10-K 1 edgarfinal10k.txt COMPANY 2001 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 ------------------------------------------------------- OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to ________________ Commission file number 1-11353 ---------------------------------------------------------- LABORATORY CORPORATION OF AMERICA HOLDINGS -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 13-3757370 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 358 South Main Street, Burlington, North Carolina 27215 (Address of principal executive offices) (Zip Code) 336-229-1127 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of exchange on which registered ------------------------------ ------------------------------------- Common Stock, $0.10 par value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None 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. ------- State the aggregate market value of the voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of a specified date within the past 60 days: $4,898,940,023 at February 28, 2002. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: 70,829,522 shares as of February 28, 2002, of which 10,705,074 shares are held by indirect wholly owned subsidiaries of Roche Holdings Ltd. PART I Item 1. DESCRIPTION OF BUSINESS Laboratory Corporation of America Holdings (the "Company"), headquartered in Burlington, North Carolina, is the second largest independent clinical laboratory company in the United States based on 2001 net revenues. Through a national network of laboratories, the Company offers more than 4,000 different clinical laboratory tests which are used by the medical profession in routine testing, patient diagnosis, and in the monitoring and treatment of disease. Since its founding in 1971, the Company has grown into a network of 24 primary testing facilities and approximately 1,200 service sites consisting of branches, patient service centers and STAT laboratories, serving clients in 50 states. The Clinical Laboratory Testing Industry Laboratory tests and procedures are used generally by hospitals, physicians and other health care providers and commercial clients to assist in the diagnosis, evaluation, detection, monitoring and treatment of diseases and other medical conditions through the examination of substances in the blood, tissues and other specimens. Clinical laboratory testing is generally categorized as either clinical testing, which is performed on body fluids including blood and urine, or anatomical pathology testing, which is performed on cytologic samples, tissue and other samples, including human cells. Clinical and anatomical pathology procedures are frequently ordered as part of regular physician office visits and hospital admissions in connection with the diagnosis and treatment of illnesses. Certain of these tests and procedures are used principally as tools in the diagnosis and treatment of a wide variety of medical conditions such as cancer, AIDS, endocrine disorders, cardiac disorders and genetic disease. The most frequently requested tests include blood chemistry analyses, urinalyses, blood cell counts, thin layer cytology Pap smears, HIV tests, microbiology cultures and procedures and alcohol and other substance-abuse tests. The clinical laboratory industry consists primarily of three types of providers: hospital-based laboratories, physician-office laboratories and independent clinical laboratories, such as those owned by the Company. The Company believes that in 2001 approximately 49% of the clinical testing revenues in the United States were derived by hospital-based laboratories, approximately 12% were derived by physicians in their offices and laboratories, and approximately 39% were derived by independent clinical laboratories. The Health Care Financing Administration ("HCFA") of the Department of Health and Human Services ("HHS") has estimated that in 2001 there were approximately 5,000 independent clinical laboratories in the United States. Effect of Market Changes on the Clinical Laboratory Business Many market-based changes in the clinical laboratory business have occurred over the past ten years, primarily as a result of the shift away from traditional, fee-for-service medicine to managed-cost health care. The growth of the managed care sector presents various challenges to the Company and other independent clinical laboratories. Managed care organizations typically contract with a limited number of clinical laboratories and negotiate discounts to the fees charged by such laboratories in an effort to control costs. Such discounts have historically resulted in price erosion and have negatively impacted the Company's operating margins. In addition, managed care organizations have used capitated payment contracts in an attempt to fix the cost of laboratory testing services for their enrollees. Under a capitated payment contract, the clinical laboratory and the managed care organization agree to a per member, per month payment to cover all laboratory tests during the month, regardless of the number or cost of the tests actually performed. Such contracts shift the risks of additional testing beyond that covered by the capitated payment to the clinical laboratory. For the year ended December 31, 2001 such capitated contracts accounted for approximately $106.3 million of the Company's net sales. The increase in managed care and insurance companies' attempts to control utilization of medical services overall has also resulted in declines in the utilization of laboratory testing services. In addition, Medicare (which principally services patients 65 and older), Medicaid (which principally serves indigent patients) and insurers have increased their efforts to control the cost, utilization and delivery of health care services. Measures to regulate health care delivery in general and clinical laboratories in particular have resulted in reduced prices, added costs and decreased test utilization for the clinical laboratory industry by increasing complexity and adding new regulatory and administrative requirements. From time to time, Congress has also considered changes to the Medicare fee schedules in conjunction with certain budgetary bills. The Company believes that reductions in reimbursement for Medicare services will continue to be implemented from time to time. Reductions in the reimbursement rates of other third-party payors are likely to occur as well. Despite the market changes discussed above, the Company believes that the volume of clinical laboratory testing will be positively influenced by several factors, including: the expanded base of genomics knowledge, which has led to an enhanced appreciation of the value of gene-based diagnostic assays for guiding both the development and stratification of patient-related data for new therapeutics, as well as an increased awareness by physicians that clinical laboratory testing is a cost-effective means of prevention, early detection of disease and monitoring of treatment. In an effort to better promote this appreciation in the marketplace, the Company recently announced partnerships with Myriad Genetics, Inc., to make Myriad's predictive medicine products broadly available to primary care physicians throughout the United States; and EXACT Sciences, to exclusively license EXACT's proprietary technologies for the detection of colorectal cancer. Additional factors which may lead to future volume growth include: an increase in the number and types of tests which are readily available (due to advances in technology and increased cost efficiencies) on a more affordable basis to physicians; expanded substance-abuse testing by corporations and governmental agencies; increased testing for sexually transmitted diseases such as AIDS; and the general aging of the population in the United States. The impact of these factors is expected to be partially offset by declines in volume as a result of increased controls over the utilization of laboratory services by Medicare and other third-party payors, particularly managed care organizations. Laboratory Testing Operations and Services The Company has 24 primary testing facilities, and approximately 1,200 service sites consisting of branches, patient service centers and STAT laboratories. A "branch" is a central office which collects specimens in a region for shipment to one of the Company's laboratories for testing. Test results can be printed at a branch and conveniently delivered to the client. A branch also is used as a base for sales staff. Generally, a "patient service center" is a facility maintained by the Company to serve the physicians in a medical professional building or other strategic location. The patient service center collects the specimens as requested by the physician. The specimens are sent, principally through the Company's in-house courier system (and, to a lesser extent, through independent couriers), to one of the Company's major laboratories for testing. Some of the Company's patient service centers also function as "STAT labs", which are laboratories that have the ability to perform certain routine tests quickly and report results to the physician immediately. The Company processed an average of approximately 281,000 patient specimens per day in 2001. Patient specimens are delivered to the Company accompanied by a test request form. These forms, which are completed by the client, indicate the tests to be performed and provide the necessary billing information. Each specimen and related request form is checked for completeness and then given a unique identification number. The unique identification number assigned to each specimen helps to assure that the results are attributed to the correct patient. The test request forms are sent to a data entry terminal where a file is established for each patient and the necessary testing and billing information is entered. Once this information is entered into the computer system, the tests are performed and the results are entered through computer interface or manually, depending upon the tests and the type of equipment involved. Most of the Company's computerized testing equipment is directly linked with the Company's information systems. Most routine testing is completed by early the next morning and test results are printed and prepared for distribution by service representatives that day. Some clients have local printing capability and have reports printed out directly in their offices. Clients who request that they be called with a result are so notified in the morning. It is Company policy to notify the client immediately if a life- threatening result is found at any point during the course of the testing process. Testing Services Routine Testing The Company currently offers approximately 4,000 different clinical laboratory tests or procedures. Several hundred of these are frequently used in general patient care by physicians to establish or support a diagnosis, to monitor treatment or medication, or to search for an otherwise undiagnosed condition. The most frequently requested routine tests include blood chemistry analyses, urinalyses, blood cell counts, Pap smears and HIV tests. These routine procedures are most often used by practicing physicians in their outpatient office practices. Physicians may elect to send such procedures to an independent laboratory or they may choose to establish an in-house laboratory to perform some of the tests. The Company performs this core group of routine tests in each of its 24 primary testing facilities, which constitutes a majority of the testing performed by the Company. The Company generally performs and reports most routine procedures within 24 hours, utilizing a variety of sophisticated and computerized laboratory testing instruments. Specialty and Niche Testing While the information provided by many routine tests may be used by nearly all physicians, regardless of specialty, many other procedures are more specialized in nature. One of the primary growth strategies of the Company is the continued expansion of its specialty and niche businesses, which involve certain types of unique testing capabilities and/or client requirements. In general, the specialty and niche businesses are designed to serve two market segments: (i) markets which are not served by the routine clinical testing laboratory and therefore are subject to less stringent regulatory and reimbursement constraints; and (ii) markets which are served by the routine testing laboratory and offer the possibility of adding related services from the same supplier. The Company's research and development group continually seeks new and improved technologies for early diagnosis. For example, the Company's Center for Molecular Biology and Pathology (CMBP) is a leader in molecular diagnostics and polymerase chain reaction (PCR) technologies which are often able to provide earlier and more reliable information regarding HIV, genetic diseases, cancer and many other viral and bacterial diseases. In August 2000, the Company acquired Los Angeles- based National Genetics Institute, Inc. (NGI), a leader in the development of PCR assays for Hepatitis C (HCV). In June 2001, the Company acquired Minneapolis-based Viro-Med, Inc which offers molecular microbial testing using real time PCR platforms. Management believes these technologies may represent a significant savings to managed care organizations by increasing the detection of early stage (treatable) diseases. The following are specialty and niche businesses in which the Company offers testing and related services: Infectious Disease. The Company provides complete viral load testing as well as HIV genotyping and phenotyping. In 2000, the Company added HIV GenoSure? to its portfolio of HIV resistance testing services. The Company's use of this leading-edge technology puts it in the forefront of HIV drug resistance testing-one of the most important issues surrounding the treatment of HIV. Additionally, the Company provides comprehensive testing for HCV including both PCR testing and genotyping at CMBP, NGI and Viro-Med. Allergy Testing. The Company offers an extensive range of allergen testing services as well as computerized analysis and a treatment program that enables primary care physicians to diagnose and treat many kinds of allergic disorders. Clinical Research Testing. The Company regularly performs clinical laboratory testing for pharmaceutical companies conducting clinical research trials on new drugs. This testing often involves periodic testing of patients participating in the trial over several years. Diagnostic Genetics. The Company offers cytogenetic, molecular cytogenetic, biochemical and molecular genetic tests. Identity Testing. The Company provides forensic identity testing used in connection with criminal proceedings and parentage evaluation services which are used to assist in the resolution of disputed parentage in child support litigation. Parentage testing involves the evaluation of immunological and genetic markers in specimens obtained from the child, the mother and the alleged father. Management believes it is now the largest provider of identity testing services in the United States. Oncology Testing. The Company offers an extensive series of testing technologies that aid in diagnosing and monitoring certain cancers and predicting the outcome of certain treatments. At NGI, scientists have novel assays for melanoma and breast cancer in varying stages of clinical trials. During 2001, The Company began offering PreGen-26, a DNA-based colorectal cancer test (using EXACT Sciences Corporation's proprietary genomics-based technology). PreGen-26 is intended to detect colorectal cancer earlier when treatment is most effective. Occupational Testing Services. The Company provides urine and hair testing for the detection of drugs of abuse for private and government customers, and also provides blood testing services for the detection of drug abuse and alcohol. These testing services are designed to produce "forensic" quality test results that satisfy the rigorous requirements for admissibility as evidence in legal proceedings. The Company also provides other analytical testing and a variety of management support services. The specialized or niche testing services noted above, as well as other complex procedures, are sent to designated facilities where the Company has concentrated the people, instruments and related resources for performing such procedures so that quality and efficiency can be most effectively monitored. CMBP, NGI and Viro-Med also specialize in new test development and education and training related thereto. Clients The Company provides testing services to a broad range of health care providers. During the year ended December 31, 2001, no client or group of clients under the same contract accounted for more than four percent of the Company's net sales. The primary client groups serviced by the Company include: Independent Physicians and Physician Groups Physicians requiring testing for their patients who are unaffiliated with a managed care plan are one of the Company's primary sources of testing services. Fees for clinical laboratory testing services rendered for these physicians are billed either to the physician, to the patient or the patient's third party payor such as insurance companies, Medicare and Medicaid. Billings are typically on a fee-for-service basis. If the billings are to the physician, they are based on the wholesale or customer fee schedule and subject to negotiation. Otherwise, the patient is billed at the laboratory's retail or patient fee schedule and subject to third party payor limitations and negotiation by physicians on behalf of their patients. Medicare and Medicaid billings are based on government-set fee schedules. Hospitals The Company provides hospitals with services ranging from routine and specialty testing to contract management services. Hospitals generally maintain an on-site laboratory to perform immediately needed testing on patients receiving care. However, they also refer less time sensitive procedures, less frequently needed procedures and highly specialized procedures to outside facilities, including independent clinical laboratories and larger medical centers. The Company typically charges hospitals for any such tests on a fee-for-service basis which is derived from the Company's customer fee schedule. Fees for management services are billed monthly at contractually agreed-upon rates. HMOs and Other Managed Care Groups The Company serves HMOs and other managed care organizations. These medical service providers typically contract with a limited number of clinical laboratories and then designate the laboratory or laboratories to be used for tests ordered by participating physicians. The majority of the Company's managed care testing is negotiated on a fee-for-service basis. Testing is sometimes reimbursed on a capitated basis for managed care organizations. Under a capitated payment contract, the Company agrees to cover certain laboratory tests during a given month for which the managed care organization agrees to pay a flat monthly fee for each covered member. The tests covered under agreements of this type are negotiated for each contract, but usually include routine tests and exclude highly specialized tests. Many of the national and large regional managed care organizations prefer to use large independent clinical labs such as the Company because they can monitor service and performance on a national basis. Other Institutions The Company serves other institutions, including governmental agencies, large employers and other independent clinical laboratories that do not have the breadth of the Company's testing capabilities. The institutions typically pay on a negotiated fee-for-service basis. Payors Most testing services are billed to a party other than the "client" that ordered the test. In addition, tests performed by a single physician may be billed to different payors depending on the medical benefits of a particular patient. Payors other than the direct patient, include, among others, insurance companies, managed care organizations, Medicare and Medicaid. For the year ended December 31, 2001, billings to the Company's respective payors (based on the total volume of accessions) are as follows: Revenue Accession Volume as per a % of Total Accession ------------------- --------- Private Patients 3.5% $111.28 Medicare, Medicaid and Insurance 17.0% $ 31.59 Commercial Clients 38.9% $ 24.46 Managed Care 40.6% $ 29.27 Affiliations and Alliances The Company's development of hospital relationships through traditional and non-traditional business models exceeded all prior year outcomes. The Company increased its focus on the traditional business model with a hospital, whereby the Company enters into a reference service agreement and establishes a Hospital Territory Manger (HTM) role. The addition of this sales/service position sets the Company at an advantage with specialized and targeted attention for the Company's Hospital customers. Significant growth also occurred due to laboratory technical support (management) contracts and shared services agreements. In 2001 the Company added a number of new traditional and nontraditional relationships with hospitals. These new hospital relationships represent approximately $48.5 million of new annualized sales. Reference agreements, or traditional business model, provide a means for hospitals to outsource patient laboratory testing services that are not time critical (e.g., test results reported within twenty-four hours of drawing the specimen as opposed to those requiring two to four hour turnaround). These agreements allow the hospital to maintain their own stat/emergency lab on-site, while eliminating certain costs of maintaining a full-service lab on their premises. A non-traditional business model is where the Company provides technical support services in a variety of health care settings. In these relationships, the Company generally supplies the laboratory manager and other laboratory personnel, as well as equipment and testing supplies, to manage a laboratory that is owned by a hospital, managed care organization or other health care provider. Under the typical laboratory technical support agreement, the laboratory manager, who is employed by the Company, reports to the hospital or clinic administration. Thus, the hospital or clinic ("Provider") maintains control of the laboratory. A pathologist designated by the Provider serves as medical director for the laboratory. Hospitals are increasingly looking beyond their in-house patient base and seek to provide services to outreach patients within their greater local community. The Company has a focus to develop cooperative testing relationships with such hospitals in which the parties combine efforts to support the needs of a specific community. These non-traditional relationships center around capitalizing on a partner hospital's excess capacity and ability to perform rapid response testing and the Company's ability to provide low cost, high quality esoteric testing. These service agreements create ventures that provide communities with synergistic, high quality testing services within a single infrastructure. An important advantage the Company offers to its clients is the flexibility of the Company's information systems used for contract management services and for creating bi-directional interfaces to support the Company's cooperative testing arrangements. In addition to the ability to be customized for a particular user's needs, the Company's information systems also interface with several hospital and clinic systems, giving the user more efficient and effective information flow. The Company's non-traditional business contracts typically have terms between three and five years. However, most contracts contain a clause that permits termination prior to the contract expiration date. The termination terms vary but they generally fall into one of the following categories: (1) termination without cause by either the Company or the contracted Provider after written notice (generally 60 to 120 days prior to termination); (2) termination by the contracted Provider only if there are uncorrected deficiencies in the Company's performance under the contract after notice by the contracted Provider; (3) termination by the contracted Provider if there is a loss of accreditation held by any Company laboratory that services the contracted Provider, which accreditation is not reinstated within 30 days of the loss, or up to 30 days' notice if there is a decline in the quality of services provided under such contract which remains uncorrected after a 15-day period; or (4) should the Company or Provider's service requirements change to the extent that the new service requirements affect the profitability or stability of the alliance relationship and the terms cannot be re-negotiated to the satisfaction of both parties. While the Company believes that it will maintain and renew its existing contracts, there can be no assurance of such maintenance or renewal. The Company has developed several different pricing formulas under its non-traditional business contracts. The Company generally bills the hospital a monthly contractually-determined management fee in addition to different fixed on-site and off-site fees per test. Highly esoteric tests are generally billed under a separate fee schedule. In certain cases, profitability may depend on the Company's ability to accurately predict test volumes, patient encounters or the number of admissions. Sales and Marketing and Client Service The Company offers its services through a combination of direct sales generalists and specialists. Sales generalists market the mainstream or traditional routine laboratory services primarily to physicians, while specialists concentrate on individual market segments, such as hospitals or managed care organizations, or on testing niches, such as identity testing or genetic testing. Specialist positions are established when an in-depth level of expertise is necessary to effectively offer the specialized services. When the need arises, specialists and generalists work cooperatively to address specific opportunities. At December 31, 2001, the Company employed 235 generalists and 114 specialists. The Company's sales generalists and specialists are compensated through a combination of salaries, commissions and bonuses, at levels commensurate with each individual's qualifications and responsibilities. Commissions are primarily based upon the individual's productivity in generating new business for the Company. The Company also employs regional service managers and account managers ("AMs") to interact with clients on an ongoing basis. AMs monitor the status of the services being provided to clients, act as problem- solvers, provide information on new testing developments and serve as the client's regular point of contact with the Company. At December 31, 2001, the Company employed 290 AMs. AMs are compensated through a combination of salaries and bonuses commensurate with each individual's qualifications and responsibilities. The Company believes that the clinical laboratory service business is shifting away from the traditional direct sales structure to one in which the purchasing decisions for laboratory services are increasingly being made by managed care organizations, insurance plans, employers and even by patients themselves. In view of these changes, the Company has adapted its sales and marketing structure to more appropriately address the opportunities presented by this shift. The Company competes primarily on the basis of the quality of its testing, reporting and information systems, its reputation in the medical community, the pricing of its services and its ability to employ qualified personnel. During 2001, one of the Company's goals has been to improve client service. An important factor in improving client service includes the Company's initiatives to improve its billing process. See "-Billing." Information Systems The Company has developed and implemented management information systems to monitor operations and control costs. All financial functions are centralized in Burlington, North Carolina including purchasing and accounting. Management believes this provides greater control over spending as well as increased supervision and monitoring of results of operations. The Company believes that the health care provider's need for data will continue to place high demands on its information systems staff. The Company operates several systems to handle laboratory, billing and financial data and transactions. The Company believes that the efficient handling of information involving clients, patients, payors and other parties will be a critical factor in the Company's future success. The Company's Corporate Information Systems Division manages its information resources and programs on a consolidated basis in order to achieve greater efficiency and economies of scale. The Company employs a Chief Information Officer, whose responsibility is to integrate, manage and develop the Company's information systems. In 2001, the Company continued to focus on its information systems activities and substantially completed the consolidation of its multiple laboratory and billing systems to standardized laboratory testing and billing systems. The Company has established regional data centers to more effectively handle the information processing needs of the Company. The Company believes that benefits have been realized from the conversion of its multiple billing systems into a centralized system and these benefits will continue in the future as the Company takes advantage of this standardization. Billing Billing for laboratory services is a complex process. Laboratories must bill many different payors such as doctors, patients, hundreds of different insurance companies, Medicare, Medicaid and employer groups, all of whom have different billing requirements. The Company believes that a majority of its bad debt expense is the result of non-credit related issues which slow the billing process. A primary cause of bad debt expense is missing or incorrect billing information on requisitions. The Company believes that this experience is similar to that of its primary competitors. The Company performs the requested tests and returns back the test results regardless of whether billing information has been provided at all or has been provided incorrectly. The Company subsequently attempts to obtain any missing information or rectify any incorrect billing information received from the health care provider. Among the many other factors complicating the billing process are more intricate billing arrangements due to contracts with third-party administrators, disputes between payors as to the party responsible for payment of the bill and auditing for specific compliance issues. During 2001, the Company's days sales outstanding (DSO) were reduced 10 days from December 31, 2000 levels to 58 days as a result of Company- wide efforts to increase cash collections from all payors, as well as on- going improvements to claim submission processes. The Company is continuing to take the steps necessary to improve DSO and cash collections by: 1) Conversion of decentralized billing locations to a centralized billing system. During 2001, the Chicago, San Antonio and Dallas locations were converted. 2) During the first quarter of 2000, the Company implemented an initiative to reduce the number of requisitions received that are missing certain billing information. This initiative involves measuring the number of clinical requisitions received by ordering client, as well as what specific information was not provided. The Company then identifies root causes of why the information was missing and takes steps to ensure that information is provided in the future. These steps include re-educating clients as to what information is needed in order for the Company to bill and collect for the test. During the year, the percentage of requisitions received which were missing billing information was 6%. Although there can be no assurance of success, the Company has developed a number of initiatives to address the complexity of the billing process and to improve collection rates. These initiatives include: i) installation of personal computer based products in client offices and Company locations to help with the accuracy and completeness of billing information captured on the front-end; ii) establishment of a project group to focus on improvements in order entry; and iii) development and implementation of enhanced eligibility checking to compare information to payor records before billing. Additionally, the Company believes that it can benefit from the conversion of its multiple billing systems into a centralized system. Currently, 90% of the Company's billing is performed on this centralized system. By the end of 2002, the Company plans to have approximately 95% of its billing performed on the centralized system. Quality Assurance The Company considers the quality of its tests to be of critical importance, and it has established a comprehensive quality assurance program for all of its laboratories and other facilities, designed to help assure accurate and timely test results. In addition to the compulsory external inspections and proficiency programs demanded by HCFA and other regulatory agencies, Company-wide systems and procedures are in place to emphasize and monitor quality assurance. All of the Company's regional laboratories are subject to on-site evaluations, the College of American Pathologists ("CAP") proficiency testing program, state surveys and the Company's own internal quality control programs. External Proficiency/ Accreditations. The Company participates in numerous externally-administered, blind quality surveillance programs, including the CAP program. The blind programs supplement all other quality assurance procedures and give Company management the opportunity to review its technical and service performance from the client's perspective. Internal Quality Control. The Company regularly performs internal quality control testing by running quality control samples with known values with patient samples submitted for testing. All quality control sample test results are entered into the Company's national laboratory computer, which connects the Company's facilities nationwide to a common on-line quality control database. This system helps technologists and technicians check quality control values and requires further prompt verification if any quality control value is out of range. The Company has an extensive, internally administered program of blind sample proficiency testing (i.e. the testing laboratory does not know the sample being tested is a quality control sample), as part of which the Company's locations receive specimens from the Company's Quality Assurance and Corporate Technical Services departments for analysis. The CAP accreditation program involves both on-site inspections of the laboratory and participation in the CAP's proficiency testing program for all categories in which the laboratory is accredited by the CAP. The CAP is an independent non-governmental organization of board-certified pathologists which offers an accreditation program to which laboratories can voluntarily subscribe. The CAP has been accredited by HCFA to inspect clinical laboratories to determine adherence to the Clinical Laboratory Improvement Act of 1967, and the Clinical Laboratory Improvement Amendments of 1988 (collectively, as amended, "CLIA") standards. A laboratory's receipt of accreditation by the CAP satisfies the Medicare requirement for participation in proficiency testing programs administered by an external source. All of the Company's major laboratories are accredited by the CAP. The Company's forensic crime laboratory, located at CMBP, is accredited by the American Society of Crime Laboratory Directors, Laboratory Accreditation Board ("ASCLD/LAB") in the category of DNA testing. Under the Crime Laboratory Accreditation Program managed by the ASCLD/LAB, a crime laboratory undergoes a comprehensive and in-depth inspection to demonstrate that its management, operations, employees, procedures and instruments, physical plant and security, and personnel safety procedures meet stringent quality standards. The Company is one of 223 ASCLD accredited crime laboratories worldwide, and is one of only six private crime laboratories holding the accreditation. Accreditation is granted for a period of five years provided that a laboratory continues to meet the standards during that period. Competition The clinical laboratory business is intensely competitive. The Company believes that in 2001 the entire United States clinical laboratory testing industry had revenues exceeding $34 billion; approximately 49% of such revenues were attributable to hospital-affiliated laboratories, approximately 39% were attributable to independent clinical laboratories and approximately 12% were attributable to physicians in their offices and laboratories. There are presently two national independent clinical laboratories: the Company; and Quest Diagnostics Incorporated ("Quest"), which had approximately $3.6 billion in revenues from clinical laboratory testing in 2001. In addition to the other national clinical laboratory, the Company competes on a regional basis with many smaller regional independent clinical laboratories as well as laboratories owned by hospitals and physicians. The Company believes that the following factors, among others, are often used by health care providers in selecting a laboratory: i) pricing of the laboratory's test services; ii) accuracy, timeliness and consistency in reporting test results; iii) number and type of tests performed; iv) service capability and convenience offered by the laboratory; and v) its reputation in the medical community. The Company believes that it competes favorably with its principal competitors in each of these areas and is currently implementing strategies to improve its competitive position. The Company believes that consolidation will continue in the clinical laboratory testing business. In addition, the Company believes that it and the other large independent clinical laboratory testing companies will be able to increase their share of the overall clinical laboratory testing market due to a number of external factors including cost efficiencies afforded by large-scale automated testing, Medicare reimbursement reductions and the growth of managed health care entities which require low-cost testing services and large service networks. In addition, legal restrictions on physician referrals and the ownership of laboratories as well as increased regulation of laboratories are expected to contribute to the continuing consolidation of the industry. Employees At December 31, 2001, the Company had approximately 19,600 full-time equivalent employees. A subsidiary of the Company has one collective bargaining agreement which covers approximately 25 employees. The Company believes that its overall relations with its employees are good. Regulation and Reimbursement General The clinical laboratory industry is subject to significant governmental regulation at the federal, state and sometimes local levels. As described below, these regulations concern licensure and operation of clinical laboratories, payment for laboratory services, health care fraud and abuse, security and confidentiality of health information, and environmental and occupational safety. Regulation of Clinical Laboratories The Clinical Laboratory Improvement Amendments of 1988 ("CLIA") extend federal oversight to virtually all clinical laboratories by requiring that they be certified by the federal government or by a federally-approved accreditation agency. Pursuant to CLIA, clinical laboratories must meet quality assurance, quality control and personnel standards. Laboratories also must undergo proficiency testing and are subject to inspections. Standards for testing under CLIA are based on the complexity of the tests performed by the laboratory, with all tests classified as either high complexity, moderate complexity, or waived. Laboratories performing high complexity testing are required to meet more stringent requirements than moderate complexity laboratories. Labs performing only waived tests, which are tests determined by the Food and Drug Administration to have a low potential for error and requiring little or no oversight, may apply for a certificate of waiver indicating that they need not comply with most of the requirements of CLIA. All major and many smaller Company facilities hold CLIA certificates to perform high complexity testing. The Company's remaining smaller testing sites hold CLIA certificates to perform moderate complexity testing or have a certificate of waiver. The sanction for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory's CLIA certificate, which is necessary to conduct business, as well as significant fines and/or criminal penalties. The loss or suspension of a license, imposition of a fine or other penalties, or future changes in the CLIA law or regulations (or interpretation of the law or regulations) could have a material adverse effect on the Company. The Company also is subject to regulation by some states. CLIA provides that a state may adopt regulations different from or more stringent than those under federal law, and a number of states have implemented their own laboratory regulatory schemes. State laws may require that laboratory personnel meet certain qualifications, specify certain quality controls, or require maintenance of certain records. For example, some of the Company's laboratories are subject to the State of New York's clinical laboratory regulations, which contain provisions that are more stringent than those under federal law. The Company believes that it is in compliance with federal and state laboratory requirements, and the Company's laboratories have continuing programs to ensure that their operations meet all applicable regulatory requirements, but no assurances can be given that the Company's laboratories will pass all future licensure or certification inspections. Payment of Clinical Laboratory Services In both 2001 and 2000, the Company derived approximately 16% of its net sales from tests performed for beneficiaries of the Medicare and Medicaid programs. In addition, the Company's other business depends significantly on continued participation in these programs because clients often want a single laboratory to perform all of their testing services. Both governmental and private sector payors have made efforts to contain or reduce health care costs, including payment for clinical laboratory services, in recent years. In 1984, Congress established a Medicare fee schedule for clinical laboratory services performed for patients covered under Part B of the Medicare program. Subsequently, Congress imposed a national ceiling on the amount that can be paid under the fee schedule. Laboratories bill the program directly and must accept the scheduled amount as payment in full for covered tests performed on behalf of Medicare beneficiaries. In addition, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limitation for clinical laboratory services furnished to Medicaid recipients. Since 1984, Congress has periodically reduced the ceilings on Medicare payment to clinical laboratories from previously authorized levels. In 1993, pursuant to provisions in the Omnibus Budget and Reconciliation Act of 1993 ("OBRA '93"), Congress reduced, effective January 1, 1994, the Medicare national limitations from 88% of the 1984 national median to 76% of the 1984 national median, which reductions were implemented on a phased-in basis from 1994 through 1996 (to 84% in 1994, 80% in 1995 and 76% in 1996). The 1996 reduction to 76% was implemented as scheduled on January 1, 1996. OBRA '93 also eliminated the provision for annual fee schedule increases based upon the Consumer Price Index for 1994 and 1995. These reductions were partially offset, however, by annual Consumer Price Index fee schedule increases of 3.2% and 2.7% in 1996 and 1997, respectively. In August 1997, Congress passed and the President signed the Balanced Budget Act of 1997 ("BBA"), which included a provision that reduced, effective January 1, 1998, the Medicare national limitation from 76% of the 1984 national median to 74% of the 1984 national median. An additional provision in the BBA froze the Consumer Price Index update for five years. Because a significant portion of the Company's costs are relatively fixed, Medicare payment reductions have a direct adverse effect on the Company's net earnings and cash flows. The Company cannot predict whether additional Medicare reductions will be implemented. On April 1, 1997, Medicare's policy for billing of automated chemistry profiles went into effect. The policy, which was developed by the Health Care Financing Administration ("HCFA"), now known as the Center for Medicare and Medicaid Services ("CMS"), working with the American Medical Association, eliminated the old commonly used "19-22 test" automated chemistry profile, sometimes referred to as a "SMAC" and replaced it with four new panels of "clinically relevant" automated tests (each containing from four to twelve chemistry tests). As a result of this policy, all major laboratory companies, including the Company, were required to eliminate the old chemistry profiles from their standard test requisition forms and standard test offerings by July 1, 1998. The Company developed and implemented a new "universal" test requisition and "standard test offerings" which successfully incorporated all required changes by the July 1, 1998 deadline. The automated chemistry profile billing policy is intended to reduce the number of non-Medicare covered "screening tests" which Medicare believes have in the past been inappropriately billed to Medicare. The BBA also required the Department of Health and Human Services to adopt uniform coverage, administration and payment policies for lab tests using a negotiated rulemaking process. Consensus was reached by the negotiated rulemaking committee which, among other things, established policies limiting Medicare coverage for certain tests to patients with specified medical conditions or diagnoses. These uniform policies will replace local Medicare coverage policies. The final rules were published on November 23, 2001 and will become generally effective on November 25, 2002. Due to the variety of new rules (including limited coverage rules) which have been adopted or proposed recently, and the lead time before the negotiated rulemaking rule becomes effective, the Company does not believe a meaningful estimate of the potential revenue impact of these developments can be made at this time. The Company will continue to monitor this issue going forward. Future changes in federal, state and local regulations (or in the interpretation of current regulations) affecting government payment for clinical laboratory testing could have a material adverse effect on the Company. However, based on currently available information, the Company is unable to predict what type of legislation, if any, will be enacted into law. Security and Confidentiality of Health Information The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") includes the following provisions: 1) Transactions and Code Sets - standardized format for all electronic claims processing maintained by a health plan, health care provider or health care data clearinghouse. The compliance date for this provision is October 16, 2002. However, Congress has approved a twelve-month extension for covered entities wishing to file a formal compliance extension plan. 2) Privacy: a) standardize the protections that must be provided for Protected Health Information ("PHI") covering all forms and types of PHI and all methods of receipt, delivery and storage; b) establish a formal privacy program and designate a privacy officer. The compliance date for this provision is April 14, 2003. The Company's HIPAA project plans have two phases: 1) assessment of current systems, applications, processes and procedure testing and validation for HIPAA compliance and; 2) remediation of affected systems, applications, processes and procedure testing and validation for HIPAA compliance. The Company has completed the assessment phase of the Transactions and Code Sets provision. Remediation is currently in progress and the Company expects to meet the October 2002 required implementation date, but will file for an extension if testing cannot be completed with all carriers. It is currently estimated that the total future expenditures relating to the Transactions and Code Sets project will be approximately $13.8, with $0.6 having been spent through December 31, 2001. The Company believes that approximately 80% of this project will add new functionality to existing systems and plans to capitalize these expenditures as incurred. The Company is in the later stage of the assessment phase of the Privacy provision. Upon completion of the assessment phase, financial projections will be completed and remediation will be initiated. The Company expects to meet the April 2003 required implementation date. The total cost associated with the requirements of HIPAA is not expected to be material to the Company's operations or cash flows. In addition to the HIPAA provisions described above, which have not yet been implemented, there are a number of state laws regarding the confidentiality of medical information, some of which apply to clinical laboratories. These laws vary widely, and new laws in this area are pending, but they most commonly restrict the use and disclosure of medical information without patient consent. Penalties for violation of these laws include sanctions against a laboratory's state licensure, as well as civil and/or criminal penalties. Fraud and Abuse Regulations Existing federal laws governing Medicare and Medicaid, as well as similar state laws, impose a variety of broadly described fraud and abuse prohibitions on healthcare providers, including clinical laboratories. These laws are interpreted liberally and enforced aggressively by multiple government agencies, including the U.S. Department of Justice, the U.S. Department of Health and Human Services Office of the Inspector General ("OIG"), and the states. The federal government's enforcement efforts have been increasing, in part as a result of the enactment of the Health Insurance Portability and Accountability Act of 1996, which, among other things, provided for the establishment of a program to coordinate federal, state and local law enforcement programs, and to conduct investigations, audits and inspections relating to payment for healthcare, and for the establishment of a federal anti-fraud and abuse account for enforcement efforts, funded through collection of penalties and fines for violations of the healthcare anti-fraud and abuse laws. Moreover, over the last several years, the clinical laboratory industry has been the focus of major governmental enforcement initiatives. The Medicare and Medicaid anti-kickback laws prohibit intentionally providing anything of value to influence the referral of Medicare and Medicaid business. HHS has published safe harbor regulations which specify certain business activities that, although literally covered by the laws, will not violate the Medicare/Medicaid anti-kickback laws if all conditions of the safe harbor are met. Failure to fall within a safe harbor does not constitute a violation of the anti-kickback laws; rather, the arrangement would remain subject to scrutiny by HHS. Most states have their own Medicaid anti-kickback laws, and several states also have anti-kickback laws that apply to attempts to gain referral of patients covered by private insurance as well as federal programs. In October 1994, the Office of the Inspector General ("OIG") of HHS issued a Special Fraud Alert, which set forth a number of practices allegedly engaged in by clinical laboratories and health care providers that the OIG believes violate the federal anti-kickback laws. These practices include providing employees to collect patient samples at physician offices if the employees perform additional services for physicians that are typically the responsibility of the physicians' staff; selling laboratory services to renal dialysis centers at prices that are below fair market value in return for referrals of Medicare tests which are billed to Medicare at higher rates; providing free testing to a physician's HMO patients in situations where the referring physicians benefit from such reducing laboratory utilizations; providing free pick-up and disposal of bio-hazardous waste for physicians for items unrelated to a laboratory's testing services; providing facsimile machines or computers to physicians that are not exclusively used in connection with the laboratory services performed; and providing free testing for health care providers, their families and their employees (professional courtesy testing). The OIG stressed in the Special Fraud Alert that when one purpose of the arrangements is to induce referral of program-reimbursed laboratory testing, both the clinical laboratory and the health care provider or physician may be liable under the anti-kickback laws, and may be subject to criminal prosecution and exclusion from participation in the Medicare and Medicaid programs. Recently, the OIG has provided additional guidance regarding arrangements that may violate the anti-kickback laws. In a 1999 Advisory Opinion, the OIG concluded that a proposed arrangement whereby a laboratory would offer physicians significant discounts on laboratory tests billed to the physician might violate the anti-kickback act. The OIG reasoned that if the discounts were greater than could otherwise be justified, the proposed arrangement could be viewed as the laboratory providing discounts to the physician in exchange for referral by the physician of non- discounted Medicare program business. Similarly, in 1999 correspondence, the OIG stated that if any direct or indirect link exists between a price discount that a laboratory offers to a skilled nursing facility ("SNF") for Prospective Payment System ("PPS")-covered services and referrals of Medicare Part B business, the anti-kickback statute would be implicated. Moreover, the OIG stated that it is continuing to monitor the situation regarding potentially unlawful contracts between SNFs and service providers, including laboratories. Under another federal provision, known as the "Stark" law or "self- referral" prohibition, physicians who have an investment or compensation relationship with a clinical laboratory may not, unless a statutory exception applies, refer Medicare or Medicaid patients for testing to the laboratory, regardless of the intent of the parties. Similarly, laboratories may not bill Medicare or Medicaid or any other party for services furnished pursuant to a prohibited referral. There are federal Stark law exceptions for fair market value compensation to a physician for reasonable and necessary services, and for discounts to physicians purchasing laboratory services. There is also an exception for physician investment in a laboratory company so long as the company's stock is traded on a public exchange, the company has stockholder equity exceeding $75,000,000, and the physician's shares may be purchased on terms generally available to the public. State self-referral laws exist as well, which apply to all patient referrals, not just Medicare and Medicaid. There are a variety of other types of federal and state anti-fraud and abuse laws, including laws prohibiting submission of false or otherwise improper claims to federal healthcare programs, and laws limiting the extent of any differences between the Company's charges to Medicare and Medicaid and its charges to other parties. The Company seeks to structure its business to comply with the federal and state anti-fraud and abuse laws. However, the Company is unable to predict how these laws will be applied in the future, and no assurances can be given that its arrangements will not be subject to scrutiny under them. Sanctions for violations of these laws may include exclusion from participation in Medicare, Medicaid and other federal healthcare programs, significant criminal and civil fines and penalties, and loss of licensure. Any exclusion from participation in a federal healthcare program, or any loss of licensure, arising from any action by any federal or state regulatory or enforcement authority, would have a material adverse affect on the Company's business. In addition, any significant criminal or civil penalty resulting from such proceedings could have a material adverse affect on the Company's business. Environmental and Occupational Safety The Company is subject to licensing and regulation under Federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials as well as to the safety and health of laboratory employees. All Company laboratories are subject to applicable Federal and state laws and regulations relating to biohazard disposal of all laboratory specimens and the Company utilizes outside vendors for disposal of such specimens. In addition, the Federal Occupational Safety and Health Administration ("OSHA") has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to, and transmission of, blood-borne pathogens. On November 6, 2000, Congress passed the Needlestick Safety and Prevention Act which required, among other things, that companies include in their safety programs the evaluation and use of engineering controls such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace. During 2001, the Company voluntarily implemented the use of safety needles at all of its service locations at a cost of over $6.0 million. Although the Company is not aware of any current material non- compliance with such Federal, state and local laws and regulations, failure to comply could subject the Company to denial of the right to conduct business, fines, criminal penalties and/or other enforcement actions. Drug Testing Drug testing for public sector employees is regulated by the Substance Abuse and Mental Health Services Administration ("SAMSHA") (formerly the National Institute on Drug Abuse), which has established detailed performance and quality standards that laboratories must meet to be approved to perform drug testing on employees of Federal government contractors and certain other entities. To the extent that the Company's laboratories perform such testing, each must be certified as meeting SAMSHA standards. The Company's Research Triangle Park, North Carolina; Raritan, New Jersey; Houston, Texas; San Diego, California and Southaven, Mississippi laboratories are SAMSHA certified. Controlled Substances The use of controlled substances in testing for drugs of abuse is regulated by the Federal Drug Enforcement Administration. Compliance Program Because of evolving interpretations of regulations and the national debate over health care fraud and abuse, compliance with all Medicare, Medicaid and other government-established rules and regulations has become a significant factor throughout the clinical laboratory industry. The Company has implemented a comprehensive company-wide compliance program, in part mandated by a comprehensive five-year Corporate Integrity Agreement with the federal government. This agreement was part of the Company's 1996 settlement of federal and state claims related to billings to Medicare and other federal programs for tests performed by the Company and its predecessors (the "1996 government settlement"). The agreement was similar to corporate integrity agreements arising out of settlements of similar claims by a number of other clinical laboratories following a broad-based government investigation and enforcement initiative. Although the Corporate Integrity Agreement expired on November 21, 2001, the Company continues to operate pursuant to its compliance program. The objective of the Company's compliance program is to develop, implement, and update compliance safeguards as necessary. Emphasis is placed on developing compliance policies and guidelines, personnel training programs and various monitoring and audit procedures to attempt to achieve implementation of all applicable rules and regulations. The Company seeks to structure its business to comply in all material respects with all statutes, regulations, and other requirements applicable to its clinical laboratory operations. The clinical laboratory testing industry is, however, subject to extensive regulation, and many of these statutes and regulations have not been interpreted by the courts. There can be no assurance therefore that applicable statutes and regulations might not be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect the Company. Potential sanctions for violation of these statutes and regulations include significant fines and the loss of various licenses, certificates, and authorizations, which could have a material adverse affect on the Company's business. Item 2. PROPERTIES The following table summarizes certain information as to the Company's principal operating and administrative facilities as of December 31, 2001. Approximate Area Nature of Location (in square feet) Occupancy -------------------- ---------------- ----------- Operating Facilities: Birmingham, Alabama 100,000 Lease expires 2005 Phoenix, Arizona 55,000 Lease expires 2009 Los Angeles, California 16,000 Lease expires 2002; one 5 year renewal option 19,000 Lease expires 2004 San Diego, California 48,000 Lease expires 2007 14,000 Lease expires 2002 Denver, Colorado 20,000 Lease expires 2002 Tampa, Florida 95,000 Lease expires 2010; one 5 year renewal option Chicago, Illinois 45,000 Lease expires 2003; two 5 year renewal options Louisville, Kentucky 60,000 Lease expires 2002; three 5 year renewal options Detroit, Michigan 32,000 Lease expires 2004; one 10 year renewal option Eden Prairie, Minnesota 49,000 Lease expires 2014 Kansas City, Missouri 78,000 Owned Reno, Nevada 16,000 Owned 14,000 Lease expires 2003; one 2 year renewal option Portsmouth, New Hampshire 43,000 Lease expires 2006; one 5 year renewal option Raritan, New Jersey 187,000 Owned Uniondale, New York 108,000 Lease expires 2007; two 5 year renewal options Burlington, North Carolina 275,000 Owned Charlotte, North Carolina 25,000 Lease expires 2003 Research Triangle Park, North Carolina 71,000 Lease expires 2008; three 5 year renewal options 111,000 Lease expires 2011; three 5 year renewal options Dublin, Ohio 82,000 Owned Southaven, Mississippi 17,000 Owned Dallas, Texas 60,000 Lease expires 2004; two 5 year renewal option Houston, Texas 70,000 Lease expires 2012; two 5 year renewal options San Antonio, Texas 44,000 Lease expires 2004; two 5 year renewal option Salt Lake City, Utah 20,000 Lease expires 2002; two 5 year renewal options Chesapeake, Virginia 21,000 Lease expires 2002; three 5 year renewal options Herndon, Virginia 80,000 Lease expires 2004 Richmond, Virginia 34,000 Lease expires 2006 Kent, Washington 42,000 Lease expires 2005; one 5 year renewal option Fairmont, West Virginia 25,000 Lease expires 2005; three 5 year renewal options Mechelen, Belgium 20,000 Lease expires 2007 Administrative facilities: Raritan, New Jersey 53,000 Owned Burlington, North Carolina 293,000 Owned 246,000 Leases expire 2002-2010; various options to purchase or renew All of the Company's major laboratory facilities have been built or improved for the single purpose of providing clinical laboratory testing services. The Company believes that these facilities are suitable and adequate and have sufficient production capacity for its currently foreseeable level of operations. The Company believes that if it were to lose the lease on any of the facilities it presently leases, it could find alternate space at competitive market rates and readily relocate its operations to such new locations without material disruption to its operations. Item 3. LEGAL PROCEEDINGS The Company is involved in litigation purporting to be a nation-wide class action involving the alledged overbilling of patients who are covered by private insurance. The Company has reached a settlement with the class that will not exceed existing reserves or have a material adverse affect on the Company. On January 9, 2001, the Company was served with a complaint in North Carolina which purports to be a class action and makes claims similar to those referred to above. The claim has been stayed pending appeal of the court approval of the settlement discussed above. The outcome cannot be presently predicted. The Company is also involved in various claims and legal actions arising in the ordinary course of business. These matters include, but are not limited to, professional liability, employee related matters, and inquiries from governmental agencies and Medicare or Medicaid carriers requesting comment on allegations of billing irregularities that are brought to their attention through billing audits or third parties. In the opinion of management, based upon the advice of counsel and consideration of all facts available at this time, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial position, results of operations or liquidity of the Company. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock trades on the New York Stock Exchange ("NYSE") under the symbol "LH". The following table sets forth for the calendar periods indicated the high and low sales prices for the Common Stock reported on the NYSE Composite Tape. High Low ------- ------- 2000 First Quarter 23.438 15.625 Second Quarter 40.500 19.688 Third Quarter 66.250 38.125 Fourth Quarter 91.500 54.125 High Low ------- ------- 2001 First Quarter 87.500 49.750 Second Quarter 82.500 56.450 Third Quarter 91.350 66.840 Fourth Quarter 90.000 73.000 High Low ------- ------- 2002 First Quarter (through February 28, 2002) 88.800 76.300 During May 2000, the Company's shareholders approved a 1-for-10 reverse stock split and on June 11, 2001, the Company effected a 2-for-1 stock split. The reported sales prices reflect such stock splits. On February 28, 2002 there were 653 holders of record of the Common Stock. It is currently the Company's policy not to pay dividends on its common stock in order to increase its flexibility with respect to its acquisition strategy. In addition, the Company's new $300 million senior credit facilities, will place certain limits on the payment of dividends. Item 6. SELECTED FINANCIAL DATA The selected financial data presented below under the captions "Statement of Operations Data" and "Balance Sheet Data" as of and for the five-year period ended December 31, 2001 are derived from consolidated financial statements of the Company, which have been audited by PricewaterhouseCoopers LLP, independent accountants. This data should be read in conjunction with the accompanying notes, the Company's consolidated financial statements and the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations," all included elsewhere herein. Year Ended December 31, ----------------------------------- 2001 2000 1999 ---------- ---------- ---------- (Dollars in millions, except per share amounts) Statement of Operations Data: ----------------------------- Net sales $ 2,199.8 $ 1,919.3 $ 1,698.7 Gross profit 925.6 766.6 629.1 Operating income (loss) 367.6 245.6(b) 149.7 Earnings (loss) before extraordinary loss 182.7 112.1 65.4 Extraordinary loss, net of tax benefit 3.2 -- -- Net earnings (loss) 179.5(a) 112.1 65.4 Basic earnings (loss) per common share before extraordinary loss $ 2.63 $ 1.65 $ 0.59 Extraordinary loss per common share, net of tax benefit $ 0.05 $ -- $ -- Basic earnings (loss) per common share $ 2.58 $ 1.65 $ 0.59 Diluted earnings (loss) per common share before extraordinary loss $ 2.59 $ 1.61 $ 0.58 Extraordinary loss per common share, net of tax benefit $ 0.05 $ -- $ -- Diluted earnings (loss) per common share $ 2.54 $ 1.61 $ 0.58 Basic weighted average common shares outstanding (in thousands) 69,419 47,081 25,332 Diluted weighted average common shares outstanding (in thousands) 70,539 48,150 25,754 Balance Sheet Data: ------------------- Cash and cash equivalents $ 149.2 $ 48.8 $ 40.3 Intangible assets, net 968.5 865.7 803.9 Total assets 1,929.6 1,666.9 1,590.2 Long-term obligations and redeemable preferred stock (c) 509.2 355.8 1,041.5 Total shareholders' equity 1,085.4 877.4 175.5 1998 1997 ---------- ---------- (Dollars in millions, except per share amounts) Statement of Operations Data: ----------------------------- Net sales $ 1,612.6 $ 1,579.9 Gross profit 563.4 499.4 Operating income (loss) 127.6 (92.0)(d) Earnings (loss) before extraordinary loss 68.8 (106.9) Extraordinary loss, net of tax benefit -- -- Net earnings (loss) 68.8 (106.9) Basic earnings (loss) per common share before extraordinary loss $ 0.98 $ (5.30) Extraordinary loss, net of tax benefit $ -- $ -- Basic earnings (loss) per common share $ 0.98 $ (5.30) Diluted earnings (loss) per common share before extraordinary loss $ 0.98 $ (5.30) Extraordinary loss, net of tax benefit $ -- $ -- Diluted earnings (loss) per common share $ 0.98 $ (5.30) Basic weighted average common shares outstanding (in thousands) 24,969 24,648 Diluted weighted average common shares outstanding (in thousands) 24,969 24,648 Balance Sheet Data: ------------------- Cash and cash equivalents $ 22.7 $ 23.3 Intangible assets, net 836.2 851.3 Total assets 1,640.9 1,658.5 Long-term obligations and redeemable preferred stock (c) 1,110.0 1,200.1 Total shareholders' equity 154.4 129.1 (a) During the third quarter of 2001, the Company recorded an extraordinary loss of $3.2 million (net of tax benefit) relating to the write-off of unamortized bank fees associated with the Company's term debt, which was repaid in September of 2001. The Company also recorded a charge of $8.9 million as a result of a payment made to a bank to terminate an interest rate swap agreement tied to the Company's term loan. (b) In the fourth quarter of 2000, the Company recorded a $4.5 million restructuring charge relating to the closing of its Memphis drug testing facility. (c) Long-term obligations include capital lease obligations of $6.1 million, $7.2 million, $4.4 million, $4.2 million and $5.8 million at December 31, 2001, 2000, 1999, 1998 and 1997, respectively. Long-term obligations also include the long-term portion of the expected value of future contractual amounts to be paid to the former principals of acquired laboratories. Such payments are principally based on a percentage of future revenues derived from the acquired customer lists or specified amounts to be paid over a period of time. At December 31, 2001, 2000, 1999, 1998 and 1997, such amounts were $0.3 million, $2.1 million, $0.0 million, $7.7 million and $9.6 million, respectively. Long-term obligations exclude amounts due to affiliates. On June 6, 2000, the Company called for redemption all of its outstanding redeemable preferred stock, resulting in the conversion of substantially all of the preferred stock into common stock. During 2001, the Company sold $744.0 aggregate principal amount at maturity of its zero coupon convertible subordinated notes due 2021 in a private placement. The Company received approximately $488.6 in net proceeds from the offering. The Company used a portion of the proceeds to repay $412.5 million of its term loan outstanding under its credit agreement (d) During the fourth quarter of 1997 the Company recorded a provision for doubtful accounts of $182.0 million, which was approximately $160.0 million greater than the amount recorded in the fourth quarter of 1996 and a $22.7 million provision for restructuring certain laboratory operations. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General During 2001, the Company experienced strong growth, primarily as a result of continued implementation of its strategic plan. The Company further expanded its managed care business while strengthening its scientific expertise and market share through acquisitions and strategic partnerships. The Company completed two important acquisitions during the current year. Path Lab Holdings, Inc., acquired in May 2001, is the largest regional laboratory in New England with annual revenues in 2000 of approximately $51.6 million. This acquisition not only expanded the Company's geographic coverage, but also helped leverage the Company's expertise in esoteric testing. Path Lab has particular skill in servicing hospitals in the New England market. Hospitals generally have a need for higher-value esoteric testing. The acquisition of Minneapolis-based Viro- Med Inc. in June 2001, further strengthened the Company's leadership position in infectious disease testing. In addition, Viro-Med's specialized laboratory space provides significant additional esoteric testing capacity and the flexibility to more efficiently direct testing workflow throughout the country. Viro-Med had clinical laboratory revenues for the twelve months ended December 31, 2000 of approximately $25.2 million. In December 2001, the Company entered into exclusive licensing and marketing relationships with EXACT Sciences and Myriad Genetics. Under the agreement with EXACT Sciences, the Company will be the only national clinical laboratory to offer testing services based on certain of EXACT Sciences' proprietary technologies for the detection of colorectal cancer. The agreement with Myriad Genetics allows the Company to market Myriad's predictive medicine markers for hypertension, melanoma, breast, ovarian and colorectal cancers to the Company's more than 200,000 primary care physicians. While the Company believes both of these agreements will have a favorable impact on its operating results going forward, it is too early in each relationship to reliably quantify their impact in 2002. In addition to the acquisitions and relationships discussed above, the Company believes future performance will be positively affected by several factors: 1) The expansion of higher-value genomic tests such as Cystic Fibrosis, HCV and HIV genotyping is occurring, along with the continued growth of HIV viral loads and HPV testing; 2) Continued conversion of traditional pap smears to the newer, high value monolayer technology; 3) Additional product licensing and business relationships (such as Myriad Genetics and Exact Sciences); 4) The Company's ongoing business acquisition strategy; 5) Growing demand for genomic testing will create a positive shift in test mix to higher value testing; and 6) Improving regulatory and reimbursement environment in Washington. Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", is expected to have a positive impact on the 2002 financial statements. The application of this new statement will result in a decrease in amortization expense of approximately $26.0 million for 2002. During 2001, the Company was involved in several transactions affecting its capital structure. On May 24, 2001, the Company's shareholders approved an amendment to the restated certificate of incorporation to increase the number of common shares authorized from 52 million shares to 265 million shares. On June 11, 2001, the Company effected a two-for-one stock split through the issuance of a stock dividend of one new share of common stock for each share of common stock held by shareholders of record on June 4, 2001. The Company also assisted in the successful placement of 12.0 million shares of the Company's common stock formerly owned by Roche, and increased the number of shares traded in the open market and available for purchase by other investors. During September and October 2001, the Company sold $744.0 million aggregate principal amount at maturity of its zero coupon convertible subordinated notes (the "Notes") due 2021 in a private placement. The Company received approximately $488.6 million net of approximately $11.2 million in underwriting fees. See "Note 9 to the Consolidated Financial Statements" for a further discussion of the Notes. In early 2002, Standard & Poor's upgraded the Company's corporate credit and bank loan ratings from BBB to BBB+. This investment-grade rating offers the Company additional financial flexibility as growth opportunities are identified. On February 21, 2002, the Company filed a Registration Statement on Form S-3, seeking to register approximately 7.7 million shares (including 700,000 shares subject to an overallotment option) of the Company's common stock, currently owned by Roche. It is anticipated that the offering of these shares will be consummated sometime during March 2002 subject to prevailing market conditions. The sale by Roche of these shares will reduce their ownership interest in the Company's common stock to 5.24% (4.25% if the overallotment option is exercised in full) compared to 15.13% as of December 31, 2001. Seasonality Volume of testing generally declines during the year-end holiday periods and other major holidays. In addition, volume declines due to inclement weather may reduce net revenues and cash flows. Therefore, comparison of the results of successive quarters may not accurately reflect trends or results for the full year. Critical Accounting Policies 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 reported periods. Significant estimates include the allowances for doubtful accounts and deferred tax assets, amortization lives for intangible assets and accruals for self-insurance reserves. The allowance for doubtful accounts is determined based on historical collection trends, the aging of accounts, current economic conditions and regulatory changes. The deferred tax valuation allowance brings the Company's net deferred tax assets to a level where management believes that it is more likely than not the tax benefits will be realized. Intangible assets are amortized on a straight-line basis over the expected periods to be benefited, generally ranging from 20 to 40 years for goodwill, legal life for patents and technology, 10 to 25 years for customer lists and contractual lives for non-compete agreements. Management periodically reviews the Company's operating and financial performance in order to determine whether it should revise its estimates of the useful lives or whether circumstances exist that indicate that the carrying amount of the Company's goodwill or other long-lived assets may not be recoverable. Accruals for self-insurance reserves (including workers compensation, auto, employee medical and professional liability) are determined based on historical payment trends and claims history, along with current and estimated future economic conditions. While management believes these estimates are reasonable and consistent; they are, by their very nature, estimates of amounts that will depend on future events. Accordingly, actual results could differ from these estimates. See "Note 1 to the Consolidated Financial Statements" for further discussion of significant accounting policies. Results of Operations Year ended December 31, 2001 compared with Year ended December 31, 2000. Net sales for 2001 were $2,199.8 million, an increase of 14.6% from $1,919.3 million reported in the comparable 2000 period. Sales increased approximately 8.2% due to an increase in volume and 5.9% due to an increase in price per accession (which reflects actual price increases and changes in the mix of tests performed). These increases occurred as a result of the Company's success in winning new business as well as retaining and increasing business from existing customers. Excluding acquisitions, revenues would have increased 10.6%. Cost of sales, which includes primarily laboratory and distribution costs, was $1,274.2 million for 2001 compared to $1,152.7 million in the corresponding 2000 period, an increase of 10.5%. The majority of the increase in cost of sales is due to an increase in volume (approximately $95.0 million), with an additional increase of $13.0 million due to increases in the volume of pap smear tests performed using monolayer technology. In addition, the Company incurred incremental costs of approximately $6.0 million as it implemented a self-mandated safety needle program in all of its patient service centers. Cost of sales as a percentage of net sales was 57.9% for 2001 and 60.0% in the corresponding 2000 period. The decrease in the cost of sales as a percentage of net sales primarily resulted from higher margin test mix, continued cost reduction efforts and economies of scale achieved through volume growth. Selling, general and administrative expenses increased to $516.5 million in 2001 from $483.0 million in the same period in 2000 representing an increase of $33.5 million or 6.9%. Selling, general and administrative expenses were 23.5% and 25.2% as a percentage of net sales in 2001 and 2000, respectively. The increase in selling, general and administrative expenses is primarily the result of the Company's acquisitions during the year combined with additional bad debt expense as a result of the increase in net sales. Interest expense was $27.0 million in 2001 compared to $38.5 million in 2000. During September 2001, the Company repaid its outstanding term loan balance of $412.5 million with the proceeds from the sale of zero coupon-subordinated notes. During the third quarter of 2001, the Company recorded an $8.9 million loss relating to a payment made to terminate an interest rate swap agreement tied to the Company's term loan. In addition, the Company recorded a $3.2 million extraordinary loss, net of tax benefit, representing the write-off of unamortized bank fees associated with the retired term debt. See "Note 9 to Consolidated Financial Statements" for a further discussion of zero coupon-subordinated notes. Also, see "Liquidity and Capital Resources." Provision for income taxes was $149.6 million in 2001 compared to $95.5 million in 2000. The effective tax rate was 45.0% in 2001 and 46.0% in 2000. The decrease in the effective rate reflects the increase in the Company's pre-tax earnings relative to the amount of non-deductible amortization of intangible assets. See "Note 14 to Consolidated Financial Statements" for a further discussion of income taxes. Year ended December 31, 2000 compared with Year ended December 31, 1999. Net sales for 2000 were $1,919.3 million, an increase of 13.0% from $1,698.7 million reported in the comparable 1999 period. Sales increased approximately 9.0% due to an increase in volume and 4.0% due to an increase in price per accession (which reflects actual price increases and changes in the mix of tests performed). These increases occurred as a result of the Company's ability to win new business and successfully retain and increase business from existing customers. Excluding acquisitions, revenues would have increased 11.6%. Cost of sales, which includes primarily laboratory and distribution costs, was $1,152.7 million for 2000 compared to $1,069.6 million in the corresponding 1999 period, an increase of 7.8%. Cost of sales increased approximately $91.0 million due to an increase in volume offset by labor efficiencies due to streamlining of operations. Cost of sales as a percentage of net sales was 60.0% for 2000 and 63.0% in the corresponding 1999 period. The decrease in the cost of sales as a percentage of net sales primarily resulted from continued cost reduction efforts and economies of scale achieved through volume growth. Selling, general and administrative expenses increased to $483.0 million in 2000 from $448.2 million in the same period in 1999 representing an increase of $34.8 million or 7.8%. Selling, general and administrative expenses were 25.2% and 26.4% as a percentage of net sales in 2000 and 1999, respectively. The increase in selling, general and administrative expenses is primarily the result of the Company's acquisitions during the year combined with billing conversion-related costs such as salaries and telephone expenses. During the fourth quarter of 2000, the Company recorded a $4.5 million restructuring charge relating to the closing of its Drug Testing laboratory in Memphis, Tennessee. These operations were absorbed by other Company facilities. This restructuring was completed during the second quarter of 2001 and resulted in annualized cost reductions of approximately $7.0 million. Interest expense was $38.5 million in 2000 compared to $41.6 million in 1999. This decrease is related to the Company's reduction in its outstanding debt of approximately $95.0 million. Provision for income taxes was $95.5 million in 2000 compared to $40.1 million in 1999. The effective rate was 46.0% in 2000 and 38.0% in 1999. The increase in the effective rate was due primarily to the Company's reduction in its deferred tax asset valuation allowance in 1999. See "Note 14 to Consolidated Financial Statements". Liquidity and Capital Resources Net cash provided by operating activities was $316.0 million, $246.7 million and $180.5 million, in 2001, 2000 and 1999, respectively. The increase in cash flow from operations in both 2001 and 2000 primarily resulted from overall improved operating results. Capital expenditures were $88.1 million, $55.5 million and $69.4 million for 2001, 2000 and 1999, respectively. The Company expects capital expenditures of approximately $85.0 million in 2002. These expenditures are intended to continue to improve information systems and further automate laboratory processes. Such expenditures are expected to be funded by cash flow from operations as well as borrowings under the Company's new senior credit facilities. The Company's DSO at the end of 2001 improved to 58 days as compared to 68 days at the end of 2000. This improvement was due to Company-wide efforts to increase cash collections from all payors, as well as on-going improvements to claim submission processes. In addition, the Company continued to take steps necessary to improve DSO and cash collections by: 1. Substantially completing the conversion of decentralized billing locations to a centralized billing system. During 2001, the Chicago, San Antonio, and Dallas locations were converted. 2. Implementing an initiative to reduce the number of requisitions received that are missing certain billing information. The billing system conversions, combined with improvements in front- end processes that enhance data capture for billing, are expected to reduce DSO to the mid 50s by the end of 2002. During September 2001, the Company repaid its outstanding balance of $412.5 million on its term loan facility with the proceeds from the issuance of zero coupon-subordinated notes. Interest expense on the zero coupon-subordinated notes in the financial statements is computed based on the notes' original issue discount amortization for an effective rate of 2% per year. This non-cash interest expense will total approximately $12.0 million in 2002 as compared to interest expense of $27.0 million in 2001 (primarily related to the Company's retired term debt). As the Company does not pay any interest on the zero coupon-subordinated notes prior to their maturity on September 11, 2021 (unless certain contingencies are met), the replacement of the Company's long-term debt with the zero coupon- subordinated notes will result in increases to the Company's available cash. This reduction in cash interest expense and the resulting retention of operating cash flows in the business is expected to provide the Company increased flexibility in pursuing strategic investments through possible acquisitions, technology purchases and key business relationships. In February 2002, the Company entered into two new senior credit facilities with Credit Suisse First Boston, acting as Administrative Agent, and a group of financial institutions totaling $300 million. The new facilities will consist of a 364-day revolving credit facility in the principal amount of $100 million and a three-year revolving credit facility in the principal amount of $200 million. The new facilities will be used for general corporate purposes, including working capital, capital expenditures, funding or share repurchases and other payments, and acquisitions. Contractual Cash Obligations Payments Due by Period ------------------------------------- 1 Yr 2-3 Yrs 4-5 Yrs > 5 Yrs ------- ------- -------- -------- Capital lease obligations $ 3.0 $ 5.4 $ 5.7 $ 1.2 Operating leases 43.7 60.2 33.1 38.9 Contingent future acquisition Payments 17.5 7.0 -- -- Zero coupon-subordinated notes -- 530.5(a) -- -- ------ ----- ----- ----- Total contractual cash obligations $ 64.2 $603.1 $ 38.8 $ 40.1 ===== ===== ===== ===== (a) Holders of the zero coupon-subordinated notes may require the Company to purchase all or a portion of their notes on September 11, 2004, 2006 and 2011 at prices ranging from $712.97 to $819.54 per note. The Company may choose to pay the purchase price in cash or common stock or a combination of cash and common stock. If the holders elect to require the Company to purchase their notes, it is the Company's current intention to retire the notes by a cash payment. Based upon current market conditions, the Company believes that the possibility of the holders of the notes exercising this put feature of the notes is remote. However, future market conditions are subject to change. Should the holders put the notes to the Company on any of the dates above, the Company believes that it will be able to obtain alternate financing to satisfy this contingent cash obligation. Other Commercial Commitments At December 31, 2001, the Company provided letters of credit aggregating approximately $36.6 million, primarily in connection with certain insurance programs. These letters of credit are secured by the Company's senior credit facilities and are renewed annually, around mid- year. Based on current and projected levels of operations, coupled with availability under its new senior credit facilities, the Company believes it has sufficient liquidity to meet both its short-term and long-term cash needs. For a discussion of the Company's zero coupon-subordinated notes, see "Note 9 to Consolidated Financial Statements." For a discussion of the Company's new senior credit facilities, see "Note 10 to Consolidated Financial Statements." FORWARD-LOOKING STATEMENTS The Company has made in this report, and from time to time may otherwise make in its public filings, press releases and discussions with Company management, forward-looking statements concerning the Company's operations, performance and financial condition, as well as its strategic objectives. Some of these forward-looking statements can be identified by the use of forward-looking words such as "believes", "expects", "may", "will", "should", "seeks", "approximately", "intends", "plans", "estimates", or "anticipates" or the negative of those words or other comparable terminology. Such forward-looking statements are subject to various risks and uncertainties and the Company claims the protection afforded by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those currently anticipated due to a number of factors in addition to those discussed elsewhere herein and in the Company's other public filings, press releases and discussions with Company management, including: 1. future changes in federal, state, local and third party payor regulations or policies (or in the interpretation of current regulations) affecting governmental and third-party reimbursement for clinical laboratory testing. 2. adverse results from investigations of clinical laboratories by the government, which may include significant monetary damages and/or exclusion from the Medicare and Medicaid programs. 3. loss or suspension of a license or imposition of a fine or penalties under, or future changes in, the law or regulations of the Clinical Laboratory Improvement Act of 1967, and the Clinical Laboratory Improvement Amendments of 1988, or those of Medicare, Medicaid or other federal, state or local agencies. 4. failure to comply with the Federal Occupational Safety and Health Administration requirements and the Needlestick Safety and Prevention Act which may result in penalties and loss of licensure. 5. failure to comply with HIPAA, which could result in significant fines and up to ten years in prison. 6. increased competition, including price competition. 7. changes in payor mix, including an increase in capitated managed-cost health care. 8. our failure to obtain and retain new customers and alliance partners, or a reduction in tests ordered or specimens submitted by existing customers. 9. our failure to integrate newly acquired businesses and the cost related to such integration. 10.adverse results in litigation matters. 11.our ability to attract and retain experienced and qualified personnel. 12.failure to maintain our days sales outstanding levels. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company addresses its exposure to market risks, principally the market risk associated with changes in interest rates, through a controlled program of risk management that has included in the past, the use of derivative financial instruments such as interest rate swap agreements. There were no interest rate swap agreements outstanding as of December 31, 2001. The Company does not hold or issue derivative financial instruments for trading purposes. The Company does not believe that its exposure to market risk is material to the Company's financial position or results of operations. There were no interest rate swap agreements outstanding as of December 31, 2001. The Company's zero coupon-subordinated notes contain the following three features that are considered to be embedded derivative instruments under FAS No. 133: 1) The Company will pay contingent cash interest on the zero coupon subordinated notes after September 11, 2006, if the average market price of the notes equals 120% or more of the sum of the issue price, accrued original issue discount and contingent additional principal, if any, for a specified measurement period. 2) Contingent additional principal will accrue on the zero coupon- subordinated notes during the two year period from September 11, 2004 to September 11, 2006, if the Company's stock price is at or below specified thresholds. 3) Holders may surrender zero coupon-subordinated notes for conversion during any period in which the rating assigned to the zero coupon- subordinated notes by Standard & Poor's Ratings Services is BB- or lower. Based upon independent appraisals, these embedded derivatives had no fair market value at December 31, 2001. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Index on Page F-1 of the Financial Report included herein. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. PART III The information required by Part III, Items 10 through 13, of Form 10- K is incorporated by reference to the registrant's definitive proxy statement for its 2002 annual meeting of stockholders, which is to be filed pursuant to Regulation 14A not later than April 30, 2002. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) List of documents filed as part of this Report: (1) Consolidated Financial Statements and Independent Auditors' Reports included herein: See Index on page F-1 (2) Financial Statement Schedules: See Index on page F-1 All other schedules are omitted as they are inapplicable or the required information is furnished in the Consolidated Financial Statements or notes thereto. (3) Index to and List of Exhibits Exhibits: Exhibits 10.3 through 10.8 and 10.14 through 10.18 are management contracts or compensatory plans or arrangements. 3.1 - Amended and Restated Certificate of Incorporation of the Company dated May 24, 2001 (incorporated herein by reference to the Company's Registration Statement on Form S-3, filed with the Commission on October 19, 2001, File No. 333- 71896). 3.2 - Amended and Restated By-Laws of the Company dated April 28, 1995 (incorporated herein by reference to the Company's report on Form 8-K, filed with the Commission on May 12 1995). 4.1* - Specimen of the Company's Common Stock Certificate. 4.2 - Indenture dated September 11, 2001 between the Company and Bank of New York, as trustee (incorporated herein by reference to the Company's Registration Statement on Form S- 3, filed with the Commission on October 19, 2001, File No. 333-71896). 4.3 - Registration Rights Agreement dated September 11, 2001 between the Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated herein by reference to the Company's Registration Statement on Form S-3, filed with the Commission on October 19, 2001, File No. 333-71896). 4.4 - Rights Agreement dated December 13, 2001 between the Company and American Stock Transfer & Trust Company, as rights Agent (incorporated herein by reference to the Company's Registration Statement on Form 8-A, filed with the Commission on December 21, 2001, File No. 001-11353). 10.1 - National Health Laboratories Incorporated Pension Equalization Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992). 10.2 - Settlement Agreement dated November 21, 1996 between the Company and the United States of America. 10.3 - National Health Laboratories 1988 Stock Option Plan, as amended (incorporated herein by reference to the Company's Registration Statement on Form S-1, filed with the Commission on July 9, 1990, File No. 33-35782). 10.4 - National Health Laboratories 1994 Stock Option Plan (incorporated herein by reference to the Company's Registration Statement on Form S-8, filed with the Commission on August 12, 1994, File No. 33-55065). 10.5 - Laboratory Corporation of America Holdings Master Senior Executive Severance Plan (incorporated herein by reference to the report on Form 8-K dated October 24, 1996 (the "October 24, 1996 8-K") filed with the Commission on October 24, 1996, File No. 1-11353). 10.6 - Special Severance Agreement dated June 28, 1996 between the Company and Timothy J. Brodnik (incorporated herein by reference to the October 24, 1996 8-K). 10.7 - Special Severance Agreement dated July 12, 1996 between the Company and John F. Markus (incorporated herein by reference to the October 24, 1996 8-K). 10.8 - Special Severance Agreement dated June 28, 1996 between the Company and Robert E. Whalen (incorporated herein by reference to the October 24, 1996 8-K). 10.9 - Tax Allocation Agreement dated as of June 26, 1990 between MacAndrews & Forbes Holding Inc., Revlon Group Incorporated, New Revlon Holdings, Inc. and the subsidiaries of Revlon set forth on Schedule A thereto (incorporated herein by reference to the 1990 S-1). 10.10 - Stockholder Agreement dated as of April 28, 1995 among the Company, HLR Holdings Inc., Hoffmann-La Roche Inc. and Roche Holdings, Inc. (incorporated herein by reference to the April 28, 1995 Form 8-K). 10.11 - Exchange Agent Agreement dated as of April 28, 1995 between the Company and American Stock Transfer & Trust Company (incorporated herein by reference to the April 28, 1995 Form 8-K). 10.12*- Three-Year Credit Agreement dated February 20, 2002 among the Company, the lenders named therein and Credit Suisse First Boston, as administrative agent. 10.13*- 364-Day Credit Agreement dated February 20, 2002 among the Company, the lenders named therein and Credit Suisse First Boston, as administrative agent. 10.14 - Laboratory Corporation of America Holdings 1995 Stock Plan for Non-Employee Directors dated September 26, 1995 (incorporated herein by reference to the Company's Registration Statement on Form S-8, filed with the Commission on September 26, 1995, File No. 33-62913). 10.15 - Laboratory Corporation of America Holdings 1997 Employee Stock Purchase Plan (incorporated herein by reference to Annex I of the Company's 1996 Annual Proxy Statement filed with the Commission on October 25, 1996). 10.16 - Amendments to the Laboratory Corporation of America Holdings 1997 Employee Stock Purchase Plan (incorporated herein by reference to Annex II of the Company's 1999 Annual Proxy Statement filed with the Commission on June 16, 1999). 10.17 - Laboratory Corporation of America Holdings Amended and Restated 1999 Stock Incentive Plan (incorporated herein by reference to Annex I of the Company's 1999 Annual Proxy Statement filed with the Commission of June 16, 1999). 10.18 - Laboratory Corporation of America Holdings 2000 Stock Incentive Plan (incorporated herein by reference to Annex I of the Company's 2000 Annual Proxy Statement filed with the Commission on April 7, 2000). 10.19 - Support Agreement between Roche Biomedical Laboratories, Inc. and Hoffmann-La Roche Inc., dated as of April 27, 1995. 10.20 - First Amendment to Support Agreement between Roche Biomedical Laboratories, Inc. and Hoffmann-La Roche Inc., dated as of July 26, 1995. 10.21 - Second Amendment to Support Agreement between Laboratory Corporation of America Holdings, Hoffmann-La Roche Inc., Roche Molecular Systems, Inc. and Roche Diagnostic Systems, Inc., dated as of January 1, 1997. 10.22 --Third Amendment to Support Agreement between Laboratory Corporation of America Holdings, Hoffmann-La Roche Inc., Roche Molecular Systems, Inc. and Roche Diagnostic Systems, Inc., dated as of October 1, 1997. 21* - List of Subsidiaries of the Company 23.1*- Consent of PricewaterhouseCoopers LLP 24.1*- Power of Attorney of Jean-Luc Belingard 24.2*- Power of Attorney of Wendy E. Lane 24.3*- Power of Attorney of Robert E. Mittelstaedt, Jr. 24.4*- Power of Attorney of James B. Powell, M.D. 24.5*- Power of Attorney of David B. Skinner 24.6*- Power of Attorney of Andrew G. Wallace, M.D. * Filed herewith. (b) Reports on Form 8-K (1) A current report on Form 8-K dated November 14, 2001 was filed on November 14, 2001 by the registrant, in connection with the press release dated November 14, 2001 which announced that Thomas P. Mac Mahon, chairman and chief executive officer, was scheduled to speak at the CSFB Health Care Conference in Phoenix, AZ on Thursday, November 15 at 9:30 a.m. Mountain Time. (2) A current report on Form 8-K date November 28, 2001 was filed on November 28, 2001 by the registrant, in connection with the press release dated November 28, 2001 which announced that Bradford T. Smith, executive vice president of public affairs, was scheduled to speak at the SG Cowen Global Health Care Conference in Paris, France on Thursday, November 29 at 10:20 a.m. (4:20 a.m. EST). (3) A current report on Form 8-K dated December 4, 2001 was filed on December 4, 2001 by the registrant and Myriad Genetics, Inc., in connection with the press release dated December 4, 2001 which announced their new partnership to make Myriad's predictive medicine products broadly available to primary care physicians throughout the United States. (4) A current report on Form 8-K date December 6, 2001 was filed on December 6, 2001 by the registrant, in connection with the press release dated December 6, 2001, which announced that PreGen-26? - a DNA-based colorectal cancer test - is now available through its nationwide network to physicians and their patients. (5) A current report on Form 8-K dated December 12, 2001 was filed on December 13, 2001 by the registrant, in connection with the press release dated December 12, 2001 which announced that its Board of Directors adopted a Stockholder Rights Plan. (6) A current report on Form 8-K dated January 4, 2002 was filed on January 7, 2002 by the registrant, in connection with the press release dated January 4, 2002 which announced that Bradford T. Smith, executive vice president of public affairs, was scheduled to speak at the JPMorgan H&Q Healthcare Conference in San Francisco on Monday, January 7 at 3:30 p.m. PST (6:30 p.m. EST). (7) A current report on Form 8-K dated January 15, 2002 was filed on January 16, 2002 by the registrant, in connection with the press release dated January 15, 2002 which announced that the Securities and Exchange Commission declared effective its registration statement on Form S-3 for the registration of the resale by the securityholders listed in the prospectus contained in the registration statement from time to time of up to $744,000,000 aggregate principal amount at maturity of its zero coupon convertible subordinated notes due 2021 and the shares of its common stock issuable upon conversion of the notes and the preferred stock purchase rights included in such shares of common stock. (8) A current report on Form 8-K dated January 28, 2002 was filed on January 29, 2002 by the registrant, in connection with the press release dated January 28, 2002 which announced that Thomas P. Mac Mahon, chairman and chief executive officer, was scheduled to speak at the US Bancorp Piper Jaffray Healthcare Conference in New York City on Tuesday, January 29, 2002 at 8:30 a.m. Eastern Time. (9) A current report on Form 8-K dated February 5, 2002 was filed on February 5, 2002 by the registrant, in connection with the press release dated February 5, 2002 which announced that Thomas P. Mac Mahon, chairman and chief executive officer, was scheduled to speak at the UBS Warburg Global Healthcare Services Conference in New York City on Monday, February 6, 2002 at 3:00 p.m. Eastern Time. (10) A current report on Form 8-K dated February 13, 2002 was filed on February 13, 2002 by the registrant, in connection with the press release dated February 13, 2002 which contained summary information relating to the Company. (11) A current report on Form 8-K dated February 13, 2002 was filed on February 13, 2002 by the registrant, in connection with the press release dated February 13, 2002 which announced results for the quarter ended December 31, 2001. (12) A current report on Form 8-K dated February 22, 2002 was filed on February 22, 2002 by the registrant, in connection with the press release dated February 22, 2002 which announced that it has entered into $300 million of new senior credit facilities with Credit Suisse First Boston, acting as Administrative Agent, and a group of financial institutions. (13) A current report on Form 8-K dated February 26, 2002 was filed on February 26, 2002 by the registrant, in connection with the press release dated February 26, 2002 which announced that it had signed an expanded agreement with Aetna Inc. to provide clinical laboratory testing and certain additional services to Aetna's Commercial HMO and Quality Point-of-Service members in New York and New Jersey. (14) A current report on Form 8-K/A dated February 13, 2002 was filed on March 6, 2002 by the registrant which amended Form 8-K filed on February 13, 2002. (15) A current report on Form 8-K dated March 12, 2002 was filed on March 12, 2002 by the registrant, in connection with the press release dated March 12, 2002 which announced an advanced suite of molecular assays developed to improve the management of patients diagnosed with the hepatitis B and/or hepatitis C virus. (16) A current report on Form 8-K dated March 12, 2002 was filed on March 12, 2002 by the registrant, in connection with the press release dated March 12, 2002 which announced that Bradford T. Smith, executive vice president of public affairs, is scheduled to speak at the SG Cowen Annual Healthcare Conference in Boston on Wednesday, March 13 at 1:15 p.m. Eastern Time. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. LABORATORY CORPORATION OF AMERICA HOLDINGS ------------------------------------------------ Registrant By: /s/ THOMAS P. MAC MAHON --------------------------------- Thomas P. Mac Mahon Chairman of the Board, President and Chief Executive Officer Dated: March 18, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on March 18, 2002 in the capacities indicated. Signature Title ----------------------- --------------------- /s/ THOMAS P. MAC MAHON Chairman of the Board, ------------------------------------------ President and Chief Thomas P. Mac Mahon Executive Officer (Principal Executive Officer) /s/ WESLEY R. ELINGBURG Executive Vice President, ------------------------------------------ Chief Financial Officer Wesley R. Elingburg and Treasurer (Principal Financial Officer and Principal Accounting Officer /s/ JEAN-LUC BELINGARD* Director ------------------------------------------ Jean-Luc Belingard /s/ WENDY E. LANE* Director ------------------------------------------ Wendy E. Lane /s/ ROBERT E. MITTELSTAEDT, JR.* Director ------------------------------------------ Robert E. Mittelstaedt, Jr. /s/ JAMES B. POWELL, M.D.* Director ------------------------------------------ James B. Powell, M.D. /s/ DAVID B. SKINNER, M.D.* Director ------------------------------------------ David B. Skinner, M.D. /s/ ANDREW G. WALLACE, M.D.* Director ------------------------------------------ Andrew G. Wallace, M.D. * Bradford T. Smith, by his signing his name hereto, does hereby sign this report on behalf of the directors of the Registrant after whose typed names asterisks appear, pursuant to powers of attorney duly executed by such directors and filed with the Securities and Exchange Commission. By:/s/ BRADFORD T. SMITH ---------------------- Bradford T. Smith Attorney-in-fact LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE Page ---- Report of Independent Accountants F-2 Consolidated Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3 Consolidated Statements of Operations for the three-year period ended December 31, 2001 F-4 Consolidated Statements of Changes in Shareholders' Equity for the three-year period ended December 31, 2001 F-6 Consolidated Statements of Cash Flows for the three-year period ended December 31, 2001 F-7 Notes to Consolidated Financial Statements F-9 Financial Statement Schedule: II - Valuation and Qualifying Accounts and Reserves F-30 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Laboratory Corporation of America Holdings In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Laboratory Corporation of America Holdings and its subsidiaries (the Company) at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Charlotte, North Carolina February 8, 2002, except for Note 10, as to which the date is February 20, 2002 PART I - FINANCIAL INFORMATION Item 1. Financial Information LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Millions, Except Per Share Data) December 31, December 31, 2001 2000 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 149.2 $ 48.8 Accounts receivable, net 365.5 368.0 Supplies inventories 38.7 31.6 Prepaid expenses and other 16.7 18.5 Deferred income taxes 54.4 44.8 ------- ------- Total current assets 624.5 511.7 Property, plant and equipment, net 309.3 272.8 Intangible assets, net 968.5 865.7 Other assets, net 27.3 16.7 --------- -------- $ 1,929.6 $ 1,666.9 ========= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 60.2 $ 52.8 Accrued expenses and other 141.0 127.1 Current portion of long-term debt -- 132.0 --------- -------- Total current liabilities 201.2 311.9 Zero coupon-subordinated notes 502.8 -- Long-term debt, less current portion -- 346.5 Capital lease obligations 6.1 7.2 Other liabilities 134.1 123.9 Commitments and contingent liabilities -- -- Shareholders' equity: Common stock, $0.10 par value; 265,000,000 shares authorized;70,553,718 and 69,739,246 shares issued and outstanding at December 31, 2001 and December 31, 2000, respectively 7.1 7.0 Additional paid-in capital 1,088.8 1,048.2 Retained earnings (deficit) 11.5 (168.0) Unearned restricted stock compensation (13.2) (9.4) Accumulated other comprehensive loss (8.8) (0.4) --------- -------- Total shareholders' equity 1,085.4 877.4 --------- -------- $ 1,929.6 $ 1,666.9 ========= ======== The accompanying notes are an integral part of these consolidated financial statements. LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Millions, Except Per Share Data) Years Ended December 31, ------------------------------------ 2001 2000 1999 --------- --------- --------- Net sales $ 2,199.8 $ 1,919.3 $ 1,698.7 Cost of sales 1,274.2 1,152.7 1,069.6 ------- ------- ------- Gross profit 925.6 766.6 629.1 Selling, general and administrative expenses 516.5 483.0 448.2 Amortization of intangibles and other assets 41.5 33.5 31.2 Restructuring charge -- 4.5 -- -------- ------- ------- Operating income 367.6 245.6 149.7 Other income (expenses): Loss on sale of assets (1.8) (1.0) (1.7) Net investment income (loss) 2.4 1.5 (0.9) Termination of interest rate swap agreement (8.9) -- -- Interest expense (27.0) (38.5) (41.6) -------- -------- -------- Earnings before income taxes and extraordinary loss 332.3 207.6 105.5 Provision for income taxes 149.6 95.5 40.1 -------- -------- -------- Earnings before extraordinary loss 182.7 112.1 65.4 Extraordinary loss, net of tax benefit 3.2 -- -- -------- -------- -------- Net earnings 179.5 112.1 65.4 Less preferred stock dividends -- (34.3) (49.6) Less accretion of mandatorily redeemable preferred stock -- (0.3) (0.8) -------- -------- -------- Net earnings attributable to common shareholders $ 179.5 $ 77.5 $ 15.0 ======== ======== ======== Basic earnings per common share before extraordinary loss $ 2.63 $ 1.65 $ 0.59 Extraordinary loss, net of tax benefit 0.05 -- -- --------- --------- --------- Basic earnings per common share $ 2.58 $ 1.65 $ 0.59 ========= ========= ========= Diluted earnings per common share before extraordinary loss $ 2.59 $ 1.61 $ 0.58 Extraordinary loss, net of tax benefit 0.05 -- -- Diluted earnings per --------- --------- --------- common share $ 2.54 $ 1.61 $ 0.58 ========= ========= ========= The accompanying notes are an integral part of these consolidated financial statements. LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in Millions) Additional Retained Common Paid-in Earnings Stock Capital (Deficit) -------- ---------- --------- BALANCE AT DECEMBER 31, 1998 $ 2.4 $ 414.5 $ (260.5) Comprehensive earnings: Net earnings -- -- 65.4 Other comprehensive earnings: Change in valuation allowance on securities, net of tax -- -- -- Foreign currency translation adjustments -- -- -- ----- ------- ------- Comprehensive earnings -- -- 65.4 Issuance of common stock 0.2 3.6 -- Issuance of restricted stock awards -- 4.5 -- Amortization of unearned restricted stock compensation -- -- -- Preferred stock dividends -- -- (49.6) Accretion of mandatorily redeemable preferred stock -- -- (0.8) ----- ------- ------- BALANCE AT DECEMBER 31, 1999 2.6 422.6 (245.5) Comprehensive earnings: Net earnings -- -- 112.1 Other comprehensive earnings: Foreign currency translation adjustments -- -- -- ----- ------- ------- Comprehensive earnings -- -- 112.1 Issuance of common stock 0.2 17.6 -- Issuance of restricted stock awards -- 9.3 -- Amortization of unearned restricted stock compensation -- -- -- Income tax benefit from stock options exercised -- 19.0 -- Conversion of preferred stock into common stock 4.2 579.7 -- Preferred stock dividends -- -- (34.3) Accretion of mandatorily redeemable preferred stock -- -- (0.3) ----- ------- ------- BALANCE AT DECEMBER 31, 2000 7.0 1,048.2 (168.0) Comprehensive earnings: Net earnings -- -- 179.5 Other comprehensive earnings: Cumulative effect of change in accounting principle (net of tax) -- -- -- Unrealized derivative loss on cash flow hedge (net of tax) -- -- -- Termination of interest rate swap agreement -- -- -- Foreign currency translation adjustments -- -- -- Minimum pension liability adjustment -- -- -- ----- ------- ------- Comprehensive earnings -- -- 179.5 Issuance of common stock 0.1 14.9 -- Issuance of restricted stock awards -- 11.3 -- Amortization of unearned restricted stock compensation -- -- -- Income tax benefit from stock options exercised -- 14.4 -- ----- ------- -------- BALANCE AT DECEMBER 31, 2001 $ 7.1 $1,088.8 $ 11.5 ===== ======= ======== LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in Millions) Unearned Accumulated Restricted Other Total Stock Comprehensive Shareholders' Compensation Loss Equity ------------- ------------- ------------ BALANCE AT DECEMBER 31, 1998 $ -- $ (2.0) $ 154.4 Comprehensive earnings: Net earnings -- -- 65.4 Other comprehensive earnings: Change in valuation allowance on securities, net of tax -- 2.0 2.0 Foreign currency translation adjustments -- (0.1) (0.1) -------- --------- --------- Comprehensive earnings -- 1.9 67.3 Issuance of common stock -- -- 3.8 Issuance of restricted stock awards (4.5) -- -- Amortization of unearned restricted stock compensation 0.4 -- 0.4 Preferred stock dividends -- -- (49.6) Accretion of mandatorily redeemable preferred stock -- -- (0.8) -------- --------- --------- BALANCE AT DECEMBER 31, 1999 ( 4.1) (0.1) 175.5 Comprehensive earnings: Net earnings -- -- 112.1 Other comprehensive earnings: Foreign currency translation adjustments -- (0.3) (0.3) -------- --------- --------- Comprehensive earnings -- (0.3) 111.8 Issuance of common stock -- -- 17.8 Issuance of restricted stock awards (9.3) -- -- Amortization of unearned restricted stock compensation 4.0 -- 4.0 Income tax benefit from stock options exercised -- -- 19.0 Conversion of preferred stock into common stock -- -- 583.9 Preferred stock dividends -- -- (34.3) Accretion of mandatorily redeemable preferred stock -- -- (0.3) -------- --------- --------- BALANCE AT DECEMBER 31, 2000 (9.4) (0.4) 877.4 Comprehensive earnings: Net earnings -- -- 179.5 Other comprehensive earnings: Cumulative effect of change in accounting principle (net of tax) -- 0.6 0.6 Unrealized derivative loss on cash flow hedge (net of tax) -- (9.5) (9.5) Termination of interest rate swap agreement -- 8.9 8.9 Foreign currency translation adjustments -- (0.6) (0.6) Minimum pension liability adjustment -- (7.8) (7.8) -------- --------- -------- Comprehensive earnings -- (8.4) 171.1 Issuance of common stock -- -- 15.0 Issuance of restricted stock awards (11.3) -- -- Amortization of unearned restricted stock compensation 7.5 -- 7.5 Income tax benefit from stock options exercised -- -- 14.4 -------- -------- -------- BALANCE AT DECEMBER 31, 2001 $ (13.2) $ (8.8) $ 1,085.4 ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Millions) Years Ended December 31, ----------------------------- 2001 2000 1999 --------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 179.5 $ 112.1 $ 65.4 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 104.0 89.6 83.8 Deferred compensation 7.5 4.0 0.4 Net losses on sale of assets 1.8 1.0 1.7 Accreted interest on zero coupon- subordinated notes 3.0 -- -- Extraordinary loss, net of tax benefit 3.2 -- -- Termination of interest rate swap agreement 8.9 -- -- Deferred income taxes 1.6 (3.2) 37.0 Investment loss -- -- 4.2 Change in assets and liabilities: Net change in restructuring reserves (5.5) (1.2) (6.2) Decrease (increase) in accounts receivable, net 16.2 (15.9) 27.4 (Increase) decrease in inventories (3.6) (2.1) 1.6 Decrease (increase) in prepaid expenses and other 5.8 21.3 (24.6) Change in income taxes receivable -- -- 11.2 (Decrease) increase in accounts payable (3.4) 7.9 (6.2) Increase (decrease) in accrued expenses and other (2.0) 32.9 (15.4) Other, net (1.0) 0.3 0.2 ------ ------ ------ Net cash provided by operating activities 316.0 246.7 180.5 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (88.1) (55.5) (69.4) Proceeds from sale of assets 4.4 1.4 1.1 Deferred payments on acquisitions (5.2) (1.0) (8.7) Acquisition of businesses (141.1) (94.9) -- ------ ------ ------ Net cash used for investing activities (230.0) (150.0) (77.0) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from revolving credit facilities $ 75.0 $ -- $ 40.0 Payments on revolving credit facilities (75.0) -- (40.0) Proceeds from zero coupon-subordinated notes 499.8 -- -- Payments on long-term debt (478.5) (95.0) (70.3) Debt issuance costs (11.2) -- -- Termination of interest rate swap agreement (8.9) -- -- Payments on long-term lease obligations (1.1) (1.2) (0.8) Payment of preferred stock dividends -- (9.5) (18.5) Net proceeds from issuance of stock to employees 14.9 17.8 3.8 ------ ------ ------ Net cash provided by (used for) financing activities 15.0 (87.9) (85.8) ------ ------ ------ Effect of exchange rate changes on cash and cash equivalents (0.6) (0.3) (0.1) Net increase in cash and cash equivalents 100.4 8.5 17.6 Cash and cash equivalents at beginning of period 48.8 40.3 22.7 ------ ------ ------ Cash and cash equivalents at end of period $ 149.2 $ 48.8 $ 40.3 ====== ====== ====== Supplemental schedule of cash flow information: Cash paid during the period for: Interest $ 23.2 $ 40.7 $ 41.8 Income taxes, net of refunds 127.7 48.8 23.9 Disclosure of non-cash financing and investing activities: Preferred stock dividends -- 24.8 31.1 Accretion of mandatorily redeemable preferred stock -- 0.3 0.8 Conversion of preferred stock into common stock -- 583.9 -- The accompanying notes are an integral part of these consolidated financial statements. LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions, except per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Financial Statement Presentation: Laboratory Corporation of America Holdings and its subsidiaries ("Company") is the second largest independent clinical laboratory company in the United States based on 2001 net revenues. Through a national network of laboratories, the Company offers a broad range of testing services used by the medical profession in the diagnosis, monitoring and treatment of disease and other clinical states. Since its founding in 1971, the Company has grown into a network of 24 primary testing facilities and approximately 1,200 service sites consisting of branches, patient service centers and STAT laboratories, serving clients in 50 states. The Company operates in one business segment. The consolidated financial statements include the accounts of Laboratory Corporation of America Holdings and its subsidiaries after elimination of all material intercompany accounts and transactions. During 2001, the Company added two new subsidiaries through acquisitions: Path Lab Holdings, Inc. and Viro-Med Inc. Disclosure of certain business combination transactions is included in Note 2 - Business Acquisitions. The financial statements of the Company's foreign subsidiary are measured using the local currency as the functional currency. Assets and liabilities are translated at exchange rates as of the balance sheet date. Revenues and expenses are translated at average monthly exchange rates prevailing during the year. Resulting translation adjustments are included in "Accumulated other comprehensive loss". Cash Equivalents: Cash equivalents (primarily investments in money market funds, time deposits, commercial paper and Eurodollars which have original maturities of three months or less at the date of purchase) are carried at cost which approximates market. As a result of the Company's cash management system, checks issued but not presented to the banks for payment may create negative book cash balances. Such negative balances are included in trade accounts payable and totaled $9.3 and $11.6 at December 31, 2001 and 2000, respectively. Inventories: Inventories, consisting primarily of purchased laboratory supplies, are stated at the lower of cost (first-in, first-out) or market. Derivative Financial Instruments: Interest rate swap agreements, which have been used by the Company from time to time in the management of interest rate exposure, are accounted for on an accrual basis. Amounts to be paid or received under such agreements are recognized as interest income or expense in the periods in which they accrue. The Company had no interest rate swap agreements in place at December 31, 2001. The Company's zero coupon-subordinated notes contain the following three features that are considered to be embedded derivative instruments under FAS No. 133: 1) The Company will pay contingent cash interest on the zero coupon- subordinated notes after September 11, 2006, if the average market price of the notes equals 120% or more of the sum of the issue price, accrued original issue discount and contingent additional principal, if any, for a specified measurement period. 2) Contingent additional principal will accrue on the zero coupon- subordinated notes during the two year period from September 11, 2004 to September 11, 2006, if the Company's stock price is at or below specified thresholds. 3) Holders may surrender zero coupon-subordinated notes for conversion during any period in which the rating assigned to the zero coupon-subordinated notes by Standard & Poor's Ratings Services is BB- or lower. Based upon independent appraisals, these embedded derivatives had no fair market value at December 31, 2001. Property, Plant and Equipment: Property, plant and equipment are recorded at cost. The cost of properties held under capital leases is equal to the lower of the net present value of the minimum lease payments or the fair value of the leased property at the inception of the lease. Depreciation and amortization expense is computed on all classes of assets based on their estimated useful lives, as indicated below, using principally the straight-line method. Years ------- Buildings and building improvements 35 Machinery and equipment 3-10 Furniture and fixtures 5-10 Leasehold improvements and assets held under capital leases are amortized over the shorter of their estimated lives or the period of the related leases. Expenditures for repairs and maintenance are charged to operations as incurred. Retirements, sales and other disposals of assets are recorded by removing the cost and accumulated depreciation from the related accounts with any resulting gain or loss reflected in operations. Capitalized Software Costs: The Company capitalizes purchased software which is ready for service and capitalizes software development costs incurred on significant projects starting from the time that the preliminary project stage is completed and management commits to funding a project until the project is substantially complete and the software is ready for its intended use. Capitalized costs include direct material and service costs and payroll and payroll- related costs. Research and development costs and other computer software maintenance costs related to software development are expensed as incurred. Capitalized software costs are amortized using the straight-line method over the estimated useful life of the underlying system, generally five years. Fair Value of Financial Instruments: The carrying amounts of cash and cash equivalents, accounts receivable, income taxes receivable and accounts payable are considered to be representative of their respective fair values due to their short-term nature. The fair market value of the zero coupon- subordinated notes, based on market pricing, was approximately $529.2 as of December 31, 2001. Concentration of Credit Risk: Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and accounts receivable. The Company maintains cash and cash equivalents with various major financial institutions. The total cash balances on deposit that exceeded the balances insured by the F.D.I.C., was approximately $12.0 at December 31, 2001. Cash equivalents at December 31, 2001, totaled $131.7, which includes amounts invested in treasury bills and short-term bonds. Substantially all of the Company's accounts receivable are with companies and individuals in the health care industry. However, concentrations of credit risk are limited due to the number of the Company's clients as well as their dispersion across many different geographic regions. Accounts receivable balances (gross) from Medicare and Medicaid were $91.2 and $87.3 at December 31, 2001 and 2000, respectively. Revenue Recognition: Sales are recognized on the accrual basis at the time test results are reported, which approximates when services are provided. Services are provided to certain patients covered by various third-party payor programs including the Medicare and Medicaid programs. Billings for services under third-party payor programs are included in sales net of allowances for contractual discounts and allowances for differences between the amounts billed and estimated program payment amounts. Adjustments to the estimated payment amounts based on final settlement with the programs are recorded upon settlement as an adjustment to revenue. In 2001, 2000 and 1999, approximately 16%, 16% and 20%, respectively, of the Company's revenues were derived from tests performed for beneficiaries of Medicare and Medicaid programs. Income Taxes: The Company accounts for income taxes utilizing the asset and liability method. Under this method 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 and for tax loss carryforwards. 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. Future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of such benefits are more likely than not. Stock Splits: On May 2, 2000, the Company effected a one-for-ten common stock reverse split whereby the number of authorized shares of common stock decreased from 520 million to 52 million and the par value increased from $0.01 to $0.10. On May 24, 2001, the Company's shareholders approved an amendment to the restated certificate of incorporation to increase the number of common shares authorized from 52 million shares to 265 million shares. On June 11, 2001, the Company effected a two-for-one stock split through the issuance of a stock dividend of one new share of common stock for each share of common stock held by shareholders of record on June 4, 2001. All references to common stock, common shares outstanding, average number of common shares outstanding, stock options, restricted shares and per share amounts in the Consolidated Financial Statements and Notes to Consolidated Financial Statements have been restated to reflect the June 11,2001 two-for-one stock split on a retroactive basis. Stock Compensation Plans: The Company accounts for its employee stock option plans using the intrinsic method under APB Opinion No. 25 and related Interpretations. Accordingly, compensation for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. The Company's employee stock purchase plan is also accounted for under APB Opinion No. 25 and is treated as non-compensatory. The Company provides supplementary disclosures using the fair value method under SFAS No. 123. Compensation cost for restricted stock awards is recorded by allocating their aggregate grant date fair value over their vesting period. Earnings per Share: Basic earnings per share is computed by dividing net income, less preferred stock dividends and accretion, by the weighted average number of common shares outstanding. Dilutive earnings per share is computed by dividing net earnings, by the weighted average number of common shares outstanding plus potentially dilutive shares, as if they had been issued at the beginning of the period presented. Potentially dilutive common shares result primarily from the Company's mandatorily redeemable preferred stock (redeemed in 2000), restricted stock awards and outstanding stock options. The following represents a reconciliation of the weighted average shares used in the calculation of basic and diluted earnings per share: Years ended December 31, 2001 2000 1999 ---------------------------------------- Basic 69,418,875 47,080,668 25,332,376 Assumed conversion/exercise of: Stock options 558,199 710,500 245,296 Restricted stock awards 561,647 358,358 176,646 ---------- ---------- ---------- Diluted 70,538,721 48,149,526 25,754,318 ========== ========== ========== The effect of conversion of the Company's redeemable preferred stock, or exercise of certain of the Company's stock options was not included in the computation of diluted earnings per common share for the years ended December 31, 2001, 2000 and 1999, as it would have been antidilutive. The following table summarizes the potential common shares not included in the computation of diluted earnings per share because their impact would have been antidilutive: December 31, 2001 2000 1999 -------- -------- --------- Stock Options 14,869 234,924 1,745,842 Series A convertible exchangeable Preferred stock -- -- 15,866,086 Series B convertible pay-in-kind Preferred stock -- -- 25,352,592 The Company's zero-coupon subordinated notes are contingently convertible into 4,988,818 shares of common stock and are not currently included in the earnings per share calculation. Investments: Investments in equity securities are reported at fair value with unrealized gains or losses, net of tax, recorded as a separate component of shareholders' equity. During 1999, the Company recorded an other than temporary loss on its investments in equity securities totaling $4.2. Use of Estimates: 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 reported periods. Significant estimates include the allowances for doubtful accounts and deferred tax assets, amortization lives for intangible assets and accruals for self-insurance reserves. The allowance for doubtful accounts is determined based on historical collection trends, the aging of accounts, current economic conditions and regulatory changes. Actual results could differ from those estimates. Long-Lived Assets: Long-lived assets, including goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Recoverability of assets to be held and used is determined by the Company at the entity level by a comparison of the carrying amount of the assets to future undiscounted net cash flows before interest expense and income taxes expected to be generated by the assets. Impairment, if any, is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets (based on market prices in an active market or on discounted cash flows). Assets to be disposed of are reported at the lower of the carrying amount or net realizable value. Intangible Assets: Intangible assets, consisting of goodwill and other intangibles (patents and technology, customer lists and non-compete agreements), are amortized on a straight-line basis over the expected periods to be benefited, generally ranging from 20 to 40 years for goodwill, legal life for patents and technology, 10 to 25 years for customer lists and contractual lives for non-compete agreements. Effective January 1 2002, the Company will adopt Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets". This standard requires that goodwill and other intangibles that are acquired in business combinations and that have indefinite useful lives are not to be amortized and are to be reviewed for impairment annually based on an assessment of fair value. The adoption of this new standard is expected to result in a reduction in annual amortization expense of approximately $26.0. 2. BUSINESS ACQUISITIONS The Company acquired two important companies in 2001, as described below. Both companies acquired have been accounted for as purchases with the excess of the purchase price over the estimated fair value of the net assets acquired recorded as goodwill. The results of each operation have been included in the consolidated financial results of the Company from the date of acquisition. The impact of these acquisitions is not considered significant to the Company's operations. On April 30, 2001, the Company completed the acquisition of all of the outstanding stock of Path Lab Holdings, Inc. (Path Lab), which is based in Portsmouth, New Hampshire for approximately $83.0 in cash and contingent future payments of $25.0 ($5.5 earned and paid in 2001) based upon attainment of specific earnings targets. Path Lab's revenues for the year ended December 31, 2000 were approximately $51.6. On June 4, 2001, the Company completed the acquisition of Minneapolis- based Viro-Med Inc. for approximately $31.7 in cash and contingent future payments of $12.0 ($7.9 earned and paid in 2001) based upon attainment of specific earnings targets. Viro-Med's revenues for the year ended December 31, 2000 were approximately $25.2. 3. RESTRUCTURING AND NON-RECURRING CHARGES The following represents the Company's restructuring activities for each of the years in the three years ended December 31, 2001: Lease and Severance Other Facility Costs Costs Total ---------- -------------- ------ Balance at January 1, 1999 $ 2.5 $ 30.5 $ 33.0 Cash payments (2.0) (4.2) (6.2) ------ ------ ------ Balance at December 31, 1999 0.5 26.3 26.8 Memphis closure 3.0 1.5 4.5 Reclassifications and non-cash items -- (3.7) (3.7) Cash payments (1.6) (4.0) (5.6) ------ ------ ------ Balance at December 31, 2000 1.9 20.1 22.0 Reclassifications and non-cash items (0.7) 0.2 (0.5) Cash payments (1.0) (4.5) (5.5) ------ ------ ------ Balance at December 31, 2001 $ 0.2 $ 15.8 $ 16.0 ====== ====== ====== Current $ 8.6 Non-current 7.4 ------ $ 16.0 ====== 4. ACCOUNTS RECEIVABLE, NET December 31, December 31, 2001 2000 ------------ ------------ Gross accounts receivable $ 485.0 $ 491.0 Less allowance for doubtful accounts (119.5) (123.0) -------- -------- $ 365.5 $ 368.0 ======== ======== The provision for doubtful accounts was $202.5, $195.9 and $191.9 in 2001, 2000 and 1999, respectively. 5. PROPERTY, PLANT AND EQUIPMENT, NET December 31, December 31, 2001 2000 ------------ ------------ Land $ 9.9 $ 9.5 Buildings and building improvements 79.2 68.5 Machinery and equipment 367.5 323.4 Leasehold improvements 66.4 63.0 Furniture and fixtures 19.9 17.8 Construction in progress 22.4 35.6 Buildings under capital leases 5.4 5.4 Equipment under capital leases 3.8 3.8 -------- -------- 574.5 527.0 Less accumulated depreciation and amortization of capital lease assets (265.2) (254.2) -------- -------- $ 309.3 $ 272.8 ======== ======== Depreciation expense and amortization of capital lease assets was $59.6, $56.1 and $52.6 for 2001, 2000 and 1999, respectively. 6. INTANGIBLE ASSETS, NET December 31, December 31, 2001 2000 ------------ ------------ Goodwill $ 911.3 $ 860.5 Other intangibles, principally patents, customer lists, non-compete agreements, and technology 338.8 245.6 ------- ------- 1,250.1 1,106.1 Less accumulated amortization (281.6) (240.4) ------- ------- $ 968.5 $ 865.7 ======= ======= Amortization of intangible assets was $41.5, $33.5 and $31.2 in 2001, 2000 and 1999, respectively. 7. ACCRUED EXPENSES AND OTHER December 31, December 31, 2001 2000 ------------ ------------ Employee compensation and benefits $ 72.6 $ 57.5 Acquisition related accruals 6.9 13.3 Restructuring reserves 8.6 12.4 Accrued taxes 4.2 10.1 Self-insurance reserves 31.5 21.1 Interest payable 0.2 3.7 Royalty payable 5.5 5.1 Other 11.5 3.9 ------- ------- $ 141.0 $ 127.1 ======= ======= 8. OTHER LIABILITIES December 31, December 31, 2001 2000 ------------ ------------ Acquisition related accruals $ 2.0 $ 8.8 Restructuring reserves 7.4 9.6 Deferred income taxes 63.5 28.5 Post-retirement benefit obligation 40.2 36.9 Self-insurance reserves 20.7 37.8 Other 0.3 2.3 ------- ------- $ 134.1 $ 123.9 ======= ======= 9. ZERO COUPON-SUBORDINATED NOTES In September 2001, the Company sold $650.0 aggregate principal amount at maturity of its zero coupon convertible subordinated notes (the "notes") due 2021 in a private placement. The Company received approximately $426.8 (net of underwriter's fees of approximately $9.8) in net proceeds from the offering. In October 2001, the underwriters exercised their rights to purchase an additional $94.0 aggregate principal amount pursuant to an overallotment option from which the Company received approximately $61.8 in net proceeds (net of underwriters fees of approximately $1.4). The notes, which are subordinate to the Company's bank debt, were sold at an issue price of $671.65 per $1,000 principal amount at maturity (representing a yield to maturity of 2.0% per year). Each one thousand dollar principal amount at maturity of the notes is convertible into 6.7054 shares of the Company's common stock, subject to adjustment in certain circumstances, if one of the following conditions occurs: 1) If the sales price of the Company's common stock reaches specified thresholds during specified measurement periods. 2) If the credit rating assigned to the notes by Standard & Poor's Ratings Services is at or below BB-. 3) If the notes are called for redemption. 4) If specified corporate transactions have occurred. Holders of the notes may require the Company to purchase all or a portion of their notes on September 11, 2004, 2006 and 2011 at prices ranging from $712.97 to $819.54, plus any accrued contingent additional principal and any accrued original issue discount thereon. The Company may choose to pay the purchase price in cash, common stock or a combination of cash and common stock. If the holders elect to require the Company to purchase their notes it is the Company's current intention to retire the notes by a cash payment. The Company may redeem for cash all or a portion of the notes at any time on or after September 11, 2006 at specified redemption prices per one thousand dollar principal amount at maturity of the notes ranging from $741.92 at September 11, 2001 to $1,000.00 at September 11, 2021 (assuming no contingent additional principal accrues on the notes). The Company used a portion of the proceeds to repay $412.5 of its term loan outstanding under its credit agreement and to pay $8.9 to terminate the interest rate swap agreement tied to the Company's term loan. The Company recorded an extraordinary loss of $3.2 (net of taxes of $2.3) relating to the write-off of unamortized bank fees associated with the Company's term debt. The Company has registered the notes and the shares of common stock issuable upon conversion of the notes with the Securities and Exchange Commission. 10. SENIOR CREDIT FACILITIES In February 2002, the Company entered into two new senior credit facilities with Credit Suisse First Boston, acting as Administrative Agent, and a group of financial institutions totaling $300.0. The new facilities will consist of a 364-day revolving credit facility in the principal amount of $100.0 and a three-year revolving credit facility in the principal amount of $200.0. The new facilities will be used for general corporate purposes, including working capital, capital expenditures, funding or share repurchases and other payments, and acquisitions. The Company's existing $450.0 revolving credit facility with a major financial institution had no amounts outstanding and was terminated on the effective date of the new credit facilities. The new senior credit facilities agreements bear interest at varying rates based upon the Company's credit rating with Standard & Poor's Rating Services. Based upon the Company's current rating, the effective rate under these agreements is LIBOR plus 75 basis points. The agreements contain certain debt covenants which require that the Company maintain leverage and interest coverage ratios. 11. STOCKHOLDER RIGHTS PLAN The Company adopted a stockholder rights plan effective as of December 13, 2001 that provides that each common stockholder of record on December 21, 2001, received a dividend of one right for each share of common stock held. Each right entitles the holder to purchase from the Company one-hundredth of a share of a new series of participating preferred stock at an initial purchase price of four hundred dollars. These rights will become exercisable and will detach from the Company's common stock if any person becomes the beneficial owner of 15% or more of the Company's common stock. In that event, each right will entitle the holder, other than the acquiring person, to purchase, for the initial purchase price, shares of the Company's common stock having a value of twice the initial purchase price. The rights will expire on December 13, 2011, unless earlier exchanged or redeemed. 12. LOSS ON INTEREST RATE SWAP AGREEMENT In conjunction with the early retirement of its long-term debt, the Company terminated its interest rate swap agreement with a bank by making a settlement payment of $8.9 with a portion of the proceeds from the sale of zero coupon-subordinated notes. In accordance with the provisions of SFAS No. 133, as amended, this interest rate swap agreement had been designated as a cash flow hedge and carried on the balance sheet at fair value with a corresponding offset in accumulated other comprehensive loss. 13. MANDATORILY REDEEMABLE PREFERRED STOCK On June 6, 2000, the Company called for redemption all of its outstanding Series A and Series B preferred stock at $52.83 per share, in accordance with the terms of the Preferred Stock Offering, by July 6, 2000. Substantially all of the holders of the Series A and Series B preferred stock elected to convert their shares into common stock. As of July 31, 2000, the Series A preferred stock was converted into 7,930,174 shares of common stock and the Series B preferred stock was converted into 13,241,576 shares of common stock. 14. INCOME TAXES The provisions for income taxes in the accompanying consolidated statements of operations consist of the following: Years Ended December 31, ---------------------------- 2001 2000 1999 Current: ------ ------ ------ Federal $ 122.8 $ 85.2 $ 0.5 State 25.2 13.5 2.6 ------ ------ ------ 148.0 98.7 3.1 ------ ------ ------ Deferred: Federal $ (2.3) $ (8.6) $ 29.1 State 3.9 5.4 7.9 ------ ------ ------ $ 1.6 $ (3.2) $ 37.0 ------ ------ ------ $ 149.6 $ 95.5 $ 40.1 ====== ====== ====== The tax benefit associated with dispositions from stock plans reduced taxes currently payable by approximately $14.3 and $19.0 in 2001 and 2000, respectively. Tax benefits related to stock plans in 1999 were immaterial. Such benefits are credited to additional paid-in-capital. The effective tax rates on earnings before income taxes is reconciled to statutory federal income tax rates as follows: Years Ended December 31, ---------------------------- 2001 2000 1999 ------ ------ ------ Statutory federal rate 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax effect 4.9 5.0 5.1 Non-deductible amortization of intangible assets 2.3 3.1 5.7 Change in valuation allowance -- -- (9.5) Other 2.8 2.9 1.7 ----- ----- ----- Effective rate 45.0% 46.0% 38.0% ===== ===== ===== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows: December 31, December 31, 2001 2000 Deferred tax assets: ------------ ------------ Accounts receivable 25.9 12.0 Self-insurance reserves 20.4 21.7 Postretirement benefit obligation 15.8 13.9 Acquisition and restructuring reserves 9.8 18.8 State net operating loss carryforwards 1.6 6.1 Employee benefits 8.2 7.4 Other 10.8 10.2 -------- -------- 92.5 90.1 Less valuation allowance (4.5) (4.5) -------- -------- Net deferred tax assets 88.0 85.6 -------- -------- Deferred tax liabilities: Intangible assets (64.0) (46.9) Property, plant and equipment (29.4) (22.7) Zero coupon-subordinated notes (4.1) -- Other (1.2) (1.2) -------- -------- Total gross deferred tax liabilities (98.7) (70.8) --------- -------- Net deferred tax assets (liabilities) $ (10.7) $ 14.8 ======== ======== The current valuation allowance brings the Company's net deferred tax assets to a level where management believes that it is more likely than not the tax benefits will be realized. The years 2000, 1999 and 1998 are currently under examination by the Internal Revenue Service. Management believes that adequate provisions have been recorded relating to the current examinations. The Company has state tax loss carryforwards of approximately $27.1 which expire 2002 through 2018. 15. STOCK COMPENSATION PLANS The Company has a number of stock option plans which authorize and reserve shares of common stock for issuance pursuant to options and stock appreciation rights that may be granted under these plans. In May 2000, the shareholders approved the 2000 Stock Incentive Plan. The principal purpose of the 2000 Stock Incentive Plan was to authorize 3.4 million additional shares for issuance under the plan. The effect of the 2000 Incentive Plan was to increase to an aggregate of 5.2 million shares available for issuance under all stock option plans (the 2000 Stock Incentive Plan, the Amended and Restated 1999 Stock Incentive Plan and the 1994 Stock Option Plan). During 2001, there were 1,048,088 options granted to officers and key employees of the Company. The exercise price for these options ranged from $66.125 to $68.50 per share. Also, during 2001, 170,200 shares of restricted stock were issued to senior management under the 2000 Incentive Plan at a market value on the date of grant of $66.575. Restrictions limit the sale or transfer of these shares during a six-year period when the restrictions lapse. Upon issuance of stock under the 2000 Incentive Plan, unearned compensation of $11.3 was recorded as additional paid-in capital and an opposite amount was charged to shareholders' equity as unearned restricted stock compensation. The plan provides for accelerated vesting of outstanding shares in percentages of 33.3%, 66.7% or 100%, if certain predefined three-year profitability targets are achieved as of December 31, 2003. The unearned restricted stock compensation is being amortized to expense over the applicable vesting periods. For 2001, 2000 and 1999, total restricted stock compensation expense was $7.5, $4.0 and $0.4, respectively. Total restricted shares granted in 2000 and 1999 were 262,800 and 324,000, respectively. At December 31, 2001, there were 1,589,251 additional shares available for grant under the Company's Stock Option Plans. The proforma weighted average fair values at date of grant for options issued during 2001, 2000 and 1999 were $39.44, $22.36 and $8.40 respectively, and were estimated using the Black-Scholes option pricing model. Weighted average assumptions for the expected life in years, volatility and dividend yield were 7 years (5 years in 1999), .5, and 0% for each of the three years ended December 31, 2001. Interest rate assumptions were 4.3%, 5.0% and 6.0% for the years ended December 31, 2001, 2000 and 1999, respectively. The Company has an employee stock purchase plan, begun in 1997 and amended in 1999, with 1,500,000 shares of common stock for authorized issuance. The plan permits substantially all employees to purchase a limited number of shares of the Corporation stock at 85% of market value. The Company issues shares to participating employees semi annually in January and July of each year. A summary of shares issued is as follows: 1999 2000 2001 2002 ------- ------- ------ ------ January 192,226 105,176 51,314 36,757 July 173,548 91,044 30,876 Pro-forma compensation expense is calculated for the fair value of the employee's purchase right using the Black-Scholes model. Assumptions include a weighted average life of approximately one-half year, dividend yield of 0%, risk free interest rates for each six month period as follows: 2001 - 5.8% and 3.5%; 2000 - 5.5% and 6.1%; and 1999 - 5.5% and 4.9% and volatility rates for each of the following six month periods: 2001 - .4 and .3; 2000 - .5 and .5; and 1999 - .5 and .4. The per share weighted average grant date fair value of the benefits under the employee stock purchase plan for the first and second six-month periods is as follows: 2001 2000 1999 ------ ------ ------ First six months $23.02 $ 5.09 $1.98 Second six months $17.58 $10.43 $3.74 The Company applies the provisions of APB Opinion No. 25 in accounting for its plans and, accordingly, no compensation cost has been recognized for its stock compensation plans in the financial statements. Had the Company determined compensation cost based on the fair value method as defined in SFAS No. 123, the impact on the Company's net earnings on a pro forma basis is indicated below: Years ended December 31, 2001 2000 1999 ------- ------- ------- Net earnings As reported $ 179.5 $ 112.1 $ 65.4 Pro forma 167.3 108.0 62.8 Basic earnings per common share As reported $ 2.58 $ 1.65 $ 0.59 Pro forma 2.41 1.56 0.49 Diluted earnings per common share As reported $ 2.54 $ 1.61 $ 0.58 Pro forma 2.37 1.53 0.48 Pro forma net earnings reflects options granted in 1998 through 2001. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma amounts presented above because compensation cost for options granted prior to January 1, 1996 is not considered. The following table summarizes grants of non-qualified options made by the Company to officers and key employees under all plans. Stock options are generally granted at an exercise price equal to or greater than the fair market price per share on the date of grant. Also, for each grant, options vest ratably over a period of two to three years on the anniversaries of the grant date, subject to their earlier expiration or termination. Changes in options outstanding under the plans for the periods indicated were as follows: Weighted-Average Number Exercise Price of Options per Option ---------- ---------------- Outstanding at January 1, 1999 1,942,899 $16.278 (564,992 exercisable) Options granted 178,472 $13.786 Canceled (115,178) $20.813 Exercised (5,028) $11.267 --------- Outstanding at December 31, 1999 2,001,165 $15.807 (1,088,413 exercisable) Options granted 829,498 $36.696 Canceled (70,724) $23.890 Exercised (1,194,562) $12.738 --------- Outstanding at December 31, 2000 1,565,377 $28.852 (335,969 exercisable) Options granted 1,048,088 $66.138 Canceled (96,062) $43.363 Exercised (560,952) $19.935 --------- Outstanding at December 31, 2001 1,956,451 $50.671 ========= Exercisable at December 31, 2001 364,786 $31.978 ========= The weighted-average remaining life of options outstanding at December 31, 2001 is approximately 8.4 years. The following table summarizes information concerning currently outstanding and exercisable options. OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------------- -------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price --------------------------------------------------------------------------- $ 9.69 - 13.75 204,217 6.66 $12.145 160,084 $11.703 $14.69 - 31.56 190,879 7.98 $20.954 20,915 $19.969 $35.38 - 35.38 248,921 8.43 $35.375 62,710 $35.375 $53.41 - 65.00 283,470 7.58 $55.708 118,501 $58.913 $66.13 - 68.50 1,028,964 9.09 $66.142 2,576 $67.655 --------- ------- 1,956,451 364,786 ========= ======= 16. RELATED PARTY TRANSACTIONS At December 31, 2001 and 2000, 10,705,074 and 22,705,074 shares of the Company's outstanding common stock, or approximately 15.2% at December 31, 2001 and 32.6% at December 31, 2000, were owned by Roche Holdings, Inc. (Roche). The reduction in Roche's ownership of the Company's common stock is a result of the sale by Roche of 12.0 million shares in 2001. The Company purchases certain items, primarily laboratory testing supplies from various affiliates of Roche. Total purchases from these affiliates, which are recorded in cost of sales, were $62.3, $42.7, and $38.3 in 2001, 2000 and 1999, respectively. In addition, the Company made royalty payments to Roche in the amounts of $4.4 in 2001, $2.8 in 2000 and $2.9 in 1999. Revenue received from Roche for laboratory services was $2.6 in 2001, $1.3 in 2000 and $0.9 in 1999. Amounts owed to Roche and its affiliates at December 31, 2001 and 2000 were $4.6 and $1.4, respectively. 17. COMMITMENTS AND CONTINGENT LIABILITIES The Company is involved in litigation purporting to be a nation-wide class action involving the alleged overbilling of patients who are covered by private insurance. The Company has reached a settlement with the class that will not exceed existing reserves or have a material adverse affect on the Company. On January 9, 2001, the Company was served with a complaint in North Carolina which purports to be a class action and makes claims similar to those referred to above. The Claim has been stayed pending appeal of the court approval of the settlement discussed above. The outcome cannot be presently predicted. The Company is also involved in various claims and legal actions arising in the ordinary course of business. These matters include, but are not limited to, professional liability, employee related matters, and inquiries from governmental agencies and Medicare or Medicaid carriers requesting comment on allegations of billing irregularities that are brought to their attention through billing audits or third parties. In the opinion of management, based upon the advice of counsel and consideration of all facts available at this time, the ultimate disposition of these matters will not have a material adverse effect on the financial position, results of operations or liquidity of the Company. The Company believes that it is in compliance in all material respects with all statutes, regulations and other requirements applicable to its clinical laboratory operations. The clinical laboratory testing industry is, however, subject to extensive regulation, and many of these statutes and regulations have not been interpreted by the courts. There can be no assurance therefore that applicable statutes and regulations might not be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect the Company. Potential sanctions for violation of these statutes and regulations include significant fines and the loss of various licenses, certificates and authorizations. Under the Company's present insurance programs, coverage is obtained for catastrophic exposures as well as those risks required to be insured by law or contract. The Company is responsible for the uninsured portion of losses related primarily to general, professional and vehicle liability, certain medical costs and workers' compensation. The self-insured retentions are on a per occurrence basis without any aggregate annual limit. Provisions for losses expected under these programs are recorded based upon the Company's estimates of the aggregated liability of claims incurred. At December 31, 2001 and 2000, the Company had provided letters of credit aggregating approximately $36.6 and $28.2, respectively, primarily in connection with certain insurance programs. The Company leases various facilities and equipment under non- cancelable lease arrangements. Future minimum rental commitments for leases with noncancellable terms of one year or more at December 31, 2001 are as follows: Operating Capital --------- ------- 2002 $ 43.7 $ 3.0 2003 34.2 2.8 2004 26.0 2.6 2005 19.4 2.8 2006 13.7 2.9 Thereafter 38.9 1.2 ----- ----- Total minimum lease payments 175.9 15.3 Less: Amounts included in restructuring accruals -- 3.9 Amount representing interest -- 4.2 Total minimum operating ----- ----- lease payments and present value of minimum capital lease payments $175.9 $ 7.2 ===== ===== Current $ 1.1 Non-current 6.1 ----- $ 7.2 ===== Rental expense, which includes rent for real estate, equipment and automobiles under operating leases, amounted to $74.8, $71.3 and $67.0 for the years ended December 31, 2001, 2000 and 1999, respectively. 18. PENSION AND POSTRETIREMENT PLANS The Company maintains a defined contribution pension plan for all eligible employees. Eligible employees are defined as individuals who are age 21 or older and have been employed by the Company for at least six consecutive months and completed 1,000 hours of service. Company contributions to the plan are based on a percentage of employee contributions. The cost of this plan was $8.3, $7.5 and $7.5 in 2001, 2000 and 1999, respectively. In addition, substantially all employees of the Company are covered by a defined benefit retirement plan (the "Company Plan"). The benefits to be paid under the Company Plan are based on years of credited service and average final compensation. The Company's policy is to fund the Company Plan with at least the minimum amount required by applicable regulations. The Company has a second defined benefit plan which covers its senior management group that provides for the payment of the difference, if any, between the amount of any maximum limitation on annual benefit payments under the Employee Retirement Income Security Act of 1974 and the annual benefit that would be payable under the Company Plan but for such limitation. This plan is an unfunded plan. The components of net periodic pension cost for both of the defined benefit plans are summarized as follows: Company Plans ------------------------ Years ended December 31, 2001 2000 1999 ------------------------ Components of net periodic benefit cost Service cost $ 11.2 $ 10.6 $ 10.5 Interest cost 11.4 10.6 9.2 Expected return on plan assets (13.5) (12.3) (12.1) Net amortization and deferral (1.5) (1.5) (1.6) ----- ----- ----- Net periodic pension cost $ 7.6 $ 7.4 $ 6.0 ===== ===== ===== Company Plans ---------------- December 31, 2001 2000 ---------------- Change in benefit obligation Benefit obligation at beginning of year $152.3 $138.3 Service cost 11.2 10.6 Interest cost 11.4 10.6 Actuarial loss 9.0 2.1 Benefits paid (10.2) (9.4) ----- ----- Benefit obligation at end of year 173.7 152.2 ----- ----- Change in plan assets Fair value of plan assets at beginning of year 151.1 138.1 Actual return on plan assets -- 13.8 Employer contributions 10.2 8.6 Benefits paid (10.2) (9.4) ----- ----- Fair value of plan assets at end of year 151.1 151.1 ----- ----- Funded status, end of year 22.6 1.2 Unrecognized net actuarial loss (33.7) (11.2) Unrecognized prior service cost 5.5 7.0 Additional minimum liability 15.4 -- ----- ----- Accrued pension liability (asset) $ 9.8 $ (3.0) ===== ===== At December 31, 2001, the additional minimum liability of the Company's Cash Balance Retirement Plan exceeded the unrecognized prior service cost by $7.8. This amount has been recorded as an increase to accumulated other comprehensive loss. Assumptions used in the accounting for the defined benefit plans were as follows: Company Plans --------------- 2001 2000 --------------- Weighted-average discount rate 7.25% 7.75% Weighted-average rate of increase in future compensation levels 4.0% 4.0% Weighted-average expected long- term rate of return 9.0% 9.0% The Company assumed obligations under a subsidiary's postretirement medical plan. Coverage under this plan is restricted to a limited number of existing employees of the subsidiary. This plan is unfunded and the Company's policy is to fund benefits as claims are incurred. The components of postretirement benefit expense are as follows: Year ended Year ended Year ended December 31, December 31, December 31, 2001 2000 1999 ------------ ------------ ------------ Service cost $ 1.0 $ 0.8 $ 1.0 Interest cost 3.4 2.5 2.6 Net amortization and deferral (1.1) (0.6) (0.1) Actuarial loss 0.7 -- -- ------- ------- ------- Postretirement benefit costs $ 4.0 $ 2.7 $ 3.5 ======= ======= ======= A summary of the components of the accumulated postretirement benefit obligation follows: December 31, 2001 2000 -------------- Retirees $ 13.1 $ 11.3 Fully eligible active plan participants 12.5 12.4 Other active plan participants 20.0 19.4 ----- ----- $ 45.6 $ 43.1 ===== ===== Reconciliation of the funded status of the December 31, postretirement benefit plan and accrued liability 2001 2000 ------------- Accumulated postretirement benefit obligation, beginning of year $ 43.1 $ 31.9 Changes in benefit obligation due to: Service cost 1.0 0.8 Interest cost 3.4 2.5 Plan participants contributions 0.2 0.2 Actuarial (gain) loss (1.1) 11.9 Amendments -- (3.0) Benefits paid (1.0) (1.2) ----- ----- Accumulated post retirement benefit obligation, end of year 45.6 43.1 Unrecognized net actuarial loss (10.4) (12.2) Unrecognized prior service cost 5.0 6.0 ----- ----- Accrued postretirement benefit obligation $ 40.2 $ 36.9 ===== ===== The weighted-average discount rates used in the calculation of the accumulated postretirement benefit obligation was 7.3% and 7.8% as of December 31, 2001 and 2000, respectively. The health care cost trend rate- medical was assumed to be 7.5% and the trend rate-prescription was assumed to be 12.0% as of December 31, 2001 and 2000, declining gradually to 5.0% in the year 2011. The health care cost trend rate has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by a percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 2001 by $7.7. The impact of a percentage point change on the aggregate of the service cost and interest cost components of the net periodic postretirement benefit cost results in an increase of $0.8 or decrease of $0.6. 19. QUARTERLY DATA (UNAUDITED) The following is a summary of unaudited quarterly data: Year ended December 31, 2001 -------------------------------------------------- 1st 2nd 3rd 4th Full Quarter Quarter Quarter Quarter Year -------- -------- -------- -------- -------- Net sales $ 525.4 $ 549.7 $ 560.9 $ 563.8 $2,199.8 Gross profit 221.6 240.9 238.0 225.1 925.6 Net earnings 43.5 52.1 43.1 40.8 179.5 Basic earnings per common share 0.63 0.75 0.62 0.59 2.58 Diluted earnings per common share 0.62 0.74 0.61 0.58 2.54 Year ended December 31, 2000 --------------------------------------------------- 1st 2nd 3rd 4th Full Quarter Quarter Quarter Quarter Year ------- -------- -------- -------- -------- Net sales $ 462.7 $ 482.4 $ 488.1 $ 486.1 $1,919.3 Gross profit 183.5 201.2 196.7 185.2 766.6 Net earnings 25.7 32.7 32.8 20.9 112.1 Less preferred dividends 14.7 19.6 -- -- 34.3 Less accretion of mandatorily redeemable preferred stock 0.2 0.1 -- -- 0.3 Net earnings attributable to common shareholders 10.8 13.0 32.8 20.9 77.5 Basic earnings per common share 0.42 0.49 0.49 0.30 1.65 Diluted earnings per common share 0.38 0.47 0.47 0.30 1.61 20. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," was issued. This Statement supersedes APB Opinion No. 16, "Business Combinations" and SFAS No. 38. "Accounting for Preacquisition Contingencies of Purchased Enterprises" and eliminates the pooling method of accounting for business acquisitions. This Statement requires all business combinations to be accounted for using the purchase method for all transactions initiated after June 30, 2001. In June 2001, SFAS No. 142 "Goodwill and Other Intangible Assets" was also issued. This Statement supersedes APB No. 17 "Intangible Assets" and addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be reviewed at least annually for impairment. Intangible assets that have finite lives will continue to be amortized over their useful lives, but without the constraint of the 40-year useful life amortization ceiling. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001, however, goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the nonamortization and amortization provisions of this Statement. The impact of the adoption of SFAS No. 142 on the 2002 financial statements, will be a decrease to amortization expense of approximately $26.0. In June 2001, SFAS No. 143, "Accounting for Asset Retirement Obligations" was issued. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long- lived assets and the associated legal obligations of such asset retirement costs. This Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect that implementation of this standard will have a significant financial impact. In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". This Statement retains the requirements of SFAS No. 121 to recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and to measure an impairment loss as the difference between the carrying amount and the fair value of the asset. However, this standard removes goodwill from its scope and revises the approach for evaluating impairment. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company is evaluating the impact of the adoption of SFAS No. 144. Schedule II LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Years Ended December 31, 2001, 2000 and 1999 (Dollars in Millions) --------------------------------------------------------------------------- Balance Charged Other at to (Deduct- Balance beginning Costs and ions) at end of year Expenses Additions of year --------------------------------------------------------------------------- Year ended December 31, 2001: Applied against asset accounts: Allowance for doubtful accounts $ 123.0 $ 202.5 $ (206.0) $ 119.5 ======= ======= ======= ======= Valuation allowance- deferred tax assets $ 4.5 $ -- $ -- $ 4.5 ======= ======= ======= ======= Year ended December 31, 2000: Applied against asset accounts: Allowance for doubtful accounts $ 147.1 $ 195.9 $ (220.0) $ 123.0 ======= ======= ======= ======= Valuation allowance- deferred tax assets $ 4.5 $ -- $ -- $ 4.5 ======= ======= ======= ======= Year ended December 31, 1999: Applied against asset accounts: Allowance for doubtful accounts $ 194.0 $ 191.9 $ (238.8) $ 147.1 ======= ======= ======= ======= Valuation allowance- deferred tax assets $ 14.5 $ (10.0) $ -- $ 4.5 ======= ======= ======= ======= 35 64 1