SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 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)
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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 April 30, 1997, there were outstanding 29,495,755 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 Months Ended March 31, 1997 and 1996 2
Consolidated Balance Sheets as of
March 31, 1997 and December 31, 1996 3
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1997 and 1996 4
Notes to Consolidated Financial Statements 5
1
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(in thousands, except per share data)
(unaudited)
1997 1996
-------- --------
Net revenues ....................................... $388,103 $401,395
Costs and expenses:
Cost of services............................... 239,314 247,118
Selling, general and administrative ........... 123,973 126,044
Interest expense, net ......................... 10,613 20,142
Amortization of intangible assets ............. 6,042 10,789
Other, net .................................... (256) (1,056)
-------- --------
Total ....................................... 379,686 403,037
-------- --------
Income (loss) before taxes.......................... 8,417 (1,642)
Income tax expense (benefit)........................ 4,370 (131)
-------- --------
Net income (loss)................................... $ 4,047 $ (1,511)
======== ========
Net income per common share......................... $ 0.14
Weighted average common shares outstanding.......... 28,870
The accompanying notes are an integral part of these statements.
2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1997 AND DECEMBER 31, 1996
(in thousands, except per share data)
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
----------- -------------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents ....................................................... $ 67,914 $ 41,960
Accounts receivable, net of allowance of $110,979 and
$115,018 at March 31, 1997 and December 31, 1996, respectively............... 291,427 297,743
Inventories ..................................................................... 28,604 28,524
Deferred taxes on income ........................................................ 90,209 98,162
Due from Corning Incorporated.................................................... 22,400 30,894
Prepaid expenses and other assets ............................................... 15,957 13,682
----------- -----------
Total current assets ........................................................ 516,511 510,965
Property, plant and equipment, net ................................................... 279,168 287,749
Intangible assets, net ............................................................... 540,421 546,457
Other assets.......................................................................... 49,453 49,895
----------- -----------
TOTAL ASSETS.......................................................................... $1,385,553 $1,395,066
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses............................................ $ 214,716 $ 206,701
Short-term borrowings............................................................ 8,827 20,785
Income taxes payable ............................................................ 16,514 21,946
----------- -----------
Total current liabilities.................................................... 240,057 249,432
Long-term debt........................................................................ 506,912 515,008
Other liabilities..................................................................... 92,149 91,907
----------- -----------
Total liabilities............................................................ 839,118 856,347
----------- -----------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock.................................................................. 1,000 1,000
Common stock, par value $0.01 per share; 100,000 shares authorized;
29,363 and 28,822 shares issued at March 31, 1997
and December 31, 1996, respectively.......................................... 294 288
Additional paid-in capital....................................................... 1,178,675 1,170,152
Accumulated deficit.............................................................. (623,886) (627,892)
Cumulative translation adjustment ............................................... (804) (619)
Market valuation adjustment...................................................... (3,796) (4,210)
Unearned compensation............................................................ (5,048) --
----------- -----------
Total stockholders' equity................................................... 546,435 538,719
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........................................... $1,385,553 $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 THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
1997 1996
-------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................................................... $ 4,047 $ (1,511)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization ................................................... 19,563 24,949
Provision for doubtful accounts ................................................. 29,077 27,784
Deferred income tax provision.................................................... 8,183 8,261
Other, net....................................................................... 1,086 1,288
Changes in operating assets and liabilities:
Accounts receivable ......................................................... (22,762) (34,045)
Accounts payable and accrued expenses ....................................... 13,652 (23,775)
Restructuring, integration and other special charges ........................ (3,400) (13,398)
Due from/to Corning Incorporated and affiliates ............................. 8,494 5,546
Other assets and liabilities, net............................................ (7,940) (4,091)
--------- --------
Net cash provided by (used in) operating activities................................... 50,000 (8,992)
--------- --------
Cash flows from investing activities:
Capital expenditures ............................................................ (5,948) (19,975)
Proceeds from disposition of assets ............................................. 775 6,081
Decrease (increase) in investments .............................................. 979 (1,849)
--------- --------
Net cash used in investing activities ................................................ (4,194) (15,743)
--------- --------
Cash flows from financing activities:
Repayments under Working Capital Facility........................................ (19,300) --
Proceeds from borrowings......................................................... -- 34,576
Repayment of long-term debt ..................................................... (552) (1,457)
--------- --------
Net cash (used in) provided by financing activities .................................. (19,852) 33,119
--------- --------
Net change in cash and cash equivalents .............................................. 25,954 8,384
Cash and cash equivalents, beginning of year ......................................... 41,960 36,446
--------- --------
Cash and cash equivalents, end of period.............................................. $ 67,914 $ 44,830
========= ========
Cash paid during the period for:
Interest......................................................................... $ 6,753 $ 22,616
Income taxes..................................................................... $ 1,963 $ 2,125
</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 period 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) 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 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 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 which are
probable of being 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 March 31, 1997, settlement reserves totaled $79.7 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 $13.8 million and $16.1 million at
March 31, 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 March 31, 1997 and
December 31, 1996 and for the three months ended March 31, 1997 and 1996. Full
financial statements of the Subsidiary Guarantors are not presented because
management believes they are not material to investors.
March 31, 1997 December 31, 1996
-------------- -----------------
Current assets................... $229,207 $230,024
Noncurrent assets................ 550,548 547,219
Current liabilities.............. 66,766 61,383
Noncurrent liabilities........... 288,521 290,980
Stockholder's equity............. 424,468 424,880
For the three months ended March 31,
1997 1996
-------- --------
Net revenues..................... $214,557 $224,214
Cost of services................. 136,664 143,311
Net loss......................... (412) (10,047)
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
Three Months Ended March 31, 1997 Compared with Three Months Ended March
31, 1996. Net income for the three months ended March 31, 1997 increased from
the prior year primarily as a result of reduced interest and amortization
expense. This was partially offset by reduced operating income due to the
Company's increased selectiveness in retaining and pursuing new business, which
has reduced volume at a rate greater than that at which costs have been reduced,
and an increase in bad debt expense.
Net Revenues
Net revenues decreased by $13.3 million, or 3.3% from the prior year level,
principally due to a 5.1% decline in clinical testing volume partially offset by
an improvement in average prices of 1.6%. The volume decline is primarily
attributable to the Company's increased selectiveness in retaining and pursuing
new business, as well as exiting certain small non-strategic businesses.
Costs and Expenses
Total operating costs for the quarter declined $9.9 million from the year
earlier period. 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. Plans are currently being implemented
which are expected to further adjust the Company's cost structure and are
expected to reduce costs as a percentage of revenue in the second half of the
year.*
Cost of services, which includes the costs of obtaining, transporting and
testing specimens, decreased $7.8 million in the quarter from the prior year,
but remained relatively flat as a percentage of net revenues. Selling, general
and administrative expenses, which includes the costs of the sales force,
billing operations, bad debt expense and general management and administrative
support, decreased $2.1 million in the quarter from the prior year, but
increased to 31.9% of net revenues from 31.4% of net revenues in the prior year.
This increase was principally due to bad debt expense which increased from 6.9%
of net revenues to 7.5% of net revenues. Bad debt expense as a percentage of net
revenues remained at approximately the same level as the fourth quarter of 1996.
The Company continues to be impacted by Medicare medical necessity documentation
requirements imposed during the past year. In the first quarter 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 by $9.5 million from the prior year level
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 by $4.7 million compared to the
prior year 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.
- ----------
*This is a forward looking statement and is based on current expectations.
Forward looking statements involve risks and uncertainties that could cause the
outcome to be materially different. These risks and uncertainties include
heightened competition, impact of changes in payor mix, the impact upon the
Company's collection rates or general and administrative 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>
The change in other, net compared with the prior year is primarily the
result of the favorable settlement of a contractual obligation in the prior
year.
The Company's effective tax rate is significantly impacted by goodwill
amortization 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 $26.0 million over the year end balance, to $67.9 million
at March 31, 1997, due to operating activities which provided cash of $50.0
million, partially offset by investing and financing activities which used cash
of $24.0 million. Net cash provided by operating activities for the quarter
improved by $59.0 million compared to the same period in the prior year. The
improvement is primarily the result of improvements in the billing operations,
changes in accounts payable and accrued expense levels 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 efficiency, was 68 days at March 31, 1997
compared to 70 days at year end and 73 days a year earlier.
Capital spending for the quarter was $5.9 million compared to $20.0 million
for the same period in the prior year. The Company estimates that it will invest
approximately $60 million during 1997 for capital expenditures, principally
related to equipment and facility upgrades and investments in information
technology.*
During the 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 approximates $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 March 31, 1997 was $38.6 million, or 9.9% of net revenues, compared to
$43.5 million, or 10.8% of net revenues, in the prior year period. The decline
was principally due to the Company's increased selectiveness in retaining and
pursuing new business, which has reduced volume at a rate greater than that at
which costs have been reduced, and an increase in bad debt expense.
- ----------
*This is a forward looking statement and is based on current expectations.
Forward looking statements involve risks and uncertainties that could cause the
outcome to be materially different. 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
collection rates or general and administrative 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.
9
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company, together with SmithKline Beecham Clinical Laboratories Inc.
and Laboratory Corporation of America Holdings, has been served with a complaint
in a purported class action brought in the Northern District of Alabama. The
complaint asserts claims for 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.
At March 31, 1997, the Company had an aggregate reserve of $79.7 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. In addition, 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). 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
10
<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.
May 9, 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
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