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EXHIBIT 99.5
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000 -
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - PRO FORMA COMPARISONS"
The following information revises and updates the supplemental pro
forma combined financial information of Quest Diagnostics included in the Pro
Forma Comparisons section of Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Quarterly Report
on Form 10-Q for the fiscal quarter ended June 30, 2000, filed on August 3,
2000.
The following table summarizes the Company's unaudited historical
results of operations for the three and six months ended June 30, 2000 and 1999
and the Company's unaudited pro forma combined results of operations for the
three and six months ended June 30, 1999 (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------ -----------------------------------------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
---------------------- --------- ------------------------- ----------
2000 1999 1999 2000 1999 1999
-------- -------- --------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
NET REVENUES............................. $877,113 $394,034 $837,533 $1,734,592 $775,875 $1,660,983
-------- -------- -------- ---------- -------- ----------
COST AND EXPENSES:
Cost of services....................... 520,437 236,071 550,521 1,049,474 473,478 1,087,521
Selling, general and administrative.... 252,846 121,230 255,634 502,681 237,831 480,176
Interest expense, net.................. 30,204 5,008 29,890 59,967 12,367 61,737
Amortization of intangible assets...... 11,954 5,219 11,405 23,894 10,313 22,684
Provision for special charges.......... 2,100 -- 15,813 2,100 -- 15,813
Minority share of income............... 5,240 1,471 1,471 5,376 2,601 2,601
Other, net............................. (1,881) 528 126 (2,309) 700 (9,522)
-------- -------- -------- ---------- -------- ----------
Total................................ 818,900 369,527 864,860 1,641,183 737,290 1,661,010
-------- -------- -------- ---------- -------- ----------
INCOME (LOSS) BEFORE TAXES............... 58,213 24,507 (27,327) 93,409 38,585 (27)
INCOME TAX EXPENSE (BENEFIT)............. 28,045 11,420 (8,157) 45,432 18,065 4,972
-------- -------- -------- ---------- -------- ----------
NET INCOME (LOSS)........................ $ 30,168 $ 13,087 $(19,170) $ 47,977 $ 20,520 $ (4,999)
======== ======== ======== ========== ======== ==========
BASIC NET INCOME (LOSS) PER
COMMON SHARE........................... $ 0.68 $ 0.44 $ (0.44) $ 1.08 $ 0.69 $ (0.12)
DILUTED NET INCOME (LOSS) PER
COMMON SHARE........................... $ 0.64 $ 0.43 $ (0.44) $ 1.03 $ 0.67 $ (0.12)
CASH EARNINGS BEFORE SPECIAL ITEMS
PER DILUTED COMMON SHARE............... $ 0.90 $ 0.57 $ 0.02 $ 1.53 $ 0.95 $ 0.44
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING -- BASIC................... 44,577 29,920 43,248 44,354 29,819 43,146
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING -- DILUTED................. 46,981 30,729 43,933 46,299 30,505 43,720
ADJUSTED EBITDA.......................... $127,844 $ 46,178 $ 85,016 $ 227,370 $ 84,097 $ 165,683
</TABLE>
PRO FORMA COMPARISONS
The pro forma combined financial information for the three and six
months ended June 30, 1999 assumes that the SBCL acquisition and borrowings
under the Credit Agreement were effected on January 1, 1999. The SBCL
acquisition agreements included a provision for a reduction in the purchase
price paid by Quest Diagnostics in the event that the combined balance sheet of
SBCL indicated that the net assets acquired, as of the acquisition date, were
below a prescribed level. On October 11, 2000, the purchase price adjustment was
finalized with the result that SmithKline Beecham owed Quest Diagnostics $98.6
million. This amount was offset by $3.6 million separately owed by Quest
Diagnostics to SmithKline Beecham, resulting in a net payment by SmithKline
Beecham of $95.0 million. This payment from SmithKline Beecham will be recorded
in the historical financial statements of the Company in the fourth quarter of
2000 as a reduction in the purchase price of the SBCL acquisition.
In addition to the purchase price reduction described above, the
purchase price allocation relating to the SBCL acquisition was completed in
conjunction with the preparation of the Company's quarterly report on Form 10-Q
for the fiscal quarter ended September 30, 2000. None of the adjustments,
resulting from the purchase price reduction or the completion of the purchase
price allocation, will have any impact on the Company's previously reported
historical financial statements.
The accompanying pro forma combined financial information reflects the
impact of finalizing the SBCL purchase price adjustment and the revised purchase
price allocation relating to the SBCL acquisition.
The unaudited pro forma combined financial information is presented for
illustrative purposes only to assist in analyzing the financial implications of
the SBCL acquisition and borrowings under the Credit Agreement. The unaudited
pro forma combined financial information may not be indicative of the combined
financial results of operations that would have been realized had Quest
Diagnostics and SBCL been a single entity during the periods presented. In
addition, the unaudited pro forma combined financial information is not
necessarily indicative of the future results that the combined company will
experience.
Significant pro forma adjustments reflected in the unaudited pro forma
combined financial information include reductions in employee benefit costs and
general corporate overhead allocated to the historical results of SBCL by
SmithKline Beecham, offset by an increase in net interest expense to reflect the
Company's Credit Agreement which was used to finance the SBCL acquisition.
Amortization of goodwill, which accounts for a majority of the acquired
intangible assets, is calculated on the straight-line basis over forty years.
Income taxes have been adjusted for the estimated income tax impact of the pro
forma adjustments at the incremental tax rate of 40%. A significant portion of
the intangible assets acquired in the SBCL acquisition is not deductible for tax
purposes, which has the overall impact of increasing the effective tax rate.
Weighted average common shares outstanding, for purposes of determining
pro forma basic and diluted earnings (loss) per common share and cash earnings
per diluted common share, have been adjusted to give effect to the common shares
issued to SmithKline Beecham in conjunction with the acquisition of SBCL and
shares of common stock granted at the closing of the SBCL acquisition to certain
employees.
HISTORICAL THREE AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED WITH
PRO FORMA THREE AND SIX MONTHS ENDED JUNE 30, 1999
The following discussion and analysis compares the Company's
historical results of operations for the three and six months ended June 30,
2000 to the pro forma combined results of operations for the three and six
months ended June 30, 1999, assuming that the SBCL acquisition and borrowings
under the Credit Agreement were effected January 1, 1999. All references in this
section to the three and six months ended June 30, 2000 refer to the historical
results of Quest Diagnostics for such periods. All references in this section to
the three and six months ended June 30, 1999 refer to the pro forma combined
results of Quest Diagnostics for such periods.
Net income for the three months ended June 30, 2000 increased to $30.2
million from a net loss of $19.2 million for the prior year period. Net income
for the six months ended June 30, 2000 increased to $48.0 million, compared to a
net
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loss of $5.0 million for the six months ended June 30, 1999. For the three and
six months ended June 30, 2000, special items included the net special charges
reflected on the face of the statement of operations and $3.1 million and $4.5
million, respectively, of costs related to the integration of SBCL which were
expensed as incurred in 2000. Special items for the three and six months ended
June 30, 1999 included the special charges reflected on the face of the pro
forma combined statement of operations and a $9.7 million gain recognized by
SBCL on the sale of its physician office-based teleprinter assets and network
which was recorded in other, net during the first quarter of 1999.
A special review of the SBCL pre-closing financial statements, called
for in the SBCL acquisition agreements, was conducted to assess the
recoverability of assets and the adequacy of liabilities existing prior to the
closing date of the acquisition. This special review resulted in adjustments,
primarily related to the recoverability of SBCL receivables and accrued
liabilities during various periods prior to the closing of the SBCL acquisition.
In addition, SBCL recorded other income and expense items prior to the closing
of the SBCL acquisition. Management believes that the adjustments resulting from
the special review and the other income and expense items, both of which have
not been reflected on the face of the pro forma combined financial information,
are of a non-recurring nature and limit the comparability of results between the
periods presented. In the discussions that follow, these matters are
collectively referred to as discrete income and expense items.
Discrete expense items for the three and six months ended June 30,
1999, totaled $35.7 million and $36.2 million, respectively, including bad debt
charges of $17.4 million and $16.7 million, respectively, to reflect the reduced
recoverability of SBCL receivables, as a result of the special review of the
SBCL financial statements; $5.1 million and $7.1 million, respectively, of
losses related to a customer contract accounted for as a loss contract beginning
in the third quarter of 1999; $7.3 million of costs, recorded in the second
quarter of 1999, for which SmithKline Beecham is obligated to indemnify the
Company, associated with two incidents, the most significant of which related to
an SBCL employee who allegedly reused certain needles when drawing blood from
patients; and, $5.6 million and $5.1 million, respectively, of expenses recorded
by SBCL prior to the acquisition, primarily to record liabilities necessary to
properly present the closing balance sheet of SBCL. Excluding the impact of the
discrete expense items, income before special items was $11.7 million and $20.4
million for the three and six months ended June 30, 1999, respectively.
Results for the three and six months ended June 30, 2000 and 1999
included the effects of testing performed by third parties under our laboratory
network management arrangements. As laboratory network manager, the Company
included in its consolidated revenues and expenses the cost of testing performed
by third parties. This treatment added $14.4 million and $46.8 million to both
reported revenues and cost of services for the three and six months ended
June 30, 2000, respectively. For the three and six months ended June 30, 1999,
this treatment added $43.1 million and $84.3 million, respectively, to both pro
forma revenues and pro forma cost of services. This treatment also serves to
increase cost of services as a percentage of net revenues and decrease selling,
general and administrative expenses as a percentage of net revenues. During the
first quarter of 2000, the Company and Aetna USHealthcare terminated one of the
Company's laboratory network management arrangements, and entered into a new
non-exclusive contract, effective April 1, 2000, under which the Company will no
longer be responsible for the cost of testing performed by third parties.
NET REVENUES
Net revenues for the three months ended June 30, 2000 increased by
$39.6 million or 4.7% from the prior year level primarily due to improvements in
volume of clinical testing and average revenue per requisition of 5% and 6%,
respectively. Net revenues for the six months ended June 30, 2000 increased by
$73.6 million or 4.4% from the prior year level primarily due to improvements in
volume of clinical testing and average revenue per requisition of 5% and 4%,
respectively. Revenue growth for the three and six months ended June 30, 2000
was partially offset by accounting for a customer contract as a loss contract
beginning in the second half of 1999. In addition, effective April 1, 2000, the
cost of testing performed by third parties under the terminated laboratory
network management contract with Aetna USHealthcare was no longer included in
consolidated revenues and cost of services. Adjusted for these changes, pro
forma revenue for the three and six months ended June 30, 2000 increased by
10.5% and 9.2%, respectively, compared to the prior year periods.
The volume increase in clinical testing was primarily attributable to
strong sales to existing and new customers, as a result of improved industry
fundamentals as well as our ability to leverage our value proposition of
offering expanded patient access, broad testing capabilities and superior
quality. While our long-standing pricing discipline continued to yield results,
other factors that contributed to the increase in average revenue per
requisition included modifications to several managed care contracts to more
favorable terms, an increase in higher value testing and a shift to greater
fee-for-service reimbursement.
OPERATING COSTS AND EXPENSES
The following discussion and analysis regarding operating costs,
including cost of services, selling, general and administrative expenses and bad
debt expense exclude the effect of testing performed by third parties under our
laboratory
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network management arrangements, and the revenues and expenses associated with a
customer contract treated as a loss contract, beginning in the third quarter of
1999. As discussed above, losses associated with this contract amounted to $5.4
million and $7.1 million, respectively, for the three and six months ended June
30, 1999. Operating costs and expenses for the three and six months ended June
30, 2000 included $3.1 million and $4.5 million, respectively, of integration
related costs which were expensed as incurred in 2000. As discussed above,
operating costs and expenses for the three and six months ended June 30, 1999
included $30.3 million and $29.1 million, respectively, of discrete expense
items, recorded in SBCL's historical financial statements prior to the closing
of the SBCL acquisition. Total operating costs for the three and six months
ended June 30, 2000 increased by $17.7 million and $67.0 million, respectively,
from the prior year period, principally as a result of the volume increase noted
above.
Cost of services, as a percentage of net revenues, for the three months
ended June 30, 2000 decreased to 58.7% from 62.5% for the prior year period.
Cost of services for the six months ended June 30, 2000 decreased to 59.4% from
62.3% for the prior year period. For the three and six months ended June 30,
1999, cost of services included $5.7 million and $5.6 million, respectively, of
discrete expense items. Excluding the discrete expense items, cost of services,
as a percentage of net revenues, for the three and six months ended June 30,
1999 was 61.7% and 61.9%, respectively. Excluding the impact of the discrete
expense items, the decreases in cost of services, as a percentage of net
revenues, were primarily due to an increase in average revenue per requisition
and to a lesser extent, the impact of the SBCL integration to date on our cost
structure. These decreases in cost of services were partially offset by an
increase in employee compensation costs.
For the three and six months ended June 30, 1999, selling, general and
administrative expenses were 32.8% and 31.2%, respectively, of net revenues.
Excluding the impact of the discrete expense items of $24.5 million and $23.5
million, respectively, selling, general and administrative expenses, as a
percentage of net revenues, for the three and six months ended June 30, 1999
were 29.7% and 29.6%, respectively. For the three and six months ended June 30,
2000, selling general and administrative expenses, as a percentage of net
revenues, decreased to 29.3% and 29.8%, respectively. Excluding the impact of
the discrete expense items in 1999, the decreases in selling, general and
administrative expenses were primarily attributable to improvements in average
revenue per requisition and bad debt expense, partially offset by an increase in
employee compensation costs and investments related to our electronic commerce
strategy. As discussed above, for the three and six months ended June 30, 1999,
bad debt expense included discrete expense items of $17.4 million and $16.7
million, respectively, which represented bad debt charges, reflecting the
reduced recoverability of SBCL receivables, as a result of the special review of
the SBCL financial statements. Excluding the impact of the discrete expense
items for the three and six months ended June 30, 1999, bad debt expense was
7.5% and 7.6%, respectively, of net revenues. For the three and six months ended
June 30, 2000, bad debt expense improved to 7.1% and 7.4%, respectively, of net
revenues. This progress was primarily due to process improvements in the SBCL
billing functions, with particular focus in the areas of obtaining missing
information and reducing billing backlogs.
INTEREST EXPENSE, NET
Excluding $1.9 million of interest income associated with a favorable
state tax settlement in the second quarter of 1999, net interest expense for the
three and six months ended June 30, 2000 decreased by $1.6 million and $3.7
million, respectively, compared to the prior year periods. These reductions were
primarily due to the repayment of long term debt under the Credit Agreement
between the closing of the SBCL acquisition and the end of the second quarter of
2000, partially offset by an increase in variable interest rates.
PROVISION FOR SPECIAL CHARGES
During the second quarter of 2000, the Company recorded a net special
charge of $2.1 million. Of the special charge, $13.4 million represented the
costs to cancel certain contracts that management believed were not economically
viable as a result of the SBCL acquisition. These costs were principally
associated with the cancellation of a co-marketing agreement for clinical trials
testing services. Management believes that the cancellation of this agreement
will not have an adverse effect on net revenues. These charges were in large
part offset by a reduction in reserves attributable to a favorable resolution of
outstanding claims for reimbursements associated with billings of certain tests.
The special charge in the second quarter of 1999 of $15.8 million was primarily
to record a provision in the results of SBCL to reflect a customer contract as a
loss contract as of June 30, 1999.
MINORITY SHARE OF INCOME
Minority share of income for the three and six months ended June 30,
2000 increased from the prior year period, primarily due to improved performance
of the Company's joint ventures.
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OTHER, NET
Other, net for the six months ended June 30, 2000 increased from the
prior year period, primarily due to a $9.7 million gain recognized by SBCL on
the sale of its physician office-based teleprinter assets and network in the
first quarter of 1999.
INCOME TAXES
The Company's effective tax rate was significantly impacted by goodwill
amortization, the majority of which is not deductible for tax purposes, and had
the effect of increasing the overall tax rate.
CASH EARNINGS PER SHARE AND ADJUSTED EBITDA
Pro forma cash earnings per common share is calculated as pro forma
cash earnings less preferred dividends, divided by pro forma diluted weighted
average common shares outstanding. Cash earnings represents income (loss) before
special items and amortization of all intangible assets, net of applicable
taxes, presented on a pro forma basis. For the three and six months ended June
30, 2000 and 1999, special items represented the provision for special charges
reflected on the face of the pro forma combined statement of operations. In
addition, special items for the six months ended June 30, 1999 included a $9.7
million gain recognized by SBCL on the sale of its physician office-based
teleprinter assets and network during the first quarter of 1999 which was
recorded in other, net. Cash earnings per common share is presented and
discussed because it highlights the impact on earnings of the non-cash charges
associated with the amortization of intangible assets from various acquisitions,
which is significant for the Company. Cash earnings per common share is not a
measure of financial performance under accounting principles generally accepted
in the United States and should not be considered as an alternative to (i) net
income (or any other measure of performance under accounting principles
generally accepted in the United States) as a measure of performance or (ii)
cash flows from operating activities as an indicator of cash flows or as a
measure of liquidity.
Cash earnings per common share was $0.90 and $1.53 for the three and
six months ended June 30, 2000, respectively, compared to pro forma cash
earnings per common share of $0.02 and $0.44 for the prior year periods,
respectively. These increases were primarily related to improvements in our
operating performance and to a lesser extent, the impact of the discrete expense
items in 1999, as discussed above. Excluding the discrete expense items, pro
forma cash earnings per common share was $0.50 and $0.94 for the three and six
months ended June 30, 1999, respectively.
Adjusted EBITDA represents income (loss) before income taxes, net
interest expense, depreciation and amortization and special items. For the three
and six months ended June 30, 2000, special items included the special charges
reflected on the face of the pro forma combined statement of operations and $3.1
million and $4.5 million, respectively, of costs related to the integration of
SBCL which were included in operating expenses and expensed as incurred. For the
three and six months ended June 30, 1999 special items included the special
charges reflected on the face of the pro forma combined statement of operations,
a $9.7 million gain recognized by SBCL on the sale of its physician office-based
teleprinter assets and network during the first quarter of 1999 which was
recorded in other, net, and discrete expense items of $35.7 million and $36.2
million, respectively, which are discussed above. Adjusted EBITDA is presented
and discussed because management believes that Adjusted EBITDA is a useful
adjunct to net income and other measurements under accounting principles
generally accepted in the United States since it is a meaningful measure of a
leveraged company's performance and ability to meet its future debt service
requirements, fund capital expenditures and meet working capital requirements.
Adjusted EBITDA is not a measure of financial performance under accounting
principles generally accepted in the United States and should not be considered
as an alternative to (i) net income (or any other measure of performance under
accounting principles generally accepted in the United States) as a measure of
performance or (ii) cash flows from operating, investing or financing activities
as an indicator of cash flows or as a measure of liquidity.
Excluding the revenue impacts of the testing performed by third parties
under the Company's laboratory network management arrangements and the loss
contract, Adjusted EBITDA for the three months ended June 30, 2000 improved to
$127.8 million, or 14.8% of net revenues, compared to pro forma Adjusted EBITDA
of $85.0 million, or 10.9% of net revenues, in the prior year period. Adjusted
EBITDA for the six months ended June 30, 2000 improved to $227.4 million, or
13.5% of net revenues, compared to pro forma Adjusted EBITDA of $165.7 million,
or 10.8% of net revenues, in the prior year period. These increases in Adjusted
EBITDA were primarily related to improvements in the operating performance of
the Company.
