-----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, TBHivEUarEePt9vI2X1rt/QKbLZ4uW+f19QEFeeoMMV1iZIxUxHKB9KxNi+9QUdH BdP5V5MNDT5CZlKaNyPrZw== 0000816151-99-000014.txt : 19990618 0000816151-99-000014.hdr.sgml : 19990618 ACCESSION NUMBER: 0000816151-99-000014 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990617 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LABONE INC CENTRAL INDEX KEY: 0000816151 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MEDICAL LABORATORIES [8071] IRS NUMBER: 480952323 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-15975 FILM NUMBER: 99648129 BUSINESS ADDRESS: STREET 1: 10101 RENNER BLVD CITY: LENEXA STATE: KS ZIP: 66219 BUSINESS PHONE: 9138888397 MAIL ADDRESS: STREET 1: 10101 RENNER BLVD CITY: LENEXA STATE: KS ZIP: 66219 FORMER COMPANY: FORMER CONFORMED NAME: HOME OFFICE REFERENCE LABORATORY INC DATE OF NAME CHANGE: 19940405 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO.3 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 ----------------- Commission file number 0-15975 ------- LabOne, Inc. ------------ 10101 Renner Blvd. Lenexa, Kansas 66219 (913) 888-1770 Incorporated in Delaware I.R.S. Employer Identification Number: 48-0952323 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $0.01 par value ----------------------------- (Title of Class) 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 such 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / Approximate aggregate market value of voting stock held by non-affiliates of Registrant: $26,970,000 (based on closing price as of March 1, 1999, of $11.56). The non-inclusion of shares held by directors, officers and beneficial owners of more than 5% of the outstanding stock shall not be deemed to constitute an admission that such persons are affiliates of the Registrant within the meaning of the Securities and Exchange Act of 1934. Number of shares outstanding of the only class of Registrant's common stock as of March 1, 1999: $0.01 par value common - 13,311,450 shares net of 1,688,550 shares held as treasury stock. The exhibit list for this Form 10-K begins on page 29. Page 1 OF 58 PART I ------ ITEM 1 BUSINESS General - ------- LabOne, Inc., a Delaware corporation, provides laboratory and investigative services for the insurance industry, clinical testing services for the healthcare industry and substance abuse testing services for employers. LabOne, Inc., together with its wholly-owned subsidiaries Lab One Canada Inc. and Systematic Business Services, Inc. (SBSI), hereinafter collectively referred to as either LabOne or the Company, is the largest provider of life insurance laboratory testing services in the United States and Canada. (See Note 8 of Notes to Consolidated Financial Statements for financial information regarding foreign operations.) LabOne provides risk-appraisal laboratory services to the insurance industry. The tests performed by the Company are specifically designed to assist an insurance company in objectively evaluating the mortality and morbidity risks posed by policy applicants. The majority of the testing is performed on specimens of individual life insurance policy applicants. The Company also provides testing services on specimens of individuals applying for individual and group medical and disability policies. Effective October 30, 1998, LabOne acquired Systematic Business Services, Inc., a Missouri corporation. SBSI provides telephone inspections, motor vehicle reports, attending physician statements, and claims investigation services to life and health insurers nationwide. LabOne's clinical testing services are provided to the healthcare industry as an aid in the diagnosis and treatment of patients. LabOne operates only one highly automated and centralized laboratory, which the Company believes has significant economic advantages over other conventional laboratory. competitors. LabOne markets its clinical testing services to the payers of healthcare--insurance companies and self-insured groups. The Company does this through exclusive arrangements with managed care organizations and through Lab Card(R), a Laboratory Benefits Management program. LabOne is certified by the Substance Abuse and Mental Health Services Administration to perform substance abuse testing services for federally regulated employers and is currently marketing these services throughout the country to both regulated and nonregulated employers. The Company's rapid turnaround times and multiple testing options help clients reduce downtime for affected employees and meet mandated drug screening guidelines. LabOne is currently 80.5% owned by Lab Holdings, Inc. On March 8, 1999, LabOne and Lab Holdings jointly announced that the Boards of Directors of both companies had approved an agreement to merge the two companies. Representatives of Lab Holdings negotiated the merger with a Special Committee of independent directors of LabOne that was established to represent the interests of the holders of the 19.5% of common stock of LabOne not owned by Lab Holdings. The Special Committee, which had the assistance of independent legal and financial advisors, also approved the merger agreement and PAGE 2 recommended its approval by the LabOne board and stockholders. The merger is expected to close in June or July following the satisfaction of a number of closing conditions. These include approval by the holders of two-thirds of the outstanding Lab Holdings shares and a majority of the shares voted by LabOne stockholders other than Lab Holdings and its affiliates. Financing must also be obtained sufficient to satisfy cash elections after the use of available cash of LabOne and Lab Holdings. See the Company's Current Report on Form 8-K dated March 8, 1999 for more information. Forward Looking Statements - -------------------------- This Annual report on Form 10-K may contain "forward-looking statements," including, but not limited to: projections of revenues, income or loss, capital expenditures, the payment or non-payment of dividends and other financial items, statements of plans and objectives, statements of future economic performance and statements of assumptions underlying such statements. Forward-looking statements involve known and unknown risks and uncertainties. Many factors could cause actual results to differ materially from those that may be expressed or implied in such forward-looking statements, including, but not limited to, the volume and pricing of laboratory tests performed by the Company, competition, the extent of market acceptance of the Company's testing services in the healthcare and substance abuse testing industries, market acceptance of the Company's Lab Card program, intense competition, the loss of one or more significant customers, general economic conditions and other factors detailed from time to time in the Company's reports and registration statements filed with the Securities and Exchange Commission, including the Cautionary Statement filed herewith as exhibit 99. Services Provided by the Company - -------------------------------- Insurance Services: Insurance companies require an objective means of evaluating the insurance risk posed by policy applicants in order to establish the appropriate level of premium payments, or to determine whether to issue a policy. Because decisions of this type are based on statistical probabilities of mortality and morbidity, insurance companies generally require quantitative data reflecting the applicant's general health. Standardized laboratory testing, tailored to the needs of the insurance industry and reported in a uniform format, provides insurance companies with an efficient means of evaluating the mortality and morbidity risks posed by policy applicants. The use of standardized blood, urine and oral fluid testing has proven a cost-effective alternative to individualized physician examinations, which utilize varying testing procedures and reports. LabOne's insurance testing services consist of certain specimen profiles that provide insurance companies with specific information that may indicate liver or kidney disorders, diabetes, the risk of cardiovascular disease, bacterial or viral infections and other health risks. The Company also offers tests to detect the presence of antibodies to human immunodeficiency virus (HIV). Insurance companies generally offer a premium discount for nonsmokers and often rely on testing to determine whether an applicant is a user of tobacco products. Standardized laboratory testing can be used to verify responses on PAGE 3 a policy application to such questions as whether the applicant is a user of tobacco products, certain controlled substances or certain prescription drugs. Cocaine use has been associated with increased risk of accidental death and cardiovascular disorders, and as a result of increasing cocaine abuse in the United States and Canada, insurance companies are testing a greater number of policy applicants to detect its presence. Therapeutic drug testing also detects the presence of certain prescription drugs that are being used by an applicant to treat a life-threatening medical condition that may not be revealed by a physical examination. Insurance specimens are normally collected from individual insurance applicants by independent paramedical personnel using LabOne's custom-designed collection kits and containers. These kits and containers are delivered to LabOne's laboratory via overnight delivery services or mail, coded for identification and processed according to each client's specifications. Results are generally transmitted to the insurance company's underwriting department that same evening. LabOne provides a one-day service guarantee on oral fluid and urine HIV specimen results. In association with Lincoln National Risk Management, the Company provides electronic data collection services and software to enable insurance companies to receive data directly into their underwriting systems. LabOne offers LabOne NET, a combination network/software product that provides a connection for insurance underwriters for ordering and delivery of risk assessment information such as laboratory results, telephone inspections, motor vehicle reports and other applicant information. LabOne handles paramedical examination paperwork and assists with administration of data for insurance underwriting. Additionally, the Company can obtain attending physician statements, telephone inspections, motor vehicle reports, and perform claims investigation through its subsidiary, SBSI. Clinical Services: Clinical laboratory tests are generally requested by physicians and other healthcare providers to diagnose and monitor diseases and other medical conditions through the detection of substances in blood and other specimens. Laboratory testing is generally categorized as either clinical testing, which is performed on bodily fluids including blood and urine, or anatomical pathology testing, which is performed on tissue. Clinical and anatomical pathology tests are frequently performed as part of regular physical examinations and hospital admissions in connection with the diagnosis and treatment of illnesses. The most frequently requested tests include blood chemistry analyses, blood cholesterol level tests, urinalyses, blood cell counts, PAP smears and AIDS-related tests. Clinical specimens are collected at the physician's office or other specified sites. The Company's couriers pick up the specimens and deliver them to local airports for express transport to the Kansas laboratory. Specimens are coded for identification and processed. The Company's testing menu includes the majority of tests requested by its clients. Tests not performed in-house are sent to reference laboratories for testing, and results are transmitted into the Company's computer system along with all other completed results. The Company has established the Lab Card(R) Program, as a vehicle for delivering outpatient laboratory services. The Lab Card Program is marketed PAGE 4 to healthcare payers (self-insured groups and insurance companies), allowing them to avoid price mark-ups and cost shifting. The Lab Card Program provides laboratory testing at reduced rates as compared to traditional laboratories. It uses a unique benefit design that shares the cost savings with the patient, creating an incentive for the patient to help direct laboratory work to LabOne. Under the Program, the patient incurs no out-of-pocket expense when the Lab Card is used, and the insurance company or self-insured group receives substantial savings on its laboratory charges. LabOne has several exclusive arrangements with managed care organizations The two most significant are Principal Healthcare of Kansas City and BlueCross BlueShield of Tennessee. With these arrangements the Company contracts with the managed care organizations, and they direct all testing for their members through LabOne. Substance Abuse Testing Services: LabOne markets substance abuse testing to large companies, third party administrators and occupational health providers. Certification by the Substance Abuse and Mental Health Services Administration enables the Company to offer substance abuse testing services to federally regulated industries. Specimens for substance abuse testing are typically collected by independent agencies who use LabOne's forms and collection supplies. Specimens are sealed with bar-coded, tamper-evident seals and shipped overnight to the Company. Automated systems monitor the specimens throughout the screening and confirmation process. Negative results are available immediately after testing is completed. Initial positive specimens are verified by the gas chromatography/mass spectrometry method, and results are generally available within 24 hours. Results can be transmitted electronically to the client's secured computer, printer or fax machine, or the client can use LabOne's LabLink Dial-In software to retrieve, store, search and print its drug testing results. Segment Information - ------------------- The following table summarizes the Company's revenues from services provided to the insurance, clinical and substance abuse testing markets (dollars in thousands): Year ended December 31, 1998 1997 1996 -------------- -------------- -------------- Insurance $ 69,149 68% $ 61,998 79% $ 50,801 85% Clinical 18,600 18% 7,512 9% 3,942 7% Substance Abuse 14,478 14% 9,416 12% 4,689 8% ------- ------ ------ $ 102,227 $ 78,926 $ 59,432 ======= ====== ====== (See Note 9 of Notes to Consolidated Financial Statements for operating income and identifiable assets by segment.) PAGE 5 Operations - ---------- The Company's operations are designed to facilitate the testing of a large number of specimens and to report the results to clients, generally within 24 hours of receipt of the specimens. The Company has internally developed, custom-designed laboratory and business processing systems. It is a centralized network system that provides an automated link between LabOne's testing equipment, data processing equipment and clients' computer systems. This system offers LabOne's clients the ability to customize their testing and reflex requirements by several parameters to best meet their needs. As a result of the number of tests it has performed over the past several years, LabOne has compiled and maintains a large statistical data base of test results. These summary statistics are useful to the actuarial and underwriting departments of an insurance client in comparing that client's test results to the results obtained by the Company's entire client base. Company-specific and industry-wide reports are frequently distributed to clients on subjects such as coronary risk analysis, cholesterol and drugs of abuse. Additionally, the company's statistical engineering department is capable of creating customized reports to aid managed care entities or employers in disease management and utilization tracking to help manage healthcare costs. The Company considers the confidentiality of its test results to be of primary importance and has established procedures to ensure that results of tests remain confidential as they are communicated to the client that requested the tests. Substantially all of the reagents and materials used by the Company in conducting its testing are commercially purchased and are readily available from multiple sources. Regulatory Affairs - ------------------ The objective of the regulatory affairs department is to ensure that accurate and reliable test results are released to clients. This is accomplished by incorporating both internal and external quality assurance programs in each area of the laboratory. In addition, quality assurance specialists share the responsibility with all LabOne employees of an ongoing commitment to quality and safety in all laboratory operations. Internal quality and education programs are designed to identify opportunities for improvement in laboratory services and to meet all required safety training and education issues. These programs help ensure the reliability and confidentiality of test results. Procedure manuals in all areas of the laboratory help maintain uniformity and accuracy and meet regulatory guidelines. Tests on control samples with known results are performed frequently to maintain and verify accuracy in the testing process. Complete documentation provides record keeping for employee reference and meets regulatory requirements. All employees are thoroughly trained to meet standards mandated by OSHA in order to maintain a safe work environment. Superblind Testing Service(tm) controls are used to challenge every aspect of service at LabOne from specimen arrival through final billing. Approximately 500 sample kits are prepared and submitted anonymously each month. These samples have at least 15 different indicators each representing PAGE 6 over 7,500 challenges to the testing, handling and reporting procedures. Specimens requiring special handling are evaluated and verified by control analysis personnel. A computer edit program is used to review and verify clinically abnormal results and all positive HIV antibody and drugs-of-abuse records. As an external quality assurance program, LabOne participates in a number of proficiency programs established by the College of American Pathologists, the American Association of Bioanalysts and the Centers for Disease Control. LabOne is accredited by the College of American Pathologists. Even though only a small portion of LabOne's business encompasses fee-for- service Medicare/Medicaid, LabOne has appointed a Chief Compliance Officer and nine Co-Compliance Officers. Additionally, the Company has developed the LabOne Compliance Plan, based on the Model Compliance Plan recommended by the Office of Inspector General of the Department of Health and Human Services to ensure compliance with anti-fraud and abuse laws and rules governing federally-financed reimbursement for lab testing services. LabOne is licensed under the Clinical Laboratory Improvement Amendments of 1988. LabOne has additional licenses for substance abuse testing from the state of Kansas and all other states where such licenses are required. LabOne is certified by the Substance Abuse and Mental Health Services Administration to perform testing to detect drugs of abuse in federal employees and in workers governed by federal regulations. Congress recently enacted the Health Insurance Portability and Accountability Act of 1996. As a transmitter of health information in electronic form, the Company will be required to maintain administrative, technical, and physical safeguards to protect the integrity and confidentiality of healthcare information against unauthorized uses or disclosures. The act will also require the Company to convert healthcare information to electronic form that had previously been required under state law to be maintained in paper form. Compliance with these regulations may be required as early as the fall of 2001. Sales and Marketing - ------------------- LabOne's client base consists primarily of insurance companies in the United States and Canada. The Company believes that its ability to provide prompt and accurate results on a cost-effective basis, and its responsiveness to customer needs have been important factors in servicing existing business. All of the Company's sales representatives for the insurance market have significant business experience in the insurance industry or clinical laboratory-related fields. These representatives call on major clients several times each year, usually meeting with a medical director or vice president of underwriting. An important part of the Company's marketing effort is directed toward providing its existing clients and prospects with information pertaining to the actuarial benefits of, and trends in, laboratory testing. The Company's sales representatives and its senior management also attend and sponsor insurance industry underwriters' and medical directors' meetings. The sales representatives for the clinical industry are experienced in the healthcare benefit market or clinical laboratory-related fields, and currently work in the geographic areas which they represent. Marketing efforts are PAGE 7 directed at insurance carriers, self-insured employers and trusts, third party administrators and other organizations nationwide. Substance abuse marketing efforts are primarily directed at Fortune 1000 companies, occupational health clinics and third party administrators. The Company's strategy is to offer quality service at competitive prices. The sales force focuses on LabOne's ability to offer multiple reporting methods, next-flight-out options, dedicated client service representatives and rapid reporting of results. Competition - ----------- The Company believes that the insurance laboratory testing market in the United States and Canada is approximately a $130 million industry. LabOne currently services more than half the market. LabOne has maintained its market leadership through the development of long term client relationships, its reputation for providing quality products and services at competitive prices, and its battery of tests which are tailored specifically to an insurance company's needs. LabOne has two other main laboratory competitors, Osborn Laboratories, Inc. and Clinical Reference Laboratory. The insurance testing industry continues to be highly competitive. The primary focus of the competition has been on pricing. This continued competition has resulted in a decrease in LabOne's average price per test. It is anticipated that prices may continue to decline in 1999. The Company continues to develop innovative data management services that differentiate its products from competitors. These services enable LabOne's clients to expedite the underwriting process, saving time and reducing underwriting costs. The outpatient clinical laboratory testing market is a $20 billion industry which is highly fragmented and very competitive. The Company faces competition from numerous independent clinical laboratories and hospital- or physician-owned laboratories. Many of the Company's competitors are significantly larger and have substantially greater financial resources than LabOne. The Company is working to establish a solid client base through the use of Lab Card and the establishment of exclusive arrangements to provide laboratory services with large groups and managed care entities. LabOne's business plan is to be the premier low-cost provider of high-quality laboratory services to self-insured employers and insurance companies in the healthcare market. The Company feels that its superior quality and centralized, low-cost operating structure enable it to compete effectively in this market. LabOne competes in the substance abuse testing market nationwide. There are presently 71 laboratories that are certified by the Substance Abuse and Mental Health Services Administration. The Company's major competitors are the three major clinical chains, Laboratory Corporation of America, Quest Diagnostics and SmithKline Beecham Clinical Laboratories, who collectively constitute approximately two-thirds of the substance abuse testing market. The Company's focus is fast turnaround with high-quality, low-cost service. PAGE 8 Foreign Markets - --------------- Lab One Canada Inc. markets insurance testing services to Canadian clients, with laboratory testing performed in the United States. The following table summarizes the revenue, profit and assets applicable to the Company's domestic operations and its subsidiary, Lab One Canada Inc. Year ended December 31, (in millions) 1998 1997* 1996 ---- ----- ---- Sales: United States $95.7 $72.4 $53.1 Canada 6.5 6.6 6.4 Operating Profit: United States 14.2 2.0 2.4 Canada 0.3 0.6 0.7 Identifiable Assets: United States 83.8 56.8 62.1 Canada 2.8 3.2 2.7 *1997 operating profit includes a one-time write-off of $6.6 million. (See Note 1 of Notes to Consolidated Financial Statements.) Technology Development - ---------------------- The technology development department evaluates new commercially available tests and technologies, or develops new assays, and compares them to competing products in order to select the most accurate laboratory procedures. Additionally, LabOne's scientists present findings to clients to aid them in choosing the best tests available to meet their requirements. Total technology development expenditures are not considered significant to the Company as a whole. Employees - --------- As of March 1, 1999, the Company had 895 employees, including 23 part-time employees, representing an increase of 230 employees from the same time in 1998. The addition of SBSI accounts for approximately 65% of the increase. None of the Company's employees are represented by a labor union. The Company believes its relations with employees are good. ITEM 2. PROPERTIES On December 26, 1998, the Company started moving into its new 268,000 square foot, custom-designed facility located in Lenexa, Kansas, approximately 15 miles from Kansas City, Missouri. This facility consolidates the Company's laboratory, administrative and warehouse functions into one building. The facility is owned by the Company and financed through $20 million in industrial revenue bonds issued by the City of Lenexa, Kansas in September, 1998. The testing laboratory has certain enhancements that improve the PAGE 9 efficiency of operations. Conveyor systems transport inbound test kits from the receiving area to the laboratory and remove waste after the opening process. All automated testing equipment requiring purified water is linked directly to a centralized water-purification system. Over 50,000 square feet of raised flooring allows laboratory instruments and PCs to be arranged or moved quickly and easily. The security system includes proximity card readers to control access and a ceiling detector system to prevent foreign substances from being thrown into the laboratory. In addition, three diesel generators and a UPS battery system are on-line in the event of electrical power shortage. These back-up power sources allow specimen testing and data processing to continue until full power is restored, thus assuring LabOne's. clients of continuous laboratory operation. SBSI utilizes two facilities in Independence, Missouri under five year leases expiring in 2003. LabOne leases 10 locations in Northern California and 9 in the Midwest which serve as LabOne Service Centers. These facilities provide specimen collection services for patients and are typically located in medical office buildings. Lab One Canada Inc. leases office space in Ontario Canada, which is used for sales and client services. This lease expires in 2000. Additionally, Lab One Canada Inc. leases space in Quebec Canada for assembly and distribution of specimen collection kits for Canadian insurance testing. This lease expires in 2000. LabOne also owns two buildings which are currently under contract to be sold in the first and second quarter of 1999. Prior to moving to the new facility, these buildings were used for laboratory operations, administrative offices and data processing. LabOne's lease on its former warehouse facility expired in February 1999. ITEM 3. LITIGATION In the normal course of business, LabOne had certain lawsuits pending at December 31, 1998. The Comptroller of the State of Texas has conducted an audit of LabOne for sales tax compliance and contends that LabOne's insurance laboratory testing services are taxable under the Texas tax code and has issued an audit assessment, including interest and penalties, of approximately $1.9 million. The Company has appealed this assessment arguing that its services do not fit within the definition of insurance services under the Texas code. The assessment is under review by the Texas State Hearing Attorney. In the opinion of management, after consultation with legal counsel and based upon currently available information, none of these lawsuits are expected to have a material impact on the financial condition or results of operations of the Company. No provisions for loss related to litigation are included in the accompanying consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS None PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Registrant's common stock trades on The NASDAQ Stock Market (R) under the symbol LABS. As of March 1, 1999, the outstanding shares were held by approximately 1850 shareholders of record. PAGE 10 The Company paid quarterly dividends of $0.18 per common share in both 1998 and 1997. The Board of Directors reviews the dividend policy on a periodic basis. There are currently no restrictions that would limit the Company's ability to make future dividend payments. The following are the high and low prices of the stock for each quarter of 1998 and 1997: 1998 1997 ---- ---- High Low High Low ---- --- ---- --- 1st Quarter $18.25 15.75 $20.00 16.25 2nd Quarter 18.50 16.63 18.50 15.25 3rd Quarter 17.13 11.50 18.75 15.38 4th Quarter 16.75 9.25 18.50 15.13 On November 13, 1998, LabOne issued a Warrant to USA Managed Care Organization (USA MCO) to purchase up to 500,000 shares of Common Stock of LabOne, par value $0.01 per share, at a purchase price of $15.44 per share. The Warrant was issued in conjunction with a Marketing Agreement entered into between LabOne and USA MCO, which is a specialist in providing managed healthcare consulting services. Under the Marketing Agreement, USA MCO agreed to market LabOne's LabCard program for providing clinical laboratory testing services to USA MCO's clients. No cash consideration was received by LabOne for the issuance of the Warrant. The Warrant is exercisable by USA MCO in respect of the number of shares of common stock of LabOne indicated below for each calendar quarter prior to March 1, 2004, in which the revenues received by LabOne during the quarter pursuant to the Marketing Agreement with USA MCO are within the ranges specified below: LabOne Quarterly Revenues Number of LabOne Received under USA MCO Shares Exercisable Marketing Agreement under the Warrant -------------------- ----------------- $500,000 to $999,999 5,000 shares $1,000,000 to $1,499,999 10,000 shares $1,500,000 to $1,999,999 15,000 shares $2,000,000 to $2,499,999 20,000 shares $2,500,000 and above 25,000 shares The number of shares of common stock issuable upon the exercise of the Warrant and the purchase price per share are subject to adjustment in the event of changes in the capital structure of LabOne. The Warrant and shares of common stock issuable upon the exercise of the Warrant were not registered under the Securities Act of 1933 in reliance upon the exemptions from the registration requirements provided by Section 4(2) of the Act and Rule 506 under Regulation D. NSS is believed to be an "accredited investor" within the meaning of Regulation D. PAGE 11 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes certain selected financial information and operating data regarding the Company. This information should be read in conjunction with Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and Item 14. (a) (1) and (2), CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE. The balance sheet data as of December 31, 1998, 1997, 1996, 1995 and 1994, and the statement of earnings data for each of the years in the five-year period ended December 31, 1998, have been derived from the Company's Consolidated Financial Statements, which have been audited by KPMG LLP, the Company's independent certified public accountants. Years Ended December 31, (in thousands, except per share amounts) 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Statement of Earnings Data: Sales $102,227 78,926 59,432 57,029 60,726 Cost of sales 56,720 42,017 32,717 29,934 29,073 ------- ------ ------ ------ ------ Gross profit 45,507 36,909 26,715 27,095 31,653 Selling, general and administrative expenses 31,028 27,707 23,623 24,908 24,821 Loss provision* -- 6,553 -- -- -- ------- ------ ------ ------ ------ Earnings from operations 14,479 2,649 3,092 2,188 6,833 Other income 702 1,122 1,784 2,562 1,700 ------- ------ ------ ------ ------ Earnings before income taxes 15,181 3,771 4,877 4,750 8,533 Income taxes 5,962 1,568 2,009 1,953 2,846 ------- ------ ------ ------ ------ Net earnings $ 9,219 2,202 2,868 2,797 5,687 ======== ====== ====== ====== ====== Diluted earnings per common share $ 0.69 0.17 0.22 0.21 0.43 ======== ====== ====== ====== ====== Dividends per common share $ 0.72 0.72 0.72 0.72 0.72 ======== ====== ====== ====== ====== Balance Sheet Data: Working capital 25,931 35,426 38,817 44,233 48,559 Total assets 86,781 59,973 64,743 70,048 76,758 Long term debt 18,097 - - - - Stockholders' equity 53,181 51,499 58,449 64,864 71,237 *The 1997 loss provision represents the one-time write-down on the value of the Company's facilities which are available for sale. (See Note 1 of Notes to Consolidated Financial Statements.) PAGE 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - --------------------- 1998 COMPARED TO 1997 Revenue for the year ended December 31, 1998 was $102.2 million as compared to $78.9 million in 1997. The increase of $23.3 million, or 30%, was due to increases in clinical laboratory revenue of $11.1 million, insurance services revenue of $7.2 million and SAT revenue of $5.1 million. Clinical laboratory revenue increased from $7.5 million during 1997 to $18.6 million in 1998 primarily due to increased testing volumes. The insurance services segment revenue increased from $62.0 million in 1997 to $69.1 million due to an increase in the total number of insurance applicants tested and an increase in non laboratory services, including SBSI revenue of $1.3 million, partially offset by a 3% decrease in the average revenue per applicant. SAT revenue increased from $9.4 million in 1997 to $14.5 million in 1998 primarily due to a 48% increase in testing volumes. Cost of sales increased $14.7 million, or 35%, for the year as compared to the prior year. This growth is primarily due to increases in inbound freight, laboratory and kit supplies and payroll expenses due to the larger specimen volume for all three business segments. Insurance segment cost of sales expenses were $32.3 million as compared to $26.7 million during 1997. Clinical cost of sales expenses were $14.5 million as compared to $8.3 million during 1997. SAT cost of sales expenses were $9.9 million as compared to $7.0 million during 1997. These increases are due to increased testing volumes. As a result of the above factors, gross profit increased $8.6 million, or 23%, from $36.9 million in 1997 to $45.5 million in 1998. Insurance gross profit increased $1.5 million, or 4%, to $36.9 million in 1998. Clinical gross profit improved $4.9 million from a loss of $0.8 million in 1997 to a gain of $4.1 million in 1998. SAT gross profit increased $2.2 million to $4.5 million in 1998. Selling, general and administrative expenses increased $3.3 million, or 12%, in 1998 as compared to 1997 primarily due to increases in payroll expenses and bad debt accruals. Bad debt expense increased primarily due to the revenue growth in clinical and SAT segments which have inherently higher bad debt experience than the insurance testing segment. Clinical overhead expenditures were $10.3 million as compared to $7.5 million in 1997. SAT overhead increased from $3.3 million in 1997 to $4.3 million in 1998. These increases are due to the growth in each segment. The allocation of corporate overhead to the clinical and SAT segments increased to $5.3 million for the year, as compared to $3.3 million in 1997, due to the increased share of total revenue for those segments. Insurance overhead expenditures decreased to $16.3 million as compared to $16.8 million in 1997. In 1997, the Company recorded a one-time write-down of $6.6 million on the value of the laboratory and administrative buildings in anticipation of their sale. (See Note 1 of Notes to Consolidated Financial Statements.) Operating income increased from $2.6 million in 1997 to $14.5 million in 1998. The insurance services segment operating income increased $2.1 million to $20.6 million in 1998. The clinical segment had an operating loss of $6.2 million for 1998 as compared to an operating loss of $8.3 million in 1997. PAGE 13 The SAT segment improved from an operating loss of $0.9 million in 1997 to a gain of $0.2 million in 1998. Other income decreased $0.4 million in 1998 as compared to 1997, primarily due to lower investment income due to less funds available to invest. Average income tax expense was 39.3% of pretax income in 1998 as compared to 41.6% in 1997. The reduction is primarily due to an increase in LabOne's income from U.S. sources taxed at U.S. rates as compared to income taxed at higher foreign rates. The combined effect of the above factors resulted in net earnings of $9.2 million, or $0.69 per share, in 1998 as compared to $2.2 million, or $0.17 per share, in 1997. Excluding the impact of the write-down in 1997, last year's net earnings would have been $6.1 million, or $0.46 per share. 1997 COMPARED TO 1996 Revenue for the year ended December 31, 1997 was $78.9 million as compared to $59.4 million in 1996. The increase of $19.5 million, or 33%, is due to increases in insurance segment revenue of $11.2 million, SAT revenue of $4.7 million and clinical laboratory revenue of $3.6 million. The insurance segment increased 22% due to an increase in the total number of insurance applicants tested and an increase in kit revenue, partially offset by a 1% decrease in the average revenue per applicant. The increase in insurance segment revenue is primarily due to an increase in market share and changes to testing thresholds. Effective January 30, 1997, LabOne acquired certain assets, including customer lists, of GIB Laboratories, Inc., a subsidiary of Prudential Insurance Company of America. Concurrently, Prudential's Individual Insurance Group agreed to use LabOne as its exclusive provider of risk assessment testing services for a three year period. At the time of the purchase, GIB served approximately 5% of the insurance laboratory testing market. Revenue in 1997 from former GIB customers, including Prudential, was approximately $3.8 million. SAT revenue increased from $4.7 million in 1996 to $9.4 million in 1997 due to a doubling in testing volumes. Clinical laboratory revenue increased from $3.9 million in 1996 to $7.5 million in 1997 due to increased testing volumes and higher revenue per patient. Cost of sales increased $9.3 million, or 28%, for the year as compared to the prior year. This increase is due primarily to increases in payroll, laboratory supplies and kit expenses due to the larger specimen volume for all three business segments. Direct and allocated clinical cost of sales expenses were $8.3 million as compared to $6.5 million during 1996. Direct and allocated SAT cost of sales expenses were $7.0 million as compared to $3.7 million during 1996. These increases are due to increased testing volumes. As a result of the above factors, gross profit increased $10.2 million, or 38%, from $26.7 million in 1996 to $36.9 million in 1997. Insurance gross profit increased $7.0 million, or 25%, in 1997 as compared to 1996. Clinical gross profit improved $1.8 million from a loss of $2.6 million in 1996 to a loss of $0.8 million in 1997. SAT gross profit increased from $1.0 million in 1996 to $2.4 million in 1997. Selling, general and administrative expenses increased $4.1 million, or 17%, in 1997 as compared to 1996 due primarily to increases in payroll expenses, travel and amortization expenses. Clinical overhead expenditures were $7.5 million as compared to $5.4 million in 1996. SAT overhead increased from $2.2 PAGE 14 million in 1996 to $3.3 million in 1997. These increases are due to the growth in each segment. In 1997, the Company recorded a one-time write-down of $6.6 million on the value of the laboratory and administrative buildings in anticipation of their sale. (See Note 1 of Notes to Consolidated Financial Statements.) Operating income decreased from $3.1 million in 1996 to $2.6 million in 1997, primarily due to the $6.6 million write down, partially offset by an increase in the insurance segment operating income of $5.9 million. The clinical segment had an operating loss of $8.3 million for 1997 as compared to a loss of $8.0 million in 1996, due to a $0.6 million increase in corporate overhead allocation over 1996. The SAT segment improved from an operating loss of $1.2 million in 1996 to a loss of $0.9 million in 1997, including a $0.9 million increase in corporate overhead allocation over last year. Other income decreased $0.7 million in 1997 as compared to 1996, due to lower investment income. Average income tax expense was 41.6% of pretax income in 1997 as compared to 41.2% in 1996. The combined effect of the above factors resulted in net earnings of $2.2 million, or $0.17 per share, in 1997 as compared to $2.9 million, or $0.22 per share, last year. Excluding the impact of the write-down, net income would have been $6.1 million, or $0.46 per share, in 1997. TRENDS - ------ The following is management's analysis of certain existing trends that have been identified as potentially affecting the future financial results of the Company. Due to the potential for a rapid rate of change in any number of factors associated with the insurance and healthcare laboratory testing industries, it is difficult to quantify with any degree of certainty LabOne's future volumes, sales or net earnings. The insurance laboratory testing industry continues to be highly competitive. The primary focus of the competition has been on pricing. LabOne continues to maintain its market leadership by providing quality products and services at competitive prices. Management expects that prices may continue to decline during 1999 due to competitive pressures. This trend may have a material impact on earnings from operations. The total number of insurance applicants tested by LabOne increased 11% in 1998 from the prior year. Approximately 80% of the increase represented oral fluid HIV tested applicants. The number of oral fluid tested applicants are expected to further increase in 1999 Effective October 30, 1998, LabOne acquired Systematic Business Services, Inc. (SBSI) which is operated as a wholly owned subsidiary of the insurance services division of LabOne. SBSI is a provider of information services to life and health insurers nationwide, and has annual revenues of approximately $7 million. With 148 employees in the Kansas City area, SBSI provides telephone inspections, motor vehicle reports, attending physician statements, and claims investigation services to life insurance companies. This addition allows LabOne to expand the services it offers to its insurance industry clients. PAGE 15 In the clinical division, BlueCross BlueShield of Tennessee selected LabOne to provide routine outpatient laboratory testing services for BlueCare members throughout Tennessee effective February 1, 1998. BlueCare is BlueCross BlueShield of Tennessee's plan for Tenncare participants. Approximately 400,000 BlueCare members are currently covered by the program. To date, the Laboratory Benefit Management programs, including BlueCare and the Lab Card Program, have more than 2.3 million lives enrolled. Revenue from Laboratory Benefit Management programs during the fourth quarter 1998 was $3.2 million or approximately 62% of total clinical revenue. The Company's new facility was financed through the City of Lenexa, Kansas, with industrial revenue bonds. In conjunction with the bonds, LabOne expects to receive income tax credits through the State of Kansas High Performance Incentive Plan to be applied against state income taxes for up to 10 years, or until the credit is completely used. The amount of the credit is expected to be approximately $4 million, and will lower LabOne's average income tax rate for the duration of the credit. On March 8, 1999, LabOne and Lab Holdings, Inc. announced that the Boards of Directors of both companies had approved an agreement to merge the two companies. If consummated, the proposed merger will have several effects which are fully discussed in the Registration Statement on Form S-4 filed by Lab Holdings with the United States Securities and Exchange Commission on April 13, 1999 (File No. 333-76131), which may be amended from time to time. One effect of the merger will be to add transaction goodwill to the balance sheet of the combined company in an estimated amount ranging from about $22.2 million to $24.9 million. This transaction goodwill reflects the expected difference between the cost of LabOne shares that Lab Holdings will be treated as acquiring in the merger and the fair value of the LabOne net assets allocated to these acquired shares. If the merger is consummated, the combined company's balance sheet will also include about $6.3 million in existing historical goodwill that currently is a Lab Holdings asset that resulted from Holding's prior acquisitions of LabOne stock. Following the merger, this historical and transaction goodwill is expected to negatively impact reported earnings of the combined company at an estimated annual rate from about $2.6 million to $2.8 million until the historical goodwill is fully amortized in April 2003, and thereafter at an estimated annual rate from about $1.1 million to $1.3 million until the 20th anniversary of the merger. The amounts in this paragraph are hypothetical assuming that the merger had occurred as shown on the pro forma financial statements included in the above Registration Statement. The actual amount of goodwill incurred in the merger will depend on the number of combined company shares issued in the merger, the actual amount of transaction costs and the fair value of the LabOne net assets at the time of the merger. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- LabOne's working capital position declined from $35.4 million at December 31, 1997, to $25.9 million at December 31, 1998. This decrease is primarily due to dividends paid and capital additions, including building payments, in excess of bond proceeds and cash provided by operations. Net cash provided by operations increased from $8.1 million in 1997 to $9.0 million in 1998. Accounts receivable grew from $12.6 million as of December 31, 1997 to $18.7 million as of December 31, 1998, due primarily to an increase in revenue growth from all three segments. Bad debt expense and reserves increased due to the increase in total revenue and a shift in revenue toward clinical and SAT sources. PAGE 16 During 1998, LabOne paid quarterly dividends of $0.18 per common share. The Board of Directors reviews this policy on a periodic basis. The total amount of dividends paid during 1998 was $0.72 per share, or $9.5 million, which was $0.5 million in excess of net cash provided by operations. There are no restrictions that would limit the Company's ability to make future dividend payments. During 1998, the Company invested $28.5 million in additional property, plant and equipment, as compared to $11.5 million in 1997 and $3.2 million in 1996. Of the amount spent in 1998, approximately $21.6 million was for construction the Company's new facility, and $3.0 million net cash was used in the purchase of SBSI. The 1997 amount included land purchased related to the new facility and the GIB Laboratories acquisition. As of April 1999, the new facility was completely operational. (See footnote 11 of Notes to Consolidated Financial Statements). Future capital asset purchases are expected to be approximately $5 million. The Company had no short-term borrowings during 1998. Management expects to be able to fund operations and future dividend payments from a combination of cash flow from operations, cash reserves, building sales and short-term borrowings. Interest on the industrial revenue bonds issued to finance the construction of the Company's new facility is based on a taxable seven day variable rate which, including letter of credit and remarketing fees, is approximately 5.8% as of March 1, 1999. The bonds mature over 11 years in increments of $1.85 million per year plus interest. Total cash and investments at December 31, 1998, were $10.2 million, as compared to $19.5 million at December 31, 1997. If the proposed merger between LabOne and Lab Holdings is consummated, the future dividend policy of the combined company in the merger will be determined by its new Board of Directors, a majority of whom will be independent non-management directors. Although nine of the twelve current LabOne directors are expected to continue as directors of the combined company, there can be no assurance as to any dividend determinations by that board in the future. That determination will be subject to the financial condition, operating results, and liquidity of the combined company and numerous other factors. In addition, the pursuit by the combined company of LabOne's growth and diversification strategy, the increased financial leverage that is expected to result from the merger, changes in the market for LabOne's products and services, negative impacts caused by other risks described in the Registration Statement on Form S-4 filed by Lab Holdings with the United States Securities and Exchange Commission on April 13, 1999 (File No. 333-76131), which may be amended from time to time, or any of them singly or together with other factors could influence the board of the combined company to reduce or eliminate the quarterly dividend. Under the merger agreement, LabOne shareholders (other than Lab Holdings) may elect to exchange each LabOne share for either one share of the combined company, $12.75 in cash, or a combination of shares and cash. Cash elections are subject to an aggregate cash limit of $16.6 million. It is expected that the combined company will need to borrow up to $13.6 million to satisfy cash elections in excess of $3 million. Additional cash could be needed if any Lab Holdings shareholders perfect dissenters' rights. These additional borrowings will increase annual interest expense and subject the combined company to the normal risks associated with debt financing. However, the amount of these borrowings is not expected to have a negative impact on earnings per share because the increased borrowing expense would be offset by the reduction in the number of shares of the combined company issued in the merger as a result of cash elections by LabOne stockholders. The additional financial leverage PAGE 17 could also impair the ability of the combined company to pursue acquisition and growth strategies that would otherwise be available or impact future operating results due to higher debt service in the event that future acquisitions are completed. The loan agreement that provides for borrowings to finance the merger and existing LabOne loan agreements do not contain covenants that will directly prohibit the board of directors of the combined company from continuing Holdings' quarterly dividends at the current amount. However, the increased debt combined with other circumstances could cause the board of the combined company to reduce or discontinue the quarterly dividend. Other circumstances include negative operating results, acquisition or other expenditures or commitments incurred to continue LabOne's diversification and growth strategy, or the effect of general financial covenants contained in the loan agreement. YEAR 2000 - --------- LabOne is actively addressing Year 2000 computer concerns. The company has established an oversight committee which includes management from all parts of the Company and meets periodically to review progress. The Company's laboratory operating systems and its business processing systems were completely rewritten as of 1991 and were brought into compliance with Year 2000 date standards at that time. Non-IT systems, which include security systems, time clocks and heating and cooling systems, have been replaced with certified compliant systems as part of construction of the new facility. Ongoing remediation efforts include regularly scheduled software upgrades and replacement of personal computers and associated equipment. The Company expects to complete all remaining internal Year 2000 objectives by the end of the second quarter, 1999. LabOne is assessing the Year 2000 preparation and contingency plans of the Company's clients and vendors. LabOne has material relationships and dependencies with its primary telecommunications provider, Sprint Corp., its inbound shipping provider, Airborne Express, and municipal services providers. In the event of a service interruption, the Company has the ability to switch telecommunications services to AT&T at any time, and maintains backup electrical generators capable of meeting its electrical needs. LabOne currently tracks and controls routing of its inbound specimens and can use United States Postal Service, airlines and other common carriers or express delivery services in the event of delivery problems with Airborne Express. The Company currently maintains approximately an eight week supply of most laboratory supplies, and does not expect significant problems in obtaining supplies. The Company continues to review the Year 2000 plans of these providers, and does not currently expect significant problems in these areas; however, there can be no assurance that the systems of clients and vendors will be converted to address Year 2000 problems in a timely and effective manner or that such conversions will be compatible with the Company's computer systems. Resources dedicated to the remaining effort are expected to cost less than $0.3 million and are not considered a material expense to the Company. These efforts have not caused delay to the Company's other ongoing information systems projects. LabOne has not hired any outside consultants or other independent validation provider at this time, and does not expect to do so. There can be no assurance that the Company's adjustments to its computer systems will completely eliminate all Year 2000 problems. Failure to properly address the Year 2000 problem could have a material adverse effect on the Company's business, financial condition and results of operations. PAGE 18 ITEM 7(a). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A foreign currency risk exposure exists due to billing Canadian subsidiary revenue in Canadian dollars and the direct laboratory expenses associated with this revenue being incurred in US dollars. This exposure is not considered to be material. Any future material Canadian currency fluctuations against the US$ could result in a decision to hedge future foreign currency cash flows, or to increase Canadian prices. An interest rate risk exposure exists due to LabOne's liability of $20 million in industrial revenue bonds. The interest expense incurred on these bonds is based on a taxable seven day variable rate, which including letter of credit and remarketing fees, is approximately 5.8% as of March 1, 1999. This exposure is not considered material. Any future increase in interest rates would result in additional interest expense and could result in a decision to enter into a long-term interest rate swap transaction. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See ITEM 14.(a). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of LabOne as of May 31, 1999 are as follows: Name Age Position - ---- --- -------- W. Thomas Grant II 49 Chairman of the Board of Directors, President, Chief Executive Officer and Director Gregg R. Sadler, FSA 48 Executive Vice President- Administration, President - Insurance Laboratory Division, Secretary and Director Robert D. Thompson 37 Executive Vice President, Chief Operating Officer, Chief Financial Officer and Director Roger K. Betts 56 Executive Vice President - Sales - Insurance Laboratory Division Thomas J. Hespe 42 Executive Vice President - Sales and Marketing, President-Clinical Sales and Marketing and Director Carl W. Ludvigsen, Jr. 46 Executive Vice President - Corporate M.D., Ph.D., J.D., Development and Chief Medical Officer FCAP, FCLM PAGE 19 Michael A. Peat, Ph.D. 51 Executive Vice President - Toxicology, and President-Substance Abuse Testing Division Thomas H. Bienvenu II 49 Executive Vice President - Information Systems and Technology Judith A. VonFeldt 52 Executive Vice President - Human Resource Kurt E. Gruenbacher, 39 Vice President - Finance, Chief CPA, CMA, CFM Accounting Officer, Treasurer and Assistant Secretary Joseph H. Brewer, M.D. 48 Director William D. Grant 82 Director Richard A. Rifkind, M.D. 68 Director Richard S. Schweiker 72 Director James R. Seward 46 Director John E. Walker 61 Director R. Dennis Wright, Esq. 56 Director The terms of office of the directors of LabOne will expire upon the election of their successors at the 1999 Annual Meeting of Stockholders. Executive officers serve at the pleasure of the Board of Directors. Mr. W. Thomas Grant II has been a director of LabOne since 1983. Mr. Grant was appointed Chairman of the Board of Directors, President and Chief Executive Officer of LabOne in October 1995. He served as Chairman of the Board of Lab Holdings, Inc. from May 1993 to September 1997. Mr. Grant is also a director of Commerce Bancshares, Inc., Kansas City Power & Light Company, Response Oncology, Inc., AMC Entertainment, Inc. He is the son of W. D. Grant. Mr. Sadler has been a director of LabOne since 1985. Mr. Sadler was appointed President-Insurance Laboratory Division in 1994 and Executive Vice President Administration in 1993. Mr. Sadler has served as Secretary since 1988. Mr. Thompson has been a director of LabOne since 1995. Mr. Thompson was appointed Chief Operating Officer in May 1997 and Executive Vice President - Finance and Chief Financial Officer in December 1993. He served as Treasurer from December 1993 to November 1997, and served as Vice President-Business Development Planning from August 1993 to December 1993. Mr. Betts was appointed Executive Vice President - Sales-Insurance Laboratory Division in 1994. From 1993 to 1994, Mr. Betts served as Senior Vice President - Sales of the Insurance Laboratory Division. Mr. Hespe has been a director of LabOne since 1995. Mr. Hespe was appointed President - Clinical Sales and Marketing and Executive Vice President - Sales and Marketing in 1995. From 1990 to 1995, Mr. Hespe served as Executive Vice President Sales and Marketing of Allscrips Pharmaceuticals, Vernon Hills, Illinois, a distributor of managed care pharmaceutical products and services with annual revenues of approximately $70 million. Mr. Hespe's responsibilities with Allscrips included developing strategies for market expansion and developing business with managed care organizations, including hospitals, physicians, HMO organizations, third party administrators, consulting firms, self-insured employers and insurance companies. PAGE 20 Dr. Ludvigsen has served as Executive Vice President - Corporate Development and Chief Medical Officer since December 1996. He served as Executive Vice President - Operations and Chief Operating Officer from December 1993 to November 1996. Dr. Peat was appointed President-Substance Abuse Testing Division and Executive Vice President - Toxicology in May 1996. Dr. Peat served as Senior Vice President - Toxicology from 1994 to 1996. Prior to joining LabOne in 1994, Dr. Peat was Vice President of Toxicology of Roche Biomedical Laboratories, Inc., Research Triangle Park, North Carolina. Mr. Bienvenu was appointed Executive Vice President - Information Systems and Technology in May 1997. Mr. Bienvenu served as Senior Vice President - Information Systems and Technology from 1994 to 1997. He served as Vice President - Marketing Information Technology from October 1994 to December 1994. Prior to October 1994, he served as Director of Marketing Information Technology. Ms. VonFeldt has served as Executive Vice President - Human Resources since August 1998. She served as Senior Vice President - Human Resources from May 1997 to August 1998, and as Vice President - Human Resources from September 1993 to May 1997. Mr. Gruenbacher was appointed Assistant Secretary in May 1999 and Treasurer in November 1997. He was appointed Vice President - Finance and Chief Accounting Officer in May 1995. Mr. Gruenbacher served as Corporate Controller from 1994 to 1995, and Director, Financial Analysis and Budgets from 1993 to 1994. Dr. Brewer has been a director of LabOne since 1988. During the past five years, Dr. Brewer has been an Infectious Disease Specialist at St. Luke's Hospital, Kansas City, Missouri and an Assistant Clinical Professor of Medicine at the University of Missouri - Kansas City. Mr. William D. Grant has been a director of LabOne since 1989. Mr. Grant is retired. From August 1990 to December 1997, he served as a consultant to Lab Holdings, Inc. Mr. Grant also served as Chairman Emeritus of Lab Holdings, Inc. from May 1993 to September 1997 and served as Chairman of the Board of Lab Holdings, Inc. prior to May 1993. He is the father of W. Thomas Grant II. Dr. Rifkind has been a director of LabOne since 1987. Dr. Rifkind has been Chairman of the Sloan-Kettering Institute, New York, New York, a medical research institution, during the past five years. Mr. Schweiker has been a director of LabOne since 1995. Mr. Schweiker has been retired for the past five years. Prior to his retirement, Mr. Schweiker served as President of the American Council of Life Insurance, Washington, D.C., a life insurance trade association. Mr. Schweiker is also a director of Tenet Healthcare Corporation. Mr. Seward has been a director of LabOne since 1995. Mr. Seward has been self-employed as an investment adviser and consultant since August 1998. From December 1996 to August 1998, Mr. Seward served as President, Chief Executive Officer and a director of SLH Corporation, Shawnee Mission, Kansas, an asset management company. SLH Corporation was a wholly-owned subsidiary of Lab Holdings, Inc. prior to its spin-off in March 1997. He was Executive Vice PAGE 21 President of Lab Holdings, Inc. from 1993-1997 and served as its Chief Financial Officer from 1990-1997. Mr. Seward is also a director of Response Oncology, Inc. and Syntroleum Corporation and Concorde Career Colleges. Mr. Walker has been a director of LabOne since 1984. Mr. Walker retired as Managing Director - Reinsurance of Business Men's Assurance Company of America in 1996. Mr. Walker served as Vice Chairman of the Board of Directors of LabOne prior to 1994. Mr. Wright has been a director of LabOne since 1987. Mr. Wright has been a partner in the law firm of Morrison & Hecker L.L.P., Kansas City, Missouri, since September 1998. Mr. Wright was a member of Hillix, Brewer, Hoffhaus, Whittaker & Wright, L.L.C., Kansas City, Missouri and Chairman of its Executive Committee prior to its merger with Morrison & Hecker, L.L.P. in September 1998. Morrison & Hecker, L.L.P. is general counsel to LabOne. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires directors, executive officers and beneficial owners of more than ten percent of the Common Stock of LabOne to file reports of beneficial ownership and reports of changes in beneficial ownership with the Securities and Exchange Commission and to provide copies to LabOne. Based solely upon a review of the copies of such reports provided to LabOne and written representations from directors and executive officers, LabOne believes that all applicable Section 16(a) filing requirements for 1998 have been met, except with respect to one late Form 5 filing by W. D. Grant. Mr. Grant initially filed a Form 5 for the 1998 fiscal year in a timely manner, but the Form 5 omitted a transaction required to be reported therein. Upon discovery of the omission, Mr. Grant filed a corrected Form 5 approximately eight days late. PAGE 22 ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table provides certain summary information concerning compensation paid or accrued by LabOne to or on behalf of (i) the person who served as its chief executive officer during 1998 and (ii) the four most highly compensated executive officers other than the chief executive officer serving as of December 31, 1998, for services rendered in all capacities to LabOne and its subsidiaries for each of the last three completed fiscal years. Long-Term Annual Compensation Compensation ------------------- ------------ Name and Fiscal Stock Option Shares All Other Principal Position Year Salary ($) Bonus ($) Granted (#) Compensation ($) (1) - ----------------- ---- ---------- --------- ----------- -------------------- W. Thomas Grant II 1998 164,769 107,261 -0- 21,670 Chairman of the 1997 86,019 131,173 75,000 9,922 Board of Directors, 1996 -0- -0- -0- -0- President and Chief Executive Officer Robert D. Thompson 1998 217,627 157,261 -0- 16,696 Executive Vice Presi- 1997 209,900 131,173 -0- 16,856 dent, Chief Operating 1996 209,277 75,000 -0- 17,086 Officer and Chief Financial Officer Carl W. Ludvigsen,Jr. 1998 239,781 42,661 -0- 21,670 Executive Vice Presi- 1997 230,900 131,173 -0- 21,470 dent-Corporate Devel- 1996 230,277 25,000 -0- 20,634 opment and Chief Medical Officer Thomas J. Hespe 1998 165,704 107,261 -0- 21,371 Executive Vice Presi- 1997 159,900 131,173 -0- 21,470 dent-Sales and 1996 159,277 50,000 -0- 20,490 Marketing Gregg R. Sadler 1998 165,704 107,261 -0- 21,670 Executive Vice Presi- 1997 156,900 131,173 -0- 21,865 dent-Administration 1996 150,277 50,000 -0- 20,923 and Secretary and President-Insurance Laboratory Division
(1) The amounts shown in this column for 1998 consist of (a) contributions by LabOne to the account of each of the named executive officers under LabOne's defined contribution pension plan in the amount of $16,421; (b) 50% matching contributions by LabOne under LabOne's profit-sharing 401(k) plan in the amount of $4,526 to the accounts of each of Messrs. Grant, Ludvigsen, Hespe and Sadler; and (c) insurance premium payments by LabOne with respect to group term life insurance in the amounts of $723 for the benefit of each of Messrs. Grant, Ludvigsen and Sadler, $274 for the benefit of Mr. Thompson and $424 for the benefit of Mr. Hespe. PAGE 23 Aggregate Option Exercises and December 31, 1998 Option Value Table The following table provides certain information concerning the exercise of stock options during 1998 by each of the named executive officers and the number and value of unexercised options held by such persons on December 31, 1998. Number of Shares Value of Underlying Unexercised Unexercised In-the-Money Options on Options on December 31, 1998 (#) December 31, 1998($) Shares Options Options Options Options Acquired on Value Exercis- Unexer- Exercis- Unexer- Name Exercise (#) Realized able cisable able cisable ------------ -------- ---- ------- ---- ------- W. Thomas 0 0 42,431 60,000 $ 84,007 $0 Grant II Robert D. 0 0 122,000 28,000 $ 39,375 $26,250 Thompson Carl W. . 0 0 81,000 8,000 $ 82,873 $10,000 Ludvigsen, Jr. Thomas J. 0 0 60,000 40,000 $ 78,750 $52,500 Hespe Gregg R. 0 0 90,400 9,600 $144,019 $0 Sadler
Compensation of Directors Directors who are not employees of LabOne receive an annual retainer fee of $5,000 in cash and a grant of a number of shares of common stock of LabOne having a value equal to $10,000, plus $500 for each Board and Committee meeting attended and reimbursement for reasonable expenses in attending meetings. Richard S. Schweiker, a Director of LabOne, has agreed to attend national meetings of insurance underwriters on LabOne's behalf and to make selected contacts in furtherance of LabOne's business, for which services LabOne will pay Mr. Schweiker additional fees of $30,000 annually. PAGE 24 Employment Agreements LabOne has Employment Agreements with Robert D. Thompson, Carl W. Ludvigsen Jr., Gregg R. Sadler and Thomas J. Hespe. Dr. Ludvigsen's Agreement provides for his employment for a two-year term ending in November 1998 and renewable annually thereafter for successive one-year terms unless LabOne elects not to extend the Agreement. Messrs. Thompson's and Sadler's Agreements are renewable annually for one-year terms unless LabOne elects not to extend them and Mr. Hespe's Agreement is terminable by LabOne on thirty days' notice. The annual base salaries provided under the Agreements are $200,900 to Mr. Thompson, $230,900 to Dr. Ludvigsen, $150,900 to Mr. Sadler and $150,900 to Mr. Hespe. In the event that LabOne terminates Messrs. Thompson, Ludvigsen or Sadler without cause (as defined in the Agreements), LabOne will pay the terminated officer a lump sum severance payment equal to his base salary for the balance of the term of the Agreement, plus 50% of one year's annual base salary. If LabOne terminates Mr. Hespe without cause, LabOne will pay Mr. Hespe a severance payment equal to one year's base salary. If a change of control of LabOne (as defined in the Agreements) occurs at any time during which the executive officer is in LabOne's full-time employment, and within one year after such a change in control the executive officer's employment is terminated for any reason other than permanent disability, death or normal retirement, LabOne will pay the officer as termination compensation a lump sum amount equal to three times the officer's average annual compensation for the most recent five taxable years(subject to certain limitations prescribed in the Internal Revenue Code) and any remaining term of the officer's Agreement shall be canceled. The proposed merger of LabOne with and into Lab Holdings, Inc. does not constitute a change of control of LabOne within the meaning of the Agreements. Under each Agreement, the executive officer agrees not to compete with LabOne for a period of two years after the termination of his employment with LabOne. Compensation Committee Interlocks and Insider Participation Mr. W. Thomas Grant II was a member of the Compensation Committee of the Board of directors of LabOne until his resignation from the Committee on February 14, 1998. Mr. Grant is Chairman of the Board of Directors, President and Chief Executive Officer of LabOne. PAGE 25 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following table shows as of March 26, 1999, the total number of shares of common stock of LabOne beneficially owned by persons known to be beneficial owners of more than 5% of the outstanding stock of LabOne. Percentage of Shares Of LabOne Outstanding Shares Beneficially owned Of LabOne Owned Beneficial Owner March 26, 1999(1) March 26, 1999 - ---------------- ----------------- -------------- Lab Holdings, Inc. 10,712,200 80.5% 5000 West 95th Street Shawnee Mission, KS 66207 (1) Lab Holdings, Inc. has sole voting and investment power with respect to the shares listed. SECURITY OWNERSHIP OF MANAGEMENT The following table shows as of March 26, 1999, for each director of LabOne, each of the executive officers of LabOne named in the Summary Compensation Table in Item 11 hereof and all directors and executive officers of LabOne as a group, the total number of shares of common stock of LabOne and of Lab Holdings, Inc. beneficially owned by such persons. Percentage of Percentage of Outstanding Outstanding Shares of Shares of Shares of Lab Shares of Lab LabOne LabOne Holdings Holdings Beneficially Beneficially Beneficially Beneficially Beneficial Owner Owned (1),(2) Owned (3) Owned (1) Owned (3) - ---------------- ------------- --------- --------- --------- Joseph H. Brewer, M.D. 27,195 * 0 * William D. Grant 38,695 (4) * 1,086,647(5) 16.7% W. Thomas Grant II 81,596 (7) * 138,089(6) 2.1% Thomas J. Hespe 60,831 (7) * 0 * Carl W. Ludvigsen, Jr., 83,313 (7) * 0 * M.D. Richard A. Rifkind, M.D 27,098 * 0 * Gregg R. Sadler 102,993 (7) * 266 * Richard S. Schweiker 19,978 * 0 * James R. Seward 22,156 (4) * 0 * Robert D. Thompson 127,949 (7) * 0 * John E. Walker 27,195 (8) * 6,099(8) * R. Dennis Wright, Esq. 24,378 * 0 * All directors and 817,198 (7) 5.8% 1,231,101 19.0% executive officers of LabOne as a group (17 persons)
Less than 1% of outstanding shares PAGE 26 - ----------------------------------------- (1) Unless otherwise indicated, each person has sole voting and investment power with respect to the shares listed. (2) Includes the following numbers of shares of LabOne Common Stock which such persons have the right to acquire within 60 days pursuant to options granted under the LabOne Long-Term Incentive Plan: Joseph H. Brewer, 22,000 shares; William D. Grant, 22,000 shares; W. Thomas Grant II, 57,431 shares; Thomas J. Hespe, 60,000 shares; Carl W. Ludvigsen, Jr., 81,000 shares; Richard A. Rifkind, 22,000 shares; Gregg R. Sadler, 95,200 shares; Richard S. Schweiker, 17,600 shares; James R. Seward, 17,600 shares; Robert D. Thompson, 126,000 shares; John E. Walker, 22,000 shares; R. Dennis Wright, 22,000 shares; and all directors and executive officers as a group, 719,831 shares. (3) For purposes of determining the percentage ownership of each beneficial owner, the outstanding shares of the respective corporation include shares that the beneficial owner has the right to acquire within 60 days pursuant to options granted to such beneficial owner. (4) Does not include 10,712,200 shares of LabOne Common Stock owned by Lab Holdings, Inc. (see "Security Ownership of Certain Beneficial Owners of LabOne" above). Mr. William D. Grant disclaims beneficial ownership of the shares of LabOne Common Stock owned by Lab Holdings, Inc. (5) Includes 403,441 shares of Lab Holdings Common Stock held by 3 family trusts for which William D. Grant serves as a co-trustee with UMB Bank, N.A., and in that capacity shares voting and investment power and 28,916 shares owned by the wife of William D. Grant, as to which he disclaims beneficial ownership. (6) Includes 22,442 shares of Lab Holdings Common Stock held by W. Thomas Grant II as custodian for his children, 45,000 shares held in a family trust for which W. Thomas Grant II serves as a co-trustee with Laura Gamble and in that capacity shares voting and investment power, 12,480 shares owned by the wife of W. Thomas Grant II, as to which he disclaims beneficial ownership. (7) Includes the following numbers of shares of LabOne Common Stock held in individually directed accounts of the named persons under LabOne's 401(k) profit-sharing plan, as to which each of such persons has sole investment power only: W. Thomas Grant II, 22,365 shares; Thomas J. Hespe, 831 shares; Carl W. Ludvigsen, Jr., 2,313 shares; Gregg R. Sadler, 5,793 shares; Robert D. Thompson, 1,949 shares; and all directors and executive officers as a group, 50,872 shares. (8) All of Mr. Walker's shares are owned by a revocable trust for Mr. Walker's wife, as to which he disclaims beneficial ownership. PAGE 27 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RELATIONSHIP WITH LAB HOLDINGS, INC. As of March 26, 1999, Lab Holdings, Inc. beneficially owned 10,712,200 shares, or 80.5%, of the outstanding common stock of LabOne. Lab Holdings, Inc., by virtue of its ownership of a majority of LabOne's common stock, has control of LabOne and is able to elect all of the members of LabOne's Board of Directors. LabOne operates independently of Lab Holdings, Inc., with the officers of LabOne having direct responsibility for all of LabOne's management and operations. Lab Holdings, Inc. and LabOne are parties to a Transition Agreement (Transition Agreement) pursuant to which they have agreed to an allocation of certain corporate opportunities and to mutual indemnification for certain liabilities and expenses. Under the Transition Agreement, so long as Lab Holdings, Inc., directly or indirectly, owns at least 20% of the outstanding voting shares of LabOne, Lab Holdings, Inc. agrees to refer to LabOne any product, service, idea or other corporate opportunity that is within the scope of LabOne's business. For purposes of this Agreement, LabOne's business is defined as providing laboratory testing services for the insurance and health care industry and the development and implementation of data processing and communications facilities for receiving test-related instructions from clients, for conducting laboratory operations and for the collection, use, storage, retrieval and transmission of test results data by both LabOne and its clients. In the event that a majority of the independent, disinterested Directors of LabOne informs Lab Holdings, Inc. that LabOne does not intend to pursue, or LabOne within a reasonable time fails to pursue, the consideration and development of any product, service, idea or other business opportunity referred to it by Lab Holdings, Inc., Lab Holdings, Inc. is entitled under the Transition Agreement to consider and develop the product, service, idea or business opportunity for its own benefit. Under the Agreement, LabOne also agrees to indemnify and hold harmless Lab Holdings, Inc., and any controlling person of Lab Holdings, Inc., with respect to certain civil liabilities, including any and all claims, losses, damages, liabilities, costs and expenses that arise from or are based on operations of LabOne. Similarly, Lab Holdings, Inc. agrees to indemnify and hold harmless LabOne and any controlling person of LabOne (other than Lab Holdings, Inc.), with respect to certain civil liabilities, including any and all claims, losses, damages, liabilities, costs and expenses that arise from or are based on the operations of Lab Holdings, Inc. (other than the business of LabOne). PAGE 28 PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (a) (1) and (2) -- The following consolidated financial statements and schedule are attached as a separate section of this report entitled "Consolidated Financial Statements and Schedule": INDEPENDENT AUDITORS' REPORT CONSOLIDATED FINANCIAL STATEMENTS: Consolidated Balance Sheets, December 31, 1998, and 1997 Consolidated Statements of Earnings, Years Ended December 31, 1998, 1997, and 1996 Consolidated Statements of Stockholders' Equity, Years Ended December 31, 1998, 1997, and 1996 Consolidated Statements of Cash Flows, Years Ended December 31, 1998, 1997, and 1996 Notes to Consolidated Financial Statements SCHEDULE: Schedule II - Valuation and qualifying accounts All other schedules are omitted because they are not applicable, not required, or the information is included in the Consolidated Financial Statements or the notes thereto. (b) Reports on Form 8-K A Form 8-K current report dated October 14, 1998, was filed with the Commission reporting under Other Events that LabOne had entered into an agreement to acquire Systematic Business Services, Inc. A Form 8-K current report dated October 22, 1998, was filed with the Commission providing under Other Events a cautionary statement in order to obtain the benefits of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. A Form 8-K current report dated March 8, 1999, was filed with the Commission reporting under Other Events that LabOne and Lab Holdings, Inc. had entered into an agreement to merge the two companies. (c) Exhibits required by Item 601 of Regulation S-K (Exhibits are hereby incorporated by reference to LabOne's Form 10-K Annual Report Filed March 30,1999.): PAGE 29 3.1* Articles of Incorporation - attached as Exhibit (3) to the Registrant's Form 10-K Annual Report dated March 28, 1988. 3.2* Certificate of Amendment of Articles of Incorporation - attached as Exhibit (3.2) to the Registrant's Form 10-K Annual Report dated March 14, 1994. 3.3* Bylaws - attached as Exhibit (3) to the Registrant's Form 10-K Annual Report dated March 28, 1988. 4.1* Trust Indenture dated as of September 1, 1998, between the City of Lenexa, Kansas and Intrust Bank, N.A. related to the issuance of Taxable Industrial Revenue Bonds for the LabOne, Inc. Facility Project - attached as Exhibit (4.1) to the Registrant's Quarterly Report on Form 10-Q dated November 13, 1998. 4.2* Lease Agreement dated as of September 1, 1998, between the City of Lenexa, Kansas and LabOne, Inc. related to the Trust Indenture - attached as Exhibit (4.2) to the Registrant's Quarterly Report on Form 10-Q dated November 13, 1998. 4.3* Reimbursement Agreement dated as of September 1, 1998, between LabOne, Inc. and Commerce Bank, N.A. - attached as Exhibit (4.3) to the Registrant's Quarterly Report on Form 10-Q dated November 13, 1998. 4.4* Warrant to Purchase Shares of Common Stock of LabOne, Inc., issued to National Support Services, Inc.,- attached as Exhibit (4) to the Registrant's Quarterly Report on Form 10-Q dated May 13, 1998. 4.5* Warrant to Purchase Shares of Common Stock of LabOne, Inc., issued to USA Managed Care Organization - attached as Exhibit (4.5) to the Registrant's Annual Report on Form 10-K dated March 30, 1999. 10.1* Registrant's 1997 Long Term Incentive Plan - attached as Exhibit (10.1) to the Registrant's Quarterly Report on Form 10-Q dated August 12, 1998. ** 10.2* Form of Stock Option Agreement pursuant to the LabOne 1997 Long-Term Incentive Plan.- attached as Exhibit (10.2) to the Registrant's Quarterly Report on Form 10-Q dated August 12, 1998. ** 10.3* Registrant's Annual Incentive Plan - attached as Exhibit (10.3) to the Registrant's Annual Report on Form 10-K dated March 30, 1999. ** 10.4* Registrant's Stock Plan for nonemployee directors - attached as Exhibit (A) to the Registrant's Proxy Statement dated April 10, 1992. *** 10.5* Form of Indemnification Agreement between the Registrant and its directors dated February 12, 1999 - attached as Exhibit (10.5) to the Registrant's Annual Report on Form 10-K dated March 30, 1999. PAGE 30 10.6* Form of Employment Agreement between the Registrant and its executive officers and certain key employees - attached as Exhibit (10) to the Registrant's Form 10-K Annual Report dated March 28, 1988. ** 10.7* Amended Employment Agreement between the Registrant and Robert D. Thompson- attached as Exhibit (10.11) to the Registrant's Form 10-K Annual Report dated March 21, 1996. ** 10.8* Employment Agreement between the Registrant and Gregg R. Sadler - attached as Exhibit (10.14) to the Registrant's Form 10-K Annual Report dated March 14, 1994. ** 10.9* Amendment to Employment Agreement between the Registrant and Gregg R. Sadler- attached as Exhibit (10.13) to the Registrant's Form 10-K Annual Report dated March 21, 1996. ** 10.10*Employment Agreement between the Registrant and Thomas J. Hespe- attached as Exhibit (10.14) to the Registrant's Form 10-K Annual Report dated March 21, 1996. ** 10.11*Amended Employment Agreement between the Registrant and Carl W. Ludvigsen, Jr. - attached as Exhibit (10.15) to the Registrant's Form 10-K Annual Report dated March 7, 1997. ** 10.12*Employment Agreement between the Registrant and Robert F. Thompson - attached as Exhibit (10.17) to the Registrant's Form 10-K Annual Report dated March 23, 1995. ** 10.13*Form of Amendment to Employment Agreement between the Registrant and Robert F. Thompson - attached as Exhibit (10.18) to the Registrant's Form 10-K Annual Report dated March 23, 1995. ** 10.14*Registrant's Long Term Incentive Plan as amended - attached as Exhibit the Registrant's Form 10-K Annual Report dated March 19, 1992. ** 10.15*Amendment to paragraphs 6 (d) and 24 (d) of the Registrant's Long Term Incentive Plan - attached as Exhibit (10.2) to the Registrant's Form 10-K Annual Report dated March 14, 1994. ** 10.16*Amendment to paragraph 3 of the Registrant's Long Term Incentive Plan - attached as Exhibit (10.3) to the Registrant's Form 10-K Annual Report dated March 14, 1994. ** 10.17*Amendment to paragraph 3 of the Registrant's Long Term Incentive Plan - attached as Exhibit (10.4) to the Registrant's Form 10-K Annual Report dated March 21, 1996. ** 10.18*Amendment to paragraph 2(a) of the Registrant's Long Term Incentive Plan- attached as Exhibit (10.5) to the Registrant's Form 10-K Annual Report dated March 23, 1998. ** 11. Statement regarding computation of per share earnings - see Note 1 of Notes to Consolidated Financial Statements, "Earnings Per Share." PAGE 31 21. Subsidiaries of Registrant - see Note 1 of Notes to Consolidated Financial Statements, "Principles of Consolidation and Basis of Presentation." 24.* Powers of Attorney - attached as Exhibit (24) to the Registrant's Annual Report on Form 10-K dated March 30, 1999. 27.* Financial Data Schedule - as submitted electronically by the Registrant in conjunction with this 1998 Form 10-K - attached as Exhibit (27) to the Registrant's Annual Report on Form 10-K dated March 30, 1999 99.* Cautionary Statement under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 - attached as Exhibit (99) to the Registrant's Annual Report on Form 10-K dated March 30, 1999. * Incorporated by reference pursuant to Rule 12b-23 ** Management Compensatory Plan *** Non-Management Director Compensatory Plan These exhibits may be obtained by stockholders of Registrant upon written request to LabOne, Inc., 10101 Renner Blvd., Lenexa, KS 66219. (d) Not applicable. PAGE 32 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Registrant has duly caused this Amendment No. 3 to be signed on its behalf by the undersigned, thereunto duly authorized. LabOne, Inc. By: /s/ Robert D. Thompson By: /s/ Kurt E. Gruenbacher ---------------------- ----------------------- Robert D. Thompson Kurt E. Gruenbacher Title: Executive V.P., Chief Title: V.P. Finance, CAO Operating Officer and and Treasurer Chief Financial Officer Date: June 17, 1999 Date: June 17, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this Amendment No.3 has been signed below by the following persons on behalf of the Registrant on June 17, 1999 in the capacities indicated. By: /s/ W. Thomas Grant II By: /s/ Robert D. Thompson ---------------------- ---------------------- W. Thomas Grant II Robert D. Thompson Title: Chairman of the Board, President Title: Executive V.P. , Chief and Chief Executive Officer Operating Officer and Chief Financial Officer By: /s/ Gregg R. Sadler By: /s/ Thomas J. Hespe ------------------- ------------------- Gregg R. Sadler Thomas J. Hespe Title: Executive V.P. Administration, Title: Executive V.P. Sales Secretary and Director and Director By: /s/ Kurt E. Gruenbacher By: */s/ Joseph H. Brewer ----------------------- --------------------- Kurt E. Gruenbacher Joseph H. Brewer Title: V.P. Finance, CAO and Treasurer Title: Director By: */s/ William D. Grant By:. */s/ Richard A Rifkind --------------------- ---------------------- William D. Grant Richard A. Rifkind Title: Director Title: Director By: */s/ Richard S. Schweiker By: */s/ James R. Seward ------------------------- -------------------- Richard S. Schweiker James R. Seward Title: Director Title: Director By: */s/ John E. Walker By: */s/ R. Dennis Wright ------------------- --------------------- John E. Walker R. Dennis Wright Title: Director Title: Director *By: /s/ Gregg R. Sadler ------------------- Gregg R. Sadler Attorney-in-fact PAGE 33 LABONE, INC. AND SUBSIDIARIES Consolidated Financial Statements and Schedule December 31, 1998, 1997 and 1996 (With Independent Auditors' Report Thereon) PAGE 34 LABONE, INC. AND SUBSIDIARIES Table of Contents Page Independent Auditors' Report 36 Consolidated Financial Statements: Consolidated Balance Sheets, December 31, 1998 and 1997 37 Consolidated Statements of Earnings, Years ended December 31, 1998,1997 and 1996 39 Consolidated Statements of Stockholders' Equity, Years ended December 31, 1998, 1997 and 1996 40 Consolidated Statements of Cash Flows, Years ended December 31, 1998, 1997 and 1996 41 Notes to Consolidated Financial Statements 43 Schedule: Schedule II - Valuation and Qualifying Accounts 56 PAGE 35 Independent Auditors' Report The Board of Directors LabOne, Inc.: We have audited the accompanying consolidated balance sheets of LabOne, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LabOne, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Kansas City, Missouri January 29, 1999, except as to note 12, which is as of March 8, 1999 PAGE 36 LABONE, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1998 and 1997 Assets 1998 1997 ------------ ------------ Current assets: Cash and cash equivalents $ 10,177,740 18,284,672 Short-term investments (note 1) - 1,204,638 Accounts receivable, net of allowance for doubtful accounts of $2,326,716 in 1998 and $968,295 in 1997 18,735,984 12,604,687 Income taxes receivable 282,229 508,704 Inventories 1,798,481 2,203,471 Real estate available-for-sale (note 1) 3,515,000 3,515,000 Prepaid expenses and other current assets 2,504,768 2,279,619 Deferred income taxes (note 5) 3,972,575 3,299,387 ----------- ----------- Total current assets 40,986,777 43,900,178 Property, plant, and equipment: Land 2,379,334 2,379,334 Laboratory equipment 18,101,286 19,044,329 Data processing equipment and software 18,878,942 17,130,254 Office and transportation equipment 5,787,762 4,909,970 Leasehold improvements 700,842 492,684 Construction in progress 27,067,631 - ----------- ----------- 72,915,797 43,956,571 Less accumulated depreciation 35,983,169 33,515,280 ----------- ----------- Net property, plant, and equipment 36,932,628 10,441,291 ----------- ----------- Other assets: Intangible assets, net of accumulated amortization (note 2) 8,469,322 5,229,708 Bond issue costs, net of accumulated amortization of $5,823 186,324 - Deferred income taxes - noncurrent (note 5) - 321,799 Deposits and miscellaneous 206,127 80,497 ----------- ----------- Total assets $ 86,781,178 59,973,473 =========== =========== (Continued) See accompanying notes to consolidated financial statements. PAGE 37 LABONE, INC. AND SUBSIDIARIES Consolidated Balance Sheets, Continued December 31, 1998 and 1997 Liabilities and Stockholders' Equity 1998 1997 ------------ ------------ Current liabilities: Accounts payable $ 4,353,733 3,326,451 Retainage and construction accounts payable 3,809,193 - Accrued payroll and benefits 4,148,593 4,530,235 Other accrued expenses 610,315 423,396 Other current liabilities 274,198 194,148 Current portion of long-term debt (note 4) 1,860,168 - ----------- ----------- Total current liabilities 15,056,200 8,474,230 Deferred income taxes (note 5) 446,745 - Long-term debt (note 4) 18,097,308 - ----------- ----------- Total liabilities 33,600,253 8,474,230 ----------- ----------- Commitments and Contingencies Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized, none issued - - Common stock, $0.01 par value per share; 40,000,000 shares authorized, 15,000,000 shares issued (note 7) 150,000 150,000 Additional paid-in capital 14,099,066 13,723,250 Accumulated other comprehensive income (849,098) (666,927) Retained earnings 59,988,073 60,259,272 ----------- ----------- 73,388,041 73,465,595 Less treasury stock of 1,688,550 shares in 1998 and 1,874,706 shares in 1997, at cost 20,207,116 21,966,352 ----------- ----------- Total stockholders' equity 53,180,925 51,499,243 ----------- ----------- Total liabilities and stockholders' equity $ 86,781,178 59,973,473 =========== =========== See accompanying notes to consolidated financial statements. PAGE 38 LABONE, INC. AND SUBSIDIARIES Consolidated Statements of Earnings Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ----------- ---------- ---------- Sales $ 102,227,216 78,926,119 59,431,855 Cost of sales 56,719,603 42,017,179 32,716,833 ----------- ---------- ---------- Gross profit 45,507,613 36,908,940 26,715,022 Selling, general, and administrative expenses 31,028,323 27,706,822 23,622,545 Provision for loss on disposal of assets - 6,553,279 - ----------- ---------- ---------- Earnings from operations 14,479,290 2,648,839 3,092,477 ----------- ---------- ---------- Other income (expenses): Investment income 814,343 1,179,947 1,769,182 Other, net (112,277) (58,245) 14,930 ----------- ---------- ---------- Total other income, net 702,066 1,121,702 1,784,112 ----------- ---------- ---------- Earnings before income taxes 15,181,356 3,770,541 4,876,589 ----------- ---------- ---------- Income taxes (benefit) (note 5): Current 6,057,345 4,392,742 2,485,473 Deferred (95,356) (2,824,296) (476,783) ----------- ---------- ---------- Total income taxes 5,961,989 1,568,446 2,008,690 ----------- ---------- ---------- Net earnings $ 9,219,367 2,202,095 2,867,899 =========== ========== ========== Basic earnings per share $ 0.70 0.17 0.22 =========== ========== ========== Diluted earnings per share $ 0.69 0.17 0.22 =========== ========== ========== See accompanying notes to consolidated financial statements. PAGE 39 LABONE, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1998, 1997 and 1996 Accumulated other comprehensive income - Additional foreign Compre- Total Common paid-in currency Retained Treasury hensive stockholders' stock capital translation earnings stock income equity --------- ----------- ----------- ---------- ---------- -------- ------------ Balance at December 31, 1995 $ 150,000 13,377,728 (545,818) 74,040,870 (22,158,451) 64,864,329 Comprehensive income: Net earnings - - - 2,867,899 - 2,867,899 2,867,899 Adjustment from foreign currency translation - - 1,859 - - 1,859 1,859 ---------- Comprehensive income 2,869,758 ========== Cash dividends ($.72 per share) - - - (9,414,332) - (9,414,332) Net issuance of 30,149 shares of treasury stock - 168,393 - - (38,855) 129,538 --------- ----------- ----------- ---------- ------------ ------------ Balance at December 31, 1996 150,000 13,546,121 (543,959) 67,494,437 (22,197,306) 58,449,293 Comprehensive income: Net earnings - - - 2,202,095 - 2,202,095 2,202,095 Adjustment from foreign currency translation - - (122,968) - - (122,968) (122,968) ----------- Comprehensive income 2,079,127 ============ Cash dividends ($.72 per share) - - - (9,437,260) - (9,437,260) Net issuance of 41,129 shares of treasury stock - 177,129 - - 230,954 408,083 --------- ----------- ----------- ---------- ------------- ----------- Balance at December 31, 1997 150,000 13,723,250 (666,927) 60,259,272 (21,966,352) 51,499,243 Comprehensive income: Net earnings - - - 9,219,367 - 9,219,367 9,219,367 Adjustment from foreign currency translation - - (182,171) - - (182,171) (182,171) ---------- Comprehensive income 9,037,196 ========== Cash dividends ($.72 per share) - - - (9,490,566) - (9,490,566) Issuance of 168,885 shares of treasury stock related to acquisition - 275,050 - - 1,724,950 2,000,000 Net issuance of 17,271 shares of treasury stock - 100,766 - - 34,286 135,052 --------- ----------- ----------- ---------- ------------ ------------ Balance at December 31, 1998 $ 150,000 14,099,066 (849,098) 59,988,073 (20,207,116) 53,180,925 ========= =========== ========== ========== ============ ============
See accompanying notes to consolidated financial statements. PAGE 40 LABONE, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ---------- --------- --------- Cash provided by (used for) operations: Net earnings $ 9,219,367 2,202,095 2,867,899 Adjustments to reconcile net earnings to net cash provided by operations, net of acquisitions: Depreciation and intangibles amortization 4,168,638 4,770,415 4,014,304 Amortization of investment premiums (36,767) (251,233) (103,146) Provision for loss on accounts receivable 1,502,571 571,192 493,760 Deferred income taxes (96,263) (2,832,976) (476,783) (Gain) loss on disposal of equipment (18,606) (120,087) 155,587 Provision for loss on disposal of assets - 6,553,279 - Directors' stock compensation 62,619 66,834 62,096 Changes in: Accounts receivable (6,777,322) (3,577,172) (2,365,181) Income tax receivable 226,475 (271,331) - Inventories 404,990 (755,422) 173,093 Prepaid expenses and other current assets (201,551) (442,454) 808,589 Accounts payable 886,932 355,075 863,000 Income taxes payable - - (50,560) Accrued payroll and benefits (619,281) 1,727,669 830,091 Other accrued expenses 186,919 29,585 (508,486) Other current liabilities 80,050 68,019 (23,668) ---------- --------- --------- Net cash provided by operations 8,988,771 8,093,488 6,740,595 ---------- --------- --------- Cash provided by (used for) investment activities: Purchase of investments held-to-maturity (5,461,090) (15,893,902) (15,752,895) Proceeds from maturities of investments held-to-maturity 6,701,893 18,155,062 23,394,571 Property, plant, and equipment additions, net (25,485,294) (6,676,615) (3,225,956) Acquisition of businesses (note 2) (2,967,883) (4,815,889) - Deposits and miscellaneous (5,147) (57,295) 17,559 ---------- --------- --------- Net cash provided by (used for) investment activities (27,217,521) (9,288,639) 4,433,279 ---------- --------- --------- Cash provided by (used for) financing activities: Issuance of treasury stock, net of proceeds from exercise of stock options 72,433 341,249 67,442 Proceeds from bond issue 19,900,000 - - Bond issue costs (192,147) - - Payments on long-term debt (1,937) - - Cash dividends (9,490,566) (9,437,260) (9,414,332) ---------- --------- --------- Net cash provided by (used for) financing activities 10,287,783 (9,096,011) (9,346,890) ---------- --------- --------- Effect of foreign currency translation on cash (165,965) (71,544) 11,976 ---------- --------- --------- Net increase (decrease) in cash and cash equivalents (8,106,932) (10,362,706) 1,838,960 Cash and cash equivalents at beginning of year 18,284,672 28,647,378 26,808,418 ---------- --------- --------- Cash and cash equivalents at end of year $ 10,177,740 18,284,672 28,647,378 ========== ========== ========== Continued) PAGE 41 LABONE, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ---------- --------- --------- Supplemental disclosures of cash flow information: Cash paid during the year for: Income taxes $ 6,458,641 4,586,078 2,251,320 ========== ========== ========== Interest $ 240,586 - - ========== ========== ========== Supplemental schedule of noncash investing and financing activities for the year ended December 31, 1998: Details of acquisition: Fair value of assets acquired $ 6,223,162 Liabilities assumed (645,198) Stock issued (2,000,000) ---------- Cash paid 3,577,964 Less: cash acquired 610,081 ---------- Net cash paid for acquisition $ 2,967,883 ==========
See accompanying notes to consolidated financial statements. PAGE 42 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 (1) Summary of Significant Accounting Policies - ----------------------------------------------- Principles of Consolidation and Basis of Presentation The accompanying consolidated financial statements include the accounts of LabOne, Inc. (LabOne or the Company), and its wholly-owned subsidiaries, Lab One Canada Inc. and Systematic Business Services, Inc. All significant intercompany transactions have been eliminated in consolidation. LabOne was 80.5%-owned by Lab Holdings, Inc. (Lab Holdings) at December 31, 1998. Cash and Cash Equivalents Cash and cash equivalents include demand deposits in banks, marketable securities with original maturities of three months or less, money market investments and overnight investments that are stated at cost, which approximates market value. Investment Securities LabOne determines the appropriate classification of debt and equity securities at the time of purchase. Debt securities are classified as held-to-maturity when LabOne has the intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost and investment income is included in earnings. Inventories Inventories consist of completed specimen collection kits and various materials used in the assembly of specimen collection kits for sale to clients. Inventory is valued at the lower of cost (first-in, first-out) or market. Property, Plant, and Equipment Property, plant, and equipment additions are recorded at cost which includes interest capitalized during construction, when material. Facilities leased pursuant to revenue bond financing transactions are accounted for as purchases with the cost of the leased property included in property, plant, and equipment and the related obligation included in long-term debt. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets as follows: Buildings 30 years Laboratory equipment 3 - 5 years Data processing equipment 3 - 5 years Office equipment 5 years PAGE 43 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Depreciation on the former facilities was suspended after the recognition of the impairment loss was recorded in December 1997. Depreciation expense for the years ended December 31 were recorded as follows: 1998 1997 1996 --------- --------- --------- Cost of Sales $ 2,080,725 1,768,973 1,241,284 Selling, General and Administrative 1,329,642 2,003,885 2,027,750 --------- --------- --------- Total $ 3,410,367 3,772,858 3,269,034 ========= ========= ========= On December 26, 1998, the substance abuse testing laboratory started to move to the new facility. Construction in progress was transferred and depreciation expense was recorded as portions of the new facility were completed and put into use in 1999. Cost of Borrowings Expenses directly related to the issuance of debt are deferred and amortized over the period the debt is expected to be outstanding using the interest method. Intangible Assets Intangible assets are recorded at their acquisition cost, net of amortization. The patent process utilized in coating the plates on which blood and urine testing is performed was amortized on a straight-line basis over the estimated life of the patent (184 months at date of acquisition). The excess of cost over fair value of net assets acquired is being amortized on a straight-line basis over periods of fifteen to twenty years. Impairment of Long-lived Assets When facts and circumstances indicate potential impairment, LabOne evaluates the recoverability of carrying values of long-lived assets, including intangibles, using estimates of undiscounted future cash flows over remaining asset lives. When impairment is indicated, any impairment loss is measured by the excess of carrying values over fair values. During December 1997, LabOne decided to dispose of its office and headquarters building and lab facility, which, net of accumulated depreciation, has been classified as real estate available-for-sale. LabOne plans to dispose of these facilities after moving to the new facility in early 1999. An impairment loss of $6,553,279 related to the anticipated sale was recorded in 1997 which reduced the carrying value to $3,515,000. No depreciation expense was recorded after the write-down of the facilities. At December 31, 1998, the Company has entered into real estate sales contracts to sell all real estate available-for-sale for $4,530,000. PAGE 44 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments Estimates of fair values are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could affect the estimates. The fair market value of LabOne's financial instruments at December 31, 1998 and 1997 approximates their carrying values. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Earnings Per Share Basic earnings per share is computed using the weighted average number of common shares and diluted earnings per share is computed using the weighted average number of common shares and dilutive stock options. The following table reconciles the weighted average common shares used in the basic earnings per share calculation and the weighted average common shares and common share equivalents used in the diluted per share calculation: 1998 1997 1996 ---------- ---------- ---------- Weighted average common shares (basic) 13,168,394 13,106,383 13,076,103 Employee stock options 135,174 215,655 190,013 ---------- ---------- ---------- Weighted average common shares and common shares equivalents (diluted) 13,303,568 13,322,038 13,266,116 ========== ========== ========== PAGE 45 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Financial Statement Presentation In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income, which established standards for reporting and display of comprehensive income and its components. SFAS No. 130 became effective for the year ended December 31, 1998. The presentation of previous periods has been changed to reflect the provisions of this statement. In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, which established standards for reporting operating segments. SFAS No. 131 became effective for the year ended December 31, 1998. This statement did not effect the presentation of segment information. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, effective for LabOne's quarter ending September 30, 1999. Retroactive application will not be required. The Company does not expect this statement to have a significant impact on the Company's financial position or results of operations. (2) Acquisitions and Intangible Assets - --------------------------------------- The cost and accumulated amortization of intangible assets at December 31, 1998 and 1997 are as follows: 1998 1997 ------------ ---------- Patent $ 8,000,000 8,000,000 Accumulated amortization 8,000,000 7,782,574 ------------ ---------- - 217,426 ------------ ---------- Excess of cost over fair value of assets acquired 12,587,993 8,598,959 Accumulated amortization 4,118,671 3,586,677 ------------ ---------- 8,469,322 5,012,282 ------------ ---------- Intangible assets, net of accumulated amortization $ 8,469,322 5,229,708 ============ ========== Effective October 30, 1998, LabOne acquired Systematic Business Services, Inc. (SBSI) for approximately $5.7 million. SBSI is a provider of information support services to insurance underwriters. The purchase was comprised of $3.7 million of cash and the issuance of 168,885 shares of LabOne stock having a fair market value of $2 million. The acquisition was accounted for using the purchase method of accounting. The excess of the aggregate purchase price over the fair market value of net assets acquired of approximately $4 million is being amortized over twenty years. PAGE 46 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 LabOne is obligated to pay to the prior owner of SBSI, 20% of SBSI's income before taxes (as defined) greater than a target amount approximately equal to 1998 pretax income for each of SBSI's fiscal years ending in 1999 and 2000. Any amounts paid under this obligation will result in additional excess purchase price for reporting purposes. The operating results of SBSI have been included in the consolidated statements of earnings from the date of acquisition. The following unaudited pro forma consolidated results of operations of the Company for the years ended December 31, 1998 and 1997 assumes the SBSI acquisition occurred as of January 1, 1997: 1998 1997 ----------- ---------- Sales $ 108,239,000 85,032,000 Net earnings 9,869,000 2,434,000 Earnings per share: Basic 0.74 0.18 Diluted 0.73 0.18 =========== ========== Pro forma data does not purport to be indicative of the results that would have been obtained had these events actually occurred at the beginning of the periods presented and is not intended to be a projection of future results. Effective January 30, 1997, LabOne acquired certain assets, including customer lists, of GIB Laboratories, Inc., a subsidiary of Prudential Insurance Company of America, for $4,815,889. Concurrently, Prudential's Individual Insurance Group agreed to use LabOne as its exclusive provider of risk assessment testing services for a period of three years. The excess costs over fair value of GIB Laboratories, Inc. assets acquired was $4,128,275 and is being amortized over fifteen years. PAGE 47 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 (3) Investment Securities --------------------- LabOne held no investment securities at December 31, 1998. A summary of investment securities information relating to quoted market values and unrealized holding gains and losses at December 31, 1997 is as follows: Amount at which Approxi- carried Unrealized Unrealized Amortized mate in the holding holding 1997 cost market balance gains losses sheet - ----------------------- ----------- ----------- ----------- ----------- ---------- Held-to-maturity invest- ments, all with maturities less than one year: Canadian government notes $ 702,495 702,495 702,495 - - Obligations of states and political sub- divisions 502,143 501,541 502,143 - 602 ----------- ----------- ----------- ----------- ---------- Total short-term investments $ 1,204,638 1,204,036 1,204,638 - 602 =========== ========= ========= =========== ==========
(4) Long-term Debt Long-term debt consists of the following as of December 31, 1998: Taxable industrial revenue bonds, Series 1998A, principal payable annually through September 1, 2009, interest payable monthly at a rate adjusted weekly based on short- term United States treasury obligations (5.14% at December 31, 1998), secured by the Company's facility and an irrevo- cable bank letter of credit $ 20,000,000 Various capital leases, principal and interest payable monthly through May 2003, interest ranging from 7% to 12%, collateralized by office equipment 54,446 ------------- Total long-term debt 20,054,446 Less: Current portion 1,860,168 Unamortized discount 96,970 Long-term debt, net $ 18,097,308 ============= PAGE 48 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Aggregate maturities of long-term debt as of December 31, 1998 are as follows: Bonds payable Capital leases Total ------------ --------- ---------- 1999 $ 1,850,000 10,168 1,860,168 2000 1,850,000 13,551 1,863,551 2001 1,850,000 14,933 1,864,933 2002 1,850,000 11,188 1,861,188 2003 1,800,000 4,606 1,804,606 Thereafter 10,800,000 - 10,800,000 ---------- ---------- ---------- $ 20,000,000 54,446 20,054,446 ========== =========== ========== Interest expense in 1998 amounted to approximately $70,000, net of interest capitalized as a component of property, plant, and equipment of $314,638. (5) Income Taxes ------------ The components of income taxes and deferred taxes (benefit) applicable to temporary differences are as follows (for the years ended December 31): 1998 1997 1996 ---------- --------- --------- Current: Federal $ 4,853,744 3,452,979 1,878,022 State 1,086,479 633,839 347,809 Foreign 117,122 305,924 259,642 ---------- ---------- ---------- Total current 6,057,345 4,392,742 2,485,473 ---------- ---------- ---------- Deferred: Federal (89,408) (2,339,175) (490,408) State (31,125) (487,993) (118,293) Foreign 25,177 2,872 131,918 ---------- ---------- ---------- Total deferred (95,356) (2,824,296) (476,783) ---------- ---------- ---------- $ 5,961,989 1,568,446 2,008,690 ========= ========= ========== PAGE 49 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Total income taxes differ from the amounts computed by applying the federal statutory income tax rate of 34% to earnings before income taxes for the following reasons (for the years ended December31): 1998 1997 1996 --------- --------- --------- Application of statutory income tax rate $ 5,161,661 1,281,984 1,658,040 Foreign taxes, net 7,599 72,062 113,803 State income taxes, net 696,534 99,649 151,481 Tax-exempt interest (5,788) (18,730) (44,708) Other, net 101,983 133,481 130,074 --------- --------- --------- $ 5,961,989 1,568,446 2,008,690 ========= ========= ========= The tax effects of temporary differences that create significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below: 1998 1997 ---------- ---------- Deferred current income tax assets (liabilities): Unrealized loss on real estate available-for-sale $ 2,541,126 2,606,698 Accrued vacation 303,180 253,832 Accrued medical claims 63,644 79,554 Bad debts 925,635 384,600 Inventory adjustment 40,830 26,673 Other items 98,160 (51,970) ---------- ---------- Total deferred current income tax assets, net $ 3,972,575 3,299,387 ========== ========== Deferred noncurrent tax assets (liabilities): Depreciation and amortization $ 12,878 321,799 Acquired subsidiary cash to accrual adjustment (196,438) - Other items (263,185) - ---------- ---------- Total deferred noncurrent tax assets (liabilities), net $ (446,745) 321,799 ========== ========== A valuation allowance for deferred tax assets was not necessary at December 31, 1998 or 1997. PAGE 50 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 In conjunction with building its new facility, LabOne has applied for the Kansas High Performance Incentive Program (HPIP) credit. If LabOne qualifies for the program as certified by the state of Kansas, LabOne will receive a credit available to offset all or a portion of its 1999 Kansas income tax liability related to operations of the new facility. Any unused portion of the credit can be carried forward for a period of ten years, provided LabOne continues to meet requirements of the program. HPIP credits which may be available to LabOne over the next ten years are estimated to aggregate approximately $4,000,000. (6) Benefit Plans ------------- LabOne maintains a money purchase pension plan for all employees who have completed one-half year of service and have attained age twenty and one-half years. The plan is a defined contribution plan under which LabOne contributes a percentage of a participant's annual compensation. LabOne's contributions to the plan were $1,803,000, $1,422,000 and $1,187,000 for the years ended December 31, 1998, 1997 and 1996, respectively. LabOne has a profit sharing plan for all employees who have completed six months of service and a minimum of 500 hours of service and have attained the age of twenty and one-half years. LabOne contributes on behalf of each participant an amount equal to 50% of the participant's annual contributions, but not in excess of 5% of the participant's annual compensation. LabOne contributions are invested in LabOne common stock. LabOne's contributions to the plan for the years ended December 31, 1998, 1997 and 1996 were $663,000, $558,000 and $509,000, respectively. (7) Stock Options and Warrants -------------------------- LabOne has a long-term incentive plan which provides for granting awards, including stock options, for not more than 3,150,000 shares of LabOne common stock. LabOne has granted certain stock options which entitle the grantee to purchase shares for a price equal to the fair market value at date of grant with option periods up to ten years. The Company accounts for stock options in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations (APB 25). As such, compensation expense s recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. On December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, (SFAS 123) which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternately, SFAS 123 allows entities to continue to apply the provisions of APB 25 and provide pro forma net earnings and pro forma earnings per share disclosures for employee stock option grants made in 1995 and subsequent years as if the fair-value based method defined in SFAS 123 had been applied. The Company has elected to continue to apply the provisions of APB 25 and provide the pro forma disclosure provisions of SFAS 123. PAGE 51 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 A summary of the status of the Company's stock option plan as of December 31, 1998, 1997 and 1996 and changes during the years then ended is presented below: 1998 1997 1996 ------------------- -------------------- -------------------- Weighted- Weighted- Weighted- Number average Number average Number average of exercise of exercise of exercise Fixed options shares price shares price shares price - --------------------- --------- --------- --------- --------- --------- --------- Outstanding at begin- ing of year 1,614,068 $ 14.30 1,459,559 $ 13.63 1,572,167 $ 13.07 Granted 330,859 15.02 253,316 17.36 314,297 16.39 Exercised (40,300) 10.64 (71,907) 10.84 (120,305) 10.67 Forfeited (66,700) 17.87 (26,900) 15.95 (306,600) 14.74 --------- --------- --------- --------- --------- --------- Outstanding at end of year 1,837,927 14.38 1,614,068 14.30 1,459,559 13.63 ========= ========= ========= ========= ========= ========= Options exercisable at year-end 968,683 $ 13.44 820,609 $ 12.94 718,705 $ 12.21 ========= ========= ========= ========= ========= =========
The following table summarizes information about stock options at December 31, 1998. Options outstanding Options exercisable ------------------------------------- ----------------------- Weighted- average Weighted- Weighted- remaining average average Range of Number contractual exercise Number exercise exercise prices outstanding life (years) price exercisable price ---------------- ----------- ----------- ---------- ----------- ----------- $ 9.88 - 9.88 188,583 2.0 $ 9.88 188,583 $ 9.88 11.13 - 11.63 420,513 5.2 11.44 313,513 11.38 13.38 - 14.13 154,397 6.3 13.93 85,618 13.95 14.38 - 14.38 205,859 6.7 14.38 120,000 14.38 14.75 - 15.22 241,000 9.3 15.04 24,000 14.75 15.50 - 16.63 305,885 7.9 16.42 117,877 16.44 16.69 - 23.88 321,690 7.4 18.65 119,092 19.96 ---------- ---------- 9.88 - 23.88 1,837,927 6.5 14.38 968,683 13.44 ================ ========== ========== ========== ========== ==========
The weighted-average per share fair value of stock options granted during 1998, 1997 and 1996 was $3.54, $5.08 and $4.77, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions: 1998 - expected dividend yield of 4.8%, risk-free interest rate of 5.0%, expected volatility factor of 33.9% and an expected life of six years; 1997 - expected dividend yield of 4.2%, risk-free interest PAGE 52 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 rate of 6.3%, expected volatility factor of 35.4% and an expected life of six years; 1996 - expected dividend yield of 4.4%, risk-free interest rate of 6.0%, expected volatility factor of 36.6% and an expected life of six years. Since the Company applies APB 25 in accounting for its plans, no compensation cost has been recognized for its stock options in the financial statements. Had the Company recorded compensation cost based on the fair value of options at the grant date the Company's net earnings and earnings per share would have been reduced by approximately the following: $515,000, or $.04 per share, in 1998; $416,000, or $.03 per share, in 1997; and $199,000, or $.02 per share, in 1996. Pro forma net earnings reflect only options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS 123 is not reflected in the pro forma net earnings amounts presented above because compensation costs are reflected over the options' vesting period of five years for the 1998, 1997, and 1996 options. Compensation cost for options granted prior to January 1, 1995 is not considered. LabOne entered marketing agreements with two companies during 1998. In conjunction with these agreements, LabOne granted warrants for the purchase of 1,000,000 shares of common stock at an exercise price equal to the fair value of the stock at the grant date (500,000 shares at $17.00 and 500,000 shares at $15.44). A portion of the warrants become exercisable each quarter for five years provided certain conditions are met including achievement of certain levels of revenues. The Company will recognize expense, measured as the excess of fair value of the warrants over the exercise price at the date such warrants become exercisable. No warrants became exercisable in 1998. LabOne has reserved 1,000,000 shares of common stock for issuance of shares upon exercise of the warrants. (8) Foreign Operations ------------------ The following summarizes financial information for LabOne's wholly-owned Canadian subsidiary, Lab One Canada Inc., for the years ended December 31: 1998 1997 1996 ----------- ----------- ----------- Revenues $ 6,462,814 6,564,786 6,379,505 Operating earnings 314,112 644,842 718,567 Total assets 2,841,854 3,192,854 2,668,434 =========== =========== ========== (9) Business Segment Information ---------------------------- The Company operates principally in three lines of business: insurance, clinical testing, and substance abuse testing. The insurance line of business involves risk appraisal laboratory testing and information services to the insurance industry. The tests performed and information provided by the PAGE 53 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Company are specifically designed to assist an insurance company in objectively evaluating the risks posed by policy applicants. Clinical testing services are provided to the health care industry to aid in the diagnosis and treatment of patients. Substance abuse testing services are provided to both regulated and nonregulated employers who employ drug screening guidelines. Operating income (loss) of each line of business is computed as sales less identifiable and allocated expenses. All expenses that can be identified as specific to a certain segment of business are charged to that segment. All shared resources and expenses are totaled and allocated to each segment based on the relative revenue of each segment each month. Allocated expenses include administrative salaries, information systems support, accounting, human resources and facilities. In computing operating income (loss) of lines of business, none of the following items have been added or deducted: general corporate expenses, investment income or other income (expenses). Identifiable assets by line of business are those assets that are used in the Company's operations in each line of business. General corporate assets at December 31, 1997 and 1996 were primarily cash and investments, income taxes receivable, deferred income taxes and real estate available for sale. At December 31, 1998, general corporate assets were primarily construction in Progress (the new facility), cash, income taxes receivable, deferred income taxes and real estate available for sale. PAGE 54 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Following is a summary of line of business information as of and for the years ended December 31, 1998, 1997, and 1996: 1998 1997 1996 ------------ ----------- ----------- Sales: Insurance services $ 69,149,050 61,997,817 50,800,650 Clinical services 18,599,583 7,511,889 3,941,704 Substance abuse testing 14,478,583 9,416,413 4,689,501 ------------ ----------- ----------- Total sales $ 102,227,216 78,926,119 59,431,855 ============ =========== =========== Operating income (loss): Insurance services $ 20,630,337 18,507,849 12,610,224 Clinical services (6,187,744) (8,303,741) (7,967,348) Substance abuse testing 203,828 (933,832) (1,235,982) General corporate expenses (167,131) (188,245) (158,830) Investment income 814,343 1,179,947 1,769,182 Other expense, net (112,277) (6,491,437) (140,657) ------------ ----------- ----------- Earnings before income taxes 15,181,356 3,770,541 4,876,589 Income tax expense 5,961,989 1,568,446 2,008,690 ------------ ----------- ----------- Net earnings $ 9,219,367 2,202,095 2,867,899 ============ =========== =========== Identifiable assets: Insurance services $ 29,295,799 25,020,052 24,327,970 Clinical services 5,492,624 3,512,587 4,022,258 Substance abuse testing 6,448,663 4,994,104 3,323,245 General corporate assets 45,544,092 26,446,730 33,069,702 ------------ ----------- ----------- Total assets $ 86,781,178 59,973,473 64,743,175 ============ =========== =========== Capital expenditures: Insurance services $ 2,089,869 3,308,320 2,558,275 Clinical services 501,380 468,538 162,814 Substance abuse testing 423,664 946,268 504,867 General corporate 22,470,381 2,553,218 - ============ =========== =========== Depreciation and amortization: Insurance services $ 2,560,962 3,185,661 2,504,472 Clinical services 797,385 940,223 1,141,210 Substance abuse testing 810,291 644,531 368,622 ============ =========== =========== PAGE 55 (10) Quarterly Financial Data (Unaudited) ------------------------------------ A summary of unaudited quarterly results of operations for 1998 and 1997 is as follows (in thousands except per share data): Three months ended --------------------------------------------------- March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ 1998: Sales $ 23,333 25,762 25,834 27,298 Gross profit 10,374 11,931 11,305 11,898 Earnings before income taxes 3,297 4,234 3,630 4,020 Net earnings 2,000 2,516 2,227 2,476 Basic earnings per share 0.15 0.19 0.17 0.19 Diluted earnings per share 0.15 0.19 0.17 0.18 Dividends per share 0.18 0.18 0.18 0.18 ============ ============ ============ ============ 1997: Sales $ 17,740 20,307 19,728 21,151 Gross profit 8,290 9,671 9,064 9,884 Earnings (loss) before income taxes 2,287 2,853 2,603 (3,972) Net earnings (loss) 1,359 1,687 1,536 (2,380) Basic earnings (loss) per share 0.10 0.13 0.12 (0.18) Diluted earnings (loss) per share 0.10 0.13 0.12 (0.18) Dividends per share 0.18 0.18 0.18 0.18 ============ ============ ============= =========== (11) Commitments and Contingencies ----------------------------- Tax Assessment The Comptroller of the State of Texas has conducted an audit of LabOne for sales and use tax compliance for the years 1991 through 1997 and contends that LabOne's insurance laboratory services are taxable under the Texas tax code. The Texas Comptroller has issued a tax audit assessment, including interest and penalties, of approximately $1,900,000. The Company has appealed this assessment arguing that its services do not fit within the definition of insurance services under the Texas code. The assessment is under review by the Texas State Hearing Attorney. At this time, the Company is unable to estimate the possible liability, if any, that may be incurred as a result of this assessment. PAGE 56 LABONE, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 Leases LabOne has several noncancelable operating leases, primarily for land and buildings, and other commitments that expire through 2003, including a lease for office space from an entity owned by an employee. Rental expense for these operating leases during 1998, 1997, and 1996 amounted to $538,000, $486,000, and $626,000, respectively. Future minimum lease payments and other commitments under these agreements as of December 31, 1998 are: Year Amount ---- -------- 1999 $ 519,880 2000 346,912 2001 228,510 2002 195,192 2003 162,660 ======== Construction and Equipment Costs At December 31, 1998, management estimates additional cost to complete construction of the new facility and to acquire related equipment approximates $3,500,000, substantially all of which will be paid in the first half of 1999. The move to the new facility was completed in April 1999. (12) Subsequent Event - Merger Agreement ----------------------------------- On March 8, 1999, LabOne and Lab Holdings jointly announced that the Board of Directors of both companies have approved an agreement to merge the two companies. Under the merger agreement, LabOne is to be merged into Lab Holdings and the merged entities name will be changed to LabOne, Inc. Stockholders of Lab Holdings will have their Lab Holdings shares split immediately before the merger into 1.5 shares of the merged entity. Stockholders of LabOne, other than Lab Holdings, will be entitled to elect to have each of their existing LabOne shares exchanged for one share of the merged entity or $12.75 in cash or a combination of cash and shares up to a limit of $16.6 million in cash (approximately 50% of eligible shares). LabOne will use cash from operations and additional borrowings, if necessary, to cover the purchase of shares from stockholders that choose the cash election option. The merger is subject to approval by the holders of two-thirds of the outstanding Lab Holdings shares and a majority of the shares voted by LabOne stockholders, other than Lab Holdings and its affiliates, and other closing conditions. PAGE 57 LABONE, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Years ended December 31, 1998, 1997 and 1996 Schedule II ----------- Additions - charged to Balance selling, at general, and Deductions - Balance beginning administrative uncollectible at end Description of year expenses accounts of year -------------- -------------- ------------- -------------- Allowance for doubtful accounts: Year ended December 31,1998 $ 968,295 1,502,572 144,151 2,326,716 ============== ============== ============= ============== Year ended , December 31,1997 $ 657,558 521,193 210,456 968,295 ============== ============== ============= ============== Year ended December 31, 1996 $ 329,995 493,760 166,197 657,558 ============== ============== ============= ==============
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