SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
Commission file number 1-12215
Quest Diagnostics Incorporated
(formerly known as Corning Clinical Laboratories Inc.)
One Malcolm Avenue
Teterboro, NJ 07608
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of July 31, 1997, there were outstanding 29,723,790 shares of Common Stock,
$.01 par value.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Index to consolidated financial statements filed as part of this report:
Page
Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1997 and 1996 2
Consolidated Balance Sheets as of
June 30, 1997 and December 31, 1996 3
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1997 and 1996 4
Notes to Consolidated Financial Statements 5
1
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1997 June 30, 1996 June 30, 1997 June 30, 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenues .................................... $ 401,523 $ 424,543 $ 789,626 $ 825,938
Costs and expenses:
Cost of services............................ 239,593 266,301 478,907 513,419
Selling, general and administrative ........ 127,854 120,205 251,827 246,249
Interest expense, net ...................... 10,499 19,879 21,112 40,021
Amortization of intangible assets .......... 5,980 10,655 12,022 21,444
Provision for restructuring and
other special charges..................... -- 46,000 -- 46,000
Other, net ................................. 1,153 (979) 897 (2,035)
--------- --------- --------- ---------
Total .................................... 385,079 462,061 764,765 865,098
--------- --------- --------- ---------
Income (loss) before taxes....................... 16,444 (37,518) 24,861 (39,160)
Income tax expense............................... 8,356 404 12,726 273
--------- --------- --------- ---------
Net income (loss)................................ $ 8,088 $ (37,922) $ 12,135 $ (39,433)
========= ========= ========= =========
Net income per common share...................... $ 0.28 $ 0.42
Weighted average common shares
outstanding................................. 29,102 28,987
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1997 AND DECEMBER 31, 1996
(in thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
---- ----
(unaudited)
<S> <C> <C>
ASSETS
- ------
Current Assets:
Cash and cash equivalents .............................................. $ 75,834 $ 41,960
Accounts receivable, net of allowance of $108,622 and
$115,018 at June 30, 1997 and December 31, 1996, respectively....... 287,987 297,743
Inventories ............................................................ 27,921 28,524
Deferred taxes on income ............................................... 95,402 98,162
Due from Corning Incorporated........................................... 22,400 30,894
Prepaid expenses and other assets ...................................... 13,926 13,682
----------- ----------
Total current assets ............................................... 523,470 510,965
Property, plant and equipment, net .......................................... 273,140 287,749
Intangible assets, net ...................................................... 551,813 546,457
Other assets................................................................. 48,770 49,895
----------- ----------
TOTAL ASSETS................................................................. $ 1,397,193 $1,395,066
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities:
Accounts payable and accrued expenses................................... $ 210,073 $ 206,701
Short-term borrowings................................................... 16,535 20,785
Income taxes payable ................................................... 24,858 21,946
----------- ----------
Total current liabilities........................................... 251,466 249,432
Long-term debt............................................................... 499,207 515,008
Other liabilities............................................................ 85,308 91,907
----------- ----------
Total liabilities................................................... 835,981 856,347
----------- ----------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock......................................................... 1,000 1,000
Common stock, par value $0.01 per share; 100,000 shares authorized;
29,615 and 28,822 shares issued at June 30, 1997 and
December 31, 1996, respectively..................................... 296 288
Additional paid-in capital.............................................. 1,182,750 1,170,152
Accumulated deficit..................................................... (615,827) (627,892)
Cumulative translation adjustment ...................................... (910) (619)
Market valuation adjustment............................................. (1,946) (4,210)
Unearned compensation................................................... (4,151) --
------------ ----------
Total stockholders' equity.......................................... 561,212 538,719
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................................. $ 1,397,193 $1,395,066
=========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................................... $ 12,135 $ (39,433)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization ................................... 38,760 50,232
Provision for doubtful accounts ................................. 59,825 51,352
Provision for restructuring and other special charges............ -- 46,000
Deferred income tax provision.................................... 6,089 7,016
Other, net....................................................... 3,412 (651)
Changes in operating assets and liabilities:
Accounts receivable ......................................... (50,070) (54,311)
Accounts payable and accrued expenses ....................... 7,814 (15,906)
Restructuring, integration and other special charges ........ (8,031) (17,290)
Due from/to Corning Incorporated and affiliates ............. 8,494 3,208
Other assets and liabilities, net............................ 2,056 (13,516)
--------- -----------
Net cash provided by operating activities............................. 80,484 16,701
--------- -----------
Cash flows from investing activities:
Capital expenditures ............................................ (12,973) (46,890)
Proceeds from disposition of assets ............................. 1,076 9,279
Acquisition of business.......................................... (16,000) --
Decrease (increase) in investments .............................. 1,338 (7,582)
----------- -----------
Net cash used in investing activities ................................ (26,559) (45,193)
------------ -----------
Cash flows from financing activities:
Repayments under Working Capital Facility........................ (19,300) --
Proceeds from borrowings......................................... -- 64,619
Repayment of long-term debt ..................................... (711) (33,796)
Dividends paid................................................... (40) (1,172)
----------- -----------
Net cash (used in) provided by financing activities .................. (20,051) 29,651
----------- -----------
Net change in cash and cash equivalents .............................. 33,874 1,159
Cash and cash equivalents, beginning of year ......................... 41,960 36,446
----------- -----------
Cash and cash equivalents, end of period.............................. $ 75,834 $ 37,605
=========== ===========
Cash paid during the period for:
Interest......................................................... $ 21,760 $ 43,152
Income taxes..................................................... $ 4,389 $ 5,652
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
1. BASIS OF PRESENTATION
Background
Prior to January 1, 1997, Quest Diagnostics Incorporated and its
subsidiaries (the "Company") was a wholly-owned subsidiary of Corning
Incorporated ("Corning"). On December 31, 1996, Corning distributed all of the
outstanding shares of common stock of the Company to the stockholders of
Corning, with one share of common stock of the Company being distributed for
each eight shares of outstanding common stock of Corning (the "Spin-Off
Distribution").
Basis of Presentation
The interim consolidated financial statements reflect all adjustments
which, in the opinion of management, are necessary for a fair statement of the
results of operations for the periods presented. All such adjustments are of a
normal recurring nature. The interim consolidated financial statements have been
compiled without audit and are subject to year-end adjustments. Operating
results for the interim periods are not necessarily indicative of the results
that may by expected for the full year. These interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements included in the Company's Form 10-K for the year ended December 31,
1996.
Earnings Per Share
Earnings per share are computed by dividing net income less dividends on
the Company's Preferred Stock (approximately $30 per quarter) by the weighted
average number of common shares outstanding during the period. Historical
earnings per share for 1996 is not meaningful as the Company's capital structure
in 1996 is not comparable to the capital structure subsequent to the Spin-Off
Distribution.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 128, "Earnings per Share." The statement is
effective for financial statements for periods ending after December 15, 1997,
and changes the method in which earnings per share will be determined. Adoption
of this statement by the Company is not expected to have a material impact on
earnings per share in 1997.
2. COMMITMENTS AND CONTINGENCIES
The Company has entered into several settlement agreements with various
governmental and private payors during recent years relating primarily to
industry-wide billing and marketing practices that had been substantially
discontinued by early 1993. At present, a government investigation of certain
practices by Nichols Institute substantially discontinued prior to its
acquisition by the Company in 1994 is ongoing. As part of the Spin-Off
Distribution, Corning has agreed to indemnify the Company against all
settlements for any governmental claims relating to billing practices of the
Company and its predecessors that were pending on December 31, 1996. Corning
also agreed to indemnify the Company for 50% of the aggregate of all settlement
payments made by the Company that are in excess of $42 million to private
parties that relate to indemnified or previously settled governmental claims for
services provided prior to January 1, 1997; however, the indemnification of
private party claims will not exceed $25 million in the aggregate and will be
paid to the Company net of anticipated tax benefits to be realized by the
Company. Such indemnification does not cover any non-governmental claims settled
after December 31, 2001. Coincident with the Spin-Off Distribution, the Company
recorded a receivable from Corning of $22.4 million which is equal to
management's best estimate of amounts to be received from Corning to satisfy the
remaining indemnified governmental claims on an after-tax basis.
5
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
At June 30, 1997, settlement reserves totaled $78.3 million, including
$41.2 million in other long-term liabilities. Although management believes that
established reserves for both indemnified and non-indemnified claims are
sufficient, it is possible that additional information may become available
which may cause the final resolution of these matters to exceed established
reserves by an amount which could be material to the Company's results of
operations and, for non-indemnified claims, the Company's cash flows in the
period in which such claims are settled. The Company does not believe that these
issues will have a material adverse effect on its overall financial condition.
3. RESTRUCTURING RESERVES
The Company has recorded charges for restructuring plans in previous years.
Reserves relating to these programs totaled $10.9 million and $16.1 million at
June 30, 1997 and December 31, 1996, respectively. Management believes that the
costs of the restructuring plans will be financed through cash from operations
and does not anticipate any significant impact on its liquidity as a result of
the restructuring plans.
4. SUMMARIZED FINANCIAL INFORMATION
The Company's 10.75% senior subordinated notes due 2006 are guaranteed,
fully, jointly and severally, and unconditionally, on a senior subordinated
basis by substantially all of the Company's wholly-owned, domestic subsidiaries
("Subsidiary Guarantors"). Non-guarantor subsidiaries, individually and in the
aggregate, are inconsequential to the Company. The following is summarized
financial information of the Subsidiary Guarantors as of June 30, 1997 and
December 31, 1996 and for the six months ended June 30, 1997 and 1996. Full
financial statements of the Subsidiary Guarantors are not presented because
management believes they are not material to investors.
June 30, 1997 December 31, 1996
------------- -----------------
Current assets.............................. $236,901 $230,024
Noncurrent assets........................... 544,795 547,219
Current liabilities......................... 74,946 61,383
Noncurrent liabilities...................... 281,325 290,980
Stockholder's equity........................ 425,425 424,880
For the six months ended June 30,
1997 1996
---- ----
Net revenues................................ $437,935 $455,035
Cost of services............................ 275,207 286,006
Net income (loss)........................... 545 (15,516)
6
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
5. STOCKHOLDERS' EQUITY
Unearned Compensation
Under the Company's Employees Equity Participation Program, approximately
400 thousand shares of restricted stock were granted in 1997, primarily to
executive employees. These shares are contingent on achievement of financial
performance goals and are subject to forfeiture if employment terminates prior
to the end of the prescribed period. The market value of the shares awarded
under the plan is recorded as unearned compensation. The unearned amounts are
amortized to compensation expense as earned.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Net income for the three and six months ended June 30, 1997 increased from
the prior year primarily as a result of reduced interest and amortization
expense and the impact of special charges in 1996. This was partially offset by
reduced operating income primarily due to an increase in bad debt expense and
the Company's increased selectiveness in retaining and pursuing new business,
which during the first quarter of the year reduced volume faster than costs were
reduced.
Net Revenues
Net revenues for the second quarter decreased by $23.0 million, or 5.4%
from the prior year level, principally due to a 5.6% decline in clinical testing
volume and the sale in 1996 of a majority share of the Company's imaging
business, partially offset by an improvement in average prices of 2.1%. Net
revenues for the first half of 1997 decreased by $36.3 million, or 4.4% from the
prior year level, principally due to a 5.4% decline in clinical testing volume
and the sale in 1996 of a majority share of the Company's imaging business,
partially offset by an improvement in average prices of 1.8%. The volume decline
for each period is primarily attributable to the Company's increased
selectiveness in retaining and pursuing new business, in addition to mounting
government regulations and intense competition for existing business.
Costs and Expenses
Total operating costs for the second quarter and first half of 1997
declined $19.1 million and $28.9 million, respectively, from the year earlier
periods. For the second quarter and first half of 1997, $11.7 million and $12.6
million, respectively, of the declines were attributable to the sale of the
majority share of the Company's imaging business. The Company's efforts to
reduce its operating cost structure have had a favorable impact on costs as a
percentage of net revenue. However, this benefit was offset by lower volume and
higher bad debt expense. Excluding bad debt expense, operating costs were
reduced in excess of the Company's revenue decline. Plans are currently being
implemented which are expected to further adjust the Company's cost structure in
the second half of the year.*
Cost of services, which includes the costs of obtaining, transporting and
testing specimens, decreased $26.7 million in the second quarter from the prior
year, and as a percentage of net revenues decreased to 59.7% from 62.7% in the
prior year. Cost of services in the first half of 1997 decreased $34.5 million
from the prior year, and as a percentage of net revenues decreased to 60.6% from
62.2% in the prior year. These decreases reflect the Company's progress in
reducing its cost structure and the sale of the majority share of the Company's
imaging business. Selling, general and administrative expenses, which includes
the costs of the sales force, billing operations, bad debt expense and general
management and
- -------------------
* This is a forward looking statement within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 27E of the Securities Act of
1934, as amended, and is based on current expectations. Forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from the forward looking statement. These risks and
uncertainties include heightened competition, impact of changes in payor mix,
the impact upon the Company's expenses resulting from compliance with Medicare
administrative policies, and reduction in tests ordered by existing customers.
See Item 1. "Business--Cautionary Statement for Purposes of the 'Safe Harbor'
Provisions of the Private Securities Litigation Reform Act of 1995" contained in
the Company's 1996 Annual Report on Form 10-K.
8
<PAGE>
administrative support, increased from the prior year by $7.6 million in the
quarter and $5.6 million in the first half of 1997. This increase was
principally due to bad debt expense which increased from 5.6% of net revenues to
7.7% of net revenues for the second quarter and from 6.2% of net revenues to
7.6% of net revenues for the first half of 1997. The Company continues to be
impacted by Medicare medical necessity documentation requirements imposed during
the past year. In the first half of 1997, additional medical necessity
requirements were imposed by various state agencies and carriers, slowing the
progress the Company had been making in certain of its billing operations. These
requirements, when initially imposed or subsequently expanded, increase the
backlog of unbilled requisitions and further complicate the billing process. The
Company has successfully dealt with these requirements in a number of its
billing sites where they were imposed earlier and is leveraging the processes
and experiences from those locations in addressing the impact of additional
requirements across its billing operations.
Net interest expense decreased from the prior year by $9.4 million and
$18.9 for the second quarter and first half of 1997, respectively, primarily due
to reduced debt levels as a result of Corning forgiving in excess of $700
million of intercompany debt in connection with the Spin-Off Distribution.
Amortization of intangible assets decreased from the prior year by $4.7
million and $9.4 million for the second quarter and first half of 1997,
respectively, principally due to the write-down of intangible assets coincident
with the Spin-Off Distribution, as well as certain other intangible assets
having become fully amortized.
In the second quarter of 1996, the Company recorded a special charge of
$46.0 million to establish additional reserves for potential amounts which could
be required to satisfy the government's claims related to investigations ongoing
at the time.
The change in other, net for the second quarter compared with the prior
year is primarily the result of the prior year including a gain on the sale of
an investment, and the current year including a charge related to the
integration of a small, strategic acquisition completed during the quarter. In
addition to the above, affecting the comparison of the first half of 1997 to the
prior year is the favorable settlement of a contractual obligation recorded in
the first quarter of 1996.
The Company's effective tax rate is significantly impacted by goodwill
amortization, a majority of which is not deductible for tax purposes, and has
the effect of increasing the overall tax rate or reducing the tax benefit rate.
The change in the effective tax rate is due principally to a reduction in
non-deductible amortization expense associated with the write down of intangible
assets coincident with the Spin-Off Distribution.
Liquidity and Capital Resources
Cash increased by $33.9 million over the year end balance, to $75.8 million
at June 30, 1997, due to operating activities which provided cash of $80.5
million, partially offset by investing and financing activities which used cash
of $46.6 million. Net cash provided by operating activities for the period
improved by $63.8 million compared to the same period in the prior year. The
improvement is primarily the result of changes in accounts payable and accrued
expense levels, improvements in the billing operations, and a reduction in
restructuring spending. Improvements in the billing operations have led to an
improvement in the number of days sales outstanding. The number of days sales
outstanding, a measure of billing and collection efficiency, was 65 days at June
30, 1997 compared to 70 days at year end and 68 days a year earlier.
9
<PAGE>
The decrease in net cash used in investing activities is primarily the
result of reduced capital spending compared to the prior year partially offset
by a small, strategic acquisition in the second quarter of 1997. Capital
spending for the first half of 1997 was $13.0 million compared to $46.9 million
for the comparable prior year period. The Company estimates that it will invest
approximately $40 million to $45 million during 1997 for capital expenditures,
principally related to equipment and facility upgrades and investments in
information technology. *
During the first quarter the Company paid down the entire balance of $19.3
million on its revolving working capital credit facility. Other than for the
reduction for outstanding letters of credit, which currently approximate $7.5
million, all of the revolving working capital credit facility is currently
available for borrowing.
Adjusted EBITDA
Adjusted EBITDA represents earnings before interest, taxes, depreciation
and amortization and non-recurring charges. Adjusted EBITDA for the three months
ended June 30, 1997 was $46.1 million, or 11.5% of net revenues, compared to
$53.6 million, or 12.6% of net revenues, in the prior year period. Adjusted
EBITDA for the six months ended June 30, 1997 was $84.7 million, or 10.7% of net
revenues, compared to $97.1 million, or 11.8% of net revenues, in the prior year
period. These declines were principally due to an increase in bad debt expense
and the Company's increased selectiveness in retaining and pursuing new
business, which during the first quarter of the year reduced volume faster than
costs were reduced.
- -------------------
* This is a forward looking statement within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 27E of the Securities Act of
1934, as amended, and is based on current expectations. Forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from the forward looking statement. These risks and
uncertainties include computer or other system failures, development of
technologies that substantially alter the practice of medicine, and the impact
upon the Company's expenses resulting from compliance with Medicare
administrative policies. See Item 1. "Business--Cautionary Statement for
Purposes of the 'Safe Harbor' Provisions of the Private Securities Litigation
Reform Act of 1995" contained in the Company's 1996 Annual Report on Form 10-K.
10
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In March, 1997, the Company, together with SmithKline Beecham Clinical
Laboratories Inc. and Laboratory Corporation of America Holdings, was served
with a complaint in a purported class action brought in the Northern District of
Alabama. The complaint asserts claims under the federal civil RICO statute
relating to private reimbursement of billings by Damon Corporation that are
similar to those that were the subject of the plea agreement and civil
settlement and release that was signed in October 1996 between the Department of
Justice and Damon Clinical Laboratories, a subsidiary of the Company. The
ultimate outcome of the claim cannot be presently predicted. Corning
Incorporated has agreed to indemnify the Company with respect to governmental
claims pending at December 31, 1996 and (to the extent that such claims exceed
$42 million) 50% of the aggregate of all judgments or settlement payments in
respect of private claims, such as the class action, that are settled prior to
January 1, 2001 and that relate to previously settled governmental claims
(subject to a maximum indemnification of $25 million in the aggregate as to
private claims and after taking into account any tax benefits realized by the
Company). At June 30, 1997, the Company had an aggregate reserve of $78.3
million with respect to all governmental and private claims that are either
presently pending or anticipated as a consequence of settlements and
self-reported matters described in the Company's 1996 Annual Report on Form
10-K. The Company believes that these reserves are adequate. See Item 1.
"Business--Government Investigations and Related Claims" contained in the
Company's Annual Report on Form 10-K.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Number Description
-------------- -----------
27 Financial Data Schedule
(b) Reports on Form 8-K:
None
11
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
August 8, 1997
Quest Diagnostics Incorporated
By /s/ Kenneth W. Freeman Chairman of the Board,
---------------------- Chief Executive Officer
Kenneth W. Freeman and President
By /s/ Robert A. Carothers Vice President and
----------------------- Chief Financial Officer
Robert A. Carothers
12
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<ARTICLE> 5
<CIK> 0001022079
<NAME> Quest Diagnostics Incorporated
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 75,834
<SECURITIES> 0
<RECEIVABLES> 287,987
<ALLOWANCES> 108,622
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<SALES> 789,626
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