................................. 291,997 399,906 45,387 -- 737,290 ----------- ----------- ----------- ----------- ----------- Income (loss) before taxes.................. 24,208 15,993 (1,616) -- 38,585 Income tax expense.......................... 8,634 8,961 470 -- 18,065 Equity income from affiliates............... 4,946 -- -- (4,946) -- ----------- ----------- ----------- ----------- ----------- Net income (loss)........................... $ 20,520 $ 7,032 $ (2,086) $ (4,946) $ 20,520 =========== =========== =========== =========== =========== CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1998 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Net revenues................................ $ 304,085 $ 416,555 $ 13,974 $ -- $ 734,614 Costs and expenses: Cost of services......................... 178,800 249,761 7,285 -- 435,846 Selling, general and administrative...... 131,025 99,904 5,650 -- 236,579 Interest expense, net.................... 5,307 12,549 294 -- 18,150 Amortization of intangible assets........ 3,385 7,153 208 -- 10,746 Royalty (income) expense................. (36,987) 36,987 -- -- -- Other, net............................... (317) 7 1,674 -- 1,364 ----------- ----------- ----------- ----------- ----------- Total.................................. 281,213 406,361 15,111 -- 702,685 ----------- ----------- ----------- ----------- ----------- Income (loss) before taxes.................. 22,872 10,194 (1,137) -- 31,929 Income tax expense.......................... 15,553 886 5 -- 16,444 Equity income from subsidiaries............. 8,166 -- -- (8,166) -- ----------- ----------- ----------- ----------- ----------- Net income (loss)........................... $ 15,485 $ 9,308 $ (1,142) $ (8,166) $ 15,485 =========== =========== =========== =========== ===========
9 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) CONDENSED CONSOLIDATING BALANCE SHEET JUNE 30, 1999
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Current assets: Cash and cash equivalents................... $ 134,240 $ 9,339 $ 4,899 $ -- $ 148,478 Accounts receivable, net.................... 89,705 123,643 11,572 -- 224,920 Other current assets........................ 80,390 67,121 6,898 -- 154,409 ----------- ---------- ----------- ----------- ----------- Total current assets..................... 304,335 200,103 23,369 -- 527,807 Property, plant and equipment, net.......... 104,246 129,114 9,747 -- 243,107 Intangible assets, net ..................... 164,126 318,442 245 -- 482,813 Intercompany (payable) receivable........... (43,664) 60,817 (17,153) -- -- Investment in subsidiaries.................. 418,917 -- -- (418,917) -- Other assets................................ 43,634 3,517 11,929 -- 59,080 ----------- ---------- ----------- ----------- ----------- Total assets............................. $ 991,594 $ 711,993 $ 28,137 $ (418,917) $ 1,312,807 =========== ========== =========== =========== =========== Current liabilities: Accounts payable and accrued expenses....... $ 162,878 $ 80,486 $ 8,539 $ -- $ 251,903 Current portion of long-term debt........... 28,249 32,604 599 -- 61,452 ----------- ---------- ----------- ----------- ----------- Total current liabilities................ 191,127 113,090 9,138 -- 313,355 Long-term debt.............................. 158,267 176,957 3,167 -- 338,391 Other liabilities........................... 44,382 10,659 8,202 -- 63,243 Preferred stock............................. 1,000 -- -- -- 1,000 Common stockholders' equity................. 596,818 411,287 7,630 (418,917) 596,818 ----------- ---------- ----------- ----------- ----------- Total liabilities and stockholders' equity................................. $ 991,594 $ 711,993 $ 28,137 $ (418,917) $ 1,312,807 =========== ========== =========== =========== =========== CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 1998 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Current assets: Cash and cash equivalents................... $ 190,606 $ 8,206 $ 4,096 $ -- $ 202,908 Accounts receivable, net.................... 58,956 152,252 9,653 -- 220,861 Other current assets........................ 83,644 65,771 5,003 -- 154,418 ----------- ----------- ----------- ----------- ----------- Total current assets..................... 333,206 226,229 18,752 -- 578,187 Property, plant and equipment, net.......... 94,042 137,352 8,995 -- 240,389 Intangible assets, net ..................... 168,781 325,665 275 -- 494,721 Intercompany (payable) receivable........... (35,853) 48,308 (12,455) -- -- Investment in subsidiaries.................. 412,283 -- -- (412,283) -- Other assets................................ 31,470 4,658 10,815 -- 46,943 ------------ ----------- ----------- ----------- ----------- Total assets............................. $ 1,003,929 $ 742,212 $ 26,382 $ (412,283) $ 1,360,240 =========== =========== =========== =========== =========== Current liabilities: Accounts payable and accrued expenses....... $ 171,206 $ 82,475 $ 4,340 $ -- $ 258,021 Current portion of long-term debt........... 23,654 27,280 510 -- 51,444 ----------- ----------- ----------- ----------- ----------- Total current liabilities................ 194,860 109,755 4,850 -- 309,465 Long-term debt.............................. 190,712 214,557 8,157 -- 413,426 Other liabilities........................... 50,427 13,645 5,347 -- 69,419 Preferred stock............................. 1,000 -- -- -- 1,000 Common stockholders' equity................. 566,930 404,255 8,028 (412,283) 566,930 ----------- ----------- ----------- ----------- ----------- Total liabilities and stockholders' equity................................. $ 1,003,929 $ 742,212 $ 26,382 $ (412,283) $ 1,360,240 =========== =========== =========== =========== ===========
10 QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 1999
Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Cash flows from operating activities: Net income (loss)............................. $ 20,520 $ 7,032 $ (2,086) $ (4,946) $ 20,520 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization.............. 15,479 15,773 1,894 -- 33,146 Provision for doubtful accounts............ 19,319 18,875 2,048 -- 40,242 Other, net................................. 3,817 985 1,188 4,946 10,936 Changes in operating assets and liabilities... (56,532) 448 3,846 -- (52,238) ----------- ----------- ----------- ----------- ----------- Net cash provided by operating activities..... 2,603 43,113 6,890 -- 52,606 Net cash used in investing activities......... (26,008) (9,704) (241) -- (35,953) Net cash used in financing activities......... (32,961) (32,276) (5,846) -- (71,083) ----------- ----------- ----------- ----------- ----------- Net change in cash and cash equivalents....... (56,366) 1,133 803 -- (54,430) Cash and cash equivalents, beginning of year.. 190,606 8,206 4,096 -- 202,908 ----------- ----------- ----------- ----------- ----------- Cash and cash equivalents, end of period...... $ 134,240 $ 9,339 $ 4,899 $ -- $ 148,478 =========== =========== =========== =========== =========== CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 1998 Subsidiary Non-Guarantor Parent Guarantors Subsidiaries Eliminations Consolidated ------ ---------- ------------ ------------ ------------ Cash flows from operating activities: Net income (loss)............................. $ 15,485 $ 9,308 $ (1,142) $ (8,166) $ 15,485 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.............. 14,414 19,343 740 -- 34,497 Provision for doubtful accounts............ 25,522 19,075 402 -- 44,999 Other, net................................. 16,725 632 (526) -- 16,831 Changes in operating assets and liabilities... (72,797) 498 162 1,511 (70,626) ----------- ----------- ----------- ----------- ----------- Net cash (used in) provided by operating activities................................. (651) 48,856 (364) (6,655) 41,186 Net cash used in investing activities......... (16,931) (9,146) (57) 6,655 (19,479) Net cash used in financing activities......... (16,868) (13,633) (181) -- (30,682) ----------- ----------- ----------- ----------- ----------- Net change in cash and cash equivalents....... (34,450) 26,077 (602) -- (8,975) Cash and cash equivalents, beginning of year.. 123,052 35,527 3,082 -- 161,661 ----------- ----------- ----------- ----------- ----------- Cash and cash equivalents, end of period...... $ 88,602 $ 61,604 $ 2,480 $ -- $ 152,686 =========== =========== =========== =========== ===========
11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS On February 9, 1999, the Company signed a definitive agreement to acquire the clinical laboratory business of SmithKline Beecham for approximately $1.3 billion. The purchase price will be paid through the issuance of approximately 12.6 million shares of common stock of Quest Diagnostics and the payment of $1.025 billion of cash. The acquisition will be accounted for under the purchase method of accounting. Quest Diagnostics expects to close the transaction in August 1999. As a result, SmithKline Beecham will own approximately 29.5% of Quest Diagnostics' outstanding common stock. Under the terms of a stockholder agreement, SmithKline Beecham will initially have the right to designate two nominees to Quest Diagnostics' Board of Directors as long as SmithKline Beecham owns at least 20% of the outstanding common stock. (As long as SmithKline Beecham owns at least 10% but less than 20% of the outstanding common stock, it will have the right to designate one nominee.) Quest Diagnostics' Board of Directors will expand to nine directors immediately following the close. The stockholder agreement will also impose limitations on the right of SmithKline Beecham to sell or vote its shares and prohibit SmithKline Beecham from purchasing in excess of 29.5% of the outstanding common stock of Quest Diagnostics. Under the terms of the agreement, Quest Diagnostics will acquire SmithKline Beecham's clinical laboratory testing business including its domestic and foreign clinical testing operations, clinical trials testing, corporate health services, and laboratory information products businesses. SmithKline Beecham's national testing and service network consists of regional laboratories, specialty testing operations and its National Esoteric Testing Center, as well as a number of rapid-turnaround or "stat" laboratories, and patient service centers. As part of the transaction, SmithKline Beecham and Quest Diagnostics will enter into a long-term contract under which Quest Diagnostics will be the primary provider of testing to support SmithKline Beecham's clinical trials testing requirements worldwide. In addition, SmithKline Beecham has agreed to indemnify Quest Diagnostics for potential liabilities arising from certain government and private claims. On July 1, 1999, Quest Diagnostics announced that the anticipated closing of the transaction with SmithKline Beecham was delayed due to continuing negotiations regarding SmithKline Beecham's rights and access to Quest Diagnostics' proprietary clinical laboratory database. On August 9, 1999, Quest Diagnostics announced that all agreements required to complete the acquisition had been finalized by Quest Diagnostics and SmithKline Beecham. As part of the agreement, Quest Diagnostics has granted SmithKline Beecham certain non-exclusive rights to use its clinical laboratory information database. In addition, Quest Diagnostics will receive a minority interest in a company that SmithKline Beecham will form to sell health care information products and services through various channels, including the Internet. On August 10, 1999, Quest Diagnostics announced that due to unsatisfactory conditions in the high yield market, it would not proceed with its planned offering of new senior subordinated notes at this time. The Company plans to utilize its fully committed senior credit facility to provide the funds required to complete the acquisition. Quest Diagnostics believes that the acquisition will establish the Company as the leader of the clinical laboratory testing industry and provide a range of benefits. As the leading national provider with the most extensive network of laboratories and patient service centers throughout the United States, Quest Diagnostics will be able to further enhance patient access and customer service. The acquisition will improve the Company's ability to pursue profitable growth opportunities, including direct contracting with employers for laboratory services, clinical trials testing for pharmaceutical companies, testing and management services for hospitals, and genetic and other esoteric testing. Quest Diagnostics believes that 12 the acquisition will accelerate innovation and create the largest clinical laboratory database in the world, which can be used to help providers and insurers to better manage their patients' health. Finally, Quest Diagnostics believes that the acquisition will provide the Company with opportunities to achieve significant cost savings by consolidating operations and activities, including redundant facilities, applying best practices and utilizing its service infrastructure more efficiently.* Management believes the acquisition will accelerate Quest Diagnostics' earnings growth rate, generate savings exceeding $100 million annually after three years, and be accretive to earnings in 2000 before special charges related to the transaction. However, it is expected to have an adverse impact on profitability during the first year after the closing of the acquisition.* FINANCING OF THE TRANSACTIONS On May 25, 1999, Quest Diagnostics commenced an offer to purchase all of its existing 10 3/4% notes. It also solicited consents from the holders of the 10 3/4% notes to amend the 10 3/4% notes' indenture to eliminate substantially all the restrictive covenants. As of August 11, 1999, Quest Diagnostics received consents representing over 98% of the principal amount of the 10 3/4% notes. The tender offer has been extended to August 26, 1999. The offer remains subject to Quest Diagnostics obtaining adequate financing on terms satisfactory to the Company to pay all amounts due under the tender offer.* The Company is currently finalizing the terms of the external financing necessary to complete the pending acquisition. Quest Diagnostics will use the borrowings under a new senior secured credit facility to fund the cash purchase price and related transaction costs of the acquisition, and to repay its existing bank debt plus interest. The new credit facility is expected to include the following facilities: a $250 million six-year revolving credit facility; a $400 million six-year amortizing term loan; a $325 million seven-year term loan with minimal amortization until the seventh year; a $300 million eight-year term loan with minimal amortization until the eighth year; and a $300 million two-year capital markets term loan which does not amortize. The commitment under the capital markets loan will expire to the extent it is not borrowed at closing. Up to $75 million of the revolving credit facility may be used for letters of credit. Quest Diagnostics expects to borrow approximately $1.025 billion under the term loans and $50 million under the capital markets loan.* At closing, Quest Diagnostics expects that approximately $75 million of the revolving credit facility will be used to pay closing costs and to replace existing letters of credit and that the balance of the revolving credit facility will be available for borrowing.* Subsequent to the transaction with SmithKline Beecham, Quest Diagnostics expects to refinance the amounts borrowed under the capital markets facility and its existing 10 3/4% senior subordinated notes.* The new credit facility will be secured by substantially all tangible and intangible assets of Quest Diagnostics and by a guarantee from, and a pledge of all capital stock and tangible and intangible assets of, all of Quest Diagnostics' present and future wholly owned domestic subsidiaries other than certain joint ventures. The borrowings under the new credit agreement will rank senior in priority of repayment to any subordinated indebtedness. Interest will be based on certain published rates plus an applicable margin which will vary depending on the financial performance of Quest Diagnostics. The interest rates under the credit facility will be 25 basis points higher during the period that the capital markets loan is outstanding. The credit agreement will require Quest Diagnostics to maintain interest rate hedge agreements covering a notional amount of not less than 50% of its net funded debt. The credit agreement is expected to contain various covenants and conditions including the maintenance of certain financial ratios and tests, and restrict the ability of Quest Diagnostics to, among other things, incur additional indebtedness - ---------- * THESE ARE FORWARD-LOOKING STATEMENTS. SEE ITEM 1. "BUSINESS--CAUTIONARY STATEMENT FOR PURPOSES OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995" CONTAINED IN THE COMPANY'S 1998 ANNUAL REPORT ON FORM 10-K. 13 and pay dividends on its common stock. Depending on market conditions at the time of the consummation of the new credit facility, the terms, interest rates and amounts borrowed under the new credit facility may vary from that indicated above.* The Company believes the financing under the new credit facility will provide sufficient financial flexibility and access to funds to finance the costs to integrate the businesses of Quest Diagnostics and SBCL, to meet seasonal working capital requirements, to fund capital expenditures and to fund additional growth opportunities for the foreseeable future.* Management believes that Quest Diagnostics' successful integration of SmithKline Beecham's clinical laboratory business and implementation of its business strategy, together with the indemnification by Corning and SmithKline Beecham against monetary fines, penalties or losses from outstanding government and other related claims, will enable it to generate strong cash flows.* Additionally, management believes that these actions will aid the Company in meeting the ongoing challenges in the clinical laboratory industry brought on by the growth in managed care and increased regulatory complexity.* RESULTS OF OPERATIONS Net income for the three and six months ended June 30, 1999 increased from the prior year primarily as a result of improvements in gross margins and reductions in net interest expense, offset by increases in selling, general and administrative expenses and other, net. Net income for the three and six months ended June 30, 1999 includes $1.9 million of interest income ($1.2 million, net of tax) associated with a favorable state tax settlement. Net income for the six months ended June 30, 1998 includes a $2.5 million charge ($1.2 million, net of tax) recorded in selling, general and administrative expenses that represented the final costs associated with the Company's consolidation plan announced in December 1997. Results for the three and six months ended June 30, 1999 include the effects of QuestNet, the company's laboratory network management service. As laboratory network manager, Quest Diagnostics includes in its consolidated revenues and expenses the cost of testing performed by third parties. This accounting requirement added $15.4 million and $32.8 million to reported revenues and expenses for the three and six months ended June 30, 1999, respectively. NET REVENUES Excluding the effect of QuestNet, net revenues for the second quarter increased by $11.9 million, or 3.2% from the prior year level, principally due to a 7.6% improvement in average revenue per requisition, partially offset by a 3.9% decline in clinical testing volume, measured by the number of requisitions processed. While the volume of clinical testing declined in the second quarter of 1999, as compared to 1998, this represents an improvement from the first quarter of 1999 in which volume declined by 7.3%, as compared to the prior year period. Net revenues for the first half of 1999 (adjusted for QuestNet) increased $8.4 million or 1.1% from the prior year level, principally due to a 6.8% improvement in average revenue per requisition, partially offset by a 5.6% decline in clinical testing volume. The increases in average revenue per requisition, for both the second quarter and the first half of 1999, are due primarily to a number of factors, including: a shift from capitated volume to fee-for-service volume; contract renewals and new business negotiated on more favorable terms as part of our account - ---------- * THESE ARE FORWARD-LOOKING STATEMENTS. SEE ITEM 1. "BUSINESS--CAUTIONARY STATEMENT FOR PURPOSES OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995" CONTAINED IN THE COMPANY'S 1998 ANNUAL REPORT ON FORM 10-K. 14 profitability strategy; and higher value-added test offerings. The volume declines were principally due to the impact of increased competition for managed care business, actions taken on unprofitable accounts and severe weather in the first quarter of 1999 in certain service areas. COSTS AND EXPENSES Total operating costs for the second quarter and the first half of 1999, excluding the effect of QuestNet, increased by $7.9 million and $6.1 million, respectively, from the year earlier periods. Operating costs and expenses for 1998 included a first quarter charge of $2.5 million ($1.2 million, net of tax) in selling, general and administrative expenses that represented the final costs associated with the Company's consolidation plan announced in December 1997. Operating costs unrelated to volume increased during the quarter and first half of 1999, principally due to additional investments in information technology and sales and marketing capabilities, litigation expenses and employee compensation costs, including severance. Excluding the effect of QuestNet, cost of services, which includes the costs of obtaining, transporting and testing specimens, decreased during the second quarter as a percentage of net revenues to 55.5% from 59.4% a year ago. Cost of services in the first half of 1999, adjusted for QuestNet, decreased as a percentage of net revenues to 56.5% from 59.3% in the prior year. These decreases are primarily attributable to the increase in average revenue per requisition. Selling, general and administrative expenses, which includes the costs of the sales force, billing operations, bad debt expense and general management and administrative support, increased during the quarter as a percentage of net revenues to 34.8%, excluding the effect of QuestNet, from 31.7% in the prior year. For the first half of 1999, selling, general and administrative expenses increased as a percentage of net revenues, excluding the effect of QuestNet, to 34.8% from 32.2% in the prior year. These increases were principally due to additional investments in information technology and sales and marketing capabilities, litigation expenses and employee compensation costs, including severance. These increases were partially offset by a reduction in bad debt expense. During the second quarter bad debt expense improved to 5.3% of net revenues (excluding the effect of QuestNet) from 5.8% of net revenues in the prior year. For the first half of 1999, bad debt expense improved to 5.4% of net revenues (excluding the effect of QuestNet) from 6.1% of net revenues in the prior year. Net interest expense decreased from the prior year by $4.0 million and $5.8 million for the second quarter and first half of 1999, respectively. Net interest expense for the three and six months ended June 30, 1999 includes $1.9 million of interest income associated with a favorable state tax settlement. The remaining decrease in net interest expense for the second quarter and first half of 1999 is primarily attributable to a decrease in the average amount of debt outstanding during 1999 as compared to the prior year period. Other, net for the second quarter and first half of 1999 increased from the prior year level, primarily due to an increase in minority partners' share of income. The Company's effective tax rate is significantly impacted by goodwill amortization, a majority of which is not deductible for tax purposes, and has the effect of increasing the overall tax rate. 15 ADJUSTED EBITDA Adjusted EBITDA represents earnings before interest, taxes, depreciation, amortization and non-recurring charges. Adjusted EBITDA for the three months ended June 30, 1999 improved to $46.2 million, or 12.2% of net revenues (adjusted for QuestNet), from $44.5 million, or 12.1% of net revenues, in the prior year period. Adjusted EBITDA for the six months ended June 30, 1999 was $84.1 million, or 11.3% of net revenues (adjusted for QuestNet), compared to $87.1 million last year, adjusted for special charges, or 11.9% of net revenues. The decline for the six month period is principally due to the additional costs associated with the introduction of QuestNet and investments in information technology and sales and marketing capabilities. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary exposure to market risk is from changes in interest rates. The Company does not believe that its foreign exchange exposure and related hedging program are material to the Company's financial position or results of operations. The Company addresses its risks through a controlled program of risk management that includes the use of derivative financial instruments. The Company does not hold or issue derivative financial instruments for trading purposes. INTEREST RATES At June 30, 1999 and December 31, 1998, the fair value of the Company's debt was estimated at approximately $410 million and $480 million, respectively, using quoted market prices and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. Such fair values exceeded the carrying value of the debt at June 30, 1999 and December 31, 1998 by approximately $10 million and $15 million, respectively. An assumed 10% increase in interest rates would potentially reduce the fair value of the Company's debt by approximately $8 million and $9 million at June 30, 1999 and December 31, 1998, respectively. The Company had $243 million of variable interest rate debt outstanding at June 30, 1999. An assumed 10% increase in interest rates would result in a $0.4 million reduction in the Company's after-tax earnings and cash flows for the six months ended June 30, 1999 based on debt levels as of June 30, 1999. The primary interest rate exposures on the variable interest rate debt are with respect to interest rates on United States dollars as quoted in the London interbank market. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents at June 30, 1999 totaled $148.5 million, a decrease of $54.4 million from December 31, 1998. The decrease is primarily associated with the repayment of $65.0 million of debt, of which $35 million was paid ahead of schedule, and the payment of $10.1 million of transaction expenses associated with the acquisition and financing of the transaction with SmithKline Beecham. Cash flows from operating activities provided cash of $52.6 million, which was offset by investing and financing activities which required cash of $107.0 million. Cash and cash equivalents at June 30, 1998 decreased from December 31, 1997 by $9.0 million due to operating activities which provided cash of $41.2 million, offset by investing and financing activities which used cash of $50.2 million. Net cash from operating activities for 1999 was $11.4 million higher than the 1998 level. The increase is primarily the result of an increase in net earnings, decreased payments associated with restructuring and other special charges and changes in accounts payable and accrued expenses and other assets and liabilities. The impact of these changes was partially offset by changes in the Company's deferred tax position. The number of days sales outstanding, a measure of billing and collection efficiency, was 54 days, adjusted 16 for QuestNet, compared to 61 days at June 30, 1998 and 54 days in the first quarter. The number of days sales outstanding was 58 days at December 31, 1998. Increased spending on investing activities is principally related to an increase in capital expenditures, the payment of transaction costs associated with the acquisition of SmithKline Beecham's clinical laboratory business and an increase in investments. Capital spending for the first half of 1999 was $25.9 million compared to $19.5 million for the same period in the prior year. Without giving effect to the acquisition of SmithKline Beecham's clinical laboratory testing business, the Company estimates that it will invest approximately $60 million during 1999 for capital expenditures, principally related to investments in information technology infrastructure and equipment and facility upgrades. * The increase in investments is principally associated with investments to fund certain benefit plans and contributions to the Company's Arizona joint venture. During the first half of 1999, the Company repaid $65.0 million of debt, of which $35 million was paid ahead of schedule, paid $4.9 million of costs associated with the financing of the transaction with SmithKline Beecham and repurchased $1.1 million of its common stock. Other than the reduction for outstanding letters of credit, which currently approximate $17 million, all of the revolving working capital credit facility was available for borrowing. During February 1998, Quest Diagnostics' Board of Directors authorized a limited share purchase program which permits the Company to purchase up to $27 million of its outstanding common stock through 1999. Cumulative purchases under the program through June 30, 1999 total $14.1 million. The program is intended to mitigate the dilutive impact to earnings per share of issuing new shares for the Company's employee benefit plans. The Company suspended purchases of its shares when it reached a preliminary understanding of the transaction with SmithKline Beecham plc on January 15, 1999. To the extent permitted under the Company's new credit facility and its existing senior subordinated notes, the Company plans to purchase additional shares of its common stock through the remainder of 1999. YEAR 2000 READINESS DISCLOSURE The Year 2000 issue relates to the ability of computer systems and programs to properly recognize dates beginning January 1, 2000 and beyond. Also, the Year 2000 issue affects systems and equipment, such as security systems and elevators, that contain imbedded hardware or software that may be similarly date sensitive. As a result, business and governmental entities are at risk for possible miscalculations or system failures resulting from Year 2000 problems that may disrupt their operations. The Company commenced its Year 2000 readiness program in 1997 and has established a dedicated project team to implement the program. In order to address the Year 2000 issue, the Company has adopted a six-phase plan which includes: (1) inventory; (2) assessment; (3) repair/replace/upgrade; (4) testing; (5) implementation; and (6) contingency planning. This plan is common for each of the following seven major areas: INFRASTRUCTURE - Includes computer hardware, systems software (other than application software) and voice and data network components. The inventory phase and the assessment phase, for all equipment and software supplied by vendors who have responded to the Company's inquiries, is complete. Also, the Company has completed over 95% of the activities for phases three, four and five of the Company's Year 2000 plan. The remaining activities are scheduled for completion during the third and fourth quarter - ---------- * THESE ARE FORWARD-LOOKING STATEMENTS. SEE ITEM 1. "BUSINESS--CAUTIONARY STATEMENT FOR PURPOSES OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995" CONTAINED IN THE COMPANY'S 1998 ANNUAL REPORT ON FORM 10-K. 17 of 1999. For those vendors that have not responded, contingency plans are scheduled to be completed during the third quarter of 1999. APPLICATIONS - Includes all applications software including, but not limited to, the Company's clinical laboratory systems, financial systems, billing systems, human resources systems, purchasing systems and customer interface systems. The inventory phase and the assessment phase for all applications are complete. The Company is in the process of repairing, replacing or upgrading non-compliant code, testing for compliance and implementing certified systems. Approximately 96% of the overall effort is currently completed with a scheduled completion during the third quarter of 1999. LABORATORY INSTRUMENTS - Includes all clinical diagnostic instrumentation in testing facilities. The inventory phase and the assessment phase, for all vendor responses received, is complete. The Company is in the process of repairing, replacing, or upgrading non-compliant instrumentation and testing for compliance. Approximately 95% of all instruments are Year 2000 ready and the Company expects over 98% will be compliant by the end of the third quarter of 1999, with contingency plans in place for the remaining instruments. FACILITIES - Includes all building facilities (e.g. air conditioning units, generators), property owners and building service providers (e.g. waste management, public utilities). The inventory phase and assessment phase, for all vendor responses received, is complete. The Company has completed 78% of the activities for phases three, four and five of the Company's Year 2000 plan. For those vendors that have not responded, contingency plans are scheduled to be completed during the third quarter of 1999. DESKTOP ENVIRONMENT - Includes the personal computer hardware and operating systems. The inventory and assessment phases are complete and the replacement platform has been identified. An outside vendor has been selected and retained to coordinate the desktop replacement program. The rollout is 90% complete. The remaining activities are scheduled for completion during the third quarter of 1999. EXTERNAL PROVIDERS - Includes the process of identifying and prioritizing critical suppliers and communicating with them about their plans and progress in addressing the Year 2000 problem. The inventory phase and the assessment phase, for all vendor responses received, is complete. The Company is in the process of confirming that the suppliers' expected compliance dates have been met, and of obtaining any specific information omitted from earlier supplier responses. Contingency plans have been developed for all suppliers identified as critical to the Company's mission, and are being refined through dialog with the suppliers. The Company expects to refine and implement the contingency plans during the third quarter of 1999. PAYERS - Includes the process of contacting each critical payer (e.g. Medicare, Medicaid, commercial insurance carriers) regarding their plans and progress in addressing the Year 2000 problem. All critical payers have been identified and the Company is in the process of assessing the state of readiness, for all responses received, and is in the process of developing contingency plans for the critical payers. Although each of the above seven areas is at a different stage of readiness, the Company has made significant progress to date towards completing its six-phase plan under its Year 2000 readiness program. The Year 2000 readiness program will be an ongoing process until all contacted parties have responded to Company requests for Year 2000 information. The Company is continuing to work internally and with external contractors, as needed, to complete the final phases of the program. The Company also continues to work with its external vendors, whose readiness is vital for a smooth transition into the Year 2000. In addition to the phases outlined above, the Company's plan also includes regular status presentations to the Audit and Finance Committee of the Board of Directors, and a special retention bonus plan for its key information systems employees, which is based on the success in making Quest Diagnostics' systems Year 2000 compliant. The Company's goal is to have all significant systems 18 properly functioning and certified with respect to the Year 2000 during the fourth quarter of 1999.* Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party vendors and payers, the Company is unable to determine at this time whether the consequences of potential Year 2000 business disruptions will have a material impact on the Company's results of operations, liquidity and financial condition. The most reasonably likely worst case consequences of the Company or key vendors or payers not being ready by January 1, 2000 include, among other things, temporary business unit closures, delays in laboratory testing or delivery of laboratory testing results, inventory shortages and delays in collecting accounts receivable. Approximately 14% of the Company's annual net revenues are received from Medicare carriers. The Company could experience collection delays if Medicare or other large third party payers (such as insurance companies) experience Year 2000 problems. Medicare carriers are being required to implement new programs required by the 1997 Balanced Budget Act at the same time that they are attempting to make their systems Year 2000 compliant. In September 1998, the General Accounting Office reported that "HCFA and its contractors are severely behind schedule in repairing, testing and implementing the mission-critical systems supporting Medicare" and concluded that "it is highly unlikely that all of the Medicare systems will be compliant in time to ensure the delivery of uninterrupted benefits and services into the year 2000." More recently, HCFA stated that their systems and their contractors' systems supporting Medicare are compliant, tested and certified with respect to Year 2000. While the Company believes that its Year 2000 readiness program significantly reduces the potential adverse effect of any such disruptions, Quest Diagnostics cannot guarantee that the Year 2000 problem will not result in significant business disruptions. Specific factors that give rise to this uncertainty include the possible loss of technical resources to perform the remediation work, failure to identify all susceptible systems, non-compliance by third-parties whose systems impact the Company, and other similar uncertainties. Concurrent with the plans described above, the Company is in the process of developing detailed contingency plans for each major area to mitigate the possible disruption in business operations. Contingency plans may include accepting estimated payments from customers and payers, making use of alternative vendors, stockpiling inventory and temporarily moving laboratory testing services. Most of the Company's regional laboratories have similar test menus and, with the adoption of standardized test codes and progress in other standardization initiatives (including billing and lab information systems), the Company has improved its ability to move laboratory specimens to an alternative site in the event that a regional laboratory experiences disruptions. Once developed, contingency plans and related cost estimates will be continually refined as additional information becomes available. The Company's goal is to have contingency plans finalized during the third quarter of 1999 with final reviews in the fourth quarter of 1999. * Costs incurred through June 30, 1999 related to the Company's Year 2000 readiness program approximated $42 million, of which approximately $16 million was capitalized. Current estimates of the remaining costs are approximately $25 million to $40 million, of which approximately 50% to 60% will be capitalized. Capitalized costs principally represent the purchase of new software and hardware. These estimates are subject to potentially significant revisions as additional information, including vendor responses, becomes available. Costs related to the Company's Year 2000 readiness program have been, and are expected to continue being, funded by cash from operations.* - -------------- * THESE ARE FORWARD-LOOKING STATEMENTS. SEE ITEM 1. "BUSINESS--CAUTIONARY STATEMENT FOR PURPOSES OF THE 'SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995" CONTAINED IN THE COMPANY'S 1998 ANNUAL REPORT FOR FORM 10-K. 19 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There have been no material developments in any other of the government investigations or private claims reported. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The annual meeting of stockholders of the Company was held on June 29, 1999. At the meeting the matters described below were approved by the stockholders. (b-c) The following nominees for the office of director were elected for terms expiring at the 2002 annual meeting of stockholders, by the following votes: For Withheld --- -------- William F. Buehler 24,113,995 3,457,094 Van C. Campbell 27,363,030 208,059 Dan C. Stanzione 27,367,427 203,662 The following persons continue as directors: Kenneth D. Brody Mary A. Cirillo Kenneth W. Freeman Gail R. Wilensky The issuance of 12,564,336 shares of common stock of the Company to SmithKline Beecham PLC was approved by the following number of stockholder votes for, against, and abstained: For: 23,910,286 Against: 121,590 Abstained: 69,168 The Quest Diagnostics Incorporated 1999 Employee Equity Participation Program was approved by the following number of stockholder votes for, against, and abstained: For: 17,013,884 Against: 6,879,159 Abstained: 208,000 The appointment of the PricewaterhouseCoopers LLP as independent accountants to audit the financial statements of the Company and its subsidiaries for the fiscal year ending December 31, 1999, was approved by the following number of stockholder votes for, against, and abstained: For: 27,467,237 Against: 51,916 Abstained: 51,936 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: EXHIBIT NUMBER DESCRIPTION 27 Financial Data Schedule (b) Reports on Form 8-K: The Registrant has filed the following Current Report on Form 8-K during the quarter ended June 30, 1999: Current Report on Form 8-K filed on June 4, 1999 As previously disclosed in Quest Diagnostics' current report on Form 8-K dated February 17, 1999, on February 9, 1999, Quest Diagnostics signed a definitive agreement with SmithKline Beecham to purchase SmithKline Beecham's clinical laboratory testing business "(SBCL") for approximately $1.3 billion in cash and stock (the "SBCL Acquisition"). The Current Report on Form 8-K filed on June 4, 1999 included certain financial information for SBCL, management's discussion and analysis of financial condition and results of operations related thereto and unaudited pro forma combined financial information for the combined entity giving effect to the SBCL Acquisition. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. August 12, 1999 Quest Diagnostics Incorporated By /s/ Kenneth W. Freeman Chairman of the Board and ------------------------------- Chief Executive Officer Kenneth W. Freeman By /s/ Robert A. Hagemann Vice President and ------------------------------- Chief Financial Officer Robert A. Hagemann 22 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 0001022079 QUEST DIAGNOSTICS INCORPORATED 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 148,478 0 224,920 68,766 32,923 527,807 243,107 355,377 1,312,807 313,355 0 0 1,000 1,202,187 (605,369) 1,312,807 775,875 775,875 452,654 711,309 3,301 40,242 12,367 38,585 18,065 20,520 0 0 0 20,520 0.69 0.67
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