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, 1998
Commission file number 1-12215
Quest Diagnostics Incorporated
One Malcolm Avenue
Teterboro, NJ 07608
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of April 30, 1998, there were outstanding 30,207,094 shares of Common Stock,
$.01 par value.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Index to consolidated financial statements filed as part of this report:
Page
<S> <C>
Consolidated Statements of Operations for the
Three Months Ended March 31, 1998 and 1997 2
Consolidated Balance Sheets as of
March 31, 1998 and December 31, 1997 3
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1998 and 1997 4
Notes to Consolidated Financial Statements 5
</TABLE>
1
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net revenues.................................................. $367,875 $388,103
Costs and expenses:
Cost of services............................................ 218,040 239,314
Selling, general and administrative......................... 120,446 123,973
Interest expense, net....................................... 9,114 10,613
Amortization of intangible assets........................... 5,380 6,042
Other, net.................................................. 1,225 (256)
-------- --------
Total..................................................... 354,205 379,686
-------- --------
Income before taxes........................................... 13,670 8,417
Income tax expense ........................................... 7,039 4,370
-------- --------
Net income ................................................... $ 6,631 $ 4,047
======== ========
Basic and diluted net income per common share................. $ 0.22 $ 0.14
Basic weighted average common shares outstanding.............. 29,688 28,870
Diluted weighted average common shares outstanding............ 30,007 29,138
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
(in thousands, except per share data)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 172,584 $ 161,661
Accounts receivable, net of allowance of $75,150 and
$89,870 at March 31, 1998 and December 31, 1997,
respectively............................................ 242,646 238,369
Inventories............................................... 29,958 30,360
Deferred taxes on income.................................. 88,108 97,471
Due from Corning Incorporated............................. 31,600 31,600
Prepaid expenses and other assets......................... 16,722 12,423
---------- ----------
Total current assets.................................. 581,618 571,884
Property, plant and equipment, net............................ 247,690 250,223
Intangible assets, net........................................ 508,602 513,779
Other assets.................................................. 65,668 65,042
---------- ----------
TOTAL ASSETS.................................................. $1,403,578 $1,400,928
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 248,290 $ 244,885
Short-term borrowings..................................... 37,654 32,648
Income taxes payable...................................... 13,504 17,613
---------- ----------
Total current liabilities............................. 299,448 295,146
Long-term debt................................................ 469,397 482,161
Other liabilities............................................. 83,274 81,961
---------- ----------
Total liabilities..................................... 852,119 859,268
Commitments and contingencies
Stockholders' equity:
Preferred stock........................................... 1,000 1,000
Common stock, par value $0.01 per share; 100,000 shares
authorized; 30,194 (excluding 3 shares held in
treasury) and 29,986 shares issued at March 31,
1998 and December 31, 1997, respectively ............. 302 300
Additional paid-in capital................................ 1,201,532 1,198,194
Accumulated deficit....................................... (643,679) (650,281)
Accumulated other comprehensive loss...................... (2,059) (2,515)
Unearned compensation..................................... (5,637) (5,038)
---------- ----------
Total stockholders' equity............................ 551,459 541,660
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................... $1,403,578 $1,400,928
========== ==========
</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, 1998 AND 1997
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................... $ 6,631 $ 4,047
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization............................. 17,321 19,563
Provision for doubtful accounts........................... 23,830 29,077
Deferred income tax provision............................. 9,348 8,183
Other, net................................................ 1,911 1,086
Changes in operating assets and liabilities:
Accounts receivable................................... (28,107) (22,762)
Accounts payable and accrued expenses................. 9,401 13,652
Restructuring, integration and other special charges.. (3,670) (3,400)
Due from Corning Incorporated and affiliates.......... -- 8,494
Other assets and liabilities, net..................... (8,058) (7,940)
-------- --------
Net cash provided by operating activities..................... 28,607 50,000
-------- --------
Cash flows from investing activities:
Capital expenditures...................................... (10,012) (5,948)
Proceeds from disposition of assets....................... 238 775
Decrease in investments................................... -- 979
-------- --------
Net cash used in investing activities......................... (9,774) (4,194)
-------- ---------
Cash flows from financing activities:
Repayment of long-term debt............................... (7,836) (552)
Repayments under Working Capital Facility................. -- (19,300)
Purchase of treasury stock................................ (45) --
Preferred stock dividends paid............................ (29) --
-------- --------
Net cash used in financing activities......................... (7,910) (19,852)
-------- --------
Net change in cash and cash equivalents....................... 10,923 25,954
Cash and cash equivalents, beginning of year.................. 161,661 41,960
-------- --------
Cash and cash equivalents, end of period...................... $172,584 $ 67,914
======== ========
Cash paid during the period for:
Interest.................................................. $ 6,974 $ 6,753
Income taxes.............................................. $ 2,386 $ 1,963
</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,
1997.
Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This statement
establishes standards for the reporting and display of comprehensive income and
its components in the financial statements. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions with
stockholders) and includes net income, net unrealized capital gains or losses on
available-for-sale securities and foreign currency translation adjustments.
Comprehensive income was $7.1 million and $4.3 million for the three months
ended March 31, 1998 and 1997, respectively.
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.
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, a clinical laboratory company acquired in 1994,
and a former joint venture of Damon Corporation, a clinical laboratory acquired
in 1993, are 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 December
31, 1996; 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. At March 31, 1998, the
receivable from Corning totaled $31.6 million, representing 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, 1998, settlement reserves totaled $75.9 million, including
$27.5 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.
In April 1998, the Company entered into a settlement agreement with the U.S.
Attorney's office in Baltimore approximating $6.9 million related to the billing
on certain tests performed for which the Company had incomplete or missing order
forms from the physician. This settlement is covered by the indemnification from
Corning discussed above and was fully reserved for at March 31, 1998.
3. RESTRUCTURING RESERVES
The Company has recorded charges for restructuring plans in previous years.
Reserves relating to these programs totaled $29.8 million and $33.4 million at
March 31, 1998 and December 31, 1997, 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. STOCKHOLDERS' EQUITY
Stock Purchase Program
In February 1998, the Board of Directors authorized the Company to
repurchase up to $27 million of common stock through 1999. The shares will be
reissued in connection with certain employee plans. In the first quarter, the
Company paid $45 for approximately three thousand shares under the program.
Unearned Compensation
Under the Company's Employees Equity Participation Program, approximately
300 thousand shares of restricted stock were granted in 1998, 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.
5. 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"). The non-guarantor subsidiaries are foreign and less
than wholly-owned subsidiaries.
The following condensed consolidating financial data illustrates the
composition of the combined guarantors. The Company believes that separate
complete financial statements of the respective guarantors would not provide
additional material information which would be useful in assessing the financial
composition of the Subsidiary Guarantors.
6
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 1998
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues........................ $ 154,208 $ 206,834 $ 6,833 $ -- $ 367,875
Costs and expenses:
Cost of services.................. 91,387 122,900 3,753 -- 218,040
Selling, general and
administrative.................... 67,003 50,922 2,521 -- 120,446
Interest expense, net............. 2,619 6,341 154 -- 9,114
Amortization of intangible assets. 1,696 3,562 122 -- 5,380
Royalty (income) expense.......... (18,405) 18,405 -- -- --
Other, net........................ 163 2 1,060 -- 1,225
--------- --------- --------- --------- ---------
Total........................... 144,463 202,132 7,610 -- 354,205
--------- --------- --------- --------- ---------
Income (loss) before taxes.......... 9,745 4,702 (777) -- 13,670
Income tax expense (benefit)........ 6,659 469 (89) -- 7,039
Equity income from affiliates....... 3,545 -- -- (3,545) --
--------- --------- --------- --------- ---------
Net income (loss)................... $ 6,631 $ 4,233 $ (688) $ (3,545) $ 6,631
========= ========= ========= ========= =========
</TABLE>
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 1997
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues........................ $ 168,066 $ 214,557 $ 5,480 $ -- $ 388,103
Costs and expenses:
Cost of services.................. 99,772 136,664 2,878 -- 239,314
Selling, general and
administrative.................... 69,233 52,360 2,380 -- 123,973
Interest expense, net............. 4,198 6,266 149 -- 10,613
Amortization of intangible assets. 2,230 3,810 2 -- 6,042
Royalty (income) expense.......... (17,945) 17,945 -- -- --
Other, net........................ (596) (113) 453 -- (256)
--------- --------- --------- --------- ---------
Total........................... 156,892 216,932 5,862 -- 379,686
--------- --------- --------- --------- ---------
Income (loss) before taxes.......... 11,174 (2,375) (382) -- 8,417
Income tax expense (benefit)........ 6,105 (1,963) 228 -- 4,370
Equity loss from affiliates......... (1,022) -- -- 1,022 --
--------- --------- --------- --------- ---------
Net income (loss)................... $ 4,047 $ (412) $ (610) $ 1,022 $ 4,047
========= ========= ========= ========= =========
</TABLE>
7
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Balance Sheet
March 31, 1998
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ -------------------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents........... $ 123,385 $ 47,135 $ 2,064 $ -- $ 172,584
Accounts receivable, net............ 77,076 161,592 3,978 -- 242,646
Other current assets................ 114,969 49,193 2,226 -- 166,388
---------- -------- --------- --------- ----------
Total current assets.............. 315,430 257,920 8,268 -- 581,618
Property, plant and equipment, net.. 100,007 143,739 3,944 -- 247,690
Intangible assets, net ............. 155,671 352,616 315 -- 508,602
Intercompany (payable) receivable... 11,817 382 (12,199) -- --
Investment in subsidiaries.......... 414,327 -- -- (414,327) --
Other assets........................ 40,663 10,423 14,582 -- 65,668
---------- -------- --------- --------- ----------
Total assets...................... $1,037,915 $765,080 $ 14,910 $(414,327) $1,403,578
========== ======== ========= ========= ==========
Current liabilities:
Accounts payable and accrued
expenses............................ $ 184,470 $ 74,876 $ 2,448 $ -- $ 261,794
Short-term borrowings............... 17,983 19,305 366 -- 37,654
---------- -------- --------- --------- ----------
Total current liabilities......... 202,453 94,181 2,814 -- 299,448
Long-term debt...................... 219,321 245,664 4,412 -- 469,397
Other liabilities................... 64,682 16,589 2,003 -- 83,274
---------- -------- --------- --------- ----------
Total liabilities................... 486,456 356,434 9,229 -- 852,119
Stockholders' equity................ 551,459 408,646 5,681 (414,327) 551,459
---------- -------- --------- --------- ----------
Total liabilities and
stockholders' equity............ $1,037,915 $765,080 $ 14,910 $(414,327) $1,403,578
========== ======== ========= ========= ==========
</TABLE>
Condensed Consolidating Balance Sheet
December 31, 1997
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents........... $ 123,052 $ 35,527 $ 3,082 $ -- $ 161,661
Accounts receivable, net............ 87,231 148,618 2,520 -- 238,369
Other current assets................ 119,751 48,865 3,238 -- 171,854
---------- --------- --------- --------- ----------
Total current assets.............. 330,034 233,010 8,840 -- 571,884
Property, plant and equipment, net.. 101,700 144,849 3,674 -- 250,223
Intangible assets, net ............. 165,068 348,391 320 -- 513,779
Intercompany (payable) receivable... (14,134) 24,103 (9,969) -- --
Investment in subsidiaries.......... 412,413 -- -- (412,413) --
Other assets........................ 40,474 9,290 15,278 -- 65,042
---------- --------- --------- --------- ----------
Total assets...................... $1,035,555 $ 759,643 $ 18,143 $(412,413) $1,400,928
========== ========= ========= ========= ==========
Current liabilities:
Accounts payable and accrued
expenses............................ $ 188,966 $ 70,542 $ 2,990 $ -- $ 262,498
Short-term borrowings............... 15,688 16,640 320 -- 32,648
---------- --------- --------- --------- ----------
Total current liabilities......... 204,654 87,182 3,310 -- 295,146
Long-term debt...................... 225,145 252,480 4,536 -- 482,161
Other liabilities................... 64,096 15,568 2,297 -- 81,961
---------- --------- --------- --------- ----------
Total liabilities................. 493,895 355,230 10,143 -- 859,268
Stockholders' equity................ 541,660 404,413 8,000 (412,413) 541,660
---------- --------- --------- --------- ----------
Total liabilities and
stockholders' equity............ $1,035,555 $ 759,643 $ 18,143 $(412,413) $1,400,928
========== ========= ========= ========= ==========
</TABLE>
8
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, unless otherwise indicated)
(unaudited)
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 1998
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................... $ 6,631 $ 4,233 $ (688) $ (3,545) $ 6,631
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization....... 7,290 9,652 379 -- 17,321
Provision for doubtful accounts..... 13,609 10,035 186 -- 23,830
Other, net.......................... 10,578 124 557 -- 11,259
Changes in operating assets and
liabilities........................... (26,637) (4,071) (1,358) 1,632 (30,434)
--------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities.................. 11,471 19,973 (924) (1,913) 28,607
Net cash used in investing activities. (7,448) (4,218) (21) 1,913 (9,774)
Net cash used in financing activities. (3,690) (4,147) (73) -- (7,910)
--------- --------- --------- --------- ---------
Net change in cash and cash
equivalents........................... 333 11,608 (1,018) -- 10,923
Cash and cash equivalents, beginning
of year............................... 123,052 35,527 3,082 -- 161,661
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of
period................................ $ 123,385 $ 47,135 $ 2,064 $ -- $ 172,584
========= ========= ========= ========= =========
</TABLE>
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 1997
<TABLE>
<CAPTION>
Non-
Subsidiary Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................... $ 4,047 $ (412) $ (610) $ 1,022 $ 4,047
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization....... 8,817 10,293 453 -- 19,563
Provision for doubtful accounts..... 16,108 12,814 155 -- 29,077
Other, net.......................... 12,957 (5,095) 1,407 -- 9,269
Changes in operating assets and
liabilities........................... (8,139) (4,252) (271) 706 (11,956)
--------- --------- --------- --------- ---------
Net cash provided by operating
activities............................ 33,790 13,348 1,134 1,728 50,000
Net cash provided by (used in)
investing activities.................. 414 (1,935) (945) (1,728) (4,194)
Net cash used in financing activities. (11,300) (8,131) (421) -- (19,852)
--------- --------- --------- --------- ---------
Net change in cash and cash
equivalents........................... 22,904 3,282 (232) -- 25,954
Cash and cash equivalents, beginning
of year............................... 26,975 12,882 2,103 -- 41,960
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of
period................................ $ 49,879 $ 16,164 $ 1,871 $ -- $ 67,914
========= ========= ========= ========= =========
</TABLE>
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Three Months Ended March 31, 1998 Compared with Three Months Ended March 31,
1997. Net income for the three months ended March 31, 1998 increased from the
prior year primarily as a result of operating cost reductions and improved
pricing. This was partially offset by lower volume resulting from intensified
competition, changes in physician ordering patterns and actions taken on
unprofitable accounts. 1998 net income includes a $2.5 million charge ($1.2
million, net of tax) included in selling, general and administrative expenses
representing the final costs associated with the Company's consolidation plan
announced in December 1997.
Effective April 1, 1998, the Company implemented a new order form for
Medicare and Medicaid patients reflecting disease-oriented test panels developed
by the Health Care Financing Administration in conjunction with the American
Medical Association. These panels are likely to result in fewer tests ordered
per requisition and may put additional pressure on revenue and earnings.
Net Revenues
Net revenues decreased by $20.2 million, or 5.2% from the prior year level,
principally due to an 8.1% decline in clinical testing volume partially offset
by an improvement in average prices of 3.1%. The volume decline is primarily
attributable to intensified competition, changes in physician ordering patterns
and actions taken on unprofitable accounts.
Costs and Expenses
Total operating costs for the quarter declined $24.8 million from the year
earlier period. The Company's continued efforts to reduce its cost structure
have had a favorable impact on costs as a percentage of net revenue. However,
this benefit was partially offset by a $2.5 million charge representing the
final costs associated with the Company's consolidation plan announced in
December 1997. Additional actions are being taken to further reduce the
Company's cost structure. *
Cost of services, which includes the costs of obtaining, transporting and
testing specimens, decreased $21.3 million from the prior year, and as a
percentage of net revenues decreased to 59.3% from 61.7% a year ago, reflecting
the Company's progress in reducing its cost structure. Selling, general and
administrative expenses, which includes the costs of the sales force, billing
operations, bad debt expense and general management and administrative support,
increased as a percentage of net revenues to 32.7% from 31.9% in the prior year.
This increase was principally due to the $2.5 million charge related to the
Company's consolidation of its laboratory network, an increase in information
technology expenditures primarily related to preparation for the Year 2000 and
reduced revenues partially offset by a reduction in bad debt expense from 7.5%
of net revenues in the prior year to 6.5% of net revenues in the current year.
- --------------
* 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 failure
of third party payors and suppliers to adequately address the Year 2000 problem.
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 1997 Annual Report on Form 10-K.
10
<PAGE>
Net interest expense decreased by $1.5 million from the prior year level
primarily due to an increase in interest income resulting from higher average
cash balances.
Amortization of intangible assets decreased by $0.7 million compared to the
prior year principally due to the write-down of intangible assets in the fourth
quarter of 1997 in connection with the Company's consolidation plan.
The change in other, net 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 equity losses from a joint venture.
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.
Liquidity and Capital Resources
Cash increased by $10.9 million over the year end balance, to $172.6 million
at March 31, 1998, due to operating activities which provided cash of $28.6
million, partially offset by investing and financing activities which used cash
of $17.7 million. Net cash provided by operating activities for the quarter
declined by $21.4 million compared to the same period in the prior year. The
decline is primarily the result of changes in accounts receivable, accounts
payable and accrued expenses and 1997 including $8.5 million received from
Corning related to the final spin-off cash adjustment. The number of days sales
outstanding, a measure of billing and collection efficiency, declined to 58 days
from 63 days at year end and 68 days a year earlier.
Capital spending for the quarter was $10.0 million compared to $5.9 million
for the same period in the prior year. The Company estimates that it will invest
approximately $60 million to $70 million during 1998 for capital expenditures,
principally related to investments in information technology infrastructure and
equipment and facility upgrades. *
During the quarter the Company paid down $7.8 million of debt. Other than
for the reduction for outstanding letters of credit, which currently approximate
$6.4 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, 1998 was $40.1 million, or 10.9% of net revenues, compared to
$38.6 million, or 9.9% of net revenues, in the prior year period. The
improvement reflects the Company's continued progress in reducing its cost
structure.
- --------------
* 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 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
1997 Annual Report on Form 10-K.
11
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In its 1997 Annual Report on Form 10-K, the Company reported that it had
reached a tentative settlement of an investigation commenced by the Office of
the Inspector General of the Department of Health and Human Services (see Item
1. "Business-Ongoing Government Investigations-Other Government Investigations"
contained in the Company's Annual Report on Form 10-K). The settlement agreement
was completed April 13, 1998 and the total amount paid in the settlement was
$6.9 million. This settlement is covered by the indemnification from Corning
Incorporated as described in the Company's Annual Report on Form 10-K (see Item
1. "Business-Corning Indemnity" contained in the Company's Annual Report on Form
10-K) and was fully reserved for at March 31, 1998.
There have been no material developments in any other of the government
investigations or private claims reported.
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
12
<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 8, 1998
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
13
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