<PAGE>
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 June 30, 1999
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 July 30, 1999, there were outstanding 30,430,689 shares of Common Stock,
$.01 par value.
<PAGE>
PART I - FINANCIAL INFORMATION
<TABLE>
<S> <C>
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, 1999 and 1998 2
Consolidated Balance Sheets as of
June 30, 1999 and December 31, 1998 3
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 4
Notes to Consolidated Financial Statements 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations"
</TABLE>
1
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------- -------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET REVENUES....................................... $ 394,034 $ 366,739 $ 775,875 $ 734,614
COSTS AND EXPENSES:
Cost of services................................ 225,659 217,806 452,654 435,846
Selling, general and administrative............. 131,642 116,133 258,655 236,579
Interest expense, net........................... 5,008 9,036 12,367 18,150
Amortization of intangible assets............... 5,219 5,366 10,313 10,746
Other, net...................................... 1,999 139 3,301 1,364
----------- ----------- ----------- -----------
Total......................................... 369,527 348,480 737,290 702,685
----------- ----------- ----------- -----------
INCOME BEFORE TAXES................................ 24,507 18,259 38,585 31,929
INCOME TAX EXPENSE ................................ 11,420 9,405 18,065 16,444
----------- ----------- ----------- -----------
NET INCOME ........................................ $ 13,087 $ 8,854 $ 20,520 $ 15,485
=========== =========== =========== ===========
Basic net income per common share.................. $ 0.44 $ 0.30 $ 0.69 $ 0.52
Diluted net income per common share................ $ 0.43 $ 0.29 $ 0.67 $ 0.51
Basic weighted average common shares outstanding... 29,920 29,783 29,819 29,736
Diluted weighted average common shares outstanding. 30,729 30,579 30,505 30,290
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 AND DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................. $ 148,478 $ 202,908
Accounts receivable, net of allowance of $68,766 and $70,701
at June 30, 1999 and December 31, 1998, respectively.............. 224,920 220,861
Inventories........................................................... 32,923 31,164
Deferred taxes on income.............................................. 92,521 94,441
Due from Corning Incorporated......................................... 14,015 16,000
Prepaid expenses and other assets..................................... 14,950 12,813
------------ ------------
Total current assets.............................................. 527,807 578,187
PROPERTY, PLANT AND EQUIPMENT, NET......................................... 243,107 240,389
INTANGIBLE ASSETS, NET..................................................... 482,813 494,721
OTHER ASSETS............................................................... 59,080 46,943
------------ ------------
TOTAL ASSETS............................................................... $ 1,312,807 $ 1,360,240
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses................................. $ 239,224 $ 242,285
Current portion of long-term debt..................................... 61,452 51,444
Income taxes payable.................................................. 12,679 15,736
------------ ------------
Total current liabilities......................................... 313,355 309,465
LONG-TERM DEBT............................................................. 338,391 413,426
OTHER LIABILITIES.......................................................... 63,243 69,419
COMMITMENTS AND CONTINGENCIES
PREFERRED STOCK............................................................ 1,000 1,000
COMMON STOCKHOLDERS' EQUITY:
Common stock, par value $0.01 per share; 100,000 shares authorized;
30,359 and 30,241 shares issued at June 30, 1999
and December 31, 1998, respectively........................................ 304 302
Additional paid-in capital............................................ 1,201,883 1,201,006
Accumulated deficit................................................... (603,051) (623,514)
Unearned compensation................................................. (2,751) (3,895)
Accumulated other comprehensive income (loss)......................... 433 (3,038)
Common stock in treasury, at cost; 214 shares at
December 31, 1998................................................. -- (3,931)
------------ ------------
Total common stockholders' equity................................. 596,818 566,930
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 1,312,807 $ 1,360,240
============ ============
</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, 1999 AND 1998
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................. $ 20,520 $ 15,485
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization......................................... 33,146 34,497
Provision for doubtful accounts....................................... 40,242 44,999
Deferred income tax provision......................................... 6,300 13,096
Other, net............................................................ 4,636 3,735
Changes in operating assets and liabilities:
Accounts receivable............................................... (44,481) (49,868)
Accounts payable and accrued expenses............................. 8,042 2,791
Restructuring, integration and other special charges.............. (9,775) (15,719)
Due from Corning Incorporated and affiliates...................... -- 5,815
Other assets and liabilities, net................................. (6,024) (13,645)
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES.................................. 52,606 41,186
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................................. (25,938) (19,457)
Transaction costs..................................................... (5,176) --
Proceeds from disposition of assets................................... 848 460
Increase in investments............................................... (5,687) (482)
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES...................................... (35,953) (19,479)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt........................................... (64,991) (25,730)
Financing costs paid.................................................. (4,947) --
Purchase of treasury stock............................................ (1,103) (4,994)
Distributions to minority partners.................................... (975) --
Dividends paid........................................................ (58) (58)
Exercise of stock options............................................. 991 100
---------- ----------
NET CASH USED IN FINANCING ACTIVITIES...................................... (71,083) (30,682)
---------- ----------
NET CHANGE IN CASH AND CASH EQUIVALENTS.................................... (54,430) (8,975)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................... 202,908 161,661
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................... $ 148,478 $ 152,686
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest.............................................................. $ 19,259 $ 21,960
Income taxes.......................................................... $ 11,148 $ 11,699
</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" or "Quest Diagnostics") 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 be 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,
1998.
COMPREHENSIVE INCOME
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 $24.0
million and $15.8 million for the six months ended June 30, 1999 and 1998,
respectively. Comprehensive income was $15.2 million and $8.7 million for the
quarter ended June 30, 1999 and 1998, respectively.
EARNINGS PER SHARE
Basic net income per common share is calculated by dividing net income,
less preferred stock dividends (approximately $30 per quarter), by the weighted
average number of common shares outstanding. Diluted net income per common share
is calculated by dividing net income, less preferred stock dividends, by the
weighted average number of common shares outstanding after giving effect to all
potentially dilutive common shares outstanding during the period. Potentially
dilutive common shares include outstanding stock options and restricted common
shares granted under the Company's Employee Equity Participation Program.
5
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
2. ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS
On February 9, 1999, the Company signed a definitive agreement to acquire
the clinical laboratory business of SmithKline Beecham plc ("SmithKline
Beecham") for approximately $1.3 billion. The purchase price will be paid
through the issuance of approximately 12.6 million shares of common stock of
Quest Diagnostics and the payment of $1.025 billion of cash. The acquisition
will be accounted for under the purchase method of accounting. Quest Diagnostics
expects to close the transaction in August 1999. As a result, SmithKline Beecham
will own approximately 29.5% of Quest Diagnostics' outstanding common stock.
Under the terms of a stockholder agreement, SmithKline Beecham will initially
have the right to designate two nominees to Quest Diagnostics' Board of
Directors as long as SmithKline Beecham owns at least 20% of the outstanding
common stock. (As long as SmithKline Beecham owns at least 10% but less than 20%
of the outstanding common stock, it will have the right to designate one
nominee.) Quest Diagnostics' Board of Directors will expand to nine directors
immediately following the close. The stockholder agreement will also impose
limitations on the right of SmithKline Beecham to sell or vote its shares and
prohibit SmithKline Beecham from purchasing in excess of 29.5% of the
outstanding common stock of Quest Diagnostics. The transaction was approved by
Quest Diagnostics' shareholders on June 29, 1999.
In conjunction with this transaction, the Board of Directors of Quest
Diagnostics approved an amendment to the preferred share purchase rights of the
Quest Diagnostics common stock. Under the amendment, stockholders would not have
the right to purchase shares of common stock at a predefined price as a result
of SmithKline Beecham owning the shares of common stock to be issued in the
transaction or SmithKline Beecham's purchase of additional shares provided that
SmithKline Beecham does not own more than 29.5% of the Company's outstanding
common stock.
3. COMMITMENTS AND CONTINGENCIES
The Company has entered into several settlement agreements with various
governmental and private payers during recent years relating primarily to
industry-wide billing and marketing practices that had been substantially
discontinued by early 1993. At present, government investigations of certain
practices by Nichols Institute, a clinical laboratory company acquired in 1994,
are ongoing. The Company has received notices of private claims relating to
billing issues similar to those that were the subject of prior settlements with
various governmental payers. In March 1997, a former subsidiary of Damon
Corporation ("Damon"), an independent clinical laboratory acquired by Corning
and contributed to Quest Diagnostics in 1993, was served a complaint in a
purported class action. The complaint asserts claims relating to private
reimbursement of billings by Damon that are similar to those that were part of a
prior government settlement. While the ultimate outcome of these claims cannot
be predicted, based on information currently available to the Company,
management does not believe that exposure related to these claims or the
remaining government investigations in excess of recorded reserves is material.
Corning has agreed to indemnify the Company against all monetary
settlements for any governmental claims relating to the billing practices of the
Company and its predecessors based on investigations that were pending on
December 31, 1996. Corning also agreed to indemnify the Company in respect of
private claims relating to indemnified or previously settled government claims
that alleged overbillings by Quest Diagnostics or any of its existing
subsidiaries for services provided before January 1, 1997. Corning will
indemnify Quest Diagnostics in respect of private claims for 50% of the
aggregate of all judgment or settlement payments made by December 31, 2001 that
exceed $42 million. The 50% share will be limited to
6
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
a total amount of $25 million and will be reduced to take into account any
deductions or tax benefits realized by Quest Diagnostics. At June 30, 1999, the
receivable from Corning totaled $14 million, which is 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.
At June 30, 1999, recorded reserves approximated $49.8 million, including
$18.8 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 (such as the indication
by the government of criminal activity, additional tests being questioned or
other changes in the government's or private claimants' theories of wrongdoing)
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 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 for approximately $6.9 million related to
the billing of certain tests performed for which the Company had incomplete or
missing order forms from the physician. The occurrence of this practice was
relatively rare and was engaged in primarily to preserve the integrity of test
results from specimens subject to rapid deterioration. This settlement is
covered by the indemnification from Corning discussed above and was fully
reserved for.
4. RESTRUCTURING RESERVES
The Company has recorded charges for restructuring plans in previous years.
Reserves relating to these programs totaled $9.1 million and $13.6 million at
June 30, 1999 and December 31, 1998, 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.
5. COMMON STOCKHOLDERS' EQUITY
COMMON STOCK PURCHASE PROGRAM
During February 1998, Quest Diagnostics' Board of Directors authorized a
limited share purchase program which permits the Company to purchase up to $27
million of its outstanding common stock through 1999. Shares purchased under the
program are expected to be reissued in connection with certain employee benefit
plans. Cumulative purchases under the program through June 30, 1999 total $14.1
million. The Company suspended purchases of its shares when it reached a
preliminary understanding of the transaction with SmithKline Beecham on January
15, 1999.
UNEARNED COMPENSATION
Under the Company's Employee Equity Participation Program, approximately
300 thousand shares of restricted stock were granted in 1998, primarily to
executive employees. These shares were earned on achievement of financial
performance goals and are subject to forfeiture if employment terminates prior
to the end of the prescribed vesting period, which ranges primarily from three
to four years. The market value of the shares awarded under the plan is recorded
as unearned compensation and is amortized to compensation expense over the
prescribed vesting period. Due to change in control provisions included in the
restricted stock grant agreements, the remaining restricted shares will
immediately vest upon the close of the transaction with SmithKline Beecham.
7
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
6. SUMMARIZED FINANCIAL INFORMATION
The Company's 10 3/4% 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.
8
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues................................ $ 316,205 $ 415,899 $ 43,771 $ -- $ 775,875
Costs and expenses:
Cost of services......................... 195,665 231,908 25,081 -- 452,654
Selling, general and administrative...... 125,820 116,790 16,045 -- 258,655
Interest expense, net.................... 2,543 9,387 437 -- 12,367
Amortization of intangible assets........ 3,821 6,292 200 -- 10,313
Royalty (income) expense................. (35,480) 35,480 -- -- --
Other, net............................... (372) 49 3,624 -- 3,301
----------- ----------- ----------- ----------- -----------
Total.................................. 291,997 399,906 45,387 -- 737,290
----------- ----------- ----------- ----------- -----------
Income (loss) before taxes.................. 24,208 15,993 (1,616) -- 38,585
Income tax expense.......................... 8,634 8,961 470 -- 18,065
Equity income from affiliates............... 4,946 -- -- (4,946) --
----------- ----------- ----------- ----------- -----------
Net income (loss)........................... $ 20,520 $ 7,032 $ (2,086) $ (4,946) $ 20,520
=========== =========== =========== =========== ===========
<CAPTION>
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues................................ $ 304,085 $ 416,555 $ 13,974 $ -- $ 734,614
Costs and expenses:
Cost of services......................... 178,800 249,761 7,285 -- 435,846
Selling, general and administrative...... 131,025 99,904 5,650 -- 236,579
Interest expense, net.................... 5,307 12,549 294 -- 18,150
Amortization of intangible assets........ 3,385 7,153 208 -- 10,746
Royalty (income) expense................. (36,987) 36,987 -- -- --
Other, net............................... (317) 7 1,674 -- 1,364
----------- ----------- ----------- ----------- -----------
Total.................................. 281,213 406,361 15,111 -- 702,685
----------- ----------- ----------- ----------- -----------
Income (loss) before taxes.................. 22,872 10,194 (1,137) -- 31,929
Income tax expense.......................... 15,553 886 5 -- 16,444
Equity income from subsidiaries............. 8,166 -- -- (8,166) --
----------- ----------- ----------- ----------- -----------
Net income (loss)........................... $ 15,485 $ 9,308 $ (1,142) $ (8,166) $ 15,485
=========== =========== =========== =========== ===========
</TABLE>
9
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET
JUNE 30, 1999
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................... $ 134,240 $ 9,339 $ 4,899 $ -- $ 148,478
Accounts receivable, net.................... 89,705 123,643 11,572 -- 224,920
Other current assets........................ 80,390 67,121 6,898 -- 154,409
----------- ---------- ----------- ----------- -----------
Total current assets..................... 304,335 200,103 23,369 -- 527,807
Property, plant and equipment, net.......... 104,246 129,114 9,747 -- 243,107
Intangible assets, net ..................... 164,126 318,442 245 -- 482,813
Intercompany (payable) receivable........... (43,664) 60,817 (17,153) -- --
Investment in subsidiaries.................. 418,917 -- -- (418,917) --
Other assets................................ 43,634 3,517 11,929 -- 59,080
----------- ---------- ----------- ----------- -----------
Total assets............................. $ 991,594 $ 711,993 $ 28,137 $ (418,917) $ 1,312,807
=========== ========== =========== =========== ===========
Current liabilities:
Accounts payable and accrued expenses....... $ 162,878 $ 80,486 $ 8,539 $ -- $ 251,903
Current portion of long-term debt........... 28,249 32,604 599 -- 61,452
----------- ---------- ----------- ----------- -----------
Total current liabilities................ 191,127 113,090 9,138 -- 313,355
Long-term debt.............................. 158,267 176,957 3,167 -- 338,391
Other liabilities........................... 44,382 10,659 8,202 -- 63,243
Preferred stock............................. 1,000 -- -- -- 1,000
Common stockholders' equity................. 596,818 411,287 7,630 (418,917) 596,818
----------- ---------- ----------- ----------- -----------
Total liabilities and stockholders'
equity................................. $ 991,594 $ 711,993 $ 28,137 $ (418,917) $ 1,312,807
=========== ========== =========== =========== ===========
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1998
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................... $ 190,606 $ 8,206 $ 4,096 $ -- $ 202,908
Accounts receivable, net.................... 58,956 152,252 9,653 -- 220,861
Other current assets........................ 83,644 65,771 5,003 -- 154,418
----------- ----------- ----------- ----------- -----------
Total current assets..................... 333,206 226,229 18,752 -- 578,187
Property, plant and equipment, net.......... 94,042 137,352 8,995 -- 240,389
Intangible assets, net ..................... 168,781 325,665 275 -- 494,721
Intercompany (payable) receivable........... (35,853) 48,308 (12,455) -- --
Investment in subsidiaries.................. 412,283 -- -- (412,283) --
Other assets................................ 31,470 4,658 10,815 -- 46,943
------------ ----------- ----------- ----------- -----------
Total assets............................. $ 1,003,929 $ 742,212 $ 26,382 $ (412,283) $ 1,360,240
=========== =========== =========== =========== ===========
Current liabilities:
Accounts payable and accrued expenses....... $ 171,206 $ 82,475 $ 4,340 $ -- $ 258,021
Current portion of long-term debt........... 23,654 27,280 510 -- 51,444
----------- ----------- ----------- ----------- -----------
Total current liabilities................ 194,860 109,755 4,850 -- 309,465
Long-term debt.............................. 190,712 214,557 8,157 -- 413,426
Other liabilities........................... 50,427 13,645 5,347 -- 69,419
Preferred stock............................. 1,000 -- -- -- 1,000
Common stockholders' equity................. 566,930 404,255 8,028 (412,283) 566,930
----------- ----------- ----------- ----------- -----------
Total liabilities and stockholders'
equity................................. $ 1,003,929 $ 742,212 $ 26,382 $ (412,283) $ 1,360,240
=========== =========== =========== =========== ===========
</TABLE>
10
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE INDICATED)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................. $ 20,520 $ 7,032 $ (2,086) $ (4,946) $ 20,520
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization.............. 15,479 15,773 1,894 -- 33,146
Provision for doubtful accounts............ 19,319 18,875 2,048 -- 40,242
Other, net................................. 3,817 985 1,188 4,946 10,936
Changes in operating assets and liabilities... (56,532) 448 3,846 -- (52,238)
----------- ----------- ----------- ----------- -----------
Net cash provided by operating activities..... 2,603 43,113 6,890 -- 52,606
Net cash used in investing activities......... (26,008) (9,704) (241) -- (35,953)
Net cash used in financing activities......... (32,961) (32,276) (5,846) -- (71,083)
----------- ----------- ----------- ----------- -----------
Net change in cash and cash equivalents....... (56,366) 1,133 803 -- (54,430)
Cash and cash equivalents, beginning of year.. 190,606 8,206 4,096 -- 202,908
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents, end of period...... $ 134,240 $ 9,339 $ 4,899 $ -- $ 148,478
=========== =========== =========== =========== ===========
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................. $ 15,485 $ 9,308 $ (1,142) $ (8,166) $ 15,485
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization.............. 14,414 19,343 740 -- 34,497
Provision for doubtful accounts............ 25,522 19,075 402 -- 44,999
Other, net................................. 16,725 632 (526) -- 16,831
Changes in operating assets and liabilities... (72,797) 498 162 1,511 (70,626)
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by operating
activities................................. (651) 48,856 (364) (6,655) 41,186
Net cash used in investing activities......... (16,931) (9,146) (57) 6,655 (19,479)
Net cash used in financing activities......... (16,868) (13,633) (181) -- (30,682)
----------- ----------- ----------- ----------- -----------
Net change in cash and cash equivalents....... (34,450) 26,077 (602) -- (8,975)
Cash and cash equivalents, beginning of year.. 123,052 35,527 3,082 -- 161,661
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents, end of period...... $ 88,602 $ 61,604 $ 2,480 $ -- $ 152,686
=========== =========== =========== =========== ===========
</TABLE>
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS
On February 9, 1999, the Company signed a definitive agreement to acquire
the clinical laboratory business of SmithKline Beecham for approximately $1.3
billion. The purchase price will be paid through the issuance of approximately
12.6 million shares of common stock of Quest Diagnostics and the payment of
$1.025 billion of cash. The acquisition will be accounted for under the purchase
method of accounting. Quest Diagnostics expects to close the transaction in
August 1999. As a result, SmithKline Beecham will own approximately 29.5% of
Quest Diagnostics' outstanding common stock. Under the terms of a stockholder
agreement, SmithKline Beecham will initially have the right to designate two
nominees to Quest Diagnostics' Board of Directors as long as SmithKline Beecham
owns at least 20% of the outstanding common stock. (As long as SmithKline
Beecham owns at least 10% but less than 20% of the outstanding common stock, it
will have the right to designate one nominee.) Quest Diagnostics' Board of
Directors will expand to nine directors immediately following the close. The
stockholder agreement will also impose limitations on the right of SmithKline
Beecham to sell or vote its shares and prohibit SmithKline Beecham from
purchasing in excess of 29.5% of the outstanding common stock of Quest
Diagnostics.
Under the terms of the agreement, Quest Diagnostics will acquire SmithKline
Beecham's clinical laboratory testing business including its domestic and
foreign clinical testing operations, clinical trials testing, corporate health
services, and laboratory information products businesses. SmithKline Beecham's
national testing and service network consists of regional laboratories,
specialty testing operations and its National Esoteric Testing Center, as well
as a number of rapid-turnaround or "stat" laboratories, and patient service
centers. As part of the transaction, SmithKline Beecham and Quest Diagnostics
will enter into a long-term contract under which Quest Diagnostics will be the
primary provider of testing to support SmithKline Beecham's clinical trials
testing requirements worldwide. In addition, SmithKline Beecham has agreed to
indemnify Quest Diagnostics for potential liabilities arising from certain
government and private claims.
On July 1, 1999, Quest Diagnostics announced that the anticipated closing
of the transaction with SmithKline Beecham was delayed due to continuing
negotiations regarding SmithKline Beecham's rights and access to Quest
Diagnostics' proprietary clinical laboratory database. On August 9, 1999, Quest
Diagnostics announced that all agreements required to complete the acquisition
had been finalized by Quest Diagnostics and SmithKline Beecham. As part of the
agreement, Quest Diagnostics has granted SmithKline Beecham certain
non-exclusive rights to use its clinical laboratory information database. In
addition, Quest Diagnostics will receive a minority interest in a company that
SmithKline Beecham will form to sell health care information products and
services through various channels, including the Internet.
On August 10, 1999, Quest Diagnostics announced that due to unsatisfactory
conditions in the high yield market, it would not proceed with its planned
offering of new senior subordinated notes at this time. The Company plans to
utilize its fully committed senior credit facility to provide the funds required
to complete the acquisition.
Quest Diagnostics believes that the acquisition will establish the Company
as the leader of the clinical laboratory testing industry and provide a range of
benefits. As the leading national provider with the most extensive network of
laboratories and patient service centers throughout the United States, Quest
Diagnostics will be able to further enhance patient access and customer service.
The acquisition will improve the Company's ability to pursue profitable growth
opportunities, including direct contracting with employers for laboratory
services, clinical trials testing for pharmaceutical companies, testing and
management services for hospitals, and genetic and other esoteric testing. Quest
Diagnostics believes that
12
<PAGE>
the acquisition will accelerate innovation and create the largest clinical
laboratory database in the world, which can be used to help providers and
insurers to better manage their patients' health. Finally, Quest Diagnostics
believes that the acquisition will provide the Company with opportunities to
achieve significant cost savings by consolidating operations and activities,
including redundant facilities, applying best practices and utilizing its
service infrastructure more efficiently.*
Management believes the acquisition will accelerate Quest Diagnostics'
earnings growth rate, generate savings exceeding $100 million annually after
three years, and be accretive to earnings in 2000 before special charges related
to the transaction. However, it is expected to have an adverse impact on
profitability during the first year after the closing of the acquisition.*
FINANCING OF THE TRANSACTIONS
On May 25, 1999, Quest Diagnostics commenced an offer to purchase all of
its existing 10 3/4% notes. It also solicited consents from the holders of the
10 3/4% notes to amend the 10 3/4% notes' indenture to eliminate substantially
all the restrictive covenants. As of August 11, 1999, Quest Diagnostics received
consents representing over 98% of the principal amount of the 10 3/4% notes. The
tender offer has been extended to August 26, 1999. The offer remains subject to
Quest Diagnostics obtaining adequate financing on terms satisfactory to the
Company to pay all amounts due under the tender offer.*
The Company is currently finalizing the terms of the external financing
necessary to complete the pending acquisition. Quest Diagnostics will use the
borrowings under a new senior secured credit facility to fund the cash purchase
price and related transaction costs of the acquisition, and to repay its
existing bank debt plus interest.
The new credit facility is expected to include the following facilities: a
$250 million six-year revolving credit facility; a $400 million six-year
amortizing term loan; a $325 million seven-year term loan with minimal
amortization until the seventh year; a $300 million eight-year term loan with
minimal amortization until the eighth year; and a $300 million two-year capital
markets term loan which does not amortize. The commitment under the capital
markets loan will expire to the extent it is not borrowed at closing. Up to $75
million of the revolving credit facility may be used for letters of credit.
Quest Diagnostics expects to borrow approximately $1.025 billion under the term
loans and $50 million under the capital markets loan.* At closing, Quest
Diagnostics expects that approximately $75 million of the revolving credit
facility will be used to pay closing costs and to replace existing letters of
credit and that the balance of the revolving credit facility will be available
for borrowing.* Subsequent to the transaction with SmithKline Beecham, Quest
Diagnostics expects to refinance the amounts borrowed under the capital markets
facility and its existing 10 3/4% senior subordinated notes.* The new credit
facility will be secured by substantially all tangible and intangible assets of
Quest Diagnostics and by a guarantee from, and a pledge of all capital stock and
tangible and intangible assets of, all of Quest Diagnostics' present and future
wholly owned domestic subsidiaries other than certain joint ventures. The
borrowings under the new credit agreement will rank senior in priority of
repayment to any subordinated indebtedness. Interest will be based on certain
published rates plus an applicable margin which will vary depending on the
financial performance of Quest Diagnostics. The interest rates under the credit
facility will be 25 basis points higher during the period that the capital
markets loan is outstanding. The credit agreement will require Quest Diagnostics
to maintain interest rate hedge agreements covering a notional amount of not
less than 50% of its net funded debt. The credit agreement is expected to
contain various covenants and conditions including the maintenance of certain
financial ratios and tests, and restrict the ability of Quest Diagnostics to,
among other things, incur additional indebtedness
- ----------
* THESE ARE FORWARD-LOOKING STATEMENTS. 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 1998 ANNUAL REPORT ON
FORM 10-K.
13
<PAGE>
and pay dividends on its common stock. Depending on market conditions at the
time of the consummation of the new credit facility, the terms, interest rates
and amounts borrowed under the new credit facility may vary from that indicated
above.*
The Company believes the financing under the new credit facility will
provide sufficient financial flexibility and access to funds to finance the
costs to integrate the businesses of Quest Diagnostics and SBCL, to meet
seasonal working capital requirements, to fund capital expenditures and to fund
additional growth opportunities for the foreseeable future.*
Management believes that Quest Diagnostics' successful integration of
SmithKline Beecham's clinical laboratory business and implementation of its
business strategy, together with the indemnification by Corning and SmithKline
Beecham against monetary fines, penalties or losses from outstanding government
and other related claims, will enable it to generate strong cash flows.*
Additionally, management believes that these actions will aid the Company in
meeting the ongoing challenges in the clinical laboratory industry brought on by
the growth in managed care and increased regulatory complexity.*
RESULTS OF OPERATIONS
Net income for the three and six months ended June 30, 1999 increased from
the prior year primarily as a result of improvements in gross margins and
reductions in net interest expense, offset by increases in selling, general and
administrative expenses and other, net. Net income for the three and six months
ended June 30, 1999 includes $1.9 million of interest income ($1.2 million, net
of tax) associated with a favorable state tax settlement. Net income for the six
months ended June 30, 1998 includes a $2.5 million charge ($1.2 million, net of
tax) recorded in selling, general and administrative expenses that represented
the final costs associated with the Company's consolidation plan announced in
December 1997.
Results for the three and six months ended June 30, 1999 include the
effects of QuestNet, the company's laboratory network management service. As
laboratory network manager, Quest Diagnostics includes in its consolidated
revenues and expenses the cost of testing performed by third parties. This
accounting requirement added $15.4 million and $32.8 million to reported
revenues and expenses for the three and six months ended June 30, 1999,
respectively.
NET REVENUES
Excluding the effect of QuestNet, net revenues for the second quarter
increased by $11.9 million, or 3.2% from the prior year level, principally due
to a 7.6% improvement in average revenue per requisition, partially offset by a
3.9% decline in clinical testing volume, measured by the number of requisitions
processed. While the volume of clinical testing declined in the second quarter
of 1999, as compared to 1998, this represents an improvement from the first
quarter of 1999 in which volume declined by 7.3%, as compared to the prior year
period. Net revenues for the first half of 1999 (adjusted for QuestNet)
increased $8.4 million or 1.1% from the prior year level, principally due to a
6.8% improvement in average revenue per requisition, partially offset by a 5.6%
decline in clinical testing volume.
The increases in average revenue per requisition, for both the second
quarter and the first half of 1999, are due primarily to a number of factors,
including: a shift from capitated volume to fee-for-service volume; contract
renewals and new business negotiated on more favorable terms as part of our
account
- ----------
* THESE ARE FORWARD-LOOKING STATEMENTS. 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 1998 ANNUAL REPORT ON
FORM 10-K.
14
<PAGE>
profitability strategy; and higher value-added test offerings. The volume
declines were principally due to the impact of increased competition for managed
care business, actions taken on unprofitable accounts and severe weather in the
first quarter of 1999 in certain service areas.
COSTS AND EXPENSES
Total operating costs for the second quarter and the first half of 1999,
excluding the effect of QuestNet, increased by $7.9 million and $6.1 million,
respectively, from the year earlier periods. Operating costs and expenses for
1998 included a first quarter charge of $2.5 million ($1.2 million, net of tax)
in selling, general and administrative expenses that represented the final costs
associated with the Company's consolidation plan announced in December 1997.
Operating costs unrelated to volume increased during the quarter and first half
of 1999, principally due to additional investments in information technology and
sales and marketing capabilities, litigation expenses and employee compensation
costs, including severance.
Excluding the effect of QuestNet, cost of services, which includes the
costs of obtaining, transporting and testing specimens, decreased during the
second quarter as a percentage of net revenues to 55.5% from 59.4% a year ago.
Cost of services in the first half of 1999, adjusted for QuestNet, decreased as
a percentage of net revenues to 56.5% from 59.3% in the prior year. These
decreases are primarily attributable to the increase in average revenue per
requisition. 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 during the quarter as a
percentage of net revenues to 34.8%, excluding the effect of QuestNet, from
31.7% in the prior year. For the first half of 1999, selling, general and
administrative expenses increased as a percentage of net revenues, excluding the
effect of QuestNet, to 34.8% from 32.2% in the prior year. These increases were
principally due to additional investments in information technology and sales
and marketing capabilities, litigation expenses and employee compensation costs,
including severance. These increases were partially offset by a reduction in bad
debt expense. During the second quarter bad debt expense improved to 5.3% of net
revenues (excluding the effect of QuestNet) from 5.8% of net revenues in the
prior year. For the first half of 1999, bad debt expense improved to 5.4% of net
revenues (excluding the effect of QuestNet) from 6.1% of net revenues in the
prior year.
Net interest expense decreased from the prior year by $4.0 million and $5.8
million for the second quarter and first half of 1999, respectively. Net
interest expense for the three and six months ended June 30, 1999 includes $1.9
million of interest income associated with a favorable state tax settlement. The
remaining decrease in net interest expense for the second quarter and first half
of 1999 is primarily attributable to a decrease in the average amount of debt
outstanding during 1999 as compared to the prior year period.
Other, net for the second quarter and first half of 1999 increased from the
prior year level, primarily due to an increase in minority partners' share of
income.
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.
15
<PAGE>
ADJUSTED EBITDA
Adjusted EBITDA represents earnings before interest, taxes, depreciation,
amortization and non-recurring charges. Adjusted EBITDA for the three months
ended June 30, 1999 improved to $46.2 million, or 12.2% of net revenues
(adjusted for QuestNet), from $44.5 million, or 12.1% of net revenues, in the
prior year period. Adjusted EBITDA for the six months ended June 30, 1999 was
$84.1 million, or 11.3% of net revenues (adjusted for QuestNet), compared to
$87.1 million last year, adjusted for special charges, or 11.9% of net revenues.
The decline for the six month period is principally due to the additional costs
associated with the introduction of QuestNet and investments in information
technology and sales and marketing capabilities.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary exposure to market risk is from changes in interest
rates. The Company does not believe that its foreign exchange exposure and
related hedging program are material to the Company's financial position or
results of operations. The Company addresses its risks through a controlled
program of risk management that includes the use of derivative financial
instruments. The Company does not hold or issue derivative financial instruments
for trading purposes.
INTEREST RATES
At June 30, 1999 and December 31, 1998, the fair value of the Company's
debt was estimated at approximately $410 million and $480 million, respectively,
using quoted market prices and yields for the same or similar types of
borrowings, taking into account the underlying terms of the debt instruments.
Such fair values exceeded the carrying value of the debt at June 30, 1999 and
December 31, 1998 by approximately $10 million and $15 million, respectively. An
assumed 10% increase in interest rates would potentially reduce the fair value
of the Company's debt by approximately $8 million and $9 million at June 30,
1999 and December 31, 1998, respectively.
The Company had $243 million of variable interest rate debt outstanding at
June 30, 1999. An assumed 10% increase in interest rates would result in a $0.4
million reduction in the Company's after-tax earnings and cash flows for the six
months ended June 30, 1999 based on debt levels as of June 30, 1999. The primary
interest rate exposures on the variable interest rate debt are with respect to
interest rates on United States dollars as quoted in the London interbank
market.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at June 30, 1999 totaled $148.5 million, a
decrease of $54.4 million from December 31, 1998. The decrease is primarily
associated with the repayment of $65.0 million of debt, of which $35 million was
paid ahead of schedule, and the payment of $10.1 million of transaction expenses
associated with the acquisition and financing of the transaction with SmithKline
Beecham. Cash flows from operating activities provided cash of $52.6 million,
which was offset by investing and financing activities which required cash of
$107.0 million. Cash and cash equivalents at June 30, 1998 decreased from
December 31, 1997 by $9.0 million due to operating activities which provided
cash of $41.2 million, offset by investing and financing activities which used
cash of $50.2 million.
Net cash from operating activities for 1999 was $11.4 million higher than
the 1998 level. The increase is primarily the result of an increase in net
earnings, decreased payments associated with restructuring and other special
charges and changes in accounts payable and accrued expenses and other assets
and liabilities. The impact of these changes was partially offset by changes in
the Company's deferred tax position. The number of days sales outstanding, a
measure of billing and collection efficiency, was 54 days, adjusted
16
<PAGE>
for QuestNet, compared to 61 days at June 30, 1998 and 54 days in the first
quarter. The number of days sales outstanding was 58 days at December 31, 1998.
Increased spending on investing activities is principally related to an
increase in capital expenditures, the payment of transaction costs associated
with the acquisition of SmithKline Beecham's clinical laboratory business and an
increase in investments. Capital spending for the first half of 1999 was $25.9
million compared to $19.5 million for the same period in the prior year. Without
giving effect to the acquisition of SmithKline Beecham's clinical laboratory
testing business, the Company estimates that it will invest approximately $60
million during 1999 for capital expenditures, principally related to investments
in information technology infrastructure and equipment and facility upgrades. *
The increase in investments is principally associated with investments to fund
certain benefit plans and contributions to the Company's Arizona joint venture.
During the first half of 1999, the Company repaid $65.0 million of debt, of
which $35 million was paid ahead of schedule, paid $4.9 million of costs
associated with the financing of the transaction with SmithKline Beecham and
repurchased $1.1 million of its common stock. Other than the reduction for
outstanding letters of credit, which currently approximate $17 million, all of
the revolving working capital credit facility was available for borrowing.
During February 1998, Quest Diagnostics' Board of Directors authorized a
limited share purchase program which permits the Company to purchase up to $27
million of its outstanding common stock through 1999. Cumulative purchases under
the program through June 30, 1999 total $14.1 million. The program is intended
to mitigate the dilutive impact to earnings per share of issuing new shares for
the Company's employee benefit plans. The Company suspended purchases of its
shares when it reached a preliminary understanding of the transaction with
SmithKline Beecham plc on January 15, 1999. To the extent permitted under the
Company's new credit facility and its existing senior subordinated notes, the
Company plans to purchase additional shares of its common stock through the
remainder of 1999.
YEAR 2000 READINESS DISCLOSURE
The Year 2000 issue relates to the ability of computer systems and programs
to properly recognize dates beginning January 1, 2000 and beyond. Also, the Year
2000 issue affects systems and equipment, such as security systems and
elevators, that contain imbedded hardware or software that may be similarly date
sensitive. As a result, business and governmental entities are at risk for
possible miscalculations or system failures resulting from Year 2000 problems
that may disrupt their operations.
The Company commenced its Year 2000 readiness program in 1997 and has
established a dedicated project team to implement the program. In order to
address the Year 2000 issue, the Company has adopted a six-phase plan which
includes: (1) inventory; (2) assessment; (3) repair/replace/upgrade; (4)
testing; (5) implementation; and (6) contingency planning. This plan is common
for each of the following seven major areas:
INFRASTRUCTURE - Includes computer hardware, systems software (other than
application software) and voice and data network components. The inventory phase
and the assessment phase, for all equipment and software supplied by vendors who
have responded to the Company's inquiries, is complete. Also, the Company has
completed over 95% of the activities for phases three, four and five of the
Company's Year 2000 plan. The remaining activities are scheduled for completion
during the third and fourth quarter
- ----------
* THESE ARE FORWARD-LOOKING STATEMENTS. 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 1998 ANNUAL REPORT ON
FORM 10-K.
17
<PAGE>
of 1999. For those vendors that have not responded, contingency plans are
scheduled to be completed during the third quarter of 1999.
APPLICATIONS - Includes all applications software including, but not limited to,
the Company's clinical laboratory systems, financial systems, billing systems,
human resources systems, purchasing systems and customer interface systems. The
inventory phase and the assessment phase for all applications are complete. The
Company is in the process of repairing, replacing or upgrading non-compliant
code, testing for compliance and implementing certified systems. Approximately
96% of the overall effort is currently completed with a scheduled completion
during the third quarter of 1999.
LABORATORY INSTRUMENTS - Includes all clinical diagnostic instrumentation in
testing facilities. The inventory phase and the assessment phase, for all vendor
responses received, is complete. The Company is in the process of repairing,
replacing, or upgrading non-compliant instrumentation and testing for
compliance. Approximately 95% of all instruments are Year 2000 ready and the
Company expects over 98% will be compliant by the end of the third quarter of
1999, with contingency plans in place for the remaining instruments.
FACILITIES - Includes all building facilities (e.g. air conditioning units,
generators), property owners and building service providers (e.g. waste
management, public utilities). The inventory phase and assessment phase, for all
vendor responses received, is complete. The Company has completed 78% of the
activities for phases three, four and five of the Company's Year 2000 plan. For
those vendors that have not responded, contingency plans are scheduled to be
completed during the third quarter of 1999.
DESKTOP ENVIRONMENT - Includes the personal computer hardware and operating
systems. The inventory and assessment phases are complete and the replacement
platform has been identified. An outside vendor has been selected and retained
to coordinate the desktop replacement program. The rollout is 90% complete. The
remaining activities are scheduled for completion during the third quarter of
1999.
EXTERNAL PROVIDERS - Includes the process of identifying and prioritizing
critical suppliers and communicating with them about their plans and progress in
addressing the Year 2000 problem. The inventory phase and the assessment phase,
for all vendor responses received, is complete. The Company is in the process of
confirming that the suppliers' expected compliance dates have been met, and of
obtaining any specific information omitted from earlier supplier responses.
Contingency plans have been developed for all suppliers identified as critical
to the Company's mission, and are being refined through dialog with the
suppliers. The Company expects to refine and implement the contingency plans
during the third quarter of 1999.
PAYERS - Includes the process of contacting each critical payer (e.g. Medicare,
Medicaid, commercial insurance carriers) regarding their plans and progress in
addressing the Year 2000 problem. All critical payers have been identified and
the Company is in the process of assessing the state of readiness, for all
responses received, and is in the process of developing contingency plans for
the critical payers.
Although each of the above seven areas is at a different stage of
readiness, the Company has made significant progress to date towards completing
its six-phase plan under its Year 2000 readiness program. The Year 2000
readiness program will be an ongoing process until all contacted parties have
responded to Company requests for Year 2000 information. The Company is
continuing to work internally and with external contractors, as needed, to
complete the final phases of the program. The Company also continues to work
with its external vendors, whose readiness is vital for a smooth transition into
the Year 2000. In addition to the phases outlined above, the Company's plan also
includes regular status presentations to the Audit and Finance Committee of the
Board of Directors, and a special retention bonus plan for its key information
systems employees, which is based on the success in making Quest Diagnostics'
systems Year 2000 compliant. The Company's goal is to have all significant
systems
18
<PAGE>
properly functioning and certified with respect to the Year 2000 during the
fourth quarter of 1999.*
Due to the general uncertainty inherent in the Year 2000 problem, resulting
in part from the uncertainty of the Year 2000 readiness of third-party vendors
and payers, the Company is unable to determine at this time whether the
consequences of potential Year 2000 business disruptions will have a material
impact on the Company's results of operations, liquidity and financial
condition. The most reasonably likely worst case consequences of the Company or
key vendors or payers not being ready by January 1, 2000 include, among other
things, temporary business unit closures, delays in laboratory testing or
delivery of laboratory testing results, inventory shortages and delays in
collecting accounts receivable. Approximately 14% of the Company's annual net
revenues are received from Medicare carriers. The Company could experience
collection delays if Medicare or other large third party payers (such as
insurance companies) experience Year 2000 problems. Medicare carriers are being
required to implement new programs required by the 1997 Balanced Budget Act at
the same time that they are attempting to make their systems Year 2000
compliant. In September 1998, the General Accounting Office reported that "HCFA
and its contractors are severely behind schedule in repairing, testing and
implementing the mission-critical systems supporting Medicare" and concluded
that "it is highly unlikely that all of the Medicare systems will be compliant
in time to ensure the delivery of uninterrupted benefits and services into the
year 2000." More recently, HCFA stated that their systems and their contractors'
systems supporting Medicare are compliant, tested and certified with respect to
Year 2000.
While the Company believes that its Year 2000 readiness program
significantly reduces the potential adverse effect of any such disruptions,
Quest Diagnostics cannot guarantee that the Year 2000 problem will not result in
significant business disruptions. Specific factors that give rise to this
uncertainty include the possible loss of technical resources to perform the
remediation work, failure to identify all susceptible systems, non-compliance by
third-parties whose systems impact the Company, and other similar uncertainties.
Concurrent with the plans described above, the Company is in the process of
developing detailed contingency plans for each major area to mitigate the
possible disruption in business operations. Contingency plans may include
accepting estimated payments from customers and payers, making use of
alternative vendors, stockpiling inventory and temporarily moving laboratory
testing services. Most of the Company's regional laboratories have similar test
menus and, with the adoption of standardized test codes and progress in other
standardization initiatives (including billing and lab information systems), the
Company has improved its ability to move laboratory specimens to an alternative
site in the event that a regional laboratory experiences disruptions. Once
developed, contingency plans and related cost estimates will be continually
refined as additional information becomes available. The Company's goal is to
have contingency plans finalized during the third quarter of 1999 with final
reviews in the fourth quarter of 1999. *
Costs incurred through June 30, 1999 related to the Company's Year 2000
readiness program approximated $42 million, of which approximately $16 million
was capitalized. Current estimates of the remaining costs are approximately $25
million to $40 million, of which approximately 50% to 60% will be capitalized.
Capitalized costs principally represent the purchase of new software and
hardware. These estimates are subject to potentially significant revisions as
additional information, including vendor responses, becomes available. Costs
related to the Company's Year 2000 readiness program have been, and are expected
to continue being, funded by cash from operations.*
- --------------
* THESE ARE FORWARD-LOOKING STATEMENTS. 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 1998
ANNUAL REPORT FOR FORM 10-K.
19
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments in any other of the government
investigations or private claims reported.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders of the Company was held on June 29,
1999. At the meeting the matters described below were approved by the
stockholders.
(b-c) The following nominees for the office of director were elected for
terms expiring at the 2002 annual meeting of stockholders, by the
following votes:
For Withheld
--- --------
William F. Buehler 24,113,995 3,457,094
Van C. Campbell 27,363,030 208,059
Dan C. Stanzione 27,367,427 203,662
The following persons continue as directors:
Kenneth D. Brody
Mary A. Cirillo
Kenneth W. Freeman
Gail R. Wilensky
The issuance of 12,564,336 shares of common stock of the Company to
SmithKline Beecham PLC was approved by the following number of stockholder votes
for, against, and abstained:
For: 23,910,286 Against: 121,590 Abstained: 69,168
The Quest Diagnostics Incorporated 1999 Employee Equity Participation
Program was approved by the following number of stockholder votes for, against,
and abstained:
For: 17,013,884 Against: 6,879,159 Abstained: 208,000
The appointment of the PricewaterhouseCoopers LLP as independent
accountants to audit the financial statements of the Company and its
subsidiaries for the fiscal year ending December 31, 1999, was approved by the
following number of stockholder votes for, against, and abstained:
For: 27,467,237 Against: 51,916 Abstained: 51,936
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NUMBER DESCRIPTION
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Registrant has filed the following Current Report on Form 8-K
during the quarter ended June 30, 1999:
Current Report on Form 8-K filed on June 4, 1999
As previously disclosed in Quest Diagnostics' current report on Form
8-K dated February 17, 1999, on February 9, 1999, Quest Diagnostics
signed a definitive agreement with SmithKline Beecham to purchase
SmithKline Beecham's clinical laboratory testing business "(SBCL") for
approximately $1.3 billion in cash and stock (the "SBCL Acquisition").
The Current Report on Form 8-K filed on June 4, 1999 included certain
financial information for SBCL, management's discussion and analysis of
financial condition and results of operations related thereto and
unaudited pro forma combined financial information for the combined
entity giving effect to the SBCL Acquisition.
21
<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 12, 1999
Quest Diagnostics Incorporated
By /s/ Kenneth W. Freeman Chairman of the Board and
------------------------------- Chief Executive Officer
Kenneth W. Freeman
By /s/ Robert A. Hagemann Vice President and
------------------------------- Chief Financial Officer
Robert A. Hagemann
22
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