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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 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)
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Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH
REGISTERED
Common Stock New York Stock Exchange
with attached Preferred Share Purchase Right
10.75% Senior Subordinated Notes due 2006 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. /X/
As of March 10, 2000, the aggregate market value of the approximately 30.8
million shares of voting and non-voting common equity held by non-affiliates of
the registrant was approximately $1.1 billion, based on the closing price on
such date of the Company's Common Stock on the New York Stock Exchange.
As of March 10, 2000, there were outstanding 43,718,951 shares of Common Stock,
$.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Document Part of Form 10-K into which incorporated
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Portions of the Registrant's Proxy
Statement to be filed by May 1, 2000 Part III
Such Proxy Statement, except for portions thereof which have been specifically
incorporated by reference, shall not be deemed "filed" as part of this report on
Form 10-K.
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PART I
ITEM 1. BUSINESS
Quest Diagnostics Incorporated, together with its subsidiaries, is the
nation's leading provider of diagnostic testing, information and services.
Quest Diagnostics offers a broad range of clinical laboratory testing
services used by physicians in the detection, diagnosis, evaluation,
monitoring and treatment of diseases and other medical conditions. Quest
Diagnostics has a more extensive national network of laboratories and patient
service centers than its competitors and revenues nearly double that of its
nearest competitor. Quest Diagnostics has the leading market share in
clinical laboratory testing, anatomic pathology, esoteric testing and testing
for drugs of abuse. Its clinical trials business is one of the leading
providers of testing to support clinical trials of new pharmaceuticals
worldwide. Quest Informatics collects and analyzes laboratory, pharmaceutical
and other data to help large health care customers better manage the health
of their patients.
Quest Diagnostics currently processes over 100 million requisitions each
year. A requisition is an order form completed by a physician that accompanies a
patient specimen, indicating the tests to be performed and the party to be
billed for the tests. Quest Diagnostics' customers include physician practices,
hospitals, managed care organizations, employers and institutions and other
independent clinical laboratories.
Quest Diagnostics has a network of major laboratories located in about 30
major metropolitan areas throughout the United States, several joint venture
laboratories, approximately 200 smaller "stat" laboratories and about 1,400
patient service centers. Quest Diagnostics also has a leading esoteric testing
laboratory and research and development facility known as Nichols Institute
located in San Juan Capistrano, California as well as laboratory facilities in
Mexico City and near London, England. Quest Diagnostics' network increased
significantly as a result of the acquisition in August 1999 of SmithKline
Beecham Clinical Laboratories, Inc. ("SBCL"), then one of the three largest
independent clinical laboratories in the United States.
Quest Diagnostics expects to realize significant benefits from
combining its existing laboratory network with that of SBCL, while
maintaining a consistent high level of service to its customers. Quest
Diagnostics has begun the process of reducing redundant facilities and
infrastructure, which is expected to result in a 5-10% reduction in staffing
over the next several years. Quest Diagnostics does not intend to abandon any
geographic areas. Quest Diagnostics expects to realize about $100 million in
annual net synergies after three years.* See "Integration of SBCL
Operations." These benefits, along with the successful execution of the
Company's business strategy, will accelerate the Company's earnings growth
rate (before special charges related to the further integration of SBCL's
operations) by at least 30% annually over the next several years.*
Quest Diagnostics Incorporated is a Delaware corporation. We refer to
Quest Diagnostics Incorporated and its subsidiaries as "Quest Diagnostics" or
the "Company." Quest Diagnostics is the successor to a New York corporation
known as MetPath Inc. that was organized in 1967. From 1982 to 1996, Quest
Diagnostics was a subsidiary of Corning Incorporated ("Corning"). On December
31, 1996, Corning distributed all of the outstanding shares of common stock of
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (D), (E), (F), (G),
(J), (L), (N) AND (O).
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Quest Diagnostics to the stockholders of Corning. The principal executive
offices of Quest Diagnostics are located at One Malcolm Avenue, Teterboro, New
Jersey 07608, telephone number: (201) 393-5000.
ACQUISITION OF SBCL
On August 16, 1999, Quest Diagnostics completed the acquisition of SBCL, which
operated the clinical laboratory business of SmithKline Beecham plc ("SmithKline
Beecham"). The purchase price consisted of $1.025 billion in cash and about 12.6
million shares of Quest Diagnostics common stock, which represented
approximately 29% of Quest Diagnostics' then outstanding common stock. The cash
portion of the purchase price was funded principally through a new senior
secured credit facility (the "Credit Agreement"). See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The SBCL
acquisition agreement provides for a purchase price adjustment based on an
audit of the August 16, 1999 combined balance sheet of SBCL and certain
affiliates. Adjustments resulting from this audit, which are subject to
resolution as set forth in the SBCL acquisition agreement and are the subject
of ongoing discussions between the parties, have been recorded as of December
31, 1999. However, amounts due from SmithKline Beecham, as a result of the
purchase price adjustment, have not been reflected in the December 31, 1999
consolidated balance sheet of Quest Diagnostics.
As part of the acquisition agreement, Quest Diagnostics entered into a
long-term contract under which Quest Diagnostics is the primary provider of
testing to support SmithKline Beecham's clinical trials testing requirements
worldwide. In addition, Quest Diagnostics granted SmithKline Beecham certain
non-exclusive rights and access to use Quest Diagnostics' proprietary clinical
laboratory information database. Quest Diagnostics will also receive a minority
interest in a company that SmithKline Beecham expects to form to sell health
care information products and services through various channels, including the
Internet.
The pro forma combined financial information included throughout this
annual report assumes that the SBCL acquisition and borrowings under the
Company's Credit Agreement were effected on January 1, 1998. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Pro
Forma Combined Financial Information."
BUSINESS STRATEGY
Quest Diagnostics' mission is to be recognized by its customers and employees as
the best provider of comprehensive and innovative diagnostic testing,
information and services.
CAPITALIZE ON ENHANCED LABORATORY TESTING MARKET POSITION. As a result of the
acquisition of SBCL, Quest Diagnostics is the clear leader in its core clinical
laboratory testing business. Quest Diagnostics is the only truly national
provider of clinical laboratory testing services, serving all of the nation's
largest 50 metropolitan areas. Its national network of over 1400 patient service
centers, 200 stat laboratories and major facilities in about 30 major
metropolitan areas enable Quest Diagnostics to serve managed care organizations,
hospitals, physicians, employers and other health care providers and their
patients throughout the country. Quest Diagnostics believes that, with the
benefits of its leading network, it can further establish its market position
while at the same time, through its account management process, ensure that its
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accounts generate an acceptable profit.* Quest Diagnostics also plans to
continue to introduce new esoteric tests, particularly in the area of molecular
diagnostics, and focus on such growth areas as clinical trials testing and drugs
of abuse testing.
BUILD MEDICAL INFORMATION SERVICES CAPABILITIES. Quest Diagnostics seeks to
become a leading provider of medical information during the next several years.*
Quest Diagnostics believes that more than 70% of all health care decisions and
spending are impacted by laboratory testing results. Quest Diagnostics believes
that its clinical laboratory results database is the largest private database in
the world. Quest Diagnostics has traditionally used its database to assist (1)
large customers of clinical testing, who use the data to answer financial,
marketing and quality related questions, and (2) pharmaceutical customers, who
use the data (without patient identifying information) to expand their marketing
efforts as well as to promote disease management initiatives. Quest Diagnostics
is actively exploring ways to expand the use of its database to improve patient
care through opportunities ranging from Internet-based health and information
services to direct-to-consumer services. As part of this strategy, in January
2000, Quest Diagnostics announced the execution of an agreement with Caresoft
Incorporated, under which Quest Diagnostics will provide laboratory results and
testing information directly to consumers who request it over the Internet
through Caresoft's consumer web site, THEDAILYAPPLE.COM., enabling consumers to
download these results into their own confidential personal medical record.
PROVIDE THE HIGHEST QUALITY. Quest Diagnostics seeks to become recognized as the
undisputed quality leader in the health care services industry.* To help achieve
this goal, in late 1999 Quest Diagnostics recruited the Process Quality Leader
of GE Capital's Six Sigma effort, to spearhead a similar initiative for the
Company. Six Sigma is an approach to managing that requires thorough
understanding of customer needs and requirements, rigorous tracking and
measuring of services, and training of employees in methodologies so that they
can be held accountable for improving results. During 2000, the Six Sigma
methodology and high-impact quality improvement projects will be deployed across
the Company. Three of Quest Diagnostics' laboratories have achieved ISO-9001
certification, an international standard for quality management systems, with
Nichols Institute being the first clinical laboratory in North America to
achieve this certification. Quest Diagnostics' diagnostics kits facility has
also achieved ISO-9001 certification. Several of Quest Diagnostics' regional
laboratories are currently pursuing ISO-900l certification.
THE UNITED STATES CLINICAL LABORATORY TESTING MARKET
OVERVIEW. Clinical laboratory testing is an essential element in the
delivery of quality health care service. Physicians use laboratory tests to
assist in the detection, diagnosis, evaluation, monitoring and treatment of
diseases and other medical conditions. Clinical laboratory testing is generally
categorized as clinical testing and anatomical pathology testing. Clinical
- --------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (A), (G) AND (K).
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (G), (K), (L), (M) AND (N).
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (E), (G), (I), (J), (K), (L), (M)
AND (N).
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testing is performed on body fluids, such as blood and urine. Anatomical
pathology testing is performed on tissues and other samples, such as human
cells. Most clinical laboratory tests are considered routine and can be
performed by most independent clinical laboratories. Tests that are not routine
and that require more sophisticated equipment and personnel are considered
esoteric tests. Esoteric tests are generally referred to laboratories that
specialize in those tests.
Quest Diagnostics believes that the United States clinical laboratory
testing industry is between $30 billion and $35 billion in annual revenues. Most
laboratory testing is done by three types of providers: hospital-affiliated
laboratories; independent clinical laboratories such as those owned by Quest
Diagnostics; and physician-office laboratories. Quest Diagnostics believes that
in 1999 hospital-affiliated laboratories performed over one-half of the clinical
laboratory tests in the United States, independent clinical laboratories
performed approximately one-third of those tests and physician-office
laboratories performed the balance.
During the last decade, the following factors have had a negative
impact on independent clinical laboratory growth rates:
o excess capacity and intensified competition, including
competition from hospital laboratories that seek to expand
their testing services to persons who are not in- or
out-patients (see "Customers-Hospitals");
o reductions in Medicare reimbursement rates and changes in
government and private payer reimbursement policies designed
to reduce utilization of tests (see "Regulation of
Reimbursement for Clinical Laboratory Operations"); and
o growth of the managed care sector and other health care
networks, which resulted in increased bargaining power in the
hands of large buyers.
EFFECT OF THE GROWTH OF THE MANAGED CARE SECTOR. Over the last decade,
the number of patients participating in managed care plans has grown
significantly, although recently the growth rate has slowed. In addition, the
managed care industry has been consolidating, resulting in several large managed
care organizations who have significant bargaining power in negotiating fee
arrangements with health care providers, including clinical laboratories. The
challenges created by these market dynamics include:
o SHIFT TOWARD CAPITATED PAYMENT CONTRACTS. Managed care
organizations generally negotiate capitated payment contracts
for a substantial portion of their business, which shift the
risk and cost of testing from the managed care organization to
the clinical laboratory. Under a capitated payment contract,
the clinical laboratory and the managed care organization
agree to a per member, per month, payment to cover all
laboratory tests during the month, regardless of the number or
cost of the tests actually performed. Some services, such as
various esoteric tests, new technologies and anatomic
pathology services, may be carved out from a capitated rate
and, if carved out, are charged on a fee-for-service basis.
Some capitated payment contracts include retroactive or future
fee adjustments if the number of tests performed for the
managed care organization exceeds or is less than the
negotiated threshold levels. For their fee-for-service
testing, managed care organizations also typically negotiate
substantial discounts.
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o RESPONSIBILITY FOR CHARGES FOR OUT-OF-NETWORK TESTS. Recently,
managed care organizations have begun to make their principal
laboratory providers responsible for all the costs of clinical
laboratory services provided to the members of the managed
care organizations. Under these arrangements, the principal
laboratory provider (or "lab network provider") is responsible
for the charges for tests performed by other laboratory
providers even though the principal laboratory has no control
over the physicians who ultimately determine where to send the
specimens for testing. The principal provider attempts to
reduce this risk by forming a network of other subcontracted
laboratories to reduce the amount of out-of-network testing.
While managed care organizations typically agree to discourage
their affiliated physicians from sending tests to
out-of-network laboratory providers, it is often difficult to
achieve 100% compliance with these programs, and the principal
laboratory provider is responsible for the costs of the out of
network testing. The principal laboratory provider generally
receives a fee for managing the laboratory network.
o HISTORY OF AGGRESSIVE PRICING. Capitated agreements with
managed care organizations have historically been priced
aggressively. This practice was due to competitive pressures
and the expectation that a laboratory could capture not only
the testing covered under the contract, but also additional
higher priced fee-for-service business from participating
physicians. As the number of patients covered under managed
care organizations increases, more patients are covered by
capitated agreements and there is less fee-for-service
business, and therefore less profitable business to offset the
lower margin capitated managed care business. Furthermore,
physicians are increasingly affiliated with more than one
managed care organization, and, therefore, a clinical
laboratory might receive little, if any, additional
fee-for-service testing from participating physicians.
FUTURE OUTLOOK. In the long term, Quest Diagnostics believes that
pricing pressures are likely to remain due to intense competition. Increased
controls over the utilization of clinical laboratory tests by both Medicare and
the private sector will continue to negatively impact testing volume. However,
Quest Diagnostics believes that the following factors will favorably impact
testing volume, yielding modest annual industry growth:*
o general aging of the United States population;
o increased focus on early detection and prevention as the best
way to reduce the overall cost of health care and development
of more sophisticated and specialized tests for early
detection of disease and disease management;
o research and development in the area of genetics, which are
expected to ultimately yield new genetic tests and techniques;
o tests becoming more affordable due to advances in technology
and increased cost efficiencies;
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (D), (J), (L) AND (M).
6
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o increased testing for substance abuse, occupational exposures
and as part of comprehensive wellness programs;
o increased testing for diagnosis and monitoring of infectious
diseases such as AIDS and hepatitis C; and
o increased awareness of patients as to the value of clinical
laboratory testing and an increased willingness of patients to
pay for tests that may not be covered by third party payers.
The clinical laboratory testing industry is faced with changing technology and
new product introductions. Technology changes may lead to the development of
more cost effective point-of-care testing equipment that can be performed by
physicians in their offices without requiring the services of clinical
laboratories, which could negatively impact testing volume and revenues.
SERVICES
Quest Diagnostics' laboratory testing business consists of routine
testing, esoteric testing and clinical trials testing. Quest Diagnostics'
management estimates that, on a pro forma basis (adjusted to exclude the effect
of the testing performed by third parties under the Company's laboratory network
management arrangements), in 1999 routine testing generated about 83% of its net
revenues, esoteric testing generated about 12% of its net revenues and clinical
trials testing generated about 2% of its net revenues. Quest Diagnostics
derived the balance of its net revenues primarily from the manufacture and sale
of diagnostic test systems and fees charged to customers, such as managed care
organizations and pharmaceutical companies, for information products derived
from clinical laboratory data.
ROUTINE TESTING. Routine tests measure various important bodily health
parameters such as the function of the kidney, heart, liver, thyroid and other
organs. Commonly ordered tests include:
o blood cholesterol level tests;
o complete blood cell counts;
o Pap smears;
o HIV-related tests;
o urinalyses;
o pregnancy and other pre-natal tests; and
o alcohol and other substance-abuse tests.
Quest Diagnostics performs routine testing through its network of major
laboratories, stat laboratories and patient service centers. It also performs
routine testing at hospital laboratories it manages. Major laboratories offer a
full line of routine clinical tests. Stat laboratories are local facilities
where Quest Diagnostics can quickly perform an abbreviated line of routine tests
for customers that require rapid turnaround. Patient service centers are
facilities at which specimens are collected. Patient service centers are
typically located in or near a building for medical professionals.
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Quest Diagnostics operates 24 hours a day, 365 days a year. It performs
and reports most routine procedures within 24 hours. Most test results are
delivered electronically.
ESOTERIC TESTING. Nichols Institute is one of the leading esoteric
clinical testing laboratories in the world. In 1998, Nichols Institute, located
in San Juan Capistrano, became the first clinical laboratory in North America to
achieve ISO-9001 certification. As a result of the SBCL acquisition, Quest
Diagnostics acquired SBCL's National Esoteric Testing Center, located in Van
Nuys, California. Quest Diagnostics has announced plans to transfer esoteric
testing performed at the Van Nuys facility to Nichols Institute.
Esoteric tests are those tests that are performed less frequently than
routine tests and/or require more sophisticated equipment and materials,
professional "hands-on" attention and more highly skilled personnel. Because it
is not cost-effective for most clinical laboratories to perform the low volume
of esoteric tests in-house, they generally refer many esoteric tests to an
esoteric clinical testing laboratory. Esoteric tests are generally priced higher
than routine tests.
Nichols Institute performs hundreds of esoteric tests that are not
routinely performed by Quest Diagnostics' regional laboratories. These esoteric
tests are generally in the following fields:
o endocrinology (the study of glands, their hormone secretions
and their effects on body growth and metabolism);
o genetics (the study of chromosomes, genes, and their protein
products and effects);
o immunology (the study of the immune system including
antibodies, immune system cells and their effects);
o microbiology (the study of microscopic forms of life including
bacteria, viruses, fungi and other infectious agents);
o molecular biology (a branch of biology dealing with the
organization of living matter, especially with the genetic and
molecular basis of biological phenomena);
o oncology (the study of abnormal cell growth including benign
tumors and cancer);
o serology (a science dealing with the body fluids and their
analysis, including antibodies, proteins and other
characteristics);
o special chemistry (more sophisticated testing requiring
special expertise and technology); and
o toxicology (the study of chemicals and drugs and their effects
on the body's metabolism).
Quest Diagnostics believes that it is one of the leaders in
transferring technological innovation from academic and biotechnology
laboratories to the marketplace. Nichols Institute was the first private
reference laboratory to introduce a number of new tests, including tests to
measure circulating hormone levels and tests to predict breast cancer. Quest
Diagnostics continues to develop new and more sophisticated testing to monitor
the success of therapy for cancer and AIDS and to detect other diseases and
disorders. In 1999, Nichols
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Institute introduced an improved maternal serum screening test for assessing the
risk of prenatal genetic abnormalities, such as Down syndrome and neural tube
defects.
Quest Diagnostics uses complex technologies such as branched DNA and
polymerase chain reaction (PCR) to detect lower levels of the AIDS virus than
can be measured using other technologies. The concentration of the AIDS virus,
also referred to as viral load, can also be measured. The ability to measure the
viral load permits health care providers to better tailor drug therapies for
HIV-infected patients.
Quest Diagnostics maintains a relationship with the academic community
through its Academic Associates program, under which about 40 scientists from
academia and biotechnology firms work directly with Quest Diagnostics' staff
scientists to monitor and consult on existing test procedures and develop new
esoteric test methods. In addition, Quest Diagnostics enters into licensing
arrangements and co-development agreements with biotechnology companies and
academic medical centers.
CLINICAL TRIALS TESTING. Quest Diagnostics believes that, as a result
of the acquisition of SBCL's clinical trials business, its clinical trials
business is the world's third largest provider, after Quintiles Transnational
Corp. and Covance Inc., of clinical laboratory testing performed in connection
with clinical research trials on new drugs. Clinical research trials assess
the safety and efficacy of new drugs. Quest Diagnostics has clinical trials
testing centers in the United States and in England. Prior to the acquisition,
SBCL entered into a testing agreement with Dorovitch Laboratory Services in
Australia to enhance clinical trials service in Australia and the Pacific Rim.
Clinical trials involving new drugs are increasingly being performed both
inside and outside the United States.
About $29 million (or about 41%) of Quest Diagnostics' pro forma 1999
net revenues from clinical trials testing represented testing for SmithKline
Beecham. Under a ten year agreement, Quest Diagnostics is the primary provider
of clinical trials testing services for SmithKline Beecham worldwide.
OTHER SERVICES AND PRODUCTS. Quest Diagnostics manufactures and markets
diagnostic test kits and systems primarily for esoteric testing under the
Nichols Institute Diagnostics brandname. These are sold principally to hospital
and clinical laboratories both domestically and internationally. In 1999, sales
of diagnostic test kits and systems accounted for about 1% of Quest Diagnostics'
pro forma net revenues (adjusted to exclude the effect of the testing performed
by third parties under the Company's laboratory network management
arrangements). Quest Diagnostics also provides information derived from clinical
laboratory data to customers such as managed care organizations and
pharmaceutical companies through Quest Informatics.
CUSTOMERS
Quest Diagnostics provides testing services to a broad range of health
care providers. During 1999, no single customer or affiliated group of customers
accounted for more than 3% of Quest Diagnostics' pro forma net revenues
(adjusted to exclude the effect of the testing performed by third parties under
the Company's laboratory network management arrangements). Quest Diagnostics
believes that the loss of any one of its customers would not have a material
adverse effect on its financial condition, results of operations or cash flow.
The primary types of customers are:
PHYSICIANS AND PHYSICIAN GROUPS. Physicians requiring testing for
patients who are not covered by a capitated managed care contract are one of the
primary sources of Quest Diagnostics' clinical laboratory business. Quest
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Diagnostics bills its fees for testing services to the appropriate party, who
may be (1) the physician who requested the testing, (2) the patient, or (3) a
third party who pays the bill for the patient, such as an insurance company,
Medicare or Medicaid. Some states, including New York, New Jersey and Rhode
Island, prohibit Quest Diagnostics from billing physician clients.
Quest Diagnostics typically bills its customers on a fee-for-service
basis. Fees billed to physicians are based on the laboratory's client fee
schedule and are typically negotiated. Fees billed to patients and third parties
are based on the laboratory's patient fee schedule, which may be subject to
limitations on fees imposed by third-party payers and negotiation by physicians
on behalf of their patients. Medicare and Medicaid reimbursements are based on
fee schedules set by governmental authorities.
MANAGED CARE ORGANIZATIONS. On a pro forma basis, during 1999 more than
20% of Quest Diagnostics' volume but less than 10% of its net revenues (adjusted
to exclude the effect of the testing performed by third parties under the
Company's laboratory network management arrangements) were generated from
capitated agreements with managed care organizations. Managed care organizations
typically contract with a limited number of clinical laboratories for their
capitated members and then agree to instruct their participating physicians to
use these in-network laboratories for their capitated testing. Larger managed
care organizations typically prefer to use large independent clinical
laboratories because they can provide services on a national or regional basis
and can manage networks of local or regional laboratories. In addition, larger
laboratories are better able to achieve the low-cost structures necessary to
profitably service large managed care organizations and can provide test
utilization data across their various plans. Quest Diagnostics has several
agreements with managed care organizations under which it manages laboratory
networks for the managed care organizations.
Quest Diagnostics closely reviews its arrangements with managed care
organizations and intends not to enter into any overall arrangements that are
not profitable. Quest Diagnostics cannot assure investors that it will not lose
managed care accounts to other clinical laboratories that price their laboratory
services agreements more aggressively.
HOSPITALS. Quest Diagnostics provides services to hospitals throughout
the United States that vary from esoteric testing to laboratory management.
Quest Diagnostics believes that it is the industry's market leader in servicing
hospitals. During 1999, on a pro forma basis reference testing for hospitals
accounted for about 12% of net revenues (adjusted to exclude the effect of the
testing performed by third parties under the Company's laboratory network
management arrangements). Hospitals generally maintain an on-site laboratory to
perform testing on patients and refer less frequently needed and highly
specialized procedures to outside laboratories, which typically charge the
hospitals on a negotiated fee-for-service basis. Many hospitals compete with
independent clinical laboratories by encouraging community physicians to send
their testing to the hospital's laboratory. In addition, hospitals that have
purchased physicians' practices generally require their physicians to send their
tests to the hospital's affiliated laboratory. As a result, hospital-affiliated
laboratories can be both customers and competitors for independent clinical
laboratories.
EMPLOYERS AND OTHER INSTITUTIONS. Quest Diagnostics provides testing
services to governmental agencies, including the Department of Defense and state
and federal prison systems, and to large employers. Quest Diagnostics is the
leader in the clinical laboratory industry in providing testing to employers for
substance abuse, occupational exposures and comprehensive wellness programs. The
employer market is growing faster than the overall market for clinical
laboratory testing as large companies seek to take an active role in lowering
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their overall health care costs through wellness programs to ensure that they
have a healthy, drug-free workforce. During 1999, on a pro forma basis testing
services for employers accounted for about 6% of net revenues (adjusted to
exclude the effect of the testing performed by third parties under the Company's
laboratory network management arrangements). Quest Diagnostics also performs
esoteric testing services for other independent clinical laboratories that do
not have the full range of Quest Diagnostics' testing capabilities. All of these
customers are charged on a fee-for-service basis.
PAYERS
Fees for many clinical laboratory tests are billed to a party other
than the patient or the physician who ordered the test. Tests performed may be
billed to third-party payers such as insurance companies, managed care
organizations, Medicare and Medicaid.
The following table shows current estimates of the breakdown of the
percentage of Quest Diagnostics' pro forma total volume of requisitions and
total clinical laboratory revenues (adjusted to exclude the effect of the
testing performed by third parties under the Company's laboratory network
management arrangements) in 1999 applicable to each payer group:
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REVENUE AS % OF TOTAL
REQUISITION VOLUME AS CLINICAL LABORATORY
% OF TOTAL VOLUME REVENUES
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Patient 3%-8% 10%-15%
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Medicare and Medicaid 12%-17% 12%-17%
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Monthly Bill
(Physician, Hospital,
Employer, Other) 33%-38% 30%-35%
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Third Party Fee-for-Service 20%-25% 33%-38%
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Managed Care-Capitated 20%-25% 5%-10%
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SALES AND MARKETING
Quest Diagnostics markets to and services its customers through its
direct sales force sales representatives, customer service and patient service
representatives and couriers.
Most sales representatives market routine laboratory services primarily
to physicians and hospitals. The remaining sales representatives focus on
particular market segments or on testing niches. For example, some
representatives concentrate on market segments such as hospitals or managed care
organizations, and others concentrate on testing niches such as substance-abuse
testing.
Customer service representatives perform a number of services for
patients and customers. They monitor services, answer questions and help resolve
problems. Quest Diagnostics' couriers pick up specimens from most clients daily.
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GROWTH OPPORTUNITIES
Quest Diagnostics believes that it can take advantage of several growth
opportunities with its current infrastructure.
MEDICAL INFORMATION. The demand for comprehensive medical information
continues to grow. Quest Diagnostics believes that its clinical laboratory
database is the largest private clinical laboratory results database in the
world. Quest Diagnostics intends to utilize this database and others it may
develop to become a leading provider of medical information, improving patient
care through opportunities that range from Internet-based health and information
services to direct-to-patient services. Large customers of clinical laboratories
are increasingly interested in integrating clinical laboratory data with other
health care information to answer financial, marketing and quality related
questions. Pharmaceutical customers are interested in using clinical laboratory
data (without patient identifying information) to expand their marketing
efforts as well as to promote disease management initiatives.
To meet these emerging needs for medical information, the Quest
Informatics division of Quest Diagnostics has developed a portfolio of
information products based primarily upon Quest Diagnostics' extensive
database and core medical and analytical expertise. These products maintain
patient confidentiality and require patient consent if patient identifying
information is provided to a third party. Quest Diagnostics is actively
exploring ways to expand the use of its database through opportunities
ranging from Internet-based health and information services to
direct-to-patient services. As part of this strategy, in January 2000, Quest
Diagnostics announced the execution of an agreement with Caresoft
Incorporated under which Quest Diagnostics will provide laboratory results
and testing information directly to consumers who request it over the
Internet through Caresoft's consumer web site, THEDAILYAPPLE.COM., enabling
consumers to download these results into a secured personal medical record.
Laws in a number of states restrict the ability of patients to directly
access test results and accordingly, the website will not be available in
those states that restrict access.
CONSUMER HEALTH. Currently, almost all the testing performed by
Quest Diagnostics is ordered by a physician, who receives the test results.
However, consumers are becoming increasingly interested in managing their own
health and health records. As indicated in the preceding paragraph, Quest
Diagnostics will shortly begin to allow patients to access their test results
through the Internet and download the results into a confidential personal
medical record made available by Caresoft. Quest Diagnostics believes that
consumers will increasingly want to order clinical laboratory tests
themselves, particularly for monitoring levels of cholesterol, PSA (prostate
specific antigen), glucose, hemoglobin (anemia), and TSH (thyroid disorders),
even if they may be responsible for paying for the tests themselves. Quest
Diagnostics' network of 1,400 patient service centers throughout the country,
which already service over 100,000 patients each day, could be utilized to
service testing ordered directly by the patient. Laws in a number of states
restrict the ability of patients to order tests directly and permit test
results to be provided only to the ordering physician. However, Quest
Diagnostics believes that consumer demand may result, over time, in the
re-examination of regulatory restrictions on patients' ordering clinical
tests and receiving the results directly.*
HOSPITAL ALLIANCES. In response to the growth of the managed care
sector, many health care providers have established new alliances.
Hospital-physician networks have emerged in many markets to offer a
comprehensive range of health care services, either to managed care
organizations or directly to employers.
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (J), (L), (M) AND (N).
12
<PAGE>
Quest Diagnostics has historically received substantial esoteric
testing revenues from hospital referrals. It has established a hospital alliance
group to develop nontraditional hospital arrangements, including management and
consulting agreements, strategic services and joint ventures. Quest Diagnostics
believes that most hospital laboratories perform approximately 95% to 97% of
their patients' clinical laboratory tests. Quest Diagnostics believes that, in
many cases, nontraditional hospital arrangements can be economically
advantageous for a hospital's laboratory by lowering costs and capital
requirements.
During the last several years, Quest Diagnostics and SBCL have
established joint ventures with the leading integrated health delivery networks
in several metropolitan areas: (1) UPMC Health System, based in Pittsburgh, (2)
Unity Health, based in St. Louis, 3) Banner Health System (formerly Samaritan
Health System), based in Phoenix, and (4)Community Hospitals of Indiana and
Seton Health Corporation of Central Indiana, based in Indianapolis. Quest
Diagnostics also has an existing joint venture (acquired as part of the SBCL
acquisition) with Miami Valley Hospital, based in Dayton, and an existing joint
venture with approximately 20 hospitals in northwestern Pennsylvania and
southwestern New York. These joint venture arrangements, which provide testing
for these hospitals as well as for unaffiliated physicians and other health care
providers in their geographic areas, serve as Quest Diagnostics' principal
laboratory facilities in their service areas. Quest Diagnostics has either a
majority ownership interest in or day-to-day management responsibilities for all
of its hospital joint ventures except for the joint venture with Banner Health
System.
Since the completion of the SBCL acquisition, Quest Diagnostics has
been taking steps to integrate Quest Diagnostics' businesses that are in the
regions served by the former SBCL joint ventures (as well as the integration of
SBCL's businesses that are in the regions served by the existing Quest
Diagnostics businesses). During 2000 Quest Diagnostics expects to transfer the
competing businesses to all of its existing joint ventures. However, one or more
of the joint ventures could be terminated by mutual agreement of the parties due
to changes in business objectives resulting from the acquisition of SBCL.
In addition to its joint venture arrangements, Quest Diagnostics has
outsource agreements with a group of approximately 25 hospitals in eastern
Nebraska and manages the laboratories of those hospitals. Quest Diagnostics also
manages the laboratories at a number of other hospitals.
In 1998 Quest Diagnostics entered into an agreement with Premier, Inc.
("Premier"). Premier is one of the largest group purchasing organizations in the
United States. Approximately 1,800 hospitals in the United States are affiliated
with Premier. Under this agreement, Quest Diagnostics is the only clinical
laboratory sponsored by Premier to negotiate strategic services arrangements
with hospitals affiliated with Premier, which may include a variety of
alternatives tailored to the needs of the hospital, ranging from management of
hospital laboratories to extended outsourcing arrangements. Quest Diagnostics is
also one of two clinical laboratories approved by Premier to provide reference
testing services to hospitals affiliated with Premier under a committed standard
group purchasing agreement.
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<PAGE>
INFORMATION SYSTEMS
Information systems are used in laboratory testing, billing, customer
service, logistics, management of medical data, and other aspects of Quest
Diagnostics' business. Quest Diagnostics believes that the efficient handling of
information involving customers, patients, payers and other parties will be
critical to its future success.
During the 1980's and early 1990's, when Quest Diagnostics acquired
many of its laboratory facilities, regional laboratories were operated as local,
decentralized units. When the laboratories were acquired, Quest Diagnostics did
not make significant changes in their method of operations and did not
standardize their billing, laboratory and some other information systems. As a
result, by the end of 1995 Quest Diagnostics had many different information
systems for billing, test results reporting and other transactions. Over time,
the growth in the size and network of Quest Diagnostics' customers and the
increasing complexity of billing made clear a greater need for standardized
systems.
Prior to the acquisition of SBCL, Quest Diagnostics had chosen its SYS
system as its standard billing system and its QuestLab system (which is
licensed from a third party) as its standard laboratory information system,
and had begun to convert laboratories to the standard systems. SBCL had
standardized billing and laboratory information systems (which are different
from the Quest Diagnostics systems) throughout its laboratory network. As a
result of the acquisition of SBCL, Quest Diagnostics is currently reassessing
its standard systems.
SBCL shares a data center (containing its billing system and certain
administrative systems) with SmithKline Beecham's other United States
operations. This data center is currently operating at close to capacity. In
addition, SBCL did not have a payroll system separate from that of SmithKline
Beecham. SBCL is continuing to use the SmithKline Beecham data center for a
transition period. Quest Diagnostics expects that by the end of 2000, it will
establish a new data center for the SBCL billing system. At a later date Quest
Diagnostics may decide to consolidate its other billing sites into a new system.
In addition, during 2000, Quest Diagnostics expects to install a new payroll
system for all employees. Transferring databases and masterfiles to a new data
center and converting billing and other systems present conversion risks. In
addition, workflow is interrupted during a conversion, which may cause backlogs.
The Company is continuing to invest in the development and improvement
of its connectivity products for customers and providers by developing
differentiated products that will provide friendlier, easier access to
information. The Company expects to develop new Internet-enabled connectivity
for test ordering and results reporting during the next 12 months. In addition,
the Company expects to enter into strategic alliances to enhance its ability to
introduce electronic services to a broader variety of customers across all
spectrums.* The recent selection by PC WEEK as the number 10 rated company in
its fast-track 500 list reflects the Company's continuing emphasis on
positioning itself to capitalize in the digital economy through the use of
state-of-the-art networks and capabilities.
Quest Diagnostics did not experience any significant year 2000
problems.
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (K) AND (N).
14
<PAGE>
BILLING
Billing for laboratory services is complicated. Laboratories must bill
various payers, such as patients, insurance companies, Medicare, Medicaid,
doctors and employer groups, all of which have different requirements.
Most of Quest Diagnostics' bad debt expense is the result of several
non-credit related issues, primarily missing or incorrect billing information on
requisitions. Quest Diagnostics performs the requested tests and reports test
results regardless of whether the billing information is incorrect or missing.
It subsequently attempts to obtain any missing information and rectify incorrect
billing information received from the health care provider. Missing or incorrect
information on requisitions adds complexity to and slows the billing process,
creates backlogs of unbilled requisitions and generally increases the aging of
accounts receivable. Among many other factors complicating billing are (1)
pricing differences between the fee schedules of Quest Diagnostics and those of
the payer, (2) disputes with payers as to which party is responsible for
payment, (3) disparity in coverage among various carriers and (4) auditing for
specific compliance policies and procedures. Ultimately, if all issues are not
resolved in a timely manner, the related receivables are charged to the
allowance for doubtful accounts.
Quest Diagnostics has implemented "best practices" for billing that
have significantly reduced the percentage of requisitions with missing billing
information from approximately 16% at the beginning of 1996 to approximately
5.5% immediately prior to the acquisition of SBCL. These initiatives, together
with progress in dealing with Medicare medical necessity documentation
requirements and standardizing billing systems, have significantly reduced bad
debt expense since 1996. During the twelve months ended July 31, 1999
(immediately prior to the acquisition of SBCL), Quest Diagnostics' bad debt
expense was about 6% of net revenues (adjusted to exclude the effect of the
testing performed by third parties under the Company's laboratory network
management arrangements), while SBCL, which had not implemented procedures
similar to those of Quest Diagnostics, had bad debt expense of about 10% of net
revenues (adjusted to exclude the effect of the testing performed by third
parties under SBLC's laboratory network management arrangements). Since the
acquisition, Quest Diagnostics has begun to implement Quest Diagnostics
billing practices, which Quest Diagnostics believes should be able to lower
overall bad debt expense (including that of SBCL) to (or below) the levels
immediately prior to the acquisition.*
Implementation of a standardized billing system continues to be a
priority of Quest Diagnostics. However, Quest Diagnostics believes that over the
next several years it will derive greater benefit from maintaining separate
billing systems for the former SBCL operations and focusing its attention on
implementing Quest Diagnostics' best billing practices. Converting billing
systems to a standardized system presents conversion risks to Quest Diagnostics,
as key databases and masterfiles are transferred to a standardized system. In
addition, the billing workflow is interrupted during a conversion, which may
cause backlogs.
Quest Diagnostics has not experienced any significant interruptions in
reimbursement from any payers as a result of the year 2000 problem.
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (D), (E), (G) AND (K).
15
<PAGE>
INTEGRATION OF SBCL OPERATIONS
The integration of SBCL's operations with Quest Diagnostics' existing
operations is difficult and complex. Given the large size of SBCL's operations,
the Company expects that it will take as long as four years before the
integration of SBCL is fully completed. The integration requires the dedication
of management resources, which detracts attention from day-to-day operations.
During and after the integration process, Quest Diagnostics is committed to
providing the highest levels of customer service. Nonetheless, the process of
combining operations could cause an interruption of, or a loss of momentum in,
the activities of Quest Diagnostics' business, which could have a material
adverse effect on net revenues and operating results, at least in the short
term. Any interruption or deterioration in services may result in a customer's
decision to stop using Quest Diagnostics for clinical laboratory testing. Most
clinical laboratory testing is performed under arrangements that are terminable
at will or on short notice.
Quest Diagnostics has already begun the process of reducing
redundant facilities and infrastructure, which is expected to result over the
next several years in a 5-10% reduction in staffing. The Company does not
intend to abandon any geographic areas. The Company has already successfully
completed the transfer of testing from SBCL's laboratory in the Boston
metropolitan area to Quest Diagnostics' existing laboratory in that area. The
Company has selected and announced the other redundant laboratories that will
be closed or reduced in size over the next several years, which are located
in the following metropolitan areas: Baltimore, Cleveland, Dallas, Detroit,
Long Island, Miami and Philadelphia. The Company has existing facilities in
all of these areas that can handle the additional volume and service
requirements of customers. In addition, some testing volume currently sent to
distant sites will be redirected to nearby facilities, which will improve
customer service. Also, the Company is transferring esoteric testing
performed at SBCL's National Esoteric Testing Center in Van Nuys, California
to Nichols Institute and consolidating its domestic clinical trials testing
at SBCL's clinical trials facility in Van Nuys. All of these actions are
scheduled to take place during 2000 and 2001.
The integration of SBCL's operations is costly. During 1999, the
Company recorded about $73 million in special charges relating to the
acquisition and planned integration of SBCL. During 1999, the Company also
recorded nearly $56 million in other integration costs that were not charged
to earnings but were recorded as a cost of the SBCL acquisition. The Company
also expects to incur about $15 million in integration costs that will be
charged to operations during 2000 as incurred. Approximately $109 million of
the costs and expenses outlined above are expected to involve cash outlays.
While the majority of the integration costs are expected to be paid in 2000,
there are certain severance and facility related exit costs, principally
remaining lease obligations, that have payment terms extending beyond 2000.
Management believes that the costs to integrate the SBCL business into Quest
Diagnostics will be funded primarily through cash from operations.* See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
While the aggregate amount of these cash and non-cash costs are less
than the original estimates of about $190 million included in the Company's
proxy statement for the 1999 annual meeting of shareholders, the Company may in
the future incur additional integration costs beyond what has already been
announced.*
- ----------
* THESE ARE FORWARD-LOOKING STATEMENTS. SEE "CAUTIONARY STATEMENT FOR
PURPOSES OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995." IN PARTICULAR, SEE FACTORS (C), (D), (E),
(F), (G), AND (K).
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (E) AND (G).
16
<PAGE>
Quest Diagnostics expects that the combination of its existing
laboratory network with that of SBCL will result in about $100 million of
annual net synergies after three years.* The Company has experienced, and
expects to continue to experience, some negative financial impact on its
results of operations from the SBCL acquisition, resulting principally from
pricing differences between Quest Diagnostics and SBCL, as well as from
compensation and benefits adjustments resulting from the combination of
workforces. However, the Company expects that the benefits from the
acquisition will far outweigh these impacts. Management believes that the
benefits from the SBCL acquisition, including the successful integration of
SBCL, along with the execution of the Company's business strategy, will
accelerate the Company's earnings growth rate (before special charges related
to the further integration of SBCL's operations) by at least 30% annually
over the next several years.*
ACQUISITIONS
Quest Diagnostics has added most of its regional laboratories through
acquisitions. Quest Diagnostics expects to focus future clinical laboratory
acquisition efforts on smaller laboratories that can be integrated into its
existing laboratories without impeding the integration of SBCL's operations.
This strategy will enable Quest Diagnostics to reduce costs and gain other
benefits from the elimination of redundant facilities and equipment, and
reductions in personnel. Quest Diagnostics may also consider acquisitions of
ancillary businesses as part of its overall growth strategy.
COMPETITION
The clinical laboratory testing business is fragmented and highly
competitive. Quest Diagnostics competes with three types of providers:
hospital-affiliated laboratories, other independent clinical laboratories and
physician-office laboratories.
Quest Diagnostics is the leading clinical laboratory provider in the
United States, with about $3.3 billion of annual revenues on a pro forma basis
during 1999 and facilities in substantially all of the country's major
metropolitan areas. Quest Diagnostics' largest competitor is Laboratory
Corporation of America ("LabCorp"), which had about $1.7 billion in revenues in
1999. In addition, Quest Diagnostics competes with many smaller regional and
local independent clinical laboratories, as well as laboratories owned by
physicians and hospitals.
Quest Diagnostics believes that health care providers often consider
the following factors, among others, in selecting a laboratory:
o accuracy, timeliness and consistency in reporting test
results;
o number and type of tests performed by the laboratory;
o service capability and quality;
o number, convenience and geographic coverage of patient service
centers;
o reputation in the medical community; and
o pricing.
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (A),(B), (C), (D), (E), (F), (G),
(J), (K), (L), (N), AND (O).
17
<PAGE>
Quest Diagnostics believes that it competes favorably in each of these areas.
Quest Diagnostics believes that large independent clinical laboratories
may be able to increase their share of the overall clinical laboratory testing
market due to their large service networks and lower cost structures. These
advantages should enable larger clinical laboratories to more effectively serve
large managed care organizations and more effectively deal with Medicare
reimbursement reductions and utilization controls.* In addition the company
believes that consolidation in the clinical laboratory testing business will
continue.
QUALITY ASSURANCE
Quest Diagnostics' goal is to continually improve the processes for
collection, storage and transportation of patient specimens, as well as the
precision and accuracy of analysis and result reporting. Quest Diagnostics'
quality assurance efforts focus on proficiency testing, process audits,
statistical process control and personnel training for all of its laboratories
and patient service centers. Quest Diagnostics is implementing a Six Sigma
process to help achieve its goal of becoming recognized as the undisputed
quality leader in the health care services industry.*
INTERNAL QUALITY CONTROL AND AUDITS. Quality control samples are
processed in parallel with the analysis of patient specimens. The results of
tests on quality control samples are then monitored to identify drift, shift or
imprecision in the analytical processes. In addition, Quest Diagnostics
administers an extensive internal program of "blind" proficiency testing, where
quality control samples are processed through Quest Diagnostics' systems as
routine patient samples and reported. Quest Diagnostics also performs internal
process audits as part of its comprehensive quality assurance program.
EXTERNAL PROFICIENCY TESTING AND ACCREDITATION. All Quest Diagnostics'
laboratories participate in various blind sample quality surveillance programs
conducted externally. These programs supplement all other quality assurance
procedures. They include proficiency testing programs administered by the
College of American Pathologists ("CAP"), as well as many state agencies.
CAP is an independent non-governmental organization of board certified
pathologists. CAP is approved by the Health Care Financing Administration to
inspect clinical laboratories to determine compliance with the standards
required by the Clinical Laboratory Improvement Amendments of 1988. CAP offers
an accreditation program to which laboratories may voluntarily subscribe. All of
the Company's major regional laboratories are accredited by CAP. Accreditation
includes on-site inspections and participation in the CAP proficiency test
program.
- ----------
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (D), (E), (F), (G),
(K), (L) AND (M).
* THIS IS A FORWARD-LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (E), (G), (I), (J), (K), (L),
(M) and (N).
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REGULATION OF CLINICAL LABORATORY OPERATIONS
The clinical laboratory industry is subject to significant federal and
state regulation, including inspections and audits by governmental agencies.
Governmental authorities may impose fines, criminal penalties or take other
enforcement actions to enforce laws and regulations, including revoking a
clinical laboratory's right to conduct business. Changes in regulation may
increase the costs of performing clinical laboratory tests.
CLIA. All Quest Diagnostics laboratories and patient service centers
are licensed and accredited by applicable federal and state agencies. The
Clinical Laboratory Improvement Amendments of 1988 ("CLIA") regulates virtually
all clinical laboratories by requiring they be certified by the federal
government to ensure that all clinical laboratory testing services are uniformly
accurate, reliable and timely. CLIA permits states to adopt regulations that are
more stringent than federal law. For example, state laws may require additional
personnel qualifications, quality control, record maintenance and proficiency
testing.
DRUG TESTING. The Substance Abuse and Mental Health Services
Administration ("SAMHSA") regulates drug testing for public sector employees.
SAMHSA has established detailed performance and quality standards that
laboratories must meet to perform drug testing on federal employees and
contractors and other regulated entities. Quest Diagnostics' laboratories that
perform such testing must be certified as meeting SAMHSA standards.
CONTROLLED SUBSTANCES. The federal Drug Enforcement Administration (the
"DEA") regulates access to controlled substances in drug abuse testing. Quest
Diagnostics' laboratories that use controlled substances are licensed by the
DEA.
MEDICAL WASTE, HAZARDOUS WASTE AND RADIOACTIVE MATERIALS. Clinical
laboratories are also subject to federal, state and local regulations relating
to the handling and disposal of regulated medical waste, hazardous waste and
radioactive materials. Quest Diagnostics generally uses outside suppliers for
specimen disposal.
OCCUPATIONAL SAFETY. The federal Occupational Safety and Health
Administration has established extensive requirements relating specifically to
workplace safety for health care employers. This includes clinical laboratories
whose workers may be exposed to blood-borne or airborne viruses, such as HIV and
hepatitis B. Several states have recently enacted legislation requiring use of a
"safety needle" that covers or blunts the needle after blood is drawn. Quest
Diagnostics is evaluating the use of safety needles, which are more expensive
than regular needles, throughout its patient service center network.
SPECIMEN TRANSPORTATION. Transportation of infectious substances such
as clinical laboratory specimens is subject to regulation by the Department of
Transportation, the Public Health Service ("PHS"), the United States Postal
Service and the International Civil Aviation Organization.
CONFIDENTIALITY OF HEALTH INFORMATION
Pursuant to the Health Insurance Portability and Accountability Act of
1996 ("HIPAA"), in November 1999, the Secretary of the Department of Health and
Human Resources ("HHS") issued proposed regulations that would establish
comprehensive federal standards with respect to privacy of certain health
information that is or has ever been electronically maintained or transmitted
by a health plan, healthcare provider or health care data clearinghouse. The
proposed regulations establish a complex regulatory framework on a variety of
subjects, including (a) disclosures and uses of health information that require
19
<PAGE>
patient consent, (b) patient's rights to access and amend their health
information and (c) administrative, technical and physical safeguards required
of entities that use or receive protected health information. The proposed
regulations establish a "floor" and would not supercede state laws that are
more stringent. Therefore, the Company would be required to comply with both
federal privacy standards and varying state privacy laws. The federal privacy
regulations will become effective two years after they are finalized, which is
currently expected to occur later in 2000. In addition, the proposed security
and electronic signature regulations issued by the Secretary of the HHS in
August, 1998 pursuant to HIPAA are expected to be finalized this year.
Compliance with the HIPAA requirements, when finalized, will require
significant capital and personnel resources from all healthcare organizations,
including the Company. However, the Company will not be able to estimate the
cost of complying with these regulations until after they are finalized. The
regulations, when finalized, could adversely affect the Company.
REGULATION OF REIMBURSEMENT FOR CLINICAL LABORATORY SERVICES.
OVERVIEW. The health care industry has been undergoing significant
changes. Governmental payers, such as Medicare (which principally serves
patients aged 65 years and older), Medicaid (which principally services indigent
patients), as well as private insurers and large employers have taken steps to
control the cost, utilization and delivery of health care services. Principally
as a result of recent reimbursement reductions and measures adopted by the
Health Care Financing Administration ("HCFA") to reduce utilization described
below, the percentage of Quest Diagnostics' aggregate net revenues derived from
Medicare programs declined from 20% in 1995 to 12% in 1999. Quest Diagnostics
believes its other business may significantly depend on continued participation
in the Medicare and Medicaid programs, because many clients may want a single
laboratory to perform all of their clinical laboratory testing services,
regardless of whether reimbursements are ultimately made by themselves,
Medicare, Medicaid or other payers.
Billing and reimbursement for clinical laboratory testing is subject to
significant federal and state regulation. Penalties for violations of laws
relating to billing federal healthcare programs and for violations of federal
fraud and abuse laws include: (1) exclusion from participation in
Medicare/Medicaid programs; (2) asset forfeitures; (3) civil and criminal
penalties and fines; and (4) the loss of various licenses, certificates and
authorizations necessary to operate some or all of a clinical laboratory's
business. Civil administrative penalties for a wide range of offenses are up to
$11,000 per offense plus three times the amount claimed.
REDUCED REIMBURSEMENTS. In 1984, Congress established a Medicare fee
schedule for clinical laboratory services performed for patients covered under
Part B of the Medicare program. Congress then imposed a ceiling on the amount
that would be paid under the Medicare schedule. Since then, Congress has
periodically reduced previous ceilings. The Medicare national fee schedule
limitations were reduced in 1996 to 76% of the 1984 national median and in 1998
to 74% of the 1984 national median. In addition, Congress also eliminated the
provision for annual fee schedule increases based on the consumer price index
through 2002. However, as part of the 1999 Balanced Budget Refinement Act, the
reimbursement by Medicare for Pap smear tests was increased by almost 100%.
Currently, the Clinton Administration's proposed budget for fiscal Year 2001
seeks to reduce by 1% the scheduled annual fee schedule increases based on the
consumer price index for 2003, 2004 and 2005; and to reduce by 30% the
reimbursement for four commonly ordered tests. Quest Diagnostics cannot predict
if Congress will implement the proposed reduction or any other reductions. The
Clinton Administration's proposed budget for fiscal year 2001 also calls for
reinstatement of 20% co-insurance for clinical laboratories. When co-insurance
was last in effect in 1984, clinical laboratories received from Medicare
carriers only 80% of their Medicare reimbursement rates and were required to
bill Medicare beneficiaries for the balance of the charges. If enacted, such a
proposal could adversely affect the revenues of the clinical laboratory
20
<PAGE>
industry, including Quest Diagnostics, by exposing the testing laboratory to the
credit of individuals and by increasing the number of bills. In addition, a
laboratory could be subject to potential fraud and abuse violations if adequate
procedures to bill and collect the co-insurance payments are not established and
followed.
Laboratories must bill the Medicare program directly and must accept
the scheduled amount as payment in full for most tests performed on behalf of
Medicare beneficiaries. In addition, state Medicaid programs are prohibited from
paying more (and in most instances, pay significantly less) than Medicare. Major
clinical laboratories, including Quest Diagnostics, typically use two fee
schedules:
o "Client" fees charged to physicians, hospitals, and
institutions to which a laboratory supplies services on a
wholesale basis. These are generally subject to negotiation or
discount.
o "Patient" fees charged to individual patients and third-party
payers, like Medicare and Medicaid. These generally require
separate bills for each requisition.
The fees established by Medicare are typically substantially lower than
patient fees otherwise charged by Quest Diagnostics, but are higher than Quest
Diagnostics' fees actually charged to many clients. During 1992, the Office of
the Inspector General (the "OIG") of the Department of Health and Human Services
("HHS") issued final regulations that prohibited charging Medicare fees
substantially in excess of a provider's usual charges. The OIG, however,
declined to provide any guidance concerning interpretation of these rules,
including whether or not discounts to non-governmental clients and payers or the
dual-fee structure might be inconsistent with these rules.
A proposed rule released in September 1997 would authorize the OIG to
exclude from participation in the Medicare program providers, including clinical
laboratories, that charge Medicare and other programs fees that are
"substantially in excess of . . . usual charges . . . to any of [their]
customers, clients or patients." This proposal was withdrawn by the OIG in 1998.
However, the 1997 Balanced Budget Act permits HCFA to adjust statutorily
prescribed fees for some medical services, including clinical laboratory
services, if the fees are "grossly excessive." In January 1998, HCFA issued an
interim final rule setting forth criteria to be used by HCFA in determining
whether to exercise this power. Among the factors listed in the rule are whether
the statutorily prescribed fees are "grossly higher or lower than the payment
made for the. . . services by other purchasers in the same locality." This rule
is the basis for the Clinton Administration's proposed budget to reduce by 30%
the reimbursement for four commonly ordered tests. In November 1999, the OIG
issued an advisory opinion which indicated that that a clinical laboratory that
offers discounts on client bills may violate the "usual charges" regulation if
the "charge to Medicare substantially exceeds the amount the laboratory most
frequently charges or has contractually agreed to accept from non-Federal
payors." Quest Diagnostics cannot provide any assurances to investors that fees
payable by Medicare could not be reduced as a result of the application of this
rule or that the government might not assert claims for reimbursement by
purporting to apply this rule retroactively.
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REDUCED UTILIZATION OF CLINICAL LABORATORY TESTING. In recent years,
HCFA has taken several steps to reduce utilization of clinical laboratory
testing. Since 1995, Medicare carriers have adopted policies under which they do
not pay for many commonly ordered clinical tests unless the ordering physician
has provided an appropriate diagnostic code supporting the medical necessity of
the test. Physicians are required by law to provide diagnostic information when
they order clinical tests for Medicare and Medicaid patients. However, there is
no penalty prescribed for violations of this law.
In March 1996, HCFA eliminated its prior policy under which Medicare
paid for all tests contained in an automated chemistry panel when at least one
of the tests in the panel is medically necessary. HCFA indicated that under the
new policy, Medicare will only pay for those individual tests in a chemistry
panel that are medically necessary. Subsequently the American Medical
Association ("AMA"), in conjunction with HCFA, eliminated the existing automated
chemistry panel series (CPT Codes 80002-80019) and designed four new panels of
"clinically relevant" automated chemistry panels. HCFA adopted these panels in
1998 and in 1999 and 2000 amended these new panels or created additional panels.
The elimination of the old panels has resulted in reduced utilization of
automated chemistry tests and reduced reimbursement by Medicare for such tests.
Quest Diagnostics is generally permitted to bill patients directly for
some statutorily excluded clinical laboratory services. Quest Diagnostics is
also generally permitted to bill patients for clinical laboratory tests that
Medicare does not pay for due to "medical necessity" limitations (these tests
include limited coverage tests for which an approved diagnosis code is not
provided by the ordering physician) if the patient signs an advance beneficiary
notice. Since Quest Diagnostics does not have any direct contact with most
patients, Quest Diagnostics cannot control the proper use of the advance
beneficiary notice, and may perform the tests but cannot subsequently bill the
patient for them if the appropriate notice is not timely signed.
INCONSISTENT PRACTICES. Currently, many different local carriers
administer Medicare. They have inconsistent policies on matters such as: (1)
test coverage; (2) automated chemistry panels; (3) diagnosis coding; (4) claims
documentation; and (5) fee schedules (subject to the national limitations).
Inconsistent regulation has increased the complexity of the billing process for
clinical laboratories. As part of the 1997 Balanced Budget Act, HHS was required
to adopt uniform policies on the above matters by January 1, 1999 and replace
the current local carriers with no more than five regional carriers. However,
HHS has not finalized uniform policies and has not taken any action to replace
the local carriers with five regional carriers.
HCFA plans to achieve standardization through the help of a single
claims processing system for all carriers. This initiative, however, was
suspended due to HCFA's Year 2000 compliance priorities.
COMPETITIVE BIDDING. The 1997 Balanced Budget Act requires HCFA to
conduct five Medicare bidding demonstrations involving various types of medical
services and complete them by 2002. HCFA is expected to include a clinical
laboratory demonstration project in a metropolitan statistical area as part of
the legislative mandate. If competitive bidding were implemented on a regional
or national basis for clinical laboratory testing, it could materially adversely
affect the clinical laboratory industry and Quest Diagnostics.
FUTURE LEGISLATION. Future changes in federal, state and local
regulations (or in the interpretation of current regulations) affecting
governmental reimbursement for clinical laboratory testing could adversely
affect Quest Diagnostics. Quest Diagnostics cannot predict, however, whether and
what type of legislation will be enacted into law.
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FRAUD AND ABUSE REGULATIONS. Medicare and Medicaid anti-kickback laws
prohibit clinical laboratories from making payments or furnishing other benefits
to influence the referral of tests billed to Medicare, Medicaid or other federal
programs.
Various federal enforcement agencies, including the Federal Bureau of
Investigations ("FBI") and the OIG, interpret liberally and enforce aggressively
statutory fraud and abuse provisions. According to public statements by the
Department of Justice ("DOJ"), during the last several years health care fraud
has been elevated to one of the highest priorities of the DOJ, and substantial
prosecutorial and other law enforcement resources have been committed to
investigating health care provider fraud. The OIG also is involved in
investigations of health care fraud and has, according to recent workplans,
targeted certain laboratory practices for study, investigation and prosecution.
As noted above, the penalties for violation of these laws may include criminal
and civil fines and penalties and exclusion from participation in federal
programs. Many of the anti-fraud statutes and regulations, including those
relating to joint ventures and alliances, are vague or indefinite and have not
been interpreted by the courts. The Company cannot predict if some of the fraud
and abuse rules will be interpreted contrary to the practices of Quest
Diagnostics.
In November 1999, the OIG issued an advisory opinion concluding that
the industry practice of discounting client bills may constitute a kickback if
the discounted price is below a laboratory's overall cost (including overhead)
and below the amounts reimbursed by Medicare. Advisory opinions are not binding
but may be indicative of the position that prosecutors may take in enforcement
actions. The OIG's opinion, if enforced, could result in fines and possible
exclusion and could require Quest Diagnostics to eliminate offering discounts to
clients below the rates reimbursed by Medicare.
Many states have anti-kickback, anti-rebate, anti-fee-splitting and
other laws that also affect Quest Diagnostics' relationships with clients who
refer non-government-reimbursed clinical laboratory testing business to Quest
Diagnostics.
In addition, since 1992, a federal anti-"self-referral" law, commonly
known as the "Stark" law, prohibits, with certain exceptions, Medicare payments
for laboratory tests referred by physicians who have, personally or through a
family member, an investment interest in, or a compensation arrangement with,
the testing laboratory. Since January 1995, these restrictions have also applied
to Medicaid-covered services. Many states have similar anti-"self-referral" and
other laws that also affect investment and compensation arrangements with
physicians who refer other than government-reimbursed laboratory testing to
Quest Diagnostics. The Company cannot predict if some of the state laws will be
interpreted contrary to the practices of Quest Diagnostics.
GOVERNMENT INVESTIGATIONS AND RELATED CLAIMS
Since 1993, Quest Diagnostics has settled various government and
private claims that primarily involved industry-wide billing and marketing
practices that Quest Diagnostics had substantially discontinued by early 1993.
Other independent clinical laboratories have settled similar claims. These
settlements have not resulted in the exclusion of Quest Diagnostics in any
federal health care programs.
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GOVERNMENT SETTLEMENTS
PRINCIPAL CIVIL SETTLEMENTS. In September 1993, Quest Diagnostics
entered into a civil settlement agreement with the DOJ and the OIG, under which
it paid a total of approximately $36 million. The claims were that MetPath had
wrongfully induced physicians to order laboratory tests without their realizing
that those tests would be billed to Medicare at rates higher than those the
physicians believed were applicable. SBCL (while owned by SmithKline Beecham)
entered into a civil settlement agreement under which in 1997 it paid a total of
about $325 million to settle similar claims.
THE DAMON SETTLEMENT. In October 1996, Damon Clinical Laboratories
("Damon"), which was purchased by Corning in 1993, entered into a plea agreement
and civil settlement agreement and release with the DOJ. Under these agreements,
Damon paid a total of $119 million.
OTHER GOVERNMENTAL SETTLEMENTS. In addition, since 1992, Quest
Diagnostics has settled nine other federal and state billing-related claims for
a total of approximately $46 million. Corning paid or reimbursed Quest
Diagnostics for the cost of these settlements.
ONGOING GOVERNMENT INVESTIGATIONS
THE NICHOLS INSTITUTE INVESTIGATION. In August 1993, the federal
government issued a civil subpoena and began a formal investigation of Nichols
Institute, which remains open. The investigations relate to billing and
marketing practices of Nichols Institute's former routine regional laboratories,
which practices were substantially discontinued by the time that Quest
Diagnostics acquired Nichols in 1994. While Quest Diagnostics has established
reserves in respect of the Nichols Institute investigations, it cannot predict
the outcome of this investigation. Remedies available to the government include
exclusion from participation in the Medicare and Medicaid programs. However, in
light of the corporate integrity agreement between Quest Diagnostics and the OIG
discussed below, Quest Diagnostics believes the prospect of any exclusion is
remote. This is because the matters being investigated were corrected with or
before Quest Diagnostics' acquisition of Nichols Institute, and Quest
Diagnostics cooperated in the investigation. While application of remedies and
penalties could materially and adversely affect Quest Diagnostics' business,
financial condition and prospects, management believes that the possibility of
these effects is likewise remote. As discussed below, Corning has agreed to
indemnify Quest Diagnostics against any monetary penalties, fines or settlements
for any governmental claims that may arise as a result of the Nichols Institute
investigations.
OTHER INVESTIGATIONS AND CLAIMS. Quest Diagnostics is aware of several
pending lawsuits filed under the QUI TAM provisions of the civil False Claims
Act. These lawsuits raise a variety of allegations regarding Quest Diagnostics'
marketing and billing practices which, if proven, could result in the government
recovering substantial sums in damages and penalties. Several of the cases
involve operations of SBCL prior to the acquisition of SBCL.
THE DAMON OFFICER INDICTMENTS. In January 1998 the United States
indicted four former officers of Damon for alleged health care fraud committed
during their employment by Damon. Quest Diagnostics is obligated to indemnify
these Damon officers to the fullest extent permitted by Delaware law. Quest
Diagnostics' obligations consist primarily of advancing fees and expenses of
counsel in connection with the defense of these Damon officers.
SELF-REPORTING. As an integral part of its compliance program discussed
below, Quest Diagnostics investigates all reported or suspected failures to
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<PAGE>
comply with federal health care reimbursement requirements. Any non-compliance
that results in Medicare or Medicaid overpayments is reported to the government
and reimbursed by Quest Diagnostics. As a result of these efforts, Quest
Diagnostics has periodically identified and reported overpayments. While Quest
Diagnostics has reimbursed these overpayments and taken corrective action where
appropriate, Quest Diagnostics cannot assure investors that in each instance the
government will necessarily accept these actions as sufficient.
PRIVATE SETTLEMENTS AND CLAIMS
Since 1991, Quest Diagnostics has paid about $19 million to settle
claims by private payers alleging various actions of over-billing similar to
those that were at issue in the government settlements discussed above.
In March 1997, a former subsidiary of Damon, together with SBCL and
LabCorp, was served with a complaint in a purported class action. Quest
Diagnostics was added as a defendant in 1999. The complaint asserts claims under
the federal civil RICO statute relating to billing to private parties for tests
that were the subject of the government settlements. SBCL has also been named in
several other class actions that involve similar claims.
On March 22, 1999, SBCL learned that an SBCL employee at a patient
service center in Palo Alto, California had at times reused certain needles when
drawing blood from patients. A number of civil actions, including some
purporting to be class actions, have been filed against SBCL in federal and
state courts in California on behalf of patients who may have been affected by
the phlebotomist's reuse of needles or other alleged improper practices.
SmithKline Beecham has agreed to indemnify Quest Diagnostics for the
out-of-pocket costs of the counseling and testing, for liabilities arising out
of the civil actions and for other losses arising out of the conduct of the
phlebotomist, other than consequential damages.
CORNING INDEMNITY
Corning, the former parent of Quest Diagnostics, has agreed to
indemnify Quest Diagnostics against all monetary penalties, fines or settlements
for any government claims that (1) arise out of alleged violations of applicable
federal fraud and health care statutes; (2) relate to billing practices of Quest
Diagnostics and its predecessors; and (3) were pending on December 31, 1996.
This includes the Nichols Institute investigation described above.
Corning has also agreed to indemnify Quest Diagnostics 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 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 a total amount of $25 million and will be reduced to
take into account any deductions or tax benefits realized by Quest Diagnostics
or a consolidated group of which Quest Diagnostics is a member, to the extent
that such deductions or tax benefits are deemed to reduce the tax liability of
Quest Diagnostics. Corning will not indemnify Quest Diagnostics against damages
suffered as a result of or incidental to, the billing claims and the fees and
expenses of litigation.
Quest Diagnostics will control the defense of any government claim or
investigation unless Corning elects to assume the defense. However, in the case
of all non-government claims related to indemnified government claims of alleged
over billings, Quest Diagnostics will control the defense. All disputes relating
to the Corning indemnification agreement are subject to binding arbitration.
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SMITHKLINE BEECHAM INDEMNITY
SmithKline Beecham has agreed to indemnify Quest Diagnostics against
monetary payments required to be made to the federal or any state government
arising out of claims on investigations that have been settled before or are
pending as of the closing date of the SBCL acquisition, if those claims or
investigations are related to alleged violations of applicable federal fraud and
health care statutes and the billing practices of SmithKline Beecham and its
subsidiaries. SmithKline Beecham has also agreed to indemnify Quest Diagnostics
against monetary payments required to be made to private parties, such as
insurance companies, relating to or arising out of these governmental claims.
The indemnification with respect to governmental claims is for 100% of those
claims. With respect to the private party claims, the indemnification is for
100% of those claims, up to an aggregate amount of $80 million, 50% of those
claims to the extent they exceed $80 million but are less than $130 million and
100% of those claims to the extent they exceed $130 million. The indemnification
also covers 80% of out-of-pocket costs and expenses relating to investigations
of the claims indemnified against by SmithKline Beecham. This effectively limits
Quest Diagnostics' liability for private party claims to a maximum pretax amount
of $25 million plus 20% of out-of-pocket costs and expenses.
The special indemnification does not cover:
o governmental claims that arise after the closing date of the
SBCL acquisition;
o private claims unrelated to the indemnified governmental
claims or investigations; or
o any consequential or incidental damages relating to the
billing claims including losses of revenues and profits as a
consequence of exclusion from participation in federal or
state health care programs.
SBCL has several pending claims that are covered by this
indemnification and are described above.
SmithKline Beecham also has agreed to indemnify Quest Diagnostics
against any action, matter or claim arising from SmithKline Beecham's conduct of
its business prior to the closing date of the SBCL acquisition (including
medical professional liability claims) to the extent that these claims are
covered by its insurance policies or would have been covered by policies if not
for existing alternative arrangements made by SmithKline Beecham for the payment
of such claims.
QUEST DIAGNOSTICS' RESERVES
Quest Diagnostics' aggregate reserves with respect to all government
and private claims (including pre-acquisition claims of SBCL) were about $83
million at December 31, 1999. The reserves represent amounts for future
government and private settlements of pending matters or matters deemed probable
as a result of the government and private settlements and self-reporting.
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 that may cause
the final resolution of these matters to exceed established reserves by an
amount which could be material to Quest Diagnostics' results of operations and
cash flows in the period in which such claims are settled. Quest Diagnostics
does not believe that these issues will have a material adverse effect on its
overall financial condition.
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COMPLIANCE PROGRAM
Compliance with all government rules and regulations has become a
significant concern throughout the clinical laboratory industry because of
evolving interpretations of regulations and the national debate over health
care. Quest Diagnostics began a compliance program early in 1993.
Quest Diagnostics emphasizes the development of training programs
intended to ensure the strict implementation and observance of all applicable
laws, regulations and company policies. Further, Quest Diagnostics conducts
in-depth reviews of procedures, personnel and facilities to assure regulatory
compliance throughout its operations. A compliance committee of the board of
directors requires periodic reporting of compliance operations from management.
Government officials have publicly cited this program as a model for the
industry.
In connection with the Damon settlement, Quest Diagnostics signed a
five-year corporate integrity agreement with the OIG. Under the agreement, Quest
Diagnostics has agreed to take steps to demonstrate its integrity as a provider
of services to federally sponsored health care programs. These include steps to:
o maintain its corporate compliance program;
o adopt pricing guidelines;
o audit laboratory operations; and
o investigate and report instances of noncompliance, including
any corrective actions and disciplinary steps.
This agreement also gives Quest Diagnostics the opportunity to seek clearer
guidance on matters of compliance and to resolve compliance issues directly with
the OIG. SBCL also entered into a five-year corporate integrity agreement with
the OIG that became effective in 1997. As a result of the acquisition of SBCL,
SBCL is now covered under the corporate integrity agreement of Quest
Diagnostics.
None of the undertakings included in Quest Diagnostics' corporate
integrity agreement is expected to have any material adverse effect on Quest
Diagnostics' business, financial condition, results of operations, cash flow and
prospects. Quest Diagnostics believes it complies in all material respects with
all applicable statutes and regulations. However, Quest Diagnostics cannot
assure investors that no statute or regulations will be interpreted or applied
by a prosecutorial, regulatory or judicial authority in a manner that would
adversely affect Quest Diagnostics. Potential sanctions for violation of these
statutes include significant damages, penalties and fines, exclusion from
participation in governmental health care programs and the loss of various
licenses, certificates and authorization necessary to operate some or all of
Quest Diagnostics' business.
INSURANCE
Quest Diagnostics maintains various liability and property insurance
programs (subject to maximum limits and self-insured retentions) for claims that
could result from providing or failing to provide clinical laboratory testing
services, including inaccurate testing results, and other exposures. Management
believes that present insurance coverage and reserves are sufficient to cover
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currently estimated exposures, but cannot assure investors that Quest
Diagnostics will not incur liabilities in excess of the policy limits.
Similarly, although Quest Diagnostics believes that it will be able to obtain
adequate insurance coverage in the future at acceptable costs, it cannot assure
investors that it will be able to do so.
EMPLOYEES
At February 29, 2000, Quest Diagnostics employed approximately 27,000
people, as compared to 15,000 people at December 31, 1998. The increase in
employees is due to the acquisition of SBCL. Approximately 24,000 of Quest
Diagnostics' employees were full-time at February 29, 2000. These totals exclude
employees of the joint ventures in which Quest Diagnostics does not have a
majority interest. Quest Diagnostics expects to reduce its total employment by
about 5% to 10% following the completion of the integration of SBCL's
operations.
Quest Diagnostics has no collective bargaining agreements with any
unions, and believes that its overall relations with its employees are good.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Some statements in this document are identified as forward-looking
statements. They involve risks and uncertainties that could cause actual results
to differ materially from the forward-looking statements. The Private Securities
Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking
statements to encourage companies to provide prospective information about their
companies without fear of litigation. Statements must be (1) identified as
forward-looking; and (2) accompanied by identification of important factors that
could cause actual results to differ materially from those projected in the
statements, which will serve as a meaningful caution to investors.
Quest Diagnostics would like to take advantage of the "safe harbor"
provisions of the Litigation Reform Act in connection with the forward-looking
statements included in this document. The following important factors could
cause its actual financial results to differ materially from those projected,
forecasted or estimated by it in forward-looking statements:
(a) Heightened competition, including increased pricing pressure
and competition from hospitals for testing for non-patients.
See "Business--Competition."
(b) Impact of changes in payer mix, including the shift from
traditional, fee-for-service medicine to managed-cost health
care. See "Business--The United States Clinical Laboratory
Testing Industry -- Effect of the Growth of the Managed Care
Sector."
(c) Adverse actions by government or other third-party payers,
including unilateral reduction of fee schedules payable to
Quest Diagnostics. See "Business--Regulation of Reimbursement
for Clinical Laboratory Services."
(d) The impact upon Quest Diagnostics' volume and collected
revenue or general or administrative expenses resulting from
its compliance with Medicare and Medicaid administrative
policies and requirements of third-party payers. These
include:
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(1) the requirements of Medicare carriers to provide
diagnosis codes for many commonly ordered tests and
the likelihood that third-party payers will
increasingly adopt similar requirements;
(2) the policy of HCFA to limit Medicare reimbursement
for tests contained in automated chemistry panels to
the amount that would have been paid if only the
covered tests, determined on the basis of
demonstrable "medical necessity," had been ordered;
and
(3) the recent changes in chemistry panels mandated by
HCFA.
See "Business--Regulation of Reimbursement for
Clinical Laboratory Services."
(e) Adverse results from pending or future government
investigations. These include, in particular:
(1) significant monetary damages and/or exclusion from
the Medicare and Medicaid programs and/or other
significant litigation matters;
(2) the absence of indemnification from Corning for
private claims unrelated to the indemnified
government claims or investigations and for private
claims that are not settled by December 31, 2001. See
"Business--Government Investigations and Related
Claims;"
(3) the absence of indemnification from SmithKline
Beecham for:
(a) governmental claims against SBCL that arise
after August 16, 1999; and
(b) private claims unrelated to the indemnified
governmental claims or investigations; and
(4) the absence of indemnification for consequential
damages from either SmithKline Beecham or Corning.
(f) Failure to obtain new customers at profitable pricing or
failure to retain existing customers, and reduction in tests
ordered or specimens submitted by existing customers.
(g) The inability of Quest Diagnostics to efficiently integrate
acquired clinical laboratory businesses, particularly SBCL's,
or to efficiently integrate clinical laboratory businesses
from joint ventures and alliances with hospitals, and the
costs related to any such integration, or to retain key
technical and management personnel. See "Integration of SBCL
Operations."
(h) Inability to obtain professional liability insurance coverage
or a material increase in premiums for such coverage. See
"Business--Insurance."
(i) Denial of CLIA certification or other license for any of Quest
Diagnostics' clinical laboratories under the CLIA standards,
by HCFA for Medicare and Medicaid programs or other federal,
state and local agencies. See "Business--Regulation of
Clinical Laboratory Operations."
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(j) Adverse publicity and news coverage about Quest Diagnostics or
the clinical laboratory industry.
(k) Computer or other system failures that affect Quest
Diagnostics' ability to perform tests, report test results or
properly bill customers, including potential failures
resulting from systems conversions, including from the
integration of the systems of Quest Diagnostics and SBCL. See
"Business--Information Systems" and "--Billing."
(l) Development of technologies that substantially alter the
practice of laboratory medicine, including technology changes
that lead to the development of cost-effective point-of-care
testing equipment that negatively impacts the testing volume
and revenues of Quest Diagnostics. See "Business--The United
States Clinical Laboratory Testing Business--Future Outlook."
(m) Development of an Internet based electronic commerce business
model that does not require an extensive logistics and
laboratory network.
(n) The impact of the privacy regulations to be issued under HIPAA
on the Company's medical information services as well as the
cost to comply with the regulations. See "Confidentiality of
Health Information."
(o) Changes in interest rates causing a substantial increase in
Quest Diagnostics' effective borrowing rate.
ITEM 2. PROPERTIES
Quest Diagnostics' principal laboratories (listed alphabetically by
state) are located in or near the following metropolitan areas. In certain areas
(indicated by the number (2)), Quest Diagnostics has two principal laboratories
as a result of the acquisition of SBCL. Except in the case of the Chicago area,
Quest Diagnostics intends to close or reduce in size one of the duplicate
facilities.
<TABLE>
<CAPTION>
LOCATION LEASED OR OWNED
- -------- ---------------
<S> <C>
Phoenix, Arizona Leased by Joint Venture
Los Angeles, California Owned
San Diego, California Leased
San Francisco, California Owned
San Juan Capistrano, California Owned
Denver, Colorado Leased
New Haven, Connecticut Owned
Miami, Florida (2) Leased
Tampa, Florida Owned
Atlanta, Georgia Owned
Chicago, Illinois (2) One owned, one leased
Lexington, Kentucky Owned
New Orleans, Louisiana Owned
Baltimore, Maryland (2) Owned
Boston, Massachusetts Leased
Detroit, Michigan (2) One owned, one leased
Grand Rapids, Michigan Leased
Minneapolis, Minnesota Leased
St. Louis, Missouri (2) One owned, one leased
Lincoln, Nebraska Leased
New York, New York (Teterboro, New Jersey) Owned
Long Island, New York (2) Leased
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<PAGE>
<CAPTION>
LOCATION LEASED OR OWNED
- -------- ---------------
<S> <C>
Portland, Oregon Leased
Philadelphia, Pennsylvania (2) One owned, one leased
Pittsburgh, Pennsylvania Leased
Nashville, Tennessee Leased
Dallas, Texas (2) Leased
Houston, Texas Leased
San Antonio, Texas Owned
Newport News, Virginia Leased
Seattle, Washington Leased
</TABLE>
Quest Diagnostics' executive offices are located in Teterboro, New
Jersey, in the facility that also serves as Quest Diagnostics' regional
laboratory in the New York City metropolitan area. Quest Diagnostics leases
under a capital lease an administrative office (which served as the executive
office of SBCL) in Collegeville, Pennsylvania. Quest Diagnostics owns its
laboratory facility in Mexico City and leases it laboratory facility near
London, England. Quest Diagnostics currently is assessing its need for
additional space near the Teterboro and Collegeville facilities. Quest
Diagnostics believes that, in general, its laboratory facilities are suitable
and adequate for its current and anticipated future levels of operation. Quest
Diagnostics believes that if it were unable to renew the lease on any of its
testing facilities, it could find alternative space at competitive market rates
and relocate its operations to such new location.
ITEM 3. LEGAL PROCEEDINGS
In addition to the investigations described in "Business--Government
Investigations and Related Claims," Quest Diagnostics is involved in various
legal proceedings arising in the ordinary course of business. Some of the
proceedings against the Company involve claims that are substantial in amount.
Although the Company cannot predict the outcome of such proceedings or any
claims made against the Company, it does not anticipate that the ultimate
liability of such proceedings or claims will have a material adverse effect on
the Company's financial position or results of operations as they primarily
relate to professional liability for which the Company believes it has
adequate insurance coverage. See "Business-Insurance."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is listed and traded on the New York
Stock Exchange under the symbol "DGX." The following table sets forth, for the
periods indicated, the high and low sales price per share as reported on the New
York Stock Exchange Consolidated Tape:
1998: HIGH LOW
----- -------- --------
First Calendar Quarter $17.125 $15.0625
Second Calendar Quarter $23.0625 $16.125
Third Calendar Quarter $22.00 $16.00
Fourth Calendar Quarter $18.625 $14.50
1999: HIGH LOW
----- -------- --------
First Calendar Quarter $22.8125 $17.75
Second Calendar Quarter $27.50 $21.50
Third Calendar Quarter $28.125 $23.75
Fourth Calendar Quarter $32.9375 $22.5625
As of March 10, 2000, the Company had approximately 7,150 record holders of its
common stock.
The Company has not paid dividends in 1999 and 1998, and does not
expect to pay dividends on its common stock in the foreseeable future. The bank
credit facility prohibits the Company from paying cash dividends on its common
stock. The Indenture relating to the Company's 10.75% senior subordinated notes
due 2006 restricts the ability of the Company to pay cash dividends based
primarily on a percentage of the Company's earnings, as defined.
ITEM 6. SELECTED FINANCIAL DATA
See page 39.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
See pages 40.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 (a)1 and 2.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the directors of the Company is incorporated by
reference to the information in the Company's Proxy Statement to be filed on or
before May 1, 2000 (the "Proxy Statement") appearing under the caption "Election
of Directors."
EXECUTIVE OFFICERS OF THE REGISTRANT
Officers of the Company are elected annually by the Board of Directors
and hold office at the discretion of the Board of Directors. The following
persons serve as executive officers of the Company:
KENNETH W. FREEMAN (49) is Chairman of the Board and Chief Executive
Officer of Quest Diagnostics. Mr. Freeman joined Quest Diagnostics in May 1995
as President and Chief Executive Officer, was elected a director in July 1995
and was elected Chairman of the Board in December 1996. Prior to 1995, he served
in a variety of financial and managerial positions at Corning, which he joined
in 1972. He was elected Controller and a Vice President of Corning in 1985,
Senior Vice President in 1987, General Manager of the Science Products Division
in 1989 and Executive Vice President in 1993. He was appointed President and
Chief Executive Officer of Corning Asahi Video Products Company in 1990.
DR. VIJAY AGGARWAL (50) is President of Quest Diagnostics Ventures.
He is responsible for the clinical trials testing, medical diagnostics
equipment, medical informatics, e-commerce and direct-to-consumer services
businesses. Dr. Aggarwal was head of the Technology Department for
Bio-Science Laboratories until 1985 when it was acquired by SBCL. From 1985
through August 1999, when SBCL was acquired by Quest Diagnostics, Dr.
Aggarwal served in a variety of managerial positions for SBCL, most recently
serving as Vice President and Director of SBCL's clinical laboratory business
in the United States. From 1994 through June 1998, he served as Vice
President and Director of Managed Care Markets for SBCL. Dr. Aggarwal assumed
his current responsibilities with Quest Diagnostics in August 1999.
RICHARD L. BEVAN (40) is Corporate Vice President, Human Resources
Strategy and Development. From 1982 until August 1999, Mr. Bevan served in a
variety of human resources positions for SmithKline Beecham's pharmaceutical and
clinical laboratory businesses, most recently serving as Vice President and
Director of Human Resources-Operations for SBCL. Mr. Bevan assumed his current
responsibilities with Quest Diagnostics in August 1999.
JAMES D. CHAMBERS (43) is President, Business Services. Mr. Chambers
joined Corning in 1986 and served in a variety of managerial and financial
positions for Corning and its subsidiaries, becoming Assistant Treasurer in
1991. Mr. Chambers joined Quest Diagnostics in 1992 as Treasurer and served as
Chief Financial Officer from 1994 through 1995. In 1995, he assumed
responsibilities for overseeing the Quest Diagnostics billing process; in
January 1997 he was named Chief Administrative Officer with additional
responsibilities for Information Systems, Communications and Investor Relations;
and in February 1998 he was named Marketing and Business Development Leader. In
January 1999, Mr. Chambers was named Senior Vice President and Chief Growth
Officer and in August 1999 he assumed his current responsibilities.
JULIE A. CLARKSON (39) is Corporate Vice President for Communications
and Public Affairs. She has overall responsibility for internal and external
communications and government affairs. Ms. Clarkson has more than 12 years of
experience in sales and operations with Quest Diagnostics, most recently serving
33
<PAGE>
as Vice President for Business Development in Europe. She assumed her current
responsibilities in August 1999.
ROBERT A. HAGEMANN (43) is Corporate Vice President and Chief Financial
Officer. He joined Corning Life Sciences, Inc., in 1992, where he held a variety
of senior financial positions before being named Vice President and Corporate
Controller of Quest Diagnostics in 1996. Prior to joining Quest Diagnostics, Mr.
Hagemann was employed by Prime Hospitality, Inc. and Crompton & Knowles, Inc. in
senior financial positions. He was also previously associated with Ernst &
Young. Mr. Hagemann assumed his present responsibilities in August 1998.
GERALD C. MARRONE (57) is Corporate Vice President and Chief
Information Officer. Prior to joining Quest Diagnostics in November 1997 as
Chief Information Officer, Mr. Marrone was with Citibank, N.A. for 12 years.
During his tenure he was most recently Vice President, Division Executive for
Citibank's Global Production Support Division. While at Citibank, he was also
the Chief Information Officer of Citibank's Global Cash Management business.
Prior to joining Citibank, he was the Chief Information Officer for Memorial
Sloan-Kettering Cancer Center in New York for five years.
SURYA N. MOHAPATRA, Ph.D. (50) is President and Chief Operating
Officer. Dr. Mohapatra is responsible for all aspects of Quest Diagnostics' core
clinical laboratory testing, including its medical, operations and commercial
functions. Prior to joining Quest Diagnostics in February 1999 as Senior Vice
President and Chief Operating Officer, he was Senior Vice President of Picker
International, a worldwide leader in advanced medical imaging technologies,
where he served in various executive positions during his 18-year tenure.
MICHAEL E. PREVOZNIK (38) is Corporate Vice President for Legal and
Compliance and General Counsel. Prior to joining SBCL in 1994 as its Chief Legal
Compliance Officer, Mr. Prevoznik was with Dechert Price & Rhodes. In 1996, he
became Vice President and Chief Legal Compliance officer for SmithKline Beecham
Healthcare Services. In 1998, he was appointed Vice President, Compliance for
SmithKline Beecham, assuming additional responsibilities for coordinating all
compliance activities within SmithKline Beecham, worldwide. Mr. Prevoznik
assumed his current responsibilities with Quest Diagnostics in August 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item is incorporated by reference to
the information under the caption "Executive Compensation" appearing in the
Proxy Statement. The information contained in the Proxy Statement under the
captions "Compensation Committee Report on Executive Compensation" and
"Performance Graph" is not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item is incorporated by reference to
the information under the caption "Security Ownership of Certain Beneficial
Owners and Management" appearing in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item is incorporated by reference to
the information under the caption "Certain Relationships and Related
Transactions" appearing in the Proxy Statement.
34
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Index to financial statements and supplementary data filed as part of this
report:
Item Page
Report of Independent Accountants F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Cash Flows F-4
Consolidated Statements of Stockholders' Equity F-5
Notes to Consolidated Financial Statements F-6
Supplementary Data: Quarterly Operating Results F-34
(unaudited)
2. Financial Statement Schedule:
Schedule II - Valuation Accounts and Reserves F-35
3. Exhibits filed as part of this report:
See (c) below.
(b) Reports on Form 8-K filed during the last quarter of 1999:
None.
(c) Exhibits filed as part of this report:
EXHIBIT
NUMBER DESCRIPTION
2.1 Form of Transaction Agreement among Corning Incorporated, Corning
Life Sciences Inc., Corning Clinical Laboratories Inc. (Delaware),
Covance Inc. and Corning Clinical Laboratories Inc. (Michigan),
dated as of November 22, 1996 (filed as an exhibit to the Company's
Registration Statement on Form 10 (File No. 1-12215) and
incorporated herein by reference)
3.1 Certificate of Incorporation of the Registrant (filed as an exhibit
to the Company's Registration Statement on Form 10 (File No.
1-12215) and incorporated herein by reference)
3.2 Amended and Restated By-Laws of the Registrant (filed as an exhibit
to the Company's current report on Form 8-K (Date of Report: August
16, 1999) and incorporated herein by reference)
4.1 Form of Rights Agreement dated December 31, 1996 (the "Rights
Agreement") between Corning Clinical Laboratories Inc. and Harris
Trust and Savings Bank as Rights Agent (filed as an Exhibit to the
Company's Registration Statement on Form 10 (File No. 1-12215) and
incorporated herein by reference)
4.2 Form of Amendment No. 1 effective as of July 1, 1999 to the Rights
Agreement (filed as an exhibit to the Company's current report on
Form 8-K (Date of Report: August 16, 1999)and incorporated herein
by reference)
4.3 Form of Amendment No. 2 to the Rights Agreement
10.1 Form of Tax Sharing Agreement among Corning Incorporated, Corning
Clinical Laboratories Inc. and Covance Inc. (filed as an Exhibit to
the Company's Registration Statement on Form 10 (File No. 1-12215)
and incorporated herein by reference)
10.2 Form of Spin-Off Distribution Tax Indemnification Agreement between
35
<PAGE>
Corning Incorporated and Corning Clinical Laboratories Inc. (filed
as an Exhibit to the Company's Registration Statement on Form 10
(File No. 1-12215) and incorporated herein by reference)
10.3 Form of Spin-Off Distribution Tax Indemnification Agreement between
Corning Clinical Laboratories Inc. and Covance Inc. (filed as an
Exhibit to the Company's Registration Statement on Form 10 (File
No. 1-12215) and incorporated herein by reference)
10.4 Form of Spin-Off Distribution Tax Indemnification Agreement between
Covance Inc. and Corning Clinical Laboratories Inc. (filed as an
Exhibit to the Company's Registration Statement on Form 10 (File
No. 1-12215) and incorporated herein by reference)
10.5 Form of Executive Retirement Supplemental Plan (filed as an Exhibit
to the Company's Registration Statement on Form 10 (File No.
1-12215) and incorporated herein by reference)
10.6 Form of Variable Compensation Plan (filed as an Exhibit to the
Company's Registration Statement on Form 10 (File No. 1-12215) and
incorporated herein by reference)
10.7 Stock and Asset Purchase Agreement dated as of February 9, 1999
among SmithKline Beecham plc, SmithKline Beecham Corporation and
the Company (the "Stock and Asset Purchase Agreement")(filed as
Appendix A of the Company's Definitive Proxy Statement dated May
11, 1999 and incorporated by reference)
10.8 Amendment No. 1 dated August 6, 1999 to the Stock and Asset
Purchase Agreement (filed as an exhibit to the Company's current
report on Form 8-K (Date of Report: August 16, 1999)and
incorporated herein by reference)
10.9 Non-Competition Agreement dated as of August 16, 1999 between
SmithKline Beecham plc and the Company (filed as an exhibit to the
Company's current report on Form 8-K (Date of Report: August 16,
1999)and incorporated herein by reference)
10.10 Stockholders Agreement dated as of August 16, 1999 between
SmithKline Beecham plc and the Company (filed as an exhibit to the
Company's current report on Form 8-K (Date of Report: August 16,
1999)and incorporated herein by reference)
10.11 Category One Data Access Agreement dated as of August 16, 1999
between SmithKline Beecham plc and the Company(filed as an exhibit
to the Company's current report on Form 8-K (Date of Report: August
16, 1999)and incorporated herein by reference)
10.12 Category Three Data Access Agreement dated as of August 16, 1999
between SmithKline Beecham plc and the Company (filed as an exhibit
to the Company's current report on Form 8-K (Date of Report: August
16, 1999)and incorporated herein by reference)
10.13 Participation Agreement dated as of August 16, 1999 between
SmithKline Beecham plc and the Company(filed as an exhibit to the
Company's current report on Form 8-K (Date of Report: August 16,
1999)and incorporated herein by reference)
10.14 Global Clinical Trials Agreement dated as of August 16, 1999
between SmithKline Beecham plc and the Company(filed as an exhibit
to the Company's current report on Form 8-K (Date of Report: August
16, 1999)and incorporated herein by reference)
10.15 Credit Agreement dated as of August 16, 1999 among the Company, as
Borrower, the Guarantors party thereto, Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Joint Lead
Arranger and Syndication Agent, Banc of America Securities LLC, as
Joint Lead Arranger, Bank of America, N.A., as Administrative
Agent, Wachovia Bank N.A., as Co-Documentation Agent, The Bank of
New York, as Co-Documentation Agent and the Lenders party thereto
(filed as an exhibit to the Company's current report on Form 8-K
(Date of Report: August 16, 1999)and incorporated herein by
reference)
10.16 Security Agreement dated as of August 16, 1999 among the Company,
each of the Guarantors party thereto and Bank of America, N.A., as
Administrative Agent(filed as an exhibit to the Company's current
report on Form 8-K
36
<PAGE>
(Date of Report: August 16, 1999)and incorporated herein by
reference)
10.17 Amendment No. 1 dated as of December 13, 1999 to the Credit
Agreement
10.18 Form of Employees Stock Purchase Plan (filed as an Exhibit to the
Company's Registration Statement on Form 10 (File No. 1-12215) and
incorporated herein by reference)
10.19 Form of [1996] Employee Equity Participation Program (filed as an
Exhibit to the Company's Registration Statement on Form 10 (File
No. 1-12215) and incorporated herein by reference)
10.20 Form of 1999 Employee Equity Participation Program (filed as an
Exhibit to the Company's proxy statement for the 1999 annual
meeting of shareholders and incorporated herein by reference)
10.21 Form of Stock Option Plan for Non-Employee Directors (filed as an
exhibit to the Company's proxy statement for the 1998 annual
meeting of shareholders and incorporated herein by reference)
10.22 Employment Agreement between the Company and Kenneth W. Freeman
10.23 Form of Supplemental Deferred Compensation Plan (filed as an
exhibit to the Company's annual report on Form 10-K for the year
ended December 31, 1998 and incorporated herein by reference)
10.24 Form of 10.75% Senior Subordinated Notes due 2006 (filed as an
Exhibit to the Company's Registration Statement on Form S-1 (File
No. 333-15867) and incorporated herein by reference)
10.25 Form of Indenture between Corning Clinical Laboratories Inc. and
The Bank of New York, as Trustee, dated December 16, 1996 (filed as
an Exhibit to the Company's Registration Statement on Form S-1
(File No.333-15867) and incorporated herein by reference)
21 Subsidiaries of Quest Diagnostics Incorporated
23 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule
37
<PAGE>
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) 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.
Quest Diagnostics Incorporated
By /s/ Kenneth W. Freeman Chairman of the Board March 20, 2000
--------------------------- and Chief Executive Officer
Kenneth W. Freeman
By /s/ Robert A. Hagemann Vice President and March 20, 2000
--------------------------- Chief Financial Officer
Robert A. Hagemann
By /s/ Catherine T. Doherty Chief Accounting Officer March 20, 2000
---------------------------
Catherine T. Doherty
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and on the dates indicated.
Capacity Date
-------- ----
/s/ Kenneth W. Freeman Chairman of the Board March 20, 2000
- --------------------------- and Chief Executive Officer
Kenneth W. Freeman
- --------------------------- Director March 20, 2000
Kenneth D. Brody
/s/ William F. Buehler
- --------------------------- Director March 20, 2000
William F. Buehler
/s/ Van C. Campbell
- --------------------------- Director March 20, 2000
Van C. Campbell
/s/ Mary A. Cirillo
- --------------------------- Director March 20, 2000
Mary A. Cirillo
/s/ William R. Grant
- --------------------------- Director March 20, 2000
William R. Grant
- --------------------------- Director March 20, 2000
John O. Parker
- --------------------------- Director March 20, 2000
Dan C. Stanzione
/s/ Gail R. Wilensky
- --------------------------- Director March 20, 2000
Gail R. Wilensky
38
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
SELECTED HISTORICAL FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------
1999 (a) 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Operations Data:
Net revenues .................................... $ 2,205,243 $ 1,458,607 $ 1,528,695 $ 1,616,296 $ 1,629,388
Provisions for restructuring and other
special charges .............................. 73,385 (b) -- 48,688 (c) 668,544 (d) 50,560
Income (loss) before extraordinary loss ......... (1,274)(e) 26,885 (22,260) (625,960) (52,052)(f)
Net income (loss) ............................... (3,413)(e) 26,885 (22,260) (625,960) (52,052)(f)
Basic net income (loss) per common share:(g)
Income (loss) before extraordinary loss ......... $ (0.04) $ 0.90 $ (0.77) $ (21.72) $ (1.81)
Net income (loss) ............................... $ (0.10) $ 0.90 $ (0.77) $ (21.72) $ (1.81)
Diluted net income (loss) per common share:(g)(h)
Income (loss) before extraordinary loss ......... $ (0.04) $ 0.89 $ (0.77) $ (21.72) $ (1.81)
Net income (loss) ............................... $ (0.10) $ 0.89 $ (0.77) $ (21.72) $ (1.81)
Balance Sheet Data (at end of period):
Accounts receivable, net ........................ $ 539,256 $ 220,861 $ 238,369 $ 297,743 $ 318,252
Total assets .................................... 2,887,640 1,360,240 1,400,928 1,395,066 1,853,385
Long-term debt .................................. 1,171,442 413,426 482,161 515,008 1,195,566
Preferred stock ................................. 1,000 1,000 1,000 1,000 --
Common stockholders' equity ..................... 862,062 566,930 540,660 537,719 295,801
Other Data:
Net cash provided by (used in)
operating activities .......................... $ 249,535 $ 141,382 $ 176,267 $ (88,486)(i) $ 85,828
Net cash used in investing activities ........... (1,107,990) (39,720) (35,101) (63,674) (93,087)
Net cash provided by (used in)
financing activities .......................... 682,831 (60,415) (21,465) 157,674 4,986
Adjusted EBITDA (j) ............................. 237,038 158,609 153,800 166,358 176,521 (f)
Bad debt expense ................................ 142,333 89,428 118,223 (k) 111,238 152,590 (f)
Rent expense .................................... 59,073 46,259 47,940 49,713 46,900
Capital expenditures ............................ 76,029 39,575 30,836 70,396 74,045
</TABLE>
(a) On August 16, 1999, Quest Diagnostics completed the acquisition of SBCL.
Consolidated operating results for 1999 include the results of operations
of SBCL subsequent to the closing of the acquisition. See Note 3 to the
Consolidated Financial Statements.
(b) Represents charges principally incurred in conjunction with the acquisition
and planned integration of SBCL as discussed in Note 7 to the Consolidated
Financial Statements.
(c) Includes a charge of $16 million to write-down intangible assets as
discussed in Note 7 to the Consolidated Financial Statements.
(d) Includes a charge of $445 million to reflect the impairment of intangible
assets upon the adoption of a new accounting policy in 1996 for evaluating
the recoverability of intangible assets and measuring possible impairment
under a fair value method. See Note 2 to the Consolidated Financial
Statements.
(e) In conjunction with the acquisition of SBCL, the Company repaid the entire
amount outstanding under its then existing credit agreement. The
extraordinary loss recorded in the third quarter of 1999 represented $3.6
million ($2.1 million, net of tax) of deferred financing costs which were
written off in connection with the extinguishment of the credit agreement.
(f) Includes a charge of $62 million to increase the provision for doubtful
accounts resulting from billing systems implementation and integration
problems at certain laboratories and increased regulatory requirements.
(g) Historical earnings per share data for periods prior to 1997 have been
restated to reflect common shares outstanding as a result of the Company's
recapitalization in 1996. In December 1996, 28.8 million common shares were
issued to effectuate the Spin-Off Distribution and establish the Company's
employee stock ownership plan.
(h) Potentially dilutive common shares primarily represent stock options.
(i) Includes the payment of Damon and other billing related settlements
totaling approximately $144 million and the settlement of amounts owed to
Corning of $45 million.
(j) Adjusted EBITDA represents income (loss) before income taxes, net interest
expense, depreciation and amortization and special items. Special items
include the provisions for restructuring and other special charges
reflected in the selected historical financial data above, a $3.0 million
gain related to the sale of an investment in 1999 and charges of $2.5
million and $6.8 million recorded in selling, general and administrative
expenses in 1998 and 1997, respectively, related to the Company's
consolidation of its laboratory network announced in the fourth quarter of
1997. Adjusted EBITDA is presented and discussed because management
believes that Adjusted EBITDA is a useful adjunct to net income and other
measurements under generally accepted accounting principles 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 generally accepted accounting
principles) 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.
(k) Includes a fourth quarter charge of $5.3 million, which was part of the
$6.8 million charge recorded in the same quarter, to increase the provision
for doubtful accounts to recognize the reduced recoverability of certain
receivables from accounts which will no longer be served as a result of the
Company's consolidation plan.
39
<PAGE>
QUEST DIAGNOSTICS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Over the last several years, the underlying fundamentals of the clinical
laboratory testing industry have begun to improve. During the early 1990's, the
industry was negatively impacted by significant government regulation and
investigations into various billing practices. In addition, the rapid growth of
managed care resulted in revenue and profit declines, which in turn led to
industry consolidation, particularly among commercial laboratories. As a result
of these dynamics, fewer, but larger commercial laboratories have emerged which
have greater economies of scale and a more disciplined approach to pricing
services. Additionally, most of the larger commercial laboratory companies have
implemented rigorous programs designed to assure compliance with government
billing regulations and other laws. These changes, principally led by Quest
Diagnostics, have resulted in improved profits, and reduced the risk of
non-compliance with complex government regulations. Prospects for industry
growth have also improved. Increased focus on early detection and prevention as
an effective means to reduce the overall cost of health care; an increase in the
average age of the U.S. population; consumer activism in health care; aggressive
research and development in the area of genetics which is expected to lead to
new testing; and a slowing in the growth of managed care are expected to restore
growth to the industry.* Quest Diagnostics, as the largest clinical testing
company, with a leading position in most of its geographic markets and service
offerings, is well positioned to capitalize on the growth expected in the
industry.
Payments for clinical laboratory services are made by the government,
managed care organizations, insurance companies, physicians, hospitals,
employers and patients. In recent years, there has been a significant shift away
from traditional fee-for-service health care to managed health care, as
employers and other payers of health care costs aggressively move the
populations they control into lower cost plans. The growth and consolidation of
the managed care industry has created large managed care companies that control
the delivery of health care services for millions of people, and have
significant bargaining power in negotiating fees with providers, including
clinical laboratories. Managed care organizations generally seek to enter into
capitated payment contracts, under which clinical laboratories receive a fixed
monthly fee per individual enrolled with the managed care organization for all
laboratory tests performed during the month. Capitated payment contracts shift
the risk and cost of increased testing to the clinical laboratories. Services
such as esoteric tests, new technologies and anatomic pathology services may be
excluded from a capitated rate and would then be charged on a fee-for-service
basis. Quest Diagnostics expects the use of capitated agreements will continue
for the foreseeable future. Quest Diagnostics aggressively reviews the
profitability of its existing and new business, including capitated agreements.
Business that does not meet profitability guidelines is considered for pricing
and/or service level adjustments to ensure an adequate profit level is achieved.
The clinical laboratory industry is subject to seasonal fluctuations in
operating results and cash flows. During the summer months, year-end holiday
periods and other major holidays, volume of testing declines, reducing net
revenues and resulting cash flows below annual averages. Testing volume is also
subject to declines in winter months due to inclement weather, which varies in
severity from year to year.
The clinical laboratory industry is labor intensive. Employee compensation
and benefits constitute approximately half of the Company's total costs and
expenses. Cost of services consists principally of costs for obtaining,
transporting and testing specimens. Selling, general and administrative expenses
consist principally of the costs of the sales force, billing operations
(including
- ----------
* THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES OF
THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (F), (J), AND (L).
40
<PAGE>
bad debt expense), and general management and administrative support.
Additionally, costs to address Year 2000 readiness have been principally
included in selling, general and administrative expenses. Commencing with the
1999 fourth quarter and year-end results, certain expense items, primarily
related to a portion of occupancy costs and professional liability insurance,
which previously were classified as selling, general and administrative expenses
have been reclassified to cost of services, to better reflect the cost of
performing testing. All prior year financial information has been reclassified
for comparative purposes to conform with the 1999 presentation.
ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS
On August 16, 1999, the Company completed the acquisition of the clinical
laboratory business of SmithKline Beecham for approximately $1.3 billion. The
purchase price was paid through the issuance of 12.6 million shares of common
stock of the Company (valued at $260.7 million), representing approximately 29%
of the Company's then outstanding common stock, and the payment of $1.025
billion in cash, including $20 million under a non-competition agreement between
the Company and SmithKline Beecham.
Under the terms of the acquisition agreements, Quest Diagnostics acquired
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 consisted 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. In addition, SmithKline Beecham and Quest Diagnostics
entered into a long-term contract under which Quest Diagnostics is the primary
provider of testing to support SmithKline Beecham's clinical trials testing
requirements worldwide. As part of the acquisition agreements, Quest Diagnostics
granted SmithKline Beecham certain non-exclusive rights and access to use Quest
Diagnostics' proprietary clinical laboratory information database. Quest
Diagnostics will also receive a minority interest in a company that SmithKline
Beecham expects to form to sell healthcare information products and services
through various channels, including the Internet.
Under the terms of a stockholder agreement, SmithKline Beecham has 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 was expanded to nine directors following
the closing of the acquisition. The stockholder agreement also imposes
limitations on the right of SmithKline Beecham to sell or vote its shares and
prohibits SmithKline Beecham from purchasing in excess of 29.5% of the
outstanding common stock of Quest Diagnostics.
Under the acquisition agreements, SmithKline Beecham has agreed to
indemnify Quest Diagnostics, on an after tax basis, against certain matters
primarily related to taxes and billing and professional liability claims.
The acquisition was accounted for under the purchase method of accounting.
As such, the cost to acquire SmithKline Beecham's clinical laboratory business
("SBCL") has been allocated on a preliminary basis to the assets and liabilities
acquired based on estimated fair values as of the closing date. The consolidated
financial statements include the results of operations of SBCL subsequent to the
closing of the acquisition.
The SBCL acquisition agreements include a provision for a purchase price
adjustment based on an audit of the August 16, 1999 combined balance sheet of
SBCL and certain affiliates. Adjustments resulting from this audit, which are
subject to resolution as set forth in SBCL acquisition agreements and are the
subject of on-going discussions between the parties, have been recorded as of
December 31, 1999. However, amounts due from SmithKline Beecham, as a result
41
<PAGE>
of the purchase price adjustment, have not been reflected in the December 31,
1999 consolidated balance sheet of Quest Diagnostics.
The consolidated financial statements include a preliminary allocation of
the purchase price. Goodwill of approximately $952 million, representing
acquisition cost in excess of the fair value of the net tangible assets
acquired, is amortized on the straight-line basis over forty years. The purchase
price allocation will be finalized after completion of the valuation of certain
assets and liabilities, and the final resolution of the purchase price
adjustment.
FINANCING OF THE TRANSACTION
At the closing of the SBCL acquisition, the Company used existing cash
funds and the borrowings under a new senior secured credit facility (the "Credit
Agreement") to fund the cash purchase price and related transaction costs of the
acquisition, and to repay the entire amount outstanding under its then existing
credit agreement. The extraordinary loss recorded during the third quarter of
1999 represented $3.6 million ($2.1 million, net of taxes) of deferred financing
costs which were written-off in connection with the extinguishment of its then
existing credit agreement.
The Credit Agreement includes the following facilities: a $250 million
six-year revolving credit facility; a $400 million amortizing term loan payable
through June 2005; a $325 million term loan with minimal amortization until
maturity in June 2006; a $300 million term loan with minimal amortization until
maturity in June 2006; and a $50 million two-year capital markets term loan due
August 2001, which does not amortize. (The Company had commitments for a $300
million capital markets term loan but elected to use only $50 million of the
commitment; the balance of the capital markets term loan commitment expired at
the closing). Up to $75 million of the revolving credit facility may be used for
letters of credit. At the closing, Quest Diagnostics borrowed approximately
$1.075 billion under the term loans (including $50 million under the capital
markets term loan) and $57.5 million under the revolving credit facility.
Between the closing of the SBCL acquisition and the end of 1999, the Company
repaid $107.5 million of the amounts borrowed under the Credit Agreement
including the entire amount borrowed at closing under the revolving credit
facility.
INTEGRATION OF SBCL AND QUEST DIAGNOSTICS BUSINESSES
During the fourth quarter of 1999, Quest Diagnostics finalized its plan
related to the integration of SBCL into Quest Diagnostics' laboratory network.
The plan focuses principally on laboratory consolidations in geographic markets
currently served by more than one of the Company's laboratories, and redirecting
testing volume within the Company's national network to improve customer
service. As part of the plan, laboratories in Deerfield Beach, Florida; Owings
Mills, Maryland; Farmington Hills, Michigan; Islip, New York; Valley View, Ohio;
Norristown, Pennsylvania; Dallas, Texas; and Waltham, Massachusetts will close
or be substantially reduced in capacity. Testing performed at the National
Esoteric Center located in Van Nuys, California will move to Nichols Institute.
In addition, a number of changes to redirect specimen flows to provide more
local testing and improve customer service will also impact capacity throughout
the Company's laboratory network. Employee groups to be impacted as a result of
these actions include those involved in the collection and testing of specimens,
as well as administrative and other support functions. During the fourth quarter
of 1999, the Company recorded the estimated costs associated with these
activities for 1999 and 2000 relative to the integration plan. The majority of
these integration costs were related to employee severance, contractual
obligations associated with leased facilities and equipment, and the write-off
of fixed assets which management believes will have no future economic benefit
upon combining the operations. Integration costs related to planned activities
affecting SBCL's operations and employees were recorded as a cost of the
acquisition. Integration costs associated with the planned integration of SBCL
affecting Quest Diagnostics' operations and employees were recorded as a charge
to earnings in the fourth quarter
42
<PAGE>
of 1999. These costs are more fully described under "Provisions for
Restructuring and Other Special Charges".
HISTORICAL RESULTS OF OPERATIONS
RECLASSIFICATIONS
During the fourth quarter of 1999, the Company reclassified certain expense
items, primarily related to a portion of occupancy costs and professional
liability insurance expense, from selling, general and administrative expenses
to cost of services, to better reflect the cost of performing testing. All prior
year financial information has been reclassified for comparative purposes to
conform with the 1999 presentation. The amounts reclassified from selling,
general and administrative expenses for the years ended December 31, 1999, 1998
and 1997 were $57.4 million, $35.7 million and $35.1 million, respectively.
YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998
Net income before an extraordinary loss and special items incurred in
connection with the SBCL acquisition in 1999 increased to $41.2 million from
$26.9 million in the prior year. Special items for 1999 consisted of provisions
for restructuring and other special charges of $73.4 million ($44.2 million, net
of tax) and a gain on the sale of an investment of $3.0 million ($1.8 million,
net of tax). Special items for 1998 consisted of 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. After these items and an extraordinary loss,
net of tax, of $2.1 million, incurred in connection with the acquisition of
SBCL, the Company reported a net loss for 1999 of $3.4 million, compared to net
income of $26.9 million for 1998.
Results for the year ended December 31, 1999 included the effects of
testing performed by third parties under the Company's laboratory network
management arrangements. As laboratory network manager, Quest Diagnostics
included in its consolidated revenues and expenses the cost of testing performed
by third parties. This impacts the comparability of revenues and expenses for
1999 as compared to 1998 and added $91.6 million to both reported revenues and
cost of services for the year ended December 31, 1999. 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.
NET REVENUES
Excluding the effect of the testing performed by third parties under the
Company's laboratory network management arrangements, net revenues for the year
ended December 31, 1999 increased $655.0 million over the prior year period.
This increase was primarily due to the acquisition of SBCL. Excluding the impact
of the SBCL acquisition and the third party testing performed under the
Company's laboratory network management arrangements, net revenues for the year
ended December 31, 1999 increased 1.2% from the prior year level,
principally due to an increase in average revenue per requisition partially
offset by a volume decrease of 3.3%. Exclusive of the SBCL acquisition, year
over year volume comparisons improved throughout the year and in the fourth
quarter reflected volume gains over the prior year.
OPERATING COSTS AND EXPENSES
Total operating costs for the year ended December 31, 1999, excluding the
effect of testing performed by third parties under the Company's laboratory
network management arrangements, increased from the year earlier period. The
increase was due primarily to the acquisition of SBCL. 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
43
<PAGE>
with the Company's consolidation plan announced in the fourth quarter of 1997.
The following discussion and analysis regarding cost of services, selling,
general and administrative expenses and bad debt expense exclude the effect of
testing performed by third parties under the Company's laboratory network
management arrangements, which serve to increase cost of services as a
percentage of net revenues and reduce selling, general and administrative
expenses as a percentage of net revenues. Cost of services, which included the
costs of obtaining, transporting and testing specimens, decreased during 1999 as
a percentage of net revenues to 61.0% from 61.5% a year ago. This decrease was
primarily attributable to an increase in average revenue per requisition.
Selling, general and administrative expenses, which included the costs of
the sales force, billing operations, bad debt expense and general management and
administrative support, decreased during 1999 as a percentage of net revenues to
30.4% from 30.6% in the prior year. During 1999 bad debt expense increased to
6.7% of net revenues from 6.1% of net revenues in the prior year. The increase
in bad debt expense was principally attributable to SBCL's collection
experience, which is lower than Quest Diagnostics' historical experience. A
significant portion of the difference is due to Quest Diagnostics' processes in
the billing area, most notably the processes around the collection of diagnosis,
patient and insurance information necessary to effectively bill for services
performed. While the sharing of internal best practices has begun in the billing
functions, the Company believes that additional opportunities exist in order to
drive down SBCL's historical bad debt percentage.* The remaining overall
decrease in selling, general and administrative expenses as a percentage of net
revenues was primarily attributable to the impact of the SBCL acquisition which
enabled the Company to leverage certain of its fixed costs across a larger
revenue base. While selling, general and administrative expenses decreased as a
percentage of net revenues, the Company experienced an increase in expenses in
1999 as compared to 1998 for additional investments in information technology
and sales and marketing capabilities, litigation expenses and employee
compensation costs.
INTEREST EXPENSE, NET
Net interest expense in 1999 increased from the prior year by $28.0
million. Net interest expense for the year ended December 31, 1999 included $1.9
million of interest income associated with a favorable state tax settlement. The
increase in net interest expense is primarily attributable to the amounts
borrowed under the Credit Agreement in conjunction with the SBCL acquisition and
a decrease in interest income resulting from lower average cash balances in 1999
as compared to 1998.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets increased in 1999 from the prior year by
$8.1 million, principally as a result of the SBCL acquisition.
PROVISIONS FOR RESTRUCTURING & OTHER SPECIAL CHARGES
During the third and fourth quarters of 1999, the Company recorded
provisions for restructuring and other special charges totaling $30.3 million
($18.2 million, net of tax) and $43.1 million ($26.1 million, net of tax),
respectively, principally incurred in connection with the acquisition and
planned integration of SBCL.
- ----------
* THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES OF
THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995." IN PARTICULAR, SEE FACTORS (D), (E), (G), AND (K).
44
<PAGE>
Of the total special charge recorded in the third quarter of 1999, $19.8
million represented stock-based employee compensation of which $17.8 million
related to special one-time grants of the Company's common stock to certain
individuals of the combined company, and $2.0 million related to the accelerated
vesting of restricted stock grants made in previous years due to the completion
of the SBCL acquisition. In addition, during the third quarter of 1999, the
Company incurred $9.2 million of professional and consulting fees related to
integration planning activities. The remainder of the third quarter charge was
related to costs incurred by the Company in conjunction with its planned
offering of new senior subordinated notes, the proceeds of which were expected
to be used to repay the Company's existing 10 3/4% senior subordinated notes due
2006 (the "Notes"). During the third quarter of 1999, the Company decided not to
proceed with the offering due to unsatisfactory market conditions.
Of the total special charge recorded in the fourth quarter of 1999, $36.4
million represented costs related to planned integration activities affecting
Quest Diagnostics' operations and employees. Of these costs, $23.4 million
related to employee termination costs for approximately 1,050 employees, $9.7
million related primarily to lease obligations for facilities and equipment and
$6.7 million was associated with the write-off of assets that management plans
to dispose of in conjunction with the integration of SBCL. Offsetting these
charges was the reversal of $3.4 million of reserves associated with the
Company's consolidation plan announced in the fourth quarter of 1997. Upon
finalizing the initial integration plans for SBCL in the fourth quarter of 1999,
the Company determined that $3.4 million of the remaining reserves associated
with the December 1997 consolidation plan was no longer necessary due to changes
in the plan as a result of the SBCL integration. In addition to the net charge
of $36.4 million, the Company recorded $3.5 million of special recognition
awards granted in the fourth quarter of 1999 to certain employees involved in
the transaction and integration planning processes of the SBCL acquisition. The
remainder of the fourth quarter special charge was primarily attributable to
professional and consulting fees incurred in connection with integration related
planning activities.
Integration costs, including write-offs of fixed assets, totaling $55.5
million which are related to planned integration activities affecting SBCL
assets, liabilities and employees, were recorded in the fourth quarter of 1999
as a cost of the SBCL acquisition. Of these costs, $33.8 million related to
employee termination costs for approximately 1,250 employees, and $13.4 million
related to contractual obligations including those related to facilities and
equipment leases. The remaining portion of the costs were associated with the
write-off of assets that management plans to dispose of in conjunction with the
integration of SBCL.
In addition to the integration costs discussed above, management
anticipates that in 2000, the Company will incur additional costs of
approximately $15 million relative to the integration plan which will be
expensed as incurred.* These costs are primarily related to equipment and
employee relocation costs, professional and consulting fees, company
identification and signage costs and the amortization of stock-based employee
compensation related to the special recognition awards discussed above.
While the majority of the integration costs are expected to be paid in
2000, there are certain severance and facility related exit costs, principally
remaining lease obligations, that have payment terms extending beyond 2000.
Management believes that the costs to integrate the SBCL business into Quest
Diagnostics will be funded primarily through cash from operations.*
- ----------
* THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES OF
THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995." IN PARTICULAR, SEE FACTORS (C), (D), (E), (F), (G), AND (K).
45
<PAGE>
MINORITY SHARE OF INCOME
Minority share of income for 1999 increased from the prior year level,
primarily due to the Company's contribution of its Pittsburgh, Pennsylvania and
St. Louis, Missouri businesses to two joint ventures formed in the fourth
quarter of 1998. During both 1999 and 1998, the Company maintained a 51%
controlling ownership interest in both of these affiliated companies.
OTHER, NET
Other, net for 1999 decreased from the prior year level, primarily due to a
gain of $3.0 million ($1.8 million, net of tax) associated with the sale of an
investment in the fourth quarter of 1999 and a reduction in equity losses of
$4.5 million, primarily associated with a joint venture in Arizona in which the
Company holds a 49% interest.
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. The goodwill associated with the
SBCL acquisition further increased the effective tax rate for 1999 compared to
1998.
EXTRAORDINARY LOSS
In conjunction with the acquisition of SBCL, the Company repaid the entire
amount outstanding under its then existing credit agreement. The extraordinary
loss recorded in the third quarter of 1999 represented $3.6 million ($2.1
million, net of tax) of deferred financing costs written off in connection with
the extinguishment of the related credit agreement.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Reported earnings for 1998 improved from 1997 principally as a result of
operating cost and interest expense reductions coupled with improved pricing and
a reduced level of special charges. These increases were partially offset by
lower volume resulting from intensified competition, primarily from hospital
out-reach programs, changes in physician ordering patterns, actions taken on
unprofitable accounts, and the consolidation of certain underperforming
laboratories announced in the fourth quarter of 1997. Physician ordering
patterns were impacted by the implementation, in April 1998, of a new test
requisition designed to comply with government regulations for disease-oriented
test panels recommended by the American Medical Association for Medicare and
Medicaid patients.
NET REVENUES
Net revenues for 1998 decreased by $70.1 million from 1997, principally due
to declines in base clinical testing volume of 7.2%, partially offset by a 2.5%
improvement in average revenue per requisition. The volume decline was primarily
attributable to the factors discussed above, including the impact of
consolidating certain underperforming laboratories announced in the fourth
quarter of 1997 which reduced volume by approximately 2% during 1998.
OPERATING COSTS AND EXPENSES
Total operating costs for 1998 declined $87.3 million from 1997. Included
in the 1997 expense was a $6.8 million charge in selling, general and
administrative expenses related to the Company's consolidation of its laboratory
network. The Company's efforts to reduce its fixed operating cost structure have
had a favorable impact on costs as a percentage of net revenues. However, this
benefit was partially offset by lower volume, increased spending on information
technologies and a $2.5 million charge in the first quarter of 1998 representing
the final costs associated with the Company's consolidation of its laboratory
network announced in the fourth quarter of 1997.
46
<PAGE>
Cost of services, as a percentage of net revenues, decreased to 61.5% in
1998 from 63.0% in 1997, reflecting the Company's progress in reducing its cost
structure. For both 1998 and 1997, selling, general and administrative expenses,
as a percentage of net revenues, were 30.6%. Factors which increased the
percentage were the effect of reduced revenues without a proportionate cost
decrease, increased spending related to information technology and a special
charge of $2.5 million related to the Company's consolidation of its laboratory
network. These factors were principally offset by reduced bad debt expense and
the $6.8 million charge recorded in 1997 related to the Company's consolidation
of its laboratory network. The $6.8 million charge consisted primarily of
additional provisions for doubtful accounts and recognized the Company's
estimate, based on prior experience, of the reduced recoverability of certain
receivables from accounts which would no longer be served as a result of the
consolidation plan. Bad debt expense was 6.1% of net revenues for 1998 compared
to 7.4%, excluding the special charge, in the prior year. The improvement in bad
debt expense reflected the Company's progress in dealing with Medicare medical
necessity documentation requirements, improvements in its billing processes, and
further progress in standardizing its billing systems.
INTEREST EXPENSE, NET
Net interest expense decreased from 1997 by $7.6 million primarily due to
reduced debt levels and an increase in interest income resulting from higher
average cash balances.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased from 1997 by $2.3 million
principally due to certain intangible assets having become fully amortized.
PROVISIONS FOR RESTRUCTURING AND OTHER SPECIAL CHARGES
In the fourth quarter of 1997, the Company recorded special charges
totaling $55.5 million in connection with a series of actions designed to reduce
excess capacity in its network of clinical laboratories. As noted earlier, $6.8
million of the charges were included in selling, general and administrative
expenses. The remaining $48.7 million was presented separately and consisted
primarily of workforce reduction programs, costs associated with exiting a
number of leased facilities, the write-off of certain assets and a $16.0 million
write-down of intangible assets to reflect the estimated impairment as a result
of the Company's consolidation activities.
OTHER, NET
The change in other, net compared with 1997 is primarily the result of
increased equity losses from a joint venture in Arizona in which the Company
holds a 49% ownership interest. The increased equity losses resulted from
difficulties in systems and facility conversions. Partially offsetting the
increase in equity losses was a reduction in other charges, principally related
to forming the joint venture and integrating a small, strategic acquisition in
Connecticut, both of which occurred in 1997.
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 or reducing the tax benefit rate.
The Company's 1997 tax rate was also impacted by the write-down of intangible
assets which was not deductible for tax purposes.
47
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company addresses its exposure to market risks, principally the market
risk of changes in interest rates, 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. During 1999, the Company entered into interest rate swap agreements to
mitigate the risk of changes in interest rates associated with its variable rate
bank debt in accordance with the terms of the Company's Credit Agreement. 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. See Note 2 to the Consolidated Financial Statements for additional
discussion of the Company's financial instruments and hedging activities.
INTEREST RATES
At December 31, 1999 and 1998, the fair value of the Company's debt was
estimated at approximately $1,213 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. At December
31, 1999, the carrying value of the debt exceeded the estimated fair value by
approximately $4 million. At December 31, 1998, the fair value exceeded the
carrying value of the debt by approximately $15 million. An assumed 10% increase
in interest rates (representing approximately 90 basis points) would potentially
reduce the fair value of the Company's debt by approximately $10 million and $9
million at December 31, 1999 and 1998, respectively.
The Company had approximately $1,036 million of variable interest rate debt
outstanding at December 31, 1999. The Credit Agreement requires the Company to
mitigate the risk of changes in interest rates associated with its variable
interest rate indebtedness through the use of interest rate swap agreements.
Under such arrangements, the Company converts a portion of its variable rate
indebtedness to fixed rates based on a notional principal amount. The settlement
dates are generally correlated to correspond to the interest payment dates of
the hedged debt. During the term of the Credit Agreement, the notional amounts
under the interest rate swap agreements, plus the principal amount outstanding
of the Company's fixed interest rate indebtedness, must be at least 50% of the
Company's net funded debt (as defined in the Credit Agreement). As of December
31, 1999, the aggregate notional principal amount under the interest rate swap
agreements which mature at various dates through May 2003 totaled $450.0
million. At December 31, 1999, the estimated fair value of the interest rate
swap agreements was approximately $3.8 million.
Based on the Company's overall exposure to interest rate changes, an
assumed 10% increase in interest rates (representing approximately 34 basis
points) applied to the Company's variable interest rate debt, after considering
the interest rate swap agreements, would result in a $2.2 million reduction in
the Company's after-tax earnings and cash flows for the year ended December 31,
1999 based on debt levels as of December 31, 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 December 31, 1999 totaled $27.3 million, a
decrease of $175.6 million from the prior year-end balance. The decrease in cash
and cash equivalents during 1999 is principally associated with the acquisition
and financing of the SBCL acquisition and the repayment of the entire amount
outstanding under the Company's then existing credit agreement. Cash flows from
operating and financing activities provided cash of $249.5 million and $682.8
million, respectively, and were used to fund investing activities which required
cash of $1,108.0 million. Cash and cash equivalents at December 31, 1998 totaled
$202.9 million, an increase of $41.2 million from the prior year-end balance.
The increase resulted from operating activities which provided cash of
48
<PAGE>
$141.4 million, partially offset by investing and financing activities which
required cash of $100.2 million.
Net cash from operating activities for 1999 was $108.2 million higher than
the 1998 level. The increase is primarily due to the impact of the SBCL
acquisition. Net cash from operating activities for 1998 was below the 1997
level, primarily due to a smaller reduction in accounts receivable and increased
payments associated with restructuring and other special charges.
Improvements in the billing operations during 1999 and 1998 have led to an
improvement in the number of days sales outstanding. The number of days sales
outstanding, a measure of billing and collection efficiency, was 57 days at
December 31, 1999 compared to 58 days at December 31, 1998 and 63 days at
December 31, 1997. Days sales outstanding of the SBCL business prior to the
acquisition were approximately 14 days higher than those of Quest Diagnostics.
Excluding the impact of the SBCL acquisition, Quest Diagnostics' days sales
outstanding would have improved by approximately 7 days during 1999.
Increased spending on investing activities in 1999 was principally related
to the acquisition of SBCL including transaction costs associated with the
acquisition. Capital spending, which was also impacted by the acquisition of
SBCL, increased to $76.0 million in 1999 from $39.6 million in 1998. The
increase in investments for 1999 included investments to fund certain benefit
plans and contributions to the Company's Arizona joint venture, offset by the
proceeds from the sale of an investment in the fourth quarter of 1999. Net cash
used for investing activities during 1998 consisted primarily of capital
expenditures. Net cash used for investing activities during 1997 consisted
primarily of capital expenditures and the payment for a small, strategic
acquisition, offset by proceeds from the disposition of assets.
Net cash provided by financing activities during 1999 was principally
associated with the financing of the SBCL acquisition. During 1999, the Company
borrowed $1,132.5 million, including $57.5 million under its new revolving
credit facility, to fund the cash purchase price and related transaction costs
of the SBCL acquisition, and to repay the entire amount outstanding under its
then existing credit agreement. During 1999, the Company repaid $412.0 million
of debt. Of this amount, $107.5 million represented amounts repaid under the
Credit Agreement between the closing of the SBCL acquisition and the end of
1999, including the entire amount borrowed at closing under the new revolving
credit facility of $57.5 million. The remaining amount of $304.5 million was
principally associated with the repayment of amounts outstanding under the
Company's then existing credit agreement at the closing of the SBCL acquisition.
Other than the reduction for outstanding letters of credit, which approximated
$17.3 million, all of the revolving credit facility was available for borrowing
at December 31, 1999. During 1999, the Company paid $36.8 million of costs
associated with the financing of the SBCL acquisition, distributed $4.4 million
to minority partners, repurchased $1.1 million of its common stock and received
approximately $4.4 million in proceeds from the exercise of stock options. Net
cash used for financing activities during 1998 consisted primarily of the
Company's repayment of debt (including approximately $20 million of
prepayments), and the purchase of approximately 687 thousand shares of treasury
stock. Net cash used in financing activities during 1997 consisted primarily of
repayments of long-term debt.
In 1998, the Board of Directors authorized a limited share purchase program
which permitted the Company to purchase up to $27 million of its outstanding
common stock through 1999. Cumulative purchases under the program through
December 31, 1999 totaled $14.1 million. Shares purchased under the program were
reissued in connection with certain employee benefit plans. The Company
suspended purchases of its shares when it reached a preliminary understanding of
the transaction with SmithKline Beecham on January 15, 1999.
The Company estimates that it will invest approximately $110 million to
$120 million during 2000 for capital expenditures to support its existing
operations, principally related to investments in
49
<PAGE>
information technology, equipment, and facility upgrades and expansions
necessary to accommodate the integration of the SBCL business.* The Company
believes that cash from operations coupled with the revolving credit facility
under the Credit Agreement will provide sufficient financial flexibility and
access to funds to finance the costs to integrate the operations of Quest
Diagnostics and SBCL, to meet seasonal working capital requirements, to fund
capital expenditures and additional growth opportunities for the foreseeable
future.*
The Company does not anticipate paying dividends on its common stock in the
foreseeable future. The Credit Agreement prohibits the payment of cash dividends
and the indenture relating to the Notes (the "Indenture") restricts the
Company's ability to pay cash dividends on its common stock. These restrictions
are primarily based on a percentage of the Company's earnings as defined in the
Indenture. Additionally, the Credit Agreement contains various covenants and
conditions including the maintenance of certain financial ratios and tests, and
restricts the ability of the Company to, among other things, incur additional
indebtedness and repurchase shares of its outstanding common stock. At December
31, 1999, the Company is limited in its ability to make certain acquisitions and
incur additional indebtedness due to restrictions under the Indenture.
Management believes that Quest Diagnostics' successful integration of
SmithKline Beecham's clinical laboratory business and implementation of its
business strategy, together with the indemnifications 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.*
CASH EARNINGS PER SHARE AND ADJUSTED EBITDA
Cash earnings per common share is calculated as cash earnings less
preferred dividends, divided by diluted weighted average common shares
outstanding. Cash earnings represents income (loss) before the extraordinary
loss, special items and amortization of all intangible assets, net of applicable
taxes. For purposes of determining cash earnings per common share, special items
included the provisions for restructuring and other special charges reflected on
the face of the statements of operations and a $3.0 million gain related to the
sale of an investment in the fourth quarter of 1999.
Cash earnings per common share is presented because it highlights the
impact on earnings of the non-cash charges associated with the amortization of
intangible assets from various acquisitions, which for the Company is
significant. 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 generally accepted accounting principles) 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 for 1999 improved to $1.87 from $1.48 in the
prior year period. The increase was primarily related to improvements in the
operating performance of the Company prior to the acquisition of SBCL.
Adjusted EBITDA represents income (loss) before income taxes, net interest
expense, depreciation and amortization and special items. Special items included
the provisions for restructuring and other special charges reflected on the face
of the statements of operations, a $3.0 million gain related to the sale of an
investment in the fourth quarter of 1999 and charges of $2.5 million and $6.8
million recorded in selling, general and administrative expenses in 1998 and
1997, respectively, related to the Company's consolidation of its laboratory
network announced in the fourth
- ----------
* THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES
OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (D), (E), (F), (G),
(H), (I), (J), (K), (L), (M), (N) AND (O).
50
<PAGE>
quarter of 1997. Adjusted EBITDA is presented and discussed because management
believes it is a useful adjunct to net income and other measurements under
generally accepted accounting principles. Additionally, management believes 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 generally accepted accounting principles) 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.
Adjusted EBITDA for 1999 improved to $237.0 million, or 11.2% of net
revenues (adjusted for testing performed by third parties under the Company's
laboratory network management arrangements), from $158.6 million, or 10.9% of
net revenues, in the prior year period. The dollar increase in Adjusted EBITDA
was principally associated with the SBCL acquisition. The percentage improvement
in Adjusted EBITDA is primarily related to improvements in the operating
performance of the Company prior to the acquisition of SBCL.
Adjusted EBITDA for 1998 was $158.6 million, or 10.9% of net revenues.
Adjusted EBITDA for 1997 was $153.8 million, or 10.1% of net revenues. The
improvement in Adjusted EBITDA resulted from an increase in average revenue per
requisition and the Company's continued progress in reducing its cost structure
to better match a lower volume level. This improvement was partially offset by
increased spending related to information technology, including preparation for
the Year 2000.
OUTLOOK
Quest Diagnostics believes that the acquisition of SBCL establishes the
Company as the leader in the clinical laboratory testing industry and
provides a wide 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 provide a broad range of
benefits for customers, including: continued improvements in quality,
convenience and accessibility; expanded test development; and a broader range
of medical information products to help providers and insurers better manage
their patients' health. 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 for hospitals, and genetic and other esoteric testing.
Quest Diagnostics believes that the acquisition will accelerate innovation
and has created the largest clinical laboratory results 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 realizing other
economies of scale. Management estimates that these savings will approximate
$100 million annually after three years.* The Company has experienced, and
expects to continue to experience, some negative financial impact on its
results of operations from the SBCL acquisition, resulting principally from
pricing differences between Quest Diagnostics and SBCL, as well as from
compensation and benefit adjustments resulting from the combination of
workforces. However, the
- ----------
* THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES OF
THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (D), (E), (F), (G), (J),
(K), (L), (N), AND (O).
51
<PAGE>
Company expects that the benefits from the acquisition will far outweigh these
impacts. Management believes that the benefits from the SBCL acquisition,
including the successful integration of SBCL, along with the execution of the
Company's business strategy, will accelerate the Company's earnings growth
rate (before special charges related to the further integration of SBCL's
operations) by at least 30% annually over the next several years.*
Management anticipates that additional charges will be recorded in the
latter part of 2000 or early 2001 associated with further consolidating the
operations of SBCL beyond 2000. These charges cannot be estimated at this
time, but are expected to be funded by cash from operations.
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.
After three years of planning and implementation of its Year 2000 Readiness
Program, the Company successfully transitioned its significant systems and
facilities into 2000 without any significant disruptions to its operations.
Based on the lack of significant issues encountered since December 31, 1999, the
Company does not expect any material adverse effects on its operations or
financial condition with respect to Year 2000 matters.**
Costs incurred through December 31, 1999 related to the Company's Year 2000
readiness programs approximated $82 million, of which approximately $34 million
was capitalized. Capitalized costs principally represented the purchase of new
software and hardware. Current estimates of the remaining costs expected to be
incurred in 2000 are approximately $4 million to $6 million, of which
approximately 30% to 40% will be capitalized.
While the Company has not experienced any material adverse effects on its
operations or financial condition regarding the Year 2000 readiness associated
with its systems or those of third parties with whom it has important business
relationships, there can be no assurances that all potential Year 2000 related
matters have been discovered. As part of the Company's Year 2000 readiness
program, the Company will continue to monitor its systems and those of its
critical external providers and payers to identify and remediate any Year 2000
related matters in order to mitigate any potential material adverse effect on
the Company's operations or financial condition.
INFLATION
The Company believes that inflation generally does not have a material
adverse effect on its operations or financial condition because the majority of
its contracts are short-term.
PRO FORMA COMBINED FINANCIAL INFORMATION
The following pro forma combined financial information assumes that the
SBCL acquisition and borrowings under the Credit Agreement were effected on
January 1, 1998. The SBCL acquisition agreements include a provision for a
purchase price adjustment based on an audit of the August 16, 1999 combined
balance sheet of SBCL and certain affiliates. Adjustments resulting from this
audit, which are subject to resolution as set forth in SBCL acquisition
agreements and are the subject of on-going discussions between the parties, have
been recorded in the pro forma combined financial information to the extent that
the Company believes they are applicable. The pro forma combined financial
information reflects the preliminary allocation of the purchase price. The
allocation will be finalized after completion of the valuation of certain assets
and liabilities and the final resolution of the purchase price adjustment. There
can be no assurances that the amounts
- ----------
*THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR PURPOSES OF
THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995." IN PARTICULAR, SEE FACTORS (A), (B), (C), (D), (E), (F), (G), (J),
(K), (L), (N), AND (O).
** THIS IS A FORWARD LOOKING STATEMENT. SEE "CAUTIONARY STATEMENT FOR
PURPOSES OF THE `SAFE HARBOR' PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995." IN PARTICULAR, SEE FACTOR (K).
52
<PAGE>
reflected in the pro forma combined financial information will not be subject to
change as a result of changes in the allocation of the purchase price, including
the resolution of the purchase price adjustment.
The pro forma combined financial information is presented for illustrative
purposes only to analyze the financial implications of the SBCL acquisition and
borrowings under the Credit Agreement. The 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 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 pro forma combined
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 new
credit facility which was used to finance the SBCL acquisition. Amortization of
the goodwill, which accounts for a majority of the acquired intangible assets,
is calculated on the straight-line basis over forty years. Other, net has been
adjusted to remove SBCL's non-recurring gains from the sale and license of
certain technology and its physician office-based teleprinter assets and
network. 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.
RECLASSIFICATIONS
During the fourth quarter of 1999, the Company reclassified certain expense
items, primarily related to a portion of occupancy costs and professional
liability insurance expense, from selling, general and administrative expenses
to cost of services, to better reflect the cost of performing testing. All pro
forma financial information has been reclassified for comparative purposes to
conform with the 1999 presentation. The amounts reclassified from selling,
general and administrative expenses for the years ended December 31, 1999 and
1998 were $88.8 million and $93.5 million, respectively.
53
<PAGE>
PRO FORMA COMBINED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1998 1998 1998 1998 1999 1999 1999 1999
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues .......................... $ 737,280 $ 744,154 $ 766,625 $ 779,724 $ 823,450 $ 837,533 $ 819,301 $ 814,526
Costs and expenses:
Cost of services ..................... 461,156 482,488 476,422 487,280 537,140 550,661 524,117 520,420
Selling, general and
administrative ...................... 211,051 200,166 224,764 230,194 225,525 239,200 231,483 229,601
Interest expense, net ................ 31,700 31,733 31,653 31,466 31,680 29,723 31,186 30,058
Amortization of intangible assets .... 11,143 11,128 11,293 11,183 10,856 10,982 11,160 11,659
Provisions for restructuring
and other special charges ........... -- -- -- -- -- 15,813 30,282 43,103
Minority share of income ............. 461 435 412 709 1,130 1,471 1,191 1,639
Other, net ........................... (6,805) (662) (7) (920) 6 126 (782) (3,312)
--------- --------- --------- --------- --------- --------- --------- ---------
Total ............................... 708,706 725,288 744,537 759,912 806,337 847,976 828,637 833,168
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before taxes and
extraordinary loss ................. 28,574 18,866 22,088 19,812 17,113 (10,443) (9,336) (18,642)
Income tax expense (benefit) .......... 14,666 10,955 11,307 9,869 8,885 (1,573) 805 (4,106)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before
extraordinary loss ................. 13,908 7,911 10,781 9,943 8,228 (8,870) (10,141) (14,536)
Extraordinary loss, net of taxes ...... -- -- -- -- -- -- (2,139) --
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) ..................... $ 13,908 $ 7,911 $ 10,781 $ 9,943 $ 8,228 $ (8,870) $ (12,280) $ (14,536)
========= ========= ========= ========= ========= ========= ========= =========
Income before extraordinary
loss and special items (a) ......... $ 13,908 $ 7,911 $ 10,781 $ 9,943 $ 8,228 $ 617 $ 8,029 $ 9,717
- -----------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per common share:
Net income (loss) ..................... $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ (0.21) $ (0.28) $ (0.33)
Income (loss) before
extraordinary loss ................. $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ (0.21) $ (0.23) $ (0.33)
Income before extraordinary
loss and special items ............. $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ 0.01 $ 0.18 $ 0.22
Cash earnings before
extraordinary loss and
special items (b) .................. $ 0.56 $ 0.42 $ 0.49 $ 0.47 $ 0.42 $ 0.24 $ 0.42 $ 0.46
Weighted average common
shares outstanding - basic (c) ...... 43,035 43,130 43,033 42,925 43,044 43,248 43,435 43,653
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per
common share:
Net income (loss) ..................... $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ (0.21) $ (0.28) $ (0.33)
Income (loss) before
extraordinary loss ................. $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ (0.21) $ (0.23) $ (0.33)
Income before extraordinary
loss and special items ............. $ 0.32 $ 0.18 $ 0.25 $ 0.23 $ 0.19 $ 0.01 $ 0.18 $ 0.22
Cash earnings before
extraordinary loss and
special items (b) .................. $ 0.55 $ 0.41 $ 0.48 $ 0.46 $ 0.42 $ 0.24 $ 0.41 $ 0.45
Weighted average common
shares outstanding - diluted (c) .... 43,309 43,881 43,434 43,136 43,506 43,933 44,228 44,685
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted EBITDA (d) ................... $ 87,485 $ 82,306 $ 84,638 $ 75,909 $ 80,667 $ 85,016 $ 86,599 $ 85,096
</TABLE>
(a) Special items, for purposes of determining pro forma net income and cash
earnings before extraordinary loss and special items, included the
provisions for restructuring and other special charges reflected on the
face of the pro forma combined financial information and a $3.0 million
gain recorded on the sale of an investment in the fourth quarter of 1999.
(b) Cash earnings per common share is calculated as cash earnings less
preferred dividends, divided by weighted average common shares outstanding.
Cash earnings represents income (loss) before the extraordinary loss,
special items and amortization of all intangible assets, net of applicable
taxes.
(c) Both basic and diluted weighted average common shares outstanding have been
presented on a pro forma basis giving effect to the shares issued to
SmithKline Beecham and the shares granted at closing to employees.
Potentially dilutive common shares primarily represent stock options.
During periods in which net income available for common stockholders is
negative, diluted weighted average common shares outstanding will equal
basic weighted average common shares outstanding, since the incremental
shares would have an anti-dilutive effect on earnings (loss) per common
share.
(d) Pro forma Adjusted EBITDA represents income (loss) before income taxes, net
interest expense, depreciation and amortization and special items. Special
items included the provisions for restructuring and other special charges
reflected on the face of the pro forma combined financial information, a
$3.0 million gain recorded on the sale of an investment in the fourth
quarter of 1999, a $2.5 million charge included in selling, general and
administrative expenses in the first quarter of 1998 and certain income and
expense items recorded by SBCL prior to the closing of the acquisition,
which have not been reflected on the face of the pro forma financial
information. These income and expense items impact the overall
comparability of the pro forma results for 1999 and 1998.
PRO FORMA COMBINED RESULTS OF OPERATIONS
On a pro forma basis, assuming that SBCL had been acquired by Quest
Diagnostics on January 1, 1998, net income before an extraordinary loss and
special items was $26.6 million in 1999, compared to $42.5 million in 1998.
Special items for 1999 included $89.2 million of restructuring
54
<PAGE>
and other special charges and a $3.0 million gain on the sale of an investment
in 1999. Special items for 1998 included a $2.5 million charge included in
selling, general and administrative expenses related to the Company's
consolidation of its laboratory network announced in the fourth quarter of 1997.
The decline in income before the extraordinary loss and special items was
primarily due to certain income and expense items, recorded in SBCL's historical
financial statements prior to the closing of the acquisition, which have not
been separately reflected on the face of the pro forma financial information.
These income and expense items impact the overall comparability of the pro forma
results for 1999 and 1998. Pro forma results for the year ended December 31,
1999 and 1998 included incremental expense and pre-tax profits of $24.2 million
and $14.3 million, respectively. Approximately $11 million of the 1999
incremental expenses resulted from adjustments, recorded by SBCL prior to the
closing of the acquisition, to accrue liabilities necessary to properly present
the closing balance sheet of SBCL. These adjustments impacted comparability
because they resulted in an unusually high level of expenses for the period
presented. Additionally, approximately $7 million related to losses incurred
under a loss contract, and approximately $6 million related to charges
associated with two incidents, the costs of which SmithKline Beecham is
obligated to indemnify Quest Diagnostics. The most significant of these
incidents related to an SBCL employee who allegedly reused certain needles when
drawing blood from patients. The pre-tax profit of $14.3 million included in the
year ended December 31, 1998 primarily represented the favorable settlement of a
contract dispute. Excluding the impact of these items in both years would result
in income before an extraordinary loss and special items of $41.1 million and
$33.9 million for the year ended December 31, 1999 and 1998, respectively.
Pro forma results for the year ended December 31, 1999 included the effects
of testing performed by third parties under the Company's laboratory network
management arrangements which added $154.0 million to both reported revenues and
cost of services for the year ended December 31, 1999.
PRO FORMA NET REVENUES
Excluding the effect of the testing performed by third parties under the
Company's laboratory network management arrangements, pro forma net revenues in
1999 increased by $113.0 million, or 3.7% from the prior year level due to
improvements in both average revenue per requisition and volume of clinical
testing of 3.3% and 1.1%, respectively, and a 22.6% increase in clinical trials
testing revenues which contributed approximately 0.4% to the consolidated
revenue increase. These increases were partially offset by a reduction in
revenues of 1.0% associated with the treatment in 1999 of a customer contract as
a loss contract.
Prior to the acquisition of SBCL, Quest Diagnostics experienced increases
in average revenue per requisition 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 its
account profitability strategy; and higher value-added test offerings. The
increase in average revenue per requisition experienced by Quest Diagnostics was
partially offset by declines in average revenue per requisition related to the
growth in managed care business at SBCL. The improvements in volume were
primarily attributable to the growth in managed care business at SBCL, partially
offset by volume declines at Quest Diagnostics reflecting 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.
PRO FORMA OPERATING COSTS AND EXPENSES
The following discussion and analysis regarding pro forma 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 the
Company's laboratory network management arrangements and the treatment of a
customer contract as a loss contract. Total pro forma operating
55
<PAGE>
costs in 1999 increased by $149.9 million from the year earlier period. As
discussed above, operating costs included certain other expense items, recorded
in SBCL's historical financial statements prior to the closing of the
acquisition, which have not been separately reflected on the face of the pro
forma financial information, which partially contributed to the increases.
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 the fourth quarter of 1997. Operating costs
unrelated to volume increased during 1999, principally due to additional
investments in information technology and sales and marketing capabilities, and
employee compensation costs.
Cost of services, as a percentage of net revenues, for both 1999 and 1998
were 62.3%. Included in cost of services for the year ended December 31, 1999,
were $7.8 million of certain other expense items recorded by SBCL prior to the
closing of the acquisition which have not been separately presented, as
discussed above.
Selling, general and administrative expenses, as a percentage of net
revenues, were 29.8% in 1999, compared to 29.2% in the prior year. Selling,
general and administrative expenses for the year ended December 31, 1999
included $9.4 million of other expense items recorded by SBCL prior to the
closing of the acquisition which have not been separately presented, as
discussed above. The remaining increase was principally due to additional
investments in information technology and sales and marketing capabilities,
litigation expenses and employee compensation costs. Bad debt expense in 1999
was 7.6% of net revenues, compared to 8.0% in the prior year period.
INTEREST EXPENSE, NET
Net interest expense decreased in 1999 by $3.9 million, as compared to the
prior year. Net interest expense for 1999 included $1.9 million of interest
income associated with a favorable state tax settlement. The remaining reduction
in net interest expense is primarily due to the repayment of long term debt
under the Credit Agreement between the closing of the SBCL acquisition and the
end of 1999.
PROVISIONS FOR RESTRUCTURING AND OTHER SPECIAL CHARGES
During the second, third and fourth quarters of 1999, the Company recorded
provisions for restructuring and other special charges totaling $15.8 million
($9.5 million, net of tax), $30.3 million ($18.2 million, net of tax) and $43.1
million ($26.1 million, net of tax), respectively, principally incurred in
connection with the acquisition and planned integration of SBCL.
The special charge in the second quarter of 1999 of $15.8 million was
primarily to record (on a pro forma basis) a loss provision in the results of
SBCL to reflect a contract as a loss contract.
Of the total special charge recorded in the third quarter of 1999, $19.8
million represented stock-based employee compensation of which $17.8 million
related to special one-time grants of the Company's common stock to certain
individuals of the combined company, and $2.0 million related to the accelerated
vesting of restricted stock grants made in previous years due to the completion
of the SBCL acquisition. In addition, during the third quarter of 1999, the
Company incurred $9.2 million of professional and consulting fees related to
integration planning activities. The remainder of the third quarter charge was
related to costs incurred by the Company in conjunction with its planned
offering of new senior subordinated notes, the proceeds of which were expected
to be used to repay the Company's existing Notes. During the third quarter of
1999, the Company decided not to proceed with the offering due to unsatisfactory
market conditions.
Of the $43.1 million charge recorded in the fourth quarter of 1999, $36.4
million represented costs related to planned integration activities affecting
Quest Diagnostics' operations and employees
56
<PAGE>
which were discussed above. In addition, the Company recorded $3.5 million of
special recognition awards granted in the fourth quarter of 1999 to certain
employees involved in the transaction and integration planning processes of the
SBCL acquisition. The remainder of the fourth quarter special charge was
primarily attributable to professional and consulting fees incurred in
connection with integration related planning activities.
MINORITY SHARE OF INCOME
Minority share of income for 1999 increased from the prior year level,
primarily due to the Company's contribution of its Pittsburgh, Pennsylvania and
St. Louis, Missouri businesses to two new corporate joint ventures in the fourth
quarter of 1998. During both 1999 and 1998, the Company maintained a 51%
controlling ownership interest in both of these affiliated companies.
OTHER, NET
Other, net for 1999 increased from the prior year level. The year ended
December 31, 1998 included $10.9 million of pre-tax profits primarily associated
with the favorable settlement of a contract dispute. This increase was
principally offset by a reduction in equity losses of $3.6 million, primarily
associated with a joint venture in Arizona in which the Company holds a 49%
interest, and a gain of $3.0 million associated with the sale of an investment
in the fourth 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 or reducing the tax benefit rate.
EXTRAORDINARY LOSS
In conjunction with the acquisition of SBCL, the Company repaid the entire
amount outstanding under its then existing credit agreement. The extraordinary
loss recorded in the third quarter of 1999 represented $3.6 million ($2.1
million, net of tax) of deferred financing costs written off in connection with
the extinguishment of the related credit agreement.
PRO FORMA CASH EARNINGS PER SHARE AND ADJUSTED EBITDA
Pro forma cash earnings per common share is calculated as cash earnings
less preferred dividends, divided by diluted weighted average common shares
outstanding. Pro forma cash earnings represents income (loss) before the
extraordinary loss, special items and amortization of all intangible assets, net
of applicable taxes. For purposes of determining pro forma cash earnings per
common share, special items included the provisions for restructuring and other
special charges reflected on the face of the pro forma financial information and
a $3.0 million gain related to the sale of an investment in the fourth quarter
of 1999.
Pro forma cash earnings per common share was $1.51 in 1999, compared to
$1.90 in the prior year. The decrease in pro forma cash earnings per common
share is primarily due to the income and expense items recorded by SBCL prior to
the closing of the acquisition which are discussed above.
Pro forma Adjusted EBITDA represents income (loss) before income taxes, net
interest expense, depreciation and amortization and special items. Special items
included the provisions for restructuring and other special charges reflected on
the face of the pro forma financial information, a $3.0 million gain related to
the sale of an investment in the fourth quarter of 1999, a charge of $2.5
million recorded in selling, general and administrative expenses in 1998 related
to the Company's
57
<PAGE>
consolidation of its laboratory network announced in the fourth quarter of 1997
and the income and expense items recorded by SBCL prior to the closing of the
acquisition, which are discussed above.
Pro forma Adjusted EBITDA for 1999 improved to $337.4 million, or 10.9% of
net revenues (adjusted to exclude the effects of the testing performed by third
parties under the Company's laboratory network management arrangements and the
loss contract), from $330.3 million, or 11.2% of net revenues, in the prior year
period.
58
<PAGE>
STATEMENT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of Quest Diagnostics Incorporated is responsible for the
preparation, presentation and integrity of the consolidated financial statements
and other information included in this annual report. The financial statements
have been prepared in accordance with generally accepted accounting principles
and include certain amounts based on management's best estimates and judgements.
Quest Diagnostics maintains a comprehensive system of internal controls designed
to provide reasonable assurance as to the reliability of the financial
statements as well as to safeguard assets from unauthorized use or disposition.
The system is reinforced by written policies, selection and training of highly
competent financial personnel, appropriate division of responsibilities and a
program of internal audits.
The Audit and Finance Committee of the Board of Directors is responsible for
reviewing and monitoring Quest Diagnostics' financial reporting and accounting
practices and recommending annually the appointment of the independent
accountants. The Audit and Finance Committee is comprised solely of
non-management directors who are, in the opinion of the Board of Directors, free
from any relationship that would interfere with the exercise of independent
judgement. The Audit and Finance Committee meets periodically with management,
the internal auditors and the independent accountants to review and assess the
activities of each. Both the independent accountants and the internal auditors
meet with the Audit and Finance Committee, without management present, to review
the results of their audits and their assessment of the adequacy of the system
of internal accounting control and the quality of financial reporting.
The consolidated financial statements have been audited by our independent
accountants, PricewaterhouseCoopers LLP. Their responsibility is to express an
independent, professional opinion with respect to the consolidated financial
statements on the basis of an audit conducted in accordance with generally
accepted auditing standards.
/s/ Kenneth W. Freeman
- --------------------------------
Kenneth W. Freeman
Chairman and Chief Executive Officer
/s/ Robert A. Hagemann
- --------------------------------
Robert A. Hagemann
Corporate Vice President and Chief Financial Officer
59
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Quest Diagnostics Incorporated
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14 (a) 1. present fairly, in all material respects, the
financial position of Quest Diagnostics Incorporated and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States.
In addition, in our opinion, the financial statement schedule listed in the
index appearing under Item 14 (a) 2. presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
- -------------------------------
PricewaterhouseCoopers LLP
New York, New York
January 24, 2000, except as to Note 17, which is as of March 13, 2000
F-1
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................. $ 27,284 $ 202,908
Accounts receivable, net of allowance of $121,550 and $70,701
at December 31, 1999 and 1998, respectively....................... 539,256 220,861
Inventories........................................................... 52,302 31,164
Deferred taxes on income.............................................. 192,808 94,441
Prepaid expenses and other current assets............................. 61,011 28,813
------------ ------------
Total current assets.............................................. 872,661 578,187
PROPERTY, PLANT AND EQUIPMENT, NET......................................... 427,978 240,389
INTANGIBLE ASSETS, NET..................................................... 1,435,882 494,721
DEFERRED TAXES ON INCOME................................................... 36,174 13,342
OTHER ASSETS............................................................... 105,786 33,601
------------ ------------
TOTAL ASSETS............................................................... $ 2,878,481 $ 1,360,240
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses................................. $ 626,485 $ 242,285
Current portion of long-term debt..................................... 45,435 51,444
Income taxes payable.................................................. 29,324 15,736
------------ ------------
Total current liabilities......................................... 701,244 309,465
LONG-TERM DEBT............................................................. 1,171,442 413,426
OTHER LIABILITIES.......................................................... 142,733 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; 44,353
and 30,241 shares issued at December 31,
1999 and 1998, respectively....................................... 444 302
Additional paid-in capital............................................ 1,502,551 1,201,006
Accumulated deficit................................................... (627,045) (623,514)
Unearned compensation................................................. (11,438) (3,895)
Accumulated other comprehensive loss.................................. (2,450) (3,038)
Common stock in treasury, at cost; 214 shares at
December 31, 1998................................................. - (3,931)
------------ ------------
Total common stockholders' equity................................. 862,062 566,930
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 2,878,481 $ 1,360,240
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-2
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
NET REVENUES ............................................ $ 2,205,243 $ 1,458,607 $ 1,528,695
COSTS AND EXPENSES:
Cost of services ..................................... 1,379,989 896,793 962,935
Selling, general and administrative .................. 643,440 445,885 467,052
Interest expense, net ................................ 61,450 33,403 40,996
Amortization of intangible assets .................... 29,784 21,697 23,951
Provisions for restructuring and other special charges 73,385 -- 48,688
Minority share of income ............................. 5,431 2,017 1,393
Other, net ........................................... (2,620) 4,951 2,738
----------- ----------- -----------
Total .............................................. 2,190,859 1,404,746 1,547,753
----------- ----------- -----------
INCOME (LOSS) BEFORE TAXES AND EXTRAORDINARY LOSS ....... 14,384 53,861 (19,058)
INCOME TAX EXPENSE ...................................... 15,658 26,976 3,202
----------- ----------- -----------
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS ................. (1,274) 26,885 (22,260)
EXTRAORDINARY LOSS, NET OF TAXES ........................ (2,139) -- --
----------- ----------- -----------
NET INCOME (LOSS) ....................................... $ (3,413) $ 26,885 $ (22,260)
=========== =========== ===========
BASIC NET INCOME (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary loss ................. $ (0.04) $ 0.90 $ (0.77)
Extraordinary loss, net of taxes ........................ (0.06) -- --
----------- ----------- -----------
Net income (loss) ....................................... $ (0.10) $ 0.90 $ (0.77)
=========== =========== ===========
DILUTED NET INCOME (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary loss ................. $ (0.04) $ 0.89 $ (0.77)
Extraordinary loss, net of taxes ........................ (0.06) -- --
----------- ----------- -----------
Net income (loss) ....................................... $ (0.10) $ 0.89 $ (0.77)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .......................................................... $ (3,413) $ 26,885 $ (22,260)
Extraordinary loss, net of taxes ........................................... 2,139 -- --
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization ......................................... 90,835 68,845 76,397
Provision for doubtful accounts ....................................... 142,333 89,428 118,223
Provisions for restructuring and other special charges ................ 73,385 -- 48,688
Deferred income tax (benefit) provision ............................... (29,514) 12,290 (1,090)
Other, net ............................................................ 7,186 11,032 6,117
Changes in operating assets and liabilities:
Accounts receivable ............................................... (118,693) (71,920) (63,865)
Accounts payable and accrued expenses ............................. 115,279 40,070 27,835
Integration, settlement and special charges ....................... (33,326) (39,518) (16,703)
Due from Corning Incorporated and affiliates ...................... -- 14,890 8,755
Other assets and liabilities, net ................................. 3,324 (10,620) (5,830)
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES .................................. 249,535 141,382 176,267
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisitions ................................................. (1,025,000) (948) (16,000)
Transaction costs ..................................................... (9,612) -- --
Capital expenditures .................................................. (76,029) (39,575) (30,836)
Proceeds from disposition of assets ................................... 4,982 3,035 10,397
(Increase) decrease in investments .................................... (2,331) (2,232) 1,338
----------- ----------- -----------
NET CASH USED IN INVESTING ACTIVITIES ...................................... (1,107,990) (39,720) (35,101)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings .............................................. 1,132,843 4,300 --
Repayment of long-term debt ........................................... (412,035) (54,153) (21,367)
Financing costs paid .................................................. (36,822) -- --
Purchase of treasury stock ............................................ (1,103) (13,032) --
(Distributions to) contributions from minority partners ............... (4,363) 2,443 --
Exercise of stock options ............................................. 4,429 145 --
Preferred dividends paid .............................................. (118) (118) (98)
----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ........................ 682,831 (60,415) (21,465)
----------- ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS .................................... (175,624) 41,247 119,701
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ............................... 202,908 161,661 41,960
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR ..................................... $ 27,284 $ 202,908 $ 161,661
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
Accumulated
Other Compre-
Additional Unearned Comprehensive hensive
Common Paid-In Accumulated Compen- Income Treasury Income
Stock Capital Deficit sation (Loss) Stock (Loss)
----------- ----------- ----------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 $ 288 $ 1,170,152 $ (627,892) $ -- $ (4,829) $ --
Net loss (22,260) $ (22,260)
Other comprehensive income 2,314 2,314
-----------
Comprehensive loss (19,946)
===========
Preferred dividends declared (129)
Issuance of common stock
under benefit plans
(1,164 common shares) 12 18,501 (6,975)
Adjustment to Corning
receivable 9,541
Amortization of unearned
compensation 1,937
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 300 1,198,194 (650,281) (5,038) (2,515) --
Net income 26,885 26,885
Other comprehensive loss (523) (523)
-----------
Comprehensive income 26,362
===========
Preferred dividends declared (118)
Purchase of treasury
stock (687 shares) (13,032)
Issuance of common stock
under benefit plans
(255 common shares and
473 treasury shares) 2 3,522 (970) 9,101
Adjustment to Corning
receivable (710)
Amortization of unearned
compensation 2,113
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 302 1,201,006 (623,514) (3,895) (3,038) (3,931)
Net loss (3,413) (3,413)
Other comprehensive income 588 588
-----------
Comprehensive loss $ (2,825)
===========
Preferred dividends declared (118)
Shares issued to acquire
SBCL (12,564 shares) 126 260,584
Purchase of treasury stock
(60 common shares) (1,103)
Issuance of common stock
under benefit plans
(1,269 common shares
and 274 treasury shares) 13 34,991 (11,253) 5,034
Exercise of options (279
common shares) 3 4,426
Tax benefits associated
with stock-based 3,529
compensation plans
Adjustment to Corning
receivable (1,985)
Amortization of unearned
compensation 3,710
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1999 $ 444 $ 1,502,551 $ (627,045) $ (11,438) $ (2,450) $ --
=========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
1. DESCRIPTION OF BUSINESS
Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or
the "Company") is the largest clinical laboratory testing business in the United
States. Prior to January 1, 1997, 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. This
distribution was followed immediately by the distribution to stockholders of the
Company of all the outstanding common stock of Covance Inc. ("Covance"). These
two distributions are collectively referred to as the "Spin-Off Distribution."
As the nation's leading provider of diagnostic testing, information and
services, Quest Diagnostics offers a broad range of clinical laboratory testing
services used by physicians to diagnose, treat and monitor diseases and other
medical conditions. These tests range from routine clinical testing to highly
complex tests including genetic and other esoteric testing. Quest Diagnostics
offers testing and services to help employers detect workplace drug abuse, and
to support pharmaceutical companies in clinical trials of new drugs worldwide.
Quest Informatics analyzes laboratory and other medical data to develop
information products to help providers and insurers better manage their
patients' health. Quest Diagnostics' customers include physicians, managed care
organizations, hospitals, employers and institutions, pharmaceutical companies
and other independent clinical laboratories.
On an annualized basis, Quest Diagnostics currently processes over 100
million requisitions through its extensive network of laboratories and patient
service centers in virtually every major metropolitan area throughout the United
States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of all entities
controlled by the Company. The equity method of accounting is used for
investments in affiliates, which are not Company controlled, and in which the
Company's interest is generally between 20 and 50 percent. The Company's share
of the net loss of its equity investments, which totaled $0.7 million, $5.2
million and $1.2 million for 1999, 1998 and 1997, respectively, was included in
other, net in the consolidated statements of operations. All significant
intercompany accounts and transactions are eliminated.
RECLASSIFICATIONS
During the fourth quarter of 1999, the Company reclassified certain expense
items, primarily related to a portion of occupancy costs and professional
liability insurance expense, from selling, general and administrative expenses
to cost of services, to better reflect the cost of performing testing. All prior
year financial information has been reclassified for comparative purposes to
conform with the 1999 presentation. The amounts reclassified from selling,
general and administrative expenses for the years ended December 31, 1999, 1998
and 1997 were $57.4 million, $35.7 million and $35.1 million, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
F-6
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
REVENUE RECOGNITION
The Company generally recognizes revenue for services rendered upon
completion of the testing process. Billings for services under third-party payer
programs, including Medicare and Medicaid, are recorded as revenues net of
allowances for differences between amounts billed and the estimated receipts
under such programs. Adjustments to the estimated receipts, based on final
settlement with the third-party payers, are recorded upon settlement. In 1999,
1998 and 1997, approximately 14%, 16% and 20%, respectively, of net revenues
were generated by Medicare and Medicaid programs.
TAXES ON INCOME
The Company uses the asset and liability approach to account for income
taxes. Under this method, deferred tax assets and liabilities are recognized for
the expected future tax consequences of differences between the carrying amounts
of assets and liabilities and their respective tax bases using tax rates in
effect for the year in which the differences are expected to reverse. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period when the change is enacted.
EARNINGS PER SHARE
Basic net income (loss) per common share is calculated by dividing net
income (loss), less preferred stock dividends, by the weighted average number of
common shares outstanding. Diluted net income (loss) per common share is
calculated by dividing net income (loss), 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.
The computation of basic and diluted net income (loss) per common share was
as follows (in thousands except per share data):
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Income (loss) before extraordinary loss....................... $ (1,274) $ 26,885 $ (22,260)
Less: Preferred stock dividends............................... 118 118 129
------------- ------------- -------------
Income (loss) available to common stockholders - basic and
diluted.................................................... $ (1,392) $ 26,767 $ (22,389)
============== ============= =============
Weighted average number of common shares outstanding - basic (in
thousands)................................................. 35,014 29,684 29,188
Effect of dilutive securities:
Stock options (in thousands).................................. - 401 -
Restricted common stock (in thousands) ....................... - 144 -
------------- ------------- -------------
Weighted average number of common shares outstanding - diluted
(in thousands) ............................................ 35,014 30,229 29,188
============= ============= =============
Basic net income (loss) per common share:
Income (loss) before extraordinary loss....................... $ (0.04) $ 0.90 $ (0.77)
============= ============= =============
Diluted net income (loss) per common share:
Income (loss) before extraordinary loss....................... $ (0.04) $ 0.89 $ (0.77)
============= ============= =============
</TABLE>
F-7
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The following securities were not included in the diluted net income (loss)
per share calculation due to their antidilutive effect.
1999 1998 1997
---- ---- ----
Stock options (in thousands)................. 5,741 107 1,896
Restricted common stock (in thousands)....... 568 -- 422
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), encourages, but does not require,
companies to record compensation cost for stock-based compensation plans at fair
value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"), and related interpretations.
FOREIGN CURRENCY
Assets and liabilities of foreign subsidiaries are translated into U.S.
dollars at year-end exchange rates. Income and expense items are translated at
average exchange rates prevailing during the year. The translation adjustments
are recorded as a component of accumulated other comprehensive income (loss)
within stockholders' equity. Gains and losses from foreign currency transactions
are included in consolidated income. Transaction gains and losses have not been
material.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all highly-liquid investments with
maturities, at the time acquired by the Company, of three months or less.
CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk with respect to accounts receivable are
limited due to the diversity of the Company's clients as well as their
dispersion across many different geographic regions.
INVENTORIES
Inventories, which consist principally of supplies, are valued at the lower
of cost (first in, first out method) or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation and
amortization are provided on the straight-line method over expected useful asset
lives as follows: buildings and improvements, ranging from ten to thirty years;
laboratory equipment and furniture and fixtures, ranging from three to seven
years; and leasehold improvements, the lesser of the useful life of the
improvement or the remaining life of the building or lease, as applicable.
LONG-LIVED ASSETS
The Company reviews the recoverability of its long-lived assets when events
or changes in circumstances occur that indicate that the carrying value of the
asset may not be recoverable. Evaluation of possible impairment is based on the
Company's ability to recover the asset from the expected future pre-tax cash
flows (undiscounted and without interest charges) of the related operations. If
the expected undiscounted pre-tax cash flows are less than the carrying value of
such asset, an impairment loss would be recognized for the difference between
estimated fair value and carrying value.
F-8
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
ACCOUNTING FOR INTANGIBLE ASSETS
Acquisition costs in excess of the fair value of net tangible assets
acquired are capitalized and amortized on the straight-line method over periods
not exceeding forty years. Other intangible assets are recorded at cost and
amortized on the straight-line method over periods not exceeding fifteen years.
The Company evaluates the recoverability and measures the possible
impairment of intangible assets under Accounting Principles Board Opinion No.
17, "Intangible Assets" based on the fair value of the intangible assets.
Management believes that a valuation of intangible assets based on the amount
for which each regional laboratory could be sold in an arm's-length transaction
is preferable to using projected undiscounted pre-tax cash flows. The Company
believes fair value is a better indicator of the extent to which the intangible
assets may be recoverable and, therefore, may be impaired.
The fair value method is applied to each of the regional laboratories.
Management's estimate of fair value is primarily based on multiples of
forecasted revenue or multiples of forecasted earnings before interest, taxes,
depreciation and amortization ("EBITDA"). The multiples are primarily determined
based upon publicly available information regarding comparable publicly-traded
companies in the industry, but also consider (i) the financial projections of
each regional laboratory, (ii) the future prospects of each regional laboratory,
including its growth opportunities, managed care concentration and likely
operational improvements, and (iii) comparable sales prices, if available.
Multiples of revenues are used to estimate fair value in cases where the Company
believes that the likely acquirer of a regional laboratory would be a strategic
buyer within the industry which would realize synergies from such an
acquisition. In regions where management does not believe there is a potential
strategic buyer within the industry, and, accordingly, believes the likely buyer
would not have synergy opportunities, multiples of EBITDA are used for
estimating fair value. Regional laboratories with lower levels of profitability
valued using revenue multiples would generally be ascribed a higher value than
if multiples of EBITDA were used, due to assumed synergy opportunities.
Management's estimate of fair value is currently based on multiples of revenue
primarily ranging from 0.8 to 1.1 times revenue and on multiples of EBITDA
primarily ranging from 7 to 9 times EBITDA. While management believes the
estimation methods are reasonable and reflective of common valuation practices,
there can be no assurance that a sale to a buyer for the estimated value
ascribed to a regional laboratory could be completed. Changes to the method of
valuing regional laboratories will be made only when there is a significant and
fundamental change in facts and circumstances, such as significant changes in
market position or the entrance or exit of a significant competitor from a
regional market. No changes were made to the method of valuing regional
laboratories in 1999 or 1998.
On a quarterly basis, management performs a review of each regional
laboratory to determine if events or changes in circumstances have occurred
which could have a material adverse effect on the fair value of the business and
its intangible assets. If such events or changes in circumstances were deemed to
have occurred, management would consult with one or more of its advisors in
estimating the impact on fair value of the regional laboratory. Should the
estimated fair value of a regional laboratory be less than the net book value
for such laboratory at the end of a quarter, the Company will record a charge to
operations to recognize an impairment of its intangible assets for such
difference. During 1997, the Company recorded a charge of $16.0 million related
to the impairment of intangible assets (see Note 7).
INVESTMENTS
The Company accounts for investments in equity securities, which are
included in other assets, in conformity with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115"), which requires the use of fair value
accounting for trading or available-for-sale securities. Unrealized gains and
losses for available-for-sale securities are recorded as a component of
accumulated other comprehensive income (loss) within stockholders' equity.
Gains and losses on securities sold are based on the average cost method.
Other, net for the year ended December 31, 1999 included a fourth quarter
gain of $3.0 million associated with the sale of an investment. The proceeds
from the sale of $7.7 million were classified as a component within the
change in investments in the statement of cash flows for 1999. Investments in
equity securities have not been material to the Company.
F-9
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
FINANCIAL INSTRUMENTS
The Company's policy is to use financial instruments only to manage
exposure to market risks. The Company has established a control environment that
includes policies and procedures for risk assessment and the approval, reporting
and monitoring of derivative financial instrument activities. These policies
prohibit holding or issuing derivative financial instruments for trading
purposes.
The Company defers the impact of changes in the market value of these
contracts until such time as the hedged transaction is completed. The Company
may also, from time to time, enter into interest rate and foreign currency swaps
to manage interest rates and foreign currency risk. Income and expense related
to interest rate swaps is accrued as interest rates change and is recognized in
income over the life of the agreement. Gains or losses realized and premiums
paid on foreign currency contracts are deferred and are recognized as payments
are made on the related foreign currency denominated debt, or immediately if the
obligation instrument is settled.
During 1999, the Company entered into interest rate swap agreements to
mitigate the risk of changes in interest rates associated with its variable rate
bank debt in accordance with the terms of the Company's credit agreement (see
Note 11).
During 1999 and 1998, the Company entered into foreign exchange contracts
to manage foreign currency risk. The terms of these exchange contracts are
generally one year or less. The primary purpose of the foreign currency hedging
activities is to protect the Company from the risk that the eventual cash
outflows to settle foreign currency denominated liabilities will be adversely
affected by changes in exchange rates. The unrealized gain related to an
outstanding contract at December 31, 1999 and 1998 was immaterial.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable and accrued expenses approximate fair value based on the short
maturity of these instruments. As of December 31, 1999, and 1998, the fair value
of the Company's debt was estimated at approximately $1,213 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. At December 31, 1999, the carrying value of the debt exceeded
the estimated fair value by approximately $4 million. At December 31, 1998, the
fair value exceeded the carrying value of the debt by approximately $15 million.
At December 31, 1999, the estimated fair value of the interest rate swap
agreements was approximately $3.8 million.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". This statement
establishes standards for the reporting and display of comprehensive income and
its components in the financial statements. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions with
stockholders) and includes net income (loss), net unrealized capital gains or
losses on available-for-sale securities and foreign currency translation
adjustments.
SEGMENT REPORTING
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information".
This statement establishes standards for reporting segments using the
"management approach," or the internal organization that is used by management
for making operating decisions and assessing performance, as the source of a
company's reportable segments. The adoption of this statement did not affect
results of operations, financial position or disclosures.
F-10
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
DERIVATIVE INSTRUMENTS AND HEDGING
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. SFAS 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000 (2001 for the Company). Management of the Company anticipates that, due to
its limited use of derivative instruments, the adoption of SFAS 133 will not
have a significant effect on the Company's results of operations or its
financial position.
3. ACQUISITION OF SMITHKLINE BEECHAM'S CLINICAL LABORATORY TESTING BUSINESS
On August 16, 1999, the Company completed the acquisition of the clinical
laboratory business of SmithKline Beecham plc ("SmithKline Beecham") for
approximately $1.3 billion. The purchase price was paid through the issuance of
12,564,336 shares of common stock of the Company (valued at $260.7 million),
representing approximately 29% of the Company's then outstanding common stock,
and the payment of $1.025 billion in cash, including $20 million under a
non-competition agreement between the Company and SmithKline Beecham.
Under the terms of the acquisition agreements, Quest Diagnostics acquired
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 consisted 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. In addition, SmithKline Beecham and Quest Diagnostics
entered into a long-term contract under which Quest Diagnostics is the primary
provider of testing to support SmithKline Beecham's clinical trials testing
requirements worldwide. As part of the acquisition agreements, Quest Diagnostics
granted SmithKline Beecham certain non-exclusive rights and access to use Quest
Diagnostics' proprietary clinical laboratory information database. Quest
Diagnostics will also receive a minority interest in a company that SmithKline
Beecham expects to form to sell healthcare information products and services
through various channels, including the Internet.
Under the terms of a stockholder agreement, SmithKline Beecham has 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 was expanded to nine directors following
the closing of the acquisition. The stockholder agreement also imposes
limitations on the right of SmithKline Beecham to sell or vote its shares and
prohibits SmithKline Beecham from purchasing in excess of 29.5% of the
outstanding common stock of Quest Diagnostics.
Under the acquisition agreements, SmithKline Beecham has agreed to
indemnify Quest Diagnostics, on an after tax basis, against certain matters
primarily related to taxes and billing and professional liability claims.
The acquisition was accounted for under the purchase method of accounting.
As such, the cost to acquire SmithKline Beecham's clinical laboratory business
("SBCL") has been allocated on a preliminary basis to the assets and liabilities
acquired based on estimated fair values as of the closing date. The consolidated
financial statements include the results of operations of SBCL subsequent to the
closing of the acquisition.
F-11
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The SBCL acquisition agreements include a provision for a purchase price
adjustment based on an audit of the August 16, 1999 combined balance sheet of
SBCL and certain affiliates. Adjustments resulting from this audit, which are
subject to resolution as set forth in SBCL acquisition agreements and are the
subject of on-going discussions between the parties, have been recorded as of
December 31, 1999. However, amounts due from SmithKline Beecham, as a result of
the purchase price adjustment, have not been reflected in the December 31, 1999
consolidated balance sheet of Quest Diagnostics.
Goodwill of approximately $952 million, representing acquisition cost in
excess of the fair value of the net tangible assets acquired, is amortized on
the straight-line basis over forty years. The amount paid under the non-compete
agreement is amortized on the straight-line basis over five years. The purchase
price allocation will be finalized after completion of the valuation of certain
assets and liabilities, and the final resolution of the purchase price
adjustment.
FINANCING OF THE TRANSACTION
At the closing of the SBCL acquisition, the Company used existing cash
funds and the borrowings under a new senior secured credit facility (see Note
11) to fund the cash purchase price and related transaction costs of the
acquisition, and to repay the entire amount outstanding under its then existing
credit agreement.
PRO FORMA COMBINED FINANCIAL INFORMATION (UNAUDITED)
The following pro forma combined financial information for the years ended
December 31, 1999 and 1998 assumes that the SBCL acquisition and borrowings
under the new credit facility were effected on January 1, 1998. The SBCL
acquisition agreements include a provision for a purchase price adjustment based
on an audit of the August 16, 1999 combined balance sheet of SBCL and certain
affiliates. Adjustments resulting from this audit, which are subject to
resolution as set forth in the SBCL acquisition agreements, have been recorded
in the pro forma combined financial information to the extent that the Company
believes they are applicable. The pro forma combined financial information
reflects the preliminary allocation of the purchase price. The allocation will
be finalized after completion of the valuation of certain assets and
liabilities, and the final resolution of the purchase price adjustment. There
can be no assurances that the amounts reflected in the pro forma combined
financial information will not be subject to change as a result of changes in
the allocation of the purchase price, including the resolution of the purchase
price adjustment.
Significant pro forma adjustments reflected in the 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
new credit facility which was used to finance the SBCL acquisition. Amortization
of the goodwill, which accounts for a majority of the acquired intangible
assets, is calculated on the straight-line basis over forty years. Other, net
has been adjusted to remove SBCL's non-recurring gains from the sale and license
of certain technology and its physician office-based teleprinter assets and
network. 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.
F-12
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Unaudited pro forma combined financial information for the years ended
December 31, 1999 and 1998 was as follows (in thousands, except per share data):
1999 1998
---- ----
Net revenues ....................................... $ 3,294,810 $ 3,027,783
Income (loss) before extraordinary loss ............ (25,319) 42,543
Net income (loss) .................................. (27,458) 42,543
- ---------------------------------------------------- ----------- -----------
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary loss ............ $ (0.59) $ 0.99
Net income (loss) .................................. $ (0.64) $ 0.99
Weighted average common shares outstanding - basic . 43,345 43,031
- ---------------------------------------------------- ----------- -----------
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Income (loss) before extraordinary loss ............ $ (0.59) $ 0.98
Net income (loss) .................................. $ (0.64) $ 0.98
Weighted average common shares outstanding - diluted 43,345 43,440
4. INTEGRATION OF SBCL AND QUEST DIAGNOSTICS BUSINESSES
During the fourth quarter of 1999, Quest Diagnostics finalized its plan
related to the integration of SBCL into Quest Diagnostics' laboratory network.
The plan focuses principally on laboratory consolidations in geographic markets
currently served by more than one of the Company's laboratories, and redirecting
testing volume within the Company's national network to improve customer
service. As part of the plans, laboratories in Deerfield Beach, Florida; Owings
Mills, Maryland; Farmington Hills, Michigan; Islip, New York; Valley View, Ohio;
Norristown, Pennsylvania; Dallas, Texas; and Waltham, Massachusetts will close
or be substantially reduced in capacity. Testing performed at the National
Esoteric Center located in Van Nuys, California will move to Nichols Institute.
In addition, a number of changes to redirect specimen flows to provide more
local testing and improve customer service will also impact capacity throughout
the Company's laboratory network. Employee groups to be impacted as a result of
these actions include those involved in the collection and testing of specimens,
as well as administrative and other support functions. During the fourth quarter
of 1999, the Company recorded the estimated costs associated with these
activities for 1999 and 2000 relative to the integration plan. The majority of
these integration costs were related to employee severance, contractual
obligations associated with leased facilities and equipment, and the write-off
of fixed assets which management believes will have no future economic benefit
upon combining the operations. Integration costs related to planned activities
affecting SBCL's operations and employees were recorded as a cost of the
acquisition. Integration costs associated with the planned integration of SBCL
affecting Quest Diagnostics' operations and employees were recorded as a charge
to earnings in the fourth quarter of 1999 (see Note 7).
Integration costs, including write-offs of fixed assets, totaling $55.5
million which are related to planned activities affecting SBCL assets,
liabilities and employees, were recorded in the fourth quarter of 1999 as a cost
of the SBCL acquisition. Of these costs, $33.8 million related to employee
termination costs for approximately 1,250 employees, and $13.4 million related
to contractual obligations including those related to facilities and equipment
leases. The remaining portion of the costs were associated with the write-off of
assets that management plans to dispose of in conjunction with the integration
of SBCL.
F-13
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The following table summarizes the Company's accruals for integration costs
affecting the acquired operations and employees of SBCL (in millions):
<TABLE>
<CAPTION>
Employee Costs of
Termination Exiting Leased
Costs Facilities Other Total
----- ---------- ----- -----
<S> <C> <C> <C> <C>
Amounts recognized as a cost of the SBCL
acquisition............................... $33.8 $5.6 $7.8 $47.2
Amounts utilized in 1999....................... (1.4) (0.1) -- (1.5)
---- ---- ---- -----
Balance at December 31, 1999................... $32.4 $5.5 $7.8 $45.7
===== ==== ==== =====
</TABLE>
Approximately seventy employees had been terminated in connection with
integration activities as of December 31, 1999. While the majority of the costs
are expected to be paid in 2000, there are certain severance and facility
related exit costs, principally remaining lease obligations, that have payment
terms extending beyond 2000.
Also recorded in the fourth quarter of 1999 was a charge to earnings of
$36.4 million, principally for integration costs, including write-offs of fixed
assets, associated with the integration plans affecting Quest Diagnostics'
operations and employees (see Note 7).
5. TAXES ON INCOME
In conjunction with the Spin-Off Distribution, the Company, Corning, and
Covance entered into a tax sharing agreement which allocates among them
responsibility for federal, state and local taxes relating to taxable periods
before and after the Spin-Off Distribution and provides for computing and
apportioning tax liabilities and tax benefits for such periods among the
parties. The Company, Corning, and Covance also entered into tax indemnification
agreements that provide Corning with certain rights of indemnification against
the Company and Covance. Additionally, the tax indemnification agreements
provide the Company and Covance with certain rights of indemnification against
each other.
The Company's pre-tax income (loss) consisted of approximately $17.7
million, $52.7 million and $(16.7) million from U.S. operations and
approximately $(3.3) million, $1.2 million and $(2.4) million from foreign
operations for the years ended December 31, 1999, 1998 and 1997, respectively.
The components of income tax expense for 1999, 1998 and 1997 were as
follows:
1999 1998 1997
---- ---- ----
Current:
Federal........................... $ 34,314 $ 8,754 $ 3,904
State and local................... 10,073 4,861 223
Foreign........................... 785 1,071 165
Deferred:
Federal........................... (22,336) 14,728 (885)
State and local................... (7,178) (2,438) (205)
---------- ---------- ----------
Total........................... $ 15,658 $ 26,976 $ 3,202
========== ========== ==========
F-14
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
A reconciliation of the federal statutory rate to the Company's effective
tax rate for 1999, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Tax provision (benefit) at statutory rate..................... 35.0% 35.0% (35.0%)
State and local income taxes, net of federal benefit.......... 4.3 3.4 0.1
Non-deductible goodwill amortization.......................... 55.7 9.3 25.8
Non-deductible write-down of intangible assets................ - - 29.4
Adjustment of prior years tax liabilities..................... - - (10.9)
Impact of foreign operations.................................. 11.6 1.2 5.3
Non-deductible meals and entertainment expense................ 5.1 1.2 1.7
Other, net.................................................... (2.8) - 0.4
------ ------ ------
Effective tax rate....................................... 108.9% 50.1% 16.8%
====== ====== ======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 1999 and
1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Current deferred tax asset:
Accounts receivable reserve................................ $ 11,459 $ 20,765
Liabilities not currently deductible....................... 134,206 50,611
Accrued settlement reserves................................ 19,542 9,926
Accrued restructuring and integration costs................ 17,784 4,857
Net operating losses....................................... 8,830 7,797
Other...................................................... 987 485
-------- --------
Total.................................................... $ 192,808 $ 94,441
========== ==========
Non-current deferred tax asset (liability):
Liabilities not currently deductible....................... $ 27,581 $ 16,106
Accrued settlement reserves................................ 13,351 10,863
Accrued restructuring and integration costs................ 12,886 -
Depreciation and amortization.............................. (17,644) (13,627)
---------- ----------
Total.................................................... $ 36,174 $ 13,342
========== ==========
</TABLE>
The Company had net operating losses for state income tax purposes with
expiration dates through 2019 of approximately $207 million at December 31,
1999.
Income taxes payable at December 31, 1999 and 1998 were $29.3 million and
$15.7 million, respectively, and consisted primarily of federal income taxes
payable of $24.9 million and $14.0 million, respectively.
F-15
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
6. SUPPLEMENTAL DATA
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Depreciation expense.......................................... $ 61,051 $ 47,148 $ 52,446
Interest expense.............................................. $ 69,842 $ 43,977 $ 46,040
Interest income............................................... (8,392) (10,574) (5,044)
---------- ---------- ----------
Interest expense, net......................................... $ 61,450 $ 33,403 $ 40,996
Interest paid................................................. $ 62,662 $ 41,243 $ 41,622
Income taxes paid............................................. $ 24,545 $ 16,269 $ 10,788
Business acquired:
Fair value of tangible assets acquired........................ $ 702,489 - -
Fair value of liabilities assumed............................. 378,113 - -
Common shares issued to acquire SBCL.......................... 260,710 - -
</TABLE>
7. PROVISIONS FOR RESTRUCTURING AND OTHER SPECIAL CHARGES
During the third and fourth quarters of 1999, the Company recorded
provisions for restructuring and other special charges totaling $30.3 million
and $43.1 million, respectively, principally incurred in connection with the
acquisition and planned integration of SBCL.
Of the $30.3 million special charge recorded in the third quarter of 1999,
$19.8 million represented stock-based employee compensation of which $17.8
million related to special one-time grants of the Company's common stock to
certain individuals of the combined company, and $2.0 million related to the
accelerated vesting of restricted stock grants made in previous years due to the
completion of the SBCL acquisition. In addition, during the third quarter of
1999, the Company incurred $9.2 million of professional and consulting fees
related to integration planning activities. The remainder of the third quarter
charge was related to costs incurred by the Company in conjunction with its
planned offering of new senior subordinated notes, the proceeds of which were
expected to be used to repay the Company's existing 10 3/4% senior subordinated
notes. During the third quarter of 1999, the Company decided not to proceed with
the offering due to unsatisfactory conditions in the high yield market.
Of the $43.1 million charge recorded in the fourth quarter of 1999, $36.4
million represented costs related to planned integration activities affecting
Quest Diagnostics' operations and employees. Of these costs, $23.4 million
related to employee termination costs for approximately 1,050 employees, $9.7
million related primarily to lease obligations for facilities and equipment and
$6.7 million was associated with the write-off of assets that management plans
to dispose of in conjunction with the integration of SBCL. Offsetting these
charges was the reversal of $3.4 million of reserves associated with the
Company's consolidation plan announced in the fourth quarter of 1997. Upon
finalizing the initial integration plan for SBCL in the fourth quarter of 1999,
the Company determined that $3.4 million of the remaining reserves associated
with the 1997 consolidation plan were no longer necessary due to changes in the
plan as a result of the SBCL integration. In addition to the net charge of $36.4
million, the Company recorded $3.5 million of special recognition awards granted
in the fourth quarter of 1999 to certain employees involved in the transaction
and integration planning processes of the SBCL acquisition. The remainder of the
fourth quarter special charge is primarily attributable to professional and
consulting fees incurred in connection with integration related planning
activities.
F-16
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The following table summarizes the Company's accruals for restructuring
costs associated with the planned integration of SBCL affecting Quest
Diagnostics' operations and employees (in millions):
<TABLE>
<CAPTION>
Employee Costs of
Termination Exiting Leased
Costs Facilities Other Total
----- ---------- ----- -----
<C> <C> <C> <C> <C>
1999 Provision................................. $23.4 $8.9 $0.8 $33.1
Amounts utilized in 1999....................... (2.5) - - (2.5)
---- ---- ---- -----
Balance at December 31, 1999................... $20.9 $8.9 $0.8 $30.6
===== ==== ==== =====
</TABLE>
Approximately sixty-five employees had been terminated in connection with
integration activities as of December 31, 1999. While the majority of the costs
are expected to be paid in 2000, there are certain severance and facility
related exit costs, principally remaining lease obligations, that have payment
terms extending beyond 2000.
In the fourth quarter of 1997, the Company recorded provisions for
restructuring and other special charges totaling $48.7 million in connection
with a series of actions aimed at reducing excess capacity in its network of
clinical laboratories through facility reductions and consolidations. The
charges consisted primarily of workforce reduction programs, costs associated
with exiting a number of leased facilities, the write-off of certain assets, the
write-down of a non-strategic investment and a charge of $16.0 million to
write-down intangible assets reflecting the estimated impairment as a result of
the Company's actions. In addition to the restructuring and other special
charges, the Company recorded $6.8 million in selling, general and
administrative expenses. These expenses consisted primarily of additional
provisions for doubtful accounts to recognize the reduced recoverability of
certain receivables from accounts which will no longer be served as a result of
the consolidation plan.
The following table summarizes the Company's accruals associated with prior
restructuring plans (in millions):
<TABLE>
<CAPTION>
Employee Costs of
Termination Exiting Leased
Costs Facilities Other Total
----- ---------- ----- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1996 $ 7.5 $ 5.5 $ 2.1 $15.1
1997 Provision 17.8 3.4 4.0 25.2
Amounts utilized in 1997 (6.8) (2.3) (1.0) (10.1)
----- ----- ----- -----
Balance at December 31, 1997 18.5 6.6 5.1 30.2
Amounts utilized in 1998 (13.4) (2.5) (2.8) (18.7)
----- ----- ----- -----
Balance at December 31, 1998 5.1 4.1 2.3 11.5
Amounts utilized in 1999 (4.6) (2.1) (0.1) (6.8)
Reversal (0.1) (1.3) (2.0) (3.4)
----- ----- ----- -----
Balance at December 31, 1999 $ 0.4 $ 0.7 $ 0.2 $ 1.3
===== ===== ===== =====
</TABLE>
The 1997 provision included estimated severance benefits related to the
termination of approximately 1,300 employees. Approximately 825 employees have
been terminated as of December 31, 1999. The actual number of employees to be
terminated is less than initially anticipated, primarily due to higher than
expected attrition. In the fourth quarter of 1998, the Company determined that
reserves established in the fourth quarter of 1997, primarily related to
employee termination costs, were in excess of what would ultimately be required
by approximately $3.0 million. Also, in the fourth quarter of 1998, the Company
determined that the write-down of a non-strategic investment, recorded in the
fourth quarter of 1997 and included in restructuring and other special charges,
should be increased by approximately $3.0 million. The effect of these
adjustments, which were included in the amounts utilized in 1998 above, was to
reallocate the remaining reserves associated with the 1997 fourth quarter
charge. While all prior restructuring plans were completed as of December 31,
1999, certain
F-17
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
severance and facility related exit costs included in the 1997 plan have payment
terms extending into 2000.
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 1999 and 1998 consisted of
the following:
1999 1998
---- ----
Land .......................................... $ 35,928 $ 14,827
Buildings and improvements .................... 263,232 179,906
Laboratory equipment, furniture and fixtures .. 402,675 336,843
Leasehold improvements ........................ 59,774 45,059
Construction-in-progress ...................... 33,836 12,895
--------- ---------
795,445 589,530
Less: accumulated depreciation and amortization (367,467) (349,141)
--------- ---------
Total .................................... $ 427,978 $ 240,389
========= =========
9. INTANGIBLE ASSETS
Intangible assets at December 31, 1999 and 1998 consisted of the following:
1999 1998
---- ----
Goodwill ................................. $ 1,517,527 $ 567,295
Customer lists ........................... 38,556 38,590
Other (principally non-compete agreements) 39,346 18,956
----------- -----------
1,595,429 624,841
Less: accumulated amortization ........... (159,547) (130,120)
----------- -----------
Total ............................... $ 1,435,882 $ 494,721
=========== ===========
10. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1999 and 1998
consisted of the following:
1999 1998
---- ----
Accrued expenses .......................... $288,603 $ 72,047
Accrued wages and benefits ................ 189,945 107,869
Accrued settlement reserves ............... 49,473 25,129
Accrued restructuring and integration costs 45,023 12,295
Trade accounts payable .................... 53,441 24,945
-------- --------
Total ................................ $626,485 $242,285
======== ========
F-18
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
11. LONG-TERM DEBT
Long-term debt at December 31, 1999 and 1998 consisted of the following:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Senior secured variable rate bank term loans:
Term loan, payable through June 2005; 8.6% interest as of
December 31, 1999.......................................... $ 362,600 $ -
Term loan, payable through June 2006; 9.4% interest as of
December 31, 1999.......................................... 319,425 -
Term loan, payable through June 2006; 9.8% interest as of
December 31, 1999.......................................... 295,300 -
Capital markets term loan, due August 2001; 9.2% interest as
of December 31, 1999....................................... 47,674 -
Term loan, payable through 2002; 6.9% interest as of December
31, 1998................................................... - 252,988
Term loan, payable through 2003; 7.7% interest as of December
31, 1998................................................... - 46,012
10.75% senior subordinated notes due 2006....................... 150,000 150,000
Other........................................................... 41,878 15,870
------------- -------------
Total........................................................ 1,216,877 464,870
Less current portion............................................ 45,435 51,444
------------- -------------
Total long-term debt......................................... $ 1,171,442 $ 413,426
============= =============
</TABLE>
At the closing of the SBCL acquisition on August 16, 1999, the Company
entered into a new senior secured credit facility (the "Credit Agreement"). The
Credit Agreement includes the following facilities: a $250 million six-year
revolving credit facility; a $400 million amortizing term loan payable through
June 2005; a $325 million term loan with minimal amortization until maturity in
June 2006; a $300 million term loan with minimal amortization until maturity in
June 2006; and a $50 million two-year capital markets term loan due August 2001,
which does not amortize (collectively the "Term Loans"). Up to $75 million of
the revolving credit facility may be used for letters of credit. Other than the
reduction for outstanding letters of credit, which approximated $17.3 million,
all of the revolving credit facility was available for borrowing at December 31,
1999.
Interest is based on certain published rates plus an applicable margin that
will vary depending on the financial performance of the Company. The applicable
margin will be reduced by 25 basis points after the repayment of the capital
markets term loan. At the option of the Company, the Company may elect to enter
into Libor based interest rate contracts for periods up to 180 days. Interest on
any outstanding principal amount of the Term Loans not covered under Libor based
interest rate contracts is based on the alternate base rate which is calculated
by reference to the prime rate or federal funds rate (as those terms are defined
in the Credit Agreement). Prior to the repayment of the capital markets term
loan, a commitment fee of 0.50% is payable on the unused portion of the
revolving credit facility; thereafter, the fee will range from 0.375% to 0.50%
based on the financial performance of the Company. The Credit Agreement requires
the Company to mitigate the risk of changes in interest rates associated with
its variable interest rate indebtedness through the use of interest rate swap
agreements. Under such arrangements, the Company converts a portion of its
variable rate indebtedness to fixed rates based on a notional principal amount.
The settlement dates are generally correlated to correspond to the interest
payment dates of the hedged debt. During the term of the Credit Agreement, the
notional amounts under the interest rate swap agreements, plus the principal
amount
F-19
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
outstanding of the Company's fixed interest rate indebtedness, must be at least
50% of the Company's net funded debt (as defined in the Credit Agreement). As of
December 31, 1999, the aggregate notional principal amount under interest rate
swap agreements, at a fixed interest rate of 6.1%, totaled approximately $450
million. The interest rate swap agreements mature at various dates through May
2003.
The Credit Agreement is collateralized by substantially all tangible and
intangible assets of the Company and by a guaranty from, and a pledge of all
capital stock and tangible and intangible assets of, all of the Company's
present and future wholly-owned domestic subsidiaries. The borrowings under the
Credit Agreement rank senior in priority of repayment to any subordinated
indebtedness.
On December 6, 1996, Quest Diagnostics entered into a credit agreement with
several banks providing for a $450.0 million credit facility comprised of: (i) a
$300.0 million six-year amortizing term loan, (ii) a $50.0 million seven-year
term loan with minimal amortization until the seventh year and (iii) a $100.0
million six-year revolving working capital credit facility. No amounts were
outstanding under the revolving working capital facility at December 31, 1998.
Interest was based on certain published rates plus an applicable margin which
varied depending on the financial performance of the Company. In conjunction
with the acquisition of SBCL, the Company repaid the entire amount then
outstanding under this credit agreement. The extraordinary loss recorded in the
third quarter of 1999 represented $3.6 million ($2.1 million, net of tax) of
deferred financing costs which were written off in connection with the
extinguishment of this credit agreement.
On December 16, 1996, the Company issued $150.0 million of 10.75% senior
subordinated notes due 2006 (the "Notes"). The Notes are general unsecured
obligations of the Company and are subordinated in right of payment to all
existing and future senior debt (as defined in the indenture relating to the
Notes (the "Indenture")), including all indebtedness of the Company under the
Credit Agreement. Interest is payable on June 15 and December 15. The Notes will
be redeemable, in whole or in part, at the option of the Company at any time on
or after December 15, 2001, at specified redemption prices. The Notes are
guaranteed, fully, jointly and severally, and unconditionally, on a senior
subordinated basis by substantially all of the Company's wholly-owned, domestic
subsidiaries.
The Credit Agreement and the Indenture contain various customary
affirmative and negative covenants, including, in the case of the Credit
Agreement, the maintenance of certain financial ratios and tests. The Credit
Agreement prohibits the Company from paying dividends on its common stock and
restricts the Company's ability to, among other things, incur additional
indebtedness and repurchase shares of its common stock. The Indenture restricts
the Company's ability to pay cash dividends based, primarily, on a percentage of
the Company's earnings, as defined. At December 31, 1999, the Company is limited
in its ability to make certain acquisitions and incur additional indebtedness,
other than under the revolving credit facility, due to restrictions under the
Indenture. Additionally, the Company will be required to offer to purchase the
Notes and repay amounts borrowed under the Credit Facility upon a change of
control, as defined, and in the event of certain asset sales.
Long-term debt, including capital leases, maturing in each of the years
subsequent to December 31, 2000 was as follows:
Year ending December 31
2001.............................. $ 106,939
2002.............................. 66,724
2003.............................. 104,383
2004.............................. 106,501
2005 and thereafter............... 786,895
------------
Total long-term debt........... $ 1,171,442
============
F-20
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
12. PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY
SERIES PREFERRED STOCK
Quest Diagnostics is authorized to issue up to 10 million shares of Series
Preferred Stock, par value $1.00 per share. The Company's Board of Directors has
the authority to issue such shares without stockholder approval and to determine
the designations, preferences, rights, and restrictions of such shares. Of the
authorized shares, 600,000 shares have been designated Series A Preferred Stock
and 1,000 shares have been designated Voting Cumulative Preferred Stock. No
shares have been issued, other than the Voting Cumulative Preferred Stock.
VOTING CUMULATIVE PREFERRED STOCK
At December 31, 1999 and 1998, 1,000 shares of Voting Cumulative Preferred
Stock, which have a $1.0 million aggregate liquidation preference, were issued
and outstanding. Dividends are at an annual rate of 11.75% and are payable
quarterly. The Voting Cumulative Preferred Stock is generally entitled to one
vote per share, voting together as one class with the Company's common stock.
Whenever dividends on the Voting Cumulative Preferred Stock are in arrears, no
dividends or redemptions or purchases of shares may be made with respect to any
stock ranking junior as to dividends or liquidation to the Voting Cumulative
Preferred Stock until all such amounts have been paid. The Voting Cumulative
Preferred Stock is not convertible into shares of any other class or series of
stock of the Company and will be redeemable in whole or in part, at the option
of the Company at any time on or after December 31, 2002, at specified
redemption prices. On January 1, 2022, the Company must redeem all of the then
outstanding shares of the Voting Cumulative Preferred Stock at a redemption
price equal to the liquidation preference plus any unpaid dividends. The Voting
Cumulative Preferred Stock ranks senior to the Quest Diagnostics common stock
and the Series A Preferred Stock.
PREFERRED SHARE PURCHASE RIGHTS
Each share of Quest Diagnostics common stock trades with a preferred share
purchase right, which entitles stockholders to purchase one-hundredth of a share
of Series A Preferred Stock upon the occurrence of certain events. In
conjunction with the SBCL acquisition, the Board of Directors of the Company
approved an amendment to the preferred share purchase rights. The amended rights
entitle stockholders to purchase shares of Series A Preferred Stock at a
predefined price in the event a person or group (other than SmithKline Beecham)
acquires 20% or more of the Company's outstanding common stock. The preferred
share purchase rights expire December 31, 2006.
COMMON STOCK PURCHASE PROGRAM
In 1998, the Board of Directors authorized a limited share purchase program
which permitted the Company to purchase up to $27 million of its outstanding
common stock through 1999. Cumulative purchases under the program through
December 31, 1999 totaled $14.1 million. Shares purchased under the program were
reissued in connection with certain employee benefit plans. The Company
suspended purchases of its shares when it reached a preliminary understanding of
the transaction with SmithKline Beecham on January 15, 1999.
F-21
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The components of accumulated other comprehensive income (loss) for 1999,
1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Foreign Accumulated
Currency Other
Translation Market Value Comprehensive
Adjustment Adjustment Income (Loss)
---------- ---------- -------------
<S> <C> <C> <C>
Balance, December 31, 1996....................... $ (619) $(4,210) $(4,829)
Translation adjustment........................... (551) - (551)
Market value adjustment, net of tax of $1,871.... - 2,865 2,865
------- ------- -------
Balance, December 31, 1997....................... (1,170) (1,345) (2,515)
Translation adjustment........................... (924) - (924)
Market value adjustment, net of tax of $262...... - 401 401
------- ------- -------
Balance, December 31, 1998....................... (2,094) (944) (3,038)
Translation adjustment........................... (356) - (356)
Market value adjustment, net of tax of $616...... - 944 944
------- ------- -------
Balance, December 31, 1999....................... $(2,450) $ - $(2,450)
======= ======= =======
</TABLE>
The market valuation adjustment for 1999 included holding gains, net of
taxes, of $2.8 million offset by a reclassification adjustment, net of taxes, of
$1.8 million related to the gain recognized in net income associated with the
sale of an investment during the fourth quarter of 1999.
13. STOCK OWNERSHIP AND COMPENSATION PLANS
EMPLOYEE AND NON-EMPLOYEE DIRECTORS STOCK OWNERSHIP PROGRAMS
In conjunction with the acquisition of SBCL, the Company established the
1999 Employee Equity Participation Program (the "1999 EEPP") to replace the
Company's prior plan established in 1996 (the "1996 EEPP"). The 1999 EEPP
provides for three types of awards: (a) stock options (b) stock appreciation
rights and (c) incentive stock awards. The 1999 EEPP provides for the grant to
eligible employees of either non-qualified or incentive stock options, or both,
to purchase shares of Quest Diagnostics' common stock at no less than the fair
market value on the date of grant. The stock options are subject to forfeiture
if employment terminates prior to the end of the prescribed vesting period, as
determined by the Board of Directors. The stock options expire on the date
designated by the Board of Directors but in no event more than eleven years from
date of grant. Grants of stock appreciation rights allow eligible employees to
receive a payment based on the appreciation of Quest Diagnostics' common stock
in cash, shares of Quest Diagnostics common stock or a combination thereof. The
stock appreciation rights are granted at an exercise price at no less than the
fair market value of Quest Diagnostics' common stock on the date of grant. Stock
appreciation rights expire on the date designated by the Board of Directors but
in no event more than eleven years from date of grant. No stock appreciation
rights have been granted under the 1999 EEPP. Under the incentive stock
provisions of the plan, the 1999 EEPP allows eligible employees to receive
awards of shares, or the right to receive shares, of Quest Diagnostics' common
stock, the equivalent value in cash or a combination thereof. These shares are
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 is recorded as unearned compensation. The amount of
unearned compensation is subject to adjustment based upon changes in earnings
estimates during the initial year of grant and is amortized to compensation
expense over the prescribed vesting period. Key executive, managerial and
technical employees are eligible to participate in the 1999 EEPP. The
provisions of the 1996 EEPP were similar to those outlined above for the 1999
EEPP.
F-22
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Under the 1996 EEPP, the maximum number of shares of Quest Diagnostics'
common stock that may be optioned or granted was 3 million, excluding the
Substitute Options discussed below. The 1999 EEPP increased the maximum number
of shares of Quest Diagnostics common stock that may be optioned or granted by 6
million shares. Any remaining shares under the 1996 EEPP are available for
issuance under the 1999 EEPP.
Coincident with the Spin-Off Distribution, certain Corning options
outstanding and held by Company employees which were granted in 1995 and 1996
were canceled. On January 1, 1997, the Company issued, in substitution for
two-thirds of the canceled options, approximately 725 thousand options to
purchase its common stock under the 1996 EEPP (the "Substitute Options"). The
Substitute Options become exercisable in installments from four to five years
from their original grant dates in 1995 and 1996. The adjusted Corning stock
options and the Substitute Options have the same vesting provisions, option
periods, and other terms and conditions as the awards they replaced.
Additionally, the adjusted Corning stock options and the Substitute Options have
the same ratio of the exercise price per share to the market value per share,
and the same aggregate difference between market value and exercise price as the
stock options they replaced.
In 1998, the Company established the Quest Diagnostics Incorporated Stock
Option Plan for Non-employee Directors (the "Director Option Plan"). The
Director Option Plan provides for the grant to non-employee directors of
non-qualified stock options to purchase shares of Quest Diagnostics' common
stock at no less than fair market value on the date of grant. The maximum number
of shares that may be issued under the Director Option Plan is 500 thousand. The
stock options expire ten years from date of grant and generally vest over three
years. During 1999 and 1998, grants under the Director Option Plan totaled 69
thousand shares and 52 thousand shares, respectively.
Transactions under the stock option plans were as follows (options in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Options outstanding, beginning of year ............. 2,950 1,896 --
Substitute Options granted ......................... -- -- 725
Options granted .................................... 3,359 1,336 1,209
Options exercised .................................. (294) (27) --
Options terminated ................................. (274) (255) (38)
--------- --------- ---------
Options outstanding, end of year ................... 5,741 2,950 1,896
========= ========= =========
Exercisable ........................................ 2,222 405 --
Weighted average exercise price:
Substitute Options granted .................... -- -- $ 10.56
Options granted ............................... $ 26.37 $ 16.39 16.48
Options exercised ............................. 15.98 16.36 --
Options terminated ............................ 25.77 14.65 16.40
Options outstanding, end of year .............. 21.15 15.14 14.22
Exercisable, end of year ...................... 15.61 16.50 --
Weighted average fair value of options at grant date $ 12.79 $ 7.31 $ 7.58
</TABLE>
The increase in options exercisable during 1999 was primarily related to
the completion of the SBCL acquisition which accelerated the vesting of certain
option grants made in previous years in accordance with the original terms of
such option grants.
F-23
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The following relates to options outstanding at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------------ ---------------------------------
Weighted Average
Range of Shares Remaining Weighted Average Shares Weighted Average
Exercise Price (in thousands) Contractual Life Exercise Price (in thousands) Exercise Price
-------------- -------------- ---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$10.51 to $11.33 628 5.9 $10.57 301 $10.57
$15.88 to $19.06 2,009 7.7 $16.36 1,852 $16.25
$20.31 to $25.84 86 8.5 $20.51 69 $20.53
$26.16 to $31.31 3,018 9.6 $26.56 - $26.34
</TABLE>
The following summarizes the activity relative to incentive stock awards
granted in 1999, 1998 and 1997 (shares in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Incentive shares, beginning of year ......................... 370 422 --
Incentive shares granted .................................... 555 359 436
Incentive shares vested ..................................... (348) (33) (11)
Incentive shares forfeited and canceled ..................... (9) (378) (3)
---- ---- ----
Incentive shares, end of year ............................... 568 370 422
==== ==== ====
Weighted average fair value of incentive shares at grant date $23.90 $16.06 $16.14
</TABLE>
The balance of the incentive stock awards at December 31, 1999 are subject
to forfeiture if employment terminates prior to the end of the prescribed
vesting period.
EMPLOYEE STOCK PURCHASE PLAN
Under the Company's Employee Stock Purchase Plan ("ESPP"), substantially
all employees can elect to have up to 10% of their annual wages withheld to
purchase Quest Diagnostics' common stock. The purchase price of the stock is 85%
of the lower of its beginning-of-quarter or end-of-quarter market price. Under
the ESPP, the maximum number of shares of Quest Diagnostics' common stock which
may be purchased by eligible employees is 2 million. Approximately 206, 232 and
200 thousand shares of common stock were purchased by eligible employees in
1999, 1998 and 1997, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
Prior to 1999, the Company maintained its Employee Stock Ownership Plan
("ESOP") to account for certain shares of Quest Diagnostics common stock which
had been issued for the account of all active regular employees of the Company
as of December 31, 1996. Effective with the closing of the SBCL acquisition, the
Company modified certain provisions of the ESOP to provide an additional benefit
to employees through ownership of the Company's common stock. Substantially all
of the Company's employees are eligible to participate in the ESOP. The
Company's contributions to the ESOP trust are based on 2% of eligible employee
compensation for those employees who are actively employed or on a leave of
absence on December 31 of each year. Company contributions to the trust may be
in the form of shares of Quest Diagnostics common stock, cash or any combination
of the above. The Company's contributions to this plan aggregated $7.5 million
for 1999. No contributions were made to the plan in 1998 or 1997.
F-24
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
STOCK-BASED COMPENSATION
Quest Diagnostics has adopted the disclosure-only provisions of SFAS 123,
but follows APB 25 and related interpretations to account for its stock-based
compensation plans. Stock-based compensation expense recorded in accordance with
APB 25 was $26.5 million, $2.1 million and $1.9 million in 1999, 1998 and 1997,
respectively.
If the Company had elected to recognize compensation cost based on the fair
value at the grant dates for awards under its stock-based compensation plans,
consistent with the method prescribed by SFAS 123, the Company's net income
(loss) would have been $(11.5) million, $21.4 million and $(26.1) million for
1999, 1998 and 1997, respectively. Basic net income (loss) per common share
would have been $(0.33) per common share, $0.72 per common share and $(0.90) per
common share for 1999, 1998 and 1997, respectively. Diluted net income (loss)
per common share would have been $(0.33) per common share, $0.71 per common
share and $(0.90) per common share for 1999, 1998 and 1997, respectively.
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
Adjusted
Corning Substitute
1999 1998 1997 OPTIONS OPTIONS
---- ---- ---- ------- ----------
<S> <C> <C> <C> <C> <C>
Dividend yield..................... 0.0% 0.0% 0.0% 2.3% 0.0%
Risk-free interest rate............ 5.8% 5.3% 6.3% 6.5% 5.5%
Expected volatility................ 46.8% 42.0% 55.0% 24.5% 38.0%
Expected holding period, in years.. 5 5 5 7 7
</TABLE>
14. EMPLOYEE RETIREMENT PLANS
DEFINED CONTRIBUTION PLAN
The Company maintains a defined contribution plan covering substantially
all of its employees. The Company's expense for its contributions to this plan
aggregated $18.3 million, $15.5 million and $16.9 million for 1999, 1998 and
1997, respectively.
DEFINED BENEFIT PLAN
An acquired entity had a defined benefit pension plan, which in 1990 was
frozen as to the further accrual of benefits. At December 31, 1997, the
estimated settlement obligation was $26.6 million and the fair value of the plan
assets was $24.5 million. The unfunded settlement obligation was recorded at
December 31, 1997. During 1998, the participants received lump-sum cash payments
or annuity contracts in settlement of their rights to receive pension benefits.
15. RELATED PARTY TRANSACTIONS
As part of the SBCL acquisition agreements, SmithKline Beecham and Quest
Diagnostics entered into the following agreements: a long term contract under
which Quest Diagnostics is the primary provider of testing to support SmithKline
Beecham's clinical trials testing requirements worldwide (the "Clinical Trials
Agreement"); data access agreements under which Quest Diagnostics granted
SmithKline Beecham and certain affiliated companies certain non-exclusive rights
and access to use Quest Diagnostics' proprietary clinical laboratory information
database (the "Data Access Agreements"); an arrangement in which Quest
Diagnostics will receive a minority interest in a company that SmithKline
Beecham expects to form to sell health care information products and services
through various channels, including the Internet; and an agreement under which
SmithKline Beecham agreed to provide, through December 31, 2000, various
F-25
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
administrative services that it had previously provided to SBCL prior to its
acquisition by Quest Diagnostics (the "Transitional Services Agreement").
Significant transactions with SmithKline Beecham in addition to the
acquisition of SBCL during 1999 were as follows:
1999
Clinical trials testing revenues....... $ 10,261
Transitional services expense.......... 4,577
In addition, under the SBCL acquisition agreements, SmithKline Beecham has
agreed to indemnify Quest Diagnostics, on an after tax basis, against certain
matters primarily related to taxes and billing and professional liability claims
(see Note 16).
At December 31, 1999, the amount due from SmithKline Beecham totaled $46.0
million; $18.0 million was classified in prepaid expenses and other current
assets; and $28.0 million was classified in other assets.
At December 31, 1999 and 1998, the amount due from Corning, classified in
prepaid expenses and other current assets, was $14.0 million and $16.0 million,
respectively. In addition to cash received from Corning, the receivable from
Corning was (decreased) increased in 1999, 1998 and 1997 by $(2.0) million,
$(0.7) million and $9.5 million, respectively, and recorded through an
adjustment to additional paid-in capital, based on management's best estimate of
amounts which are probable of being received from Corning to satisfy the
remaining indemnified government claims (see Note 16).
16. COMMITMENTS AND CONTINGENCIES
Minimum rental commitments under noncancelable operating leases,
primarily real estate, in effect at December 31, 1999 are as follows:
Year ending December 31
2000...................................... $ 72,154
2001...................................... 59,382
2002...................................... 43,366
2003...................................... 27,545
2004...................................... 20,759
2005 and thereafter....................... 71,633
-----------
Minimum lease payments.................... 294,839
Noncancelable sub-lease income............ (40,308)
-----------
Net minimum lease payments................ $ 254,531
===========
Operating lease rental expense for 1999, 1998 and 1997 aggregated $59.1
million, $46.3 million and $47.9 million, respectively.
The Company is substantially self-insured for all casualty losses and
maintains excess coverage primarily on a claims made basis. The basis for the
insurance reserve at December 31, 1999 and 1998 is the actuarially determined
projected losses for each program (limited by its self-insured retention) based
upon the Company's loss experience.
F-26
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
At December 31, 1999 and 1998, the Company has provided financial
guarantees aggregating approximately $3 million and $8 million, respectively,
primarily in support of outstanding debt of affiliated companies. The guarantees
have terms ranging through 2004.
The Company has entered into several settlement agreements with various
governmental and private payers during recent years relating 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. Quest Diagnostics was added to the complaint by the plaintiffs in
August 1999. The complaint asserts claims relating to private reimbursement of
billings that are similar to those that were part of a prior government
settlement.
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 $42.0 million. The 50% share will be limited to a total amount of $25.0
million and will be reduced to take into account any deductions or tax benefits
realized by Quest Diagnostics. At December 31, 1999 and 1998, the receivable
from Corning, which was classified in prepaid expenses and other current assets
totaled $14.0 million and $16.0 million, respectively. The receivable from
Corning represented 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.
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. In August 1998, the
Company entered into a settlement agreement with the Office of Inspector General
of the Department of Health and Human Services for $15.0 million related to
overcharges for medically unnecessary testing for end stage renal dialysis
patients. The settlements do not constitute an admission with respect to any
issue arising from these actions. These settlements were covered by the
indemnification from Corning discussed above and were fully reserved for.
Similar to Quest Diagnostics, SBCL has entered into settlement agreements
with various governmental agencies and private payers primarily relating to its
prior billing and marketing practices. Effective in 1997, SBCL and the U.S.
government and various states reached a settlement with respect to the
government's civil and administrative claims. SBCL is also responding to claims
from private payers relating to billing and marketing issues similar to those
that were the subject of the settlement with the government. The claims include
ten purported class actions filed in various jurisdictions in the United States
and two non-class action complaints by a number of insurance companies. Nine of
the purported class actions have been consolidated into one complaint which has
been consolidated with one of the insurers' suits, for pre-trial proceedings.
SmithKline Beecham has agreed to indemnify Quest Diagnostics, on an after
tax basis, against monetary payments for governmental claims or investigations,
relating to the billing practices of SmithKline Beecham and its affiliates, that
have been settled before or are pending as of the closing date of the SBCL
acquisition. SmithKline Beecham has also agreed to indemnify Quest Diagnostics,
on an after tax basis, against monetary
F-27
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
payments to private payers, relating to or arising out of these governmental
claims. The indemnification with respect to governmental claims is for 100% of
those claims. SmithKline Beecham will indemnify Quest Diagnostics, in respect of
private claims for: 100% of those claims, up to an aggregate amount of $80.0
million; 50% of those claims to the extent the aggregate amount exceeds $80.0
million but is less than $130.0 million; and 100% of such claims to the extent
the aggregate amount exceeds $130.0 million. The indemnification also covers 80%
of out-of-pocket costs and expenses relating to investigations of the claims
indemnified against by SmithKline Beecham. In addition, SmithKline Beecham has
agreed to indemnify the Company against all monetary payments relating to
professional liability claims of SBCL for services provided prior to the closing
of the SBCL acquisition.
On March 22, 1999, SBCL learned that an SBCL employee at a patient service
center in Palo Alto, California, had at times reused certain needles when
drawing blood from patients. A number of civil actions, including some
purporting to be class actions have been filed against SBCL in federal and state
courts in California on behalf of patients who may have been affected by the
phlebotomist's reuse of needles or other allegedly improper practices.
SmithKline Beecham has agreed to indemnify Quest Diagnostics for the
out-of-pocket costs of the counseling and testing, for liabilities arising out
of the civil actions and for other losses arising out of the conduct of the
phlebotomist, other than consequential damages.
Of the total amount due from SmithKline Beecham at December 31, 1999, $43.6
million related to the indemnified billing, professional liability and other
claims discussed above, and represented management's best estimate of the
amounts which are probable of being received from SmithKline Beecham to satisfy
the indemnified claims on an after-tax basis. The estimated reserves and the
related amount due from SmithKline Beecham are subject to change as additional
information regarding the outstanding claims is gathered and evaluated.
At December 31, 1999, recorded reserves, relating primarily to billing
claims including those indemnified by Corning and SmithKline Beecham,
approximated $83.3 million, including $33.8 million in other long-term
liabilities. The increase in reserves was related to the estimated reserves
recorded by the Company in conjunction with the SBCL acquisition which are
indemnified by SmithKline Beecham as described above. 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 matters
will have a material adverse effect on its overall financial condition.
17. SUBSEQUENT EVENTS
On January 27, 2000, the Company issued a press release which included,
among other matters, summarized financial information as of and for the quarter
and year ended December 31, 1999. The summarized financial information reflected
a preliminary allocation of the purchase price of the SBCL acquisition including
an estimated liability related to the termination of a supplier contract. Since
the date of the press release above, the Company has concluded negotiations with
the supplier resulting in a liability in an amount less than what had previously
been estimated. Although the effect of the change in estimate was not material,
the accompanying consolidated financial statements reflect the revised
preliminary purchase price allocation, incorporating the impact of the concluded
negotiations.
In March 2000, the Company funded its 1999 contributions to its ESOP by
contributing approximately 221 thousand shares of Quest Diagnostics common stock
to the ESOP trust.
F-28
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
18. SUMMARIZED FINANCIAL INFORMATION
The Notes described in Note 11 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
financial condition 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.
Investments in subsidiaries are accounted for by the parent on the equity
method for purposes of the supplemental consolidating presentation. Earnings
(losses) of subsidiaries are therefore reflected in the parent's investment
accounts and earnings. The principal elimination entries eliminate investments
in subsidiaries and intercompany balances and transactions. During 1999, the
Company acquired SBCL (see Note 3) which was included in the following condensed
consolidating financial data as a Subsidiary Guarantor. During 1998 and 1997,
two joint ventures and one joint venture, respectively, were formed and are
non-guarantor subsidiaries.
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1999
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ - $ 18,864 $ 8,420 $ - $ 27,284
Accounts receivable, net.................... 68,941 455,503 14,812 - 539,256
Other current assets........................ 113,539 185,438 7,144 - 306,121
----------- ----------- ----------- ---------- -----------
Total current assets..................... 182,480 659,805 30,376 - 872,661
Property, plant and equipment, net.......... 111,411 302,268 14,299 - 427,978
Intangible assets, net...................... 161,438 1,274,202 242 - 1,435,882
Intercompany receivable (payable)........... (43,291) 56,798 (13,507) - -
Investment in subsidiaries.................. 853,865 - - (853,865) -
Other assets................................ 11,850 106,952 23,158 - 141,960
----------- ----------- ----------- ---------- -----------
Total assets............................. $ 1,277,753 $ 2,400,025 $ 54,568 $ (853,865) $ 2,878,481
=========== =========== =========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses....... $ 192,679 $ 449,372 $ 13,758 $ - $ 655,809
Current portion of long-term debt........... 4,635 40,369 431 - 45,435
----------- ----------- ----------- ---------- -----------
Total current liabilities................ 197,314 489,741 14,189 - 701,244
Long-term debt.............................. 176,601 991,396 3,445 - 1,171,442
Other liabilities........................... 40,776 92,870 9,087 - 142,733
Preferred stock............................. 1,000 - - - 1,000
Common stockholders' equity................. 862,062 826,018 27,847 (853,865) 862,062
----------- ----------- ----------- ---------- -----------
Total liabilities and stockholders'
equity ................................ $ 1,277,753 $ 2,400,025 $ 54,568 $ (853,865) $ 2,878,481
=========== =========== =========== ========== ===========
</TABLE>
F-29
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1998
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
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
=========== =========== =========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
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>
F-30
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues................................ $ 636,778 $ 1,475,064 $ 93,401 $ - $ 2,205,243
Costs and expenses:
Cost of services......................... 407,908 915,438 56,643 - 1,379,989
Selling, general and administrative...... 232,558 380,237 30,645 - 643,440
Interest expense, net.................... 9,508 51,456 486 - 61,450
Amortization of intangible assets........ 7,307 22,103 374 - 29,784
Provisions for restructuring and other
special charges........................ 62,496 8,137 2,752 - 73,385
Royalty (income) expense................. (71,678) 71,678 - - -
Other, net............................... (3,245) (230) 6,286 - 2,811
----------- ----------- ----------- ---------- -----------
Total.................................... 644,854 1,448,819 97,186 - 2,190,859
----------- ----------- ----------- ---------- -----------
Income (loss) before taxes and extraordinary (8,076) 26,245 (3,785) - 14,384
loss........................................
Income tax expense (benefit)................ (4,524) 18,461 1,721 - 15,658
----------- ----------- ----------- ---------- -----------
Income (loss) before equity earnings and
extraordinary loss....................... (3,552) 7,784 (5,506) - (1,274)
Equity earnings from subsidiaries........... 2,278 - - (2,278) -
----------- ----------- ----------- ---------- -----------
Income (loss) before extraordinary loss..... (1,274) 7,784 (5,506) (2,278) (1,274)
Extraordinary loss, net of taxes............ (2,139) - - - (2,139)
----------- ----------- ----------- ---------- -----------
Net income (loss) ....................... $ (3,413) $ 7,784 $ (5,506) $ (2,278) $ (3,413)
=========== =========== =========== ========== ===========
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues................................ $ 594,544 $ 828,119 $ 35,944 $ - $ 1,458,607
Costs and expenses:
Cost of services......................... 365,065 510,945 20,783 - 896,793
Selling, general and administrative...... 239,329 196,984 9,572 - 445,885
Interest expense, net.................... 8,608 24,190 605 - 33,403
Amortization of intangible assets........ 7,538 13,766 393 - 21,697
Royalty (income) expense................. (73,138) 73,138 - - -
Other, net............................... (219) 6 7,181 - 6,968
----------- ----------- ----------- ---------- -----------
Total.................................... 547,183 819,029 38,534 - 1,404,746
----------- ----------- ----------- ---------- -----------
Income (loss) before taxes.................. 47,361 9,090 (2,590) - 53,861
Income tax expense (benefit)................ 18,961 9,248 (1,233) - 26,976
Equity loss from subsidiaries............... (1,515) - - 1,515 -
----------- ----------- ----------- ---------- -----------
Net income (loss)........................ $ 26,885 $ (158) $ (1,357) $ 1,515 $ 26,885
=========== =========== =========== ========== ===========
</TABLE>
F-31
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net revenues................................ $ 658,383 $ 847,348 $ 22,964 $ - $ 1,528,695
Costs and expenses:
Cost of services......................... 403,042 547,626 12,267 - 962,935
Selling, general and administrative...... 267,170 190,065 9,817 - 467,052
Interest expense, net.................... 15,514 24,891 591 - 40,996
Amortization of intangible assets........ 8,402 15,375 174 - 23,951
Provisions for restructuring and other
special charges........................ 42,986 5,702 - - 48,688
Royalty (income) expense................. (71,073) 71,073 - - -
Other, net............................... 1,214 221 2,696 - 4,131
----------- ----------- ----------- ---------- -----------
Total.................................... 667,255 854,953 25,545 - 1,547,753
----------- ----------- ----------- ---------- -----------
Loss before taxes........................... (8,872) (7,605) (2,581) - (19,058)
Income tax expense (benefit)................ 7,006 (3,857) 53 - 3,202
Equity loss from subsidiaries............... (6,382) - - 6,382 -
----------- ----------- ----------- ---------- -----------
Net loss................................. $ (22,260) $ (3,748) $ (2,634) $ 6,382 $ (22,260)
=========== =========== =========== ========== ===========
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1999
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net income (loss)........................... $ (3,413) $ 7,784 $ (5,506) $ (2,278) $ (3,413)
Extraordinary loss, net of taxes............ 2,139 - - - 2,139
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities
Depreciation and amortization............ 32,083 55,020 3,732 - 90,835
Provision for doubtful accounts ......... 36,121 101,762 4,450 - 142,333
Provisions for restructuring and other
special charges........................ 62,496 8,137 2,752 73,385
Other, net............................... (19,389) (8,954) 3,737 2,278 (22,328)
Changes in operating assets and
liabilities............................ (48,967) 11,821 3,730 - (33,416)
----------- ----------- ----------- ---------- -----------
Net cash provided by (used in) operating
activities.................................. 61,070 175,570 12,895 - 249,535
Net cash used in investing activities....... (1,068,476) (30,099) (9,415) - (1,107,990)
Net cash provided by (used in) financing
activities................................ 816,800 (134,813) 844 - 682,831
----------- ----------- ----------- ---------- -----------
Net change in cash and cash equivalents..... (190,606) 10,658 4,324 - (175,624)
Cash and cash equivalents, beginning of year 190,606 8,206 4,096 - 202,908
----------- ----------- ----------- ---------- -----------
Cash and cash equivalents, end of year...... $ - $ 18,864 $ 8,420 $ - $ 27,284
=========== =========== =========== ========== ===========
</TABLE>
F-32
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net income (loss)........................... $ 26,885 $ (158) $ (1,357) $ 1,515 $ 26,885
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities
Depreciation and amortization............ 31,749 35,339 1,757 - 68,845
Provision for doubtful accounts ......... 48,246 39,935 1,247 - 89,428
Other, net............................... 29,691 (7,390) 2,536 (1,515) 23,322
Changes in operating assets and
liabilities............................ (9,672) (50,640) (6,786) - (67,098)
----------- ----------- ----------- ---------- -----------
Net cash provided by (used in) operating
activities.................................. 126,899 17,086 (2,603) - 141,382
Net cash used in investing activities....... (20,194) (17,124) (2,402) - (39,720)
Net cash provided by (used in) financing
activities................................ (39,151) (27,283) 6,019 - (60,415)
----------- ----------- ----------- ---------- -----------
Net change in cash and cash equivalents..... 67,554 (27,321) 1,014 - 41,247
Cash and cash equivalents, beginning of year 123,052 35,527 3,082 - 161,661
----------- ----------- ----------- ---------- -----------
Cash and cash equivalents, end of year...... $ 190,606 $ 8,206 $ 4,096 $ - $ 202,908
=========== =========== =========== ========== ===========
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
<CAPTION>
Subsidiary Non-Guarantor
Parent Guarantors Subsidiaries Eliminations Consolidated
------ ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net loss.................................... $ (22,260) $ (3,748) $ (2,634) $ 6,382 $ (22,260)
Adjustments to reconcile net loss to net
cash provided by operating activities
Depreciation and amortization............ 33,313 41,953 1,131 - 76,397
Provision for doubtful accounts ......... 69,368 48,211 644 - 118,223
Provisions for restructuring and other
special charges........................ 42,986 5,702 - - 48,688
Other, net............................... 3,264 (2,927) 4,690 - 5,027
Changes in operating assets and
liabilities............................ (14,848) (33,372) (2,292) 704 (49,808)
----------- ----------- ----------- ---------- -----------
Net cash provided by operating activities... 111,823 55,819 1,539 7,086 176,267
Net cash used in investing activities....... (3,486) (24,422) (107) (7,086) (35,101)
Net cash used in financing activities....... (12,260) (8,752) (453) - (21,465)
----------- ----------- ----------- ---------- -----------
Net change in cash and cash equivalents..... 96,077 22,645 979 - 119,701
Cash and cash equivalents, beginning of year 26,975 12,882 2,103 - 41,960
----------- ----------- ----------- ---------- -----------
Cash and cash equivalents, end of year...... $ 123,052 $ 35,527 $ 3,082 $ - $ 161,661
=========== =========== =========== ========== ===========
</TABLE>
F-33
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTERLY OPERATING RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- ----
<S> <C> <C> <C> <C> <C>
1999(a)
Net revenues........................... $381,841 $394,034 $614,842 $814,526 $2,205,243
Gross profit........................... 144,433 157,963 228,752 294,106 825,254
Income (loss) before taxes and
extraordinary loss.................. 14,078 24,507 (5,559)(b) (18,642)(b) 14,384
Extraordinary loss..................... - - (2,139)(c) - (2,139)
Net income (loss)...................... 7,433 13,087 (9,396) (14,537) (3,413)
Basic net income (loss) per common share:
Net income before extraordinary loss 0.25 0.44 (0.20) (0.33) (0.04)
Net income.......................... 0.25 0.44 (0.26) (0.33) (0.10)
Diluted net income (loss) per common
share: 0.24 0.43 (0.20) (0.33) (0.04)
Net income before extraordinary loss
Net income.......................... 0.24 0.43 (0.26) (0.33) (0.10)
1998
Net revenues........................... $367,875 $366,739 $360,713 $363,280 $1,458,607
Gross profit........................... 141,503 139,552 140,610 140,149 561,814
Income before taxes.................... 13,670 18,259 12,043 9,889 53,861
Net income............................. 6,631 8,854 6,061 5,339 26,885
Basic net income per common share...... 0.22 0.30 0.20 0.18 0.90
Diluted net income per common share.... 0.22 0.29 0.20 0.18 0.89
</TABLE>
During the fourth quarter of 1999, the Company reclassified certain expense
items, primarily related to a portion of occupancy costs and professional
liability insurance expense, from selling, general and administrative expenses
to cost of services, to better reflect the cost of performing testing. The
quarterly financial information for both 1999 and 1998 has been reclassified for
comparative purposes to conform with the 1999 presentation.
(a) On August 16, 1999, Quest Diagnostics completed the acquisition of SBCL.
The quarterly operating results include the results of operations of SBCL
subsequent to the closing of the acquisition (see Note 3).
(b) During the third and fourth quarters of 1999, the Company recorded
provisions for restructuring and other special charges totaling $30.3
million ($18.2 million, net of tax) and $43.1 million ($26.1 million, net
of tax), respectively, principally incurred in connection with the
acquisition and planned integration of SBCL (see Note 7).
(c) In conjunction with the acquisition of SBCL, the Company repaid the entire
amount outstanding under its then existing credit agreement. The
extraordinary loss recorded in the third quarter of 1999 represented $3.6
million ($2.1 million, net of tax) of deferred financing costs which were
written off in connection with the extinguishment of the credit agreement
(see Note 11).
F-34
<PAGE>
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
SCHEDULE II - VALUATION ACCOUNTS AND RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
Balance at Provision for Net Deductions Balance at
1-1-99 Doubtful Accounts and Other 12-31-99
------ ----------------- --------- --------
<S> <C> <C> <C> <C>
Year ended December 31, 1999
Doubtful accounts and allowances........ $ 70,701 $ 142,333 $ 91,484 $ 121,550
Balance at Provision for Net Deductions Balance at
1-1-98 Doubtful Accounts and Other 12-31-98
------ ----------------- --------- --------
Year ended December 31, 1998
Doubtful accounts and allowances........ 89,870 89,428 108,597 70,701
Balance at Provision for Net Deductions Balance at
1-1-97 Doubtful Accounts and Other 12-31-97
------ ----------------- --------- --------
Year ended December 31, 1997
Doubtful accounts and allowances........ 115,018 118,223 143,371 89,870
</TABLE>
F-35
<PAGE>
Exhibit 4.3
AMENDMENT NO. 2 TO RIGHTS AGREEMENT
THIS AMENDMENT (this "Amendment") effective as of the 31st day of December,
1999, amends and modifies, at the Company's direction, a certain Rights
Agreement dated as of December 31, 1996 (the "Rights Agreement") between Quest
Diagnostics Incorporated (the "Company") and Harris Trust and Savings Bank, as
Rights Agent. All terms defined in the Rights Agreement shall have the same
meanings in this Amendment unless otherwise defined.
WHEREAS, on December 8, 1999, the Board of Directors of the Company adopted
a resolution approving the amendment of the Rights Agreement to increase the
exercise price of a Right under Section 7(b) of the Right Agreement from $35 to
$125.
NOW, THEREFORE, in consideration of the premises, the parties hereto agree
as follows:
1. All terms not defined herein have the meanings set forth in the Rights
Agreement.
2. Section 7(b) of the Rights Agreement is hereby deleted and replaced as
follows:
(b) The Purchase Price for each one one-hundredth of a Preferred
Share purchasable pursuant to the exercise of a Right shall be
One Hundred Twenty-five dollars ($125.00), and shall be subject
to adjustment from time to time as provided in Section 11 or 13
hereof and shall be payable in lawful money of the United States
of America in accordance with paragraph (c) below.
3. This Amendment shall be deemed to be a contract made under the laws of
the State of Delaware and for all purposes shall be governed by and construed in
accordance with the laws of such State applicable to contracts to be made and
performed entirely within such State.
4. Except as expressly amended hereby, all the terms and conditions of the
Rights Agreement shall remain in full force and effect.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date
set forth above.
QUEST DIAGNOSTICS INCORPORATED HARRIS TRUST AND SAVINGS BANK,
Rights Agent
By: By:
----------------------------- -----------------------------
Name: Leo C. Farrenkopf, Jr. Name: Deborah Hokinson
Title: Vice President and Secretary Title: Assistant Vice President
<PAGE>
Exhibit 10.17
AMENDMENT NO. 1
AMENDMENT NO. 1 ("AMENDMENT NO. 1") dated as of December 17,
1999 to the Credit Agreement dated as of August 16, 1999 (as amended, amended
and restated or otherwise modified and supplemented and in effect from time to
time, the "CREDIT AGREEMENT") among Quest Diagnostics Incorporated (the
"BORROWER"); the guarantors party thereto (the "GUARANTORS"); certain lenders
(the "LENDERS"); Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MERRILL LYNCH"), as joint lead arranger; Banc of America
Securities LLC, as joint lead arranger (in such capacity, together with its
successors and Merrill Lynch together with its successors in its capacity as
joint lead arranger, the "JOINT LEAD ARRANGERS"); Bank of America, N.A., as
administrative agent ("ADMINISTRATIVE AGENT"); Wachovia Bank, N.A. ("WACHOVIA"),
as co-documentation agent; The Bank of New York, as co-documentation agent (in
such capacity, together with Wachovia as co-documentation agent, the
"CO-DOCUMENTATION AGENTS"); and Merrill Lynch & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated, as syndication agent (in such capacity, together
with its successors in such capacity, the "SYNDICATION AGENT"). Capitalized
terms not otherwise defined in this Amendment No. 1 have the same meaning
assigned to such terms in the Credit Agreement.
W I T N E S S E T H :
WHEREAS, pursuant to Section 12.04 of the Credit Agreement,
the Obligors and the Majority Lenders hereby agree to amend or waive certain
provisions of the Credit Agreement as set forth herein;
NOW, THEREFORE, in consideration of the foregoing, and for
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto hereby agree as follows:
SECTION ONE - AMENDMENT. The Lenders and Agents amend,
effective as of the date hereof and subject to the satisfaction of the
conditions in Section Two hereof the following:
<PAGE>
-2-
(a) Section 9.08(A)(c) is amended by inserting "(i)" after
"Indebtedness and Contingent Obligations of" at the beginning of this subsection
and by adding the following immediately after the end of this subsection before
the semicolon:
"and (ii) any Company to any Receivables Co. in connection
with any Permitted Receivables Transaction; PROVIDED, HOWEVER,
that such Indebtedness and Contingent Obligations shall be
subordinated to the Obligations and on terms and conditions
acceptable to Joint Lead Arrangers"
(b) Section 9.08(A)(i) is amended by adding the following
immediately prior to the proviso thereto:
"(and, notwithstanding any provision of any Security Document
to the contrary, any Indebtedness incurred under this Section
9.08(A)(i)(ii) need not be pledged to the Creditors nor do the
Creditors have any security interest therein pursuant to the
Credit Documents)"
(c) Section 9.21 is amended by adding the following at the end
thereof as a new paragraph:
"Notwithstanding any provision to the contrary, this Section
9.21 does not apply to any Indebtedness incurred pursuant to
Section 9.08(A)(c) or Section 9.08(A)(i)(ii)"
SECTION TWO - CONDITIONS TO EFFECTIVENESS. This Amendment No.
1 shall become effective as of the date first above written when, and only when,
Administrative Agent shall have received counterparts of this Amendment No. 1
executed by each Obligor and the Majority Lenders or, as to any of the Lenders,
advice satisfactory to Administrative Agent that such Lender has executed this
Amendment No. 1.
SECTION THREE - REPRESENTATIONS AND WARRANTIES. In order to
induce the Lenders and Agents to enter into this
<PAGE>
-3-
Amendment No. 1, each Obligor represents and warrants to each of the Lenders and
Agents that after giving effect to this Amendment No. 1, (i) no Default or Event
of Default has occurred and is continuing; and (ii) all of the representations
and warranties of Borrower and the other Obligors in the Credit Agreement, after
giving effect to this Amendment No. 1, are true and complete in all material
respects on and as of the date hereof as if made on the date hereof (or, if any
such representation or warranty is expressly stated to have been made as of a
specific date, as of such specific date).
SECTION FOUR - REFERENCE TO AND EFFECT ON THE CREDIT AGREEMENT
AND THE SECURITY AGREEMENT. On and after the effectiveness of this Amendment No.
1, each reference in the Credit Agreement or the Security Agreement to "this
Agreement", "hereunder", "hereof" or words of like import referring to the
Credit Agreement or the Security Agreement, respectively, and each reference in
each of the other Credit Documents to "the Credit Agreement", "the Security
Agreement", "thereunder", "thereof" or words of like import referring to the
Credit Agreement or the Security Agreement, shall mean and be a reference to the
Credit Agreement or the Security Agreement, respectively, as amended by this
Amendment No. 1. The Credit Agreement, the Security Agreement, and each of the
other Credit Documents, as specifically amended by this Amendment No. 1, are and
shall continue to be in full force and effect and are hereby in all respects
ratified and confirmed. Without limiting the generality of the foregoing, the
Security Documents and all of the Collateral described therein do and shall
continue to secure the payment of all Obligations of the Obligors under the
Credit Documents, in each case as amended by this Amendment No. 1. The
execution, delivery and effectiveness of this Amendment No. 1 shall not, except
as expressly provided herein, operate as a waiver of any right, power or remedy
of any Lender or any Agent under any of the Credit Documents, nor constitute a
waiver of any provision of any of the Credit Documents.
SECTION FIVE - COSTS, EXPENSES AND TAXES. The Obligors agree
to pay all reasonable costs and expenses of Administrative Agent in connection
with the preparation, execution and delivery of this Amendment No. 1 and the
other instruments and documents to be delivered hereunder, if any (including,
without limitation, the reasonable fees and expenses of Cahill Gordon & Reindel)
in accordance with the terms of Section 12.03 of the Credit Agreement.
<PAGE>
-4-
SECTION SIX - EXECUTION IN COUNTERPARTS. This Amendment No. 1
may be executed in any number of counterparts and by different parties hereto in
separate counterparts, each of which when so executed shall be deemed to be an
original and all of which taken together shall constitute but one and the same
agreement. Delivery of an executed counterpart of a signature page to this
Amendment No. 1 by telecopier shall be effective as delivery of a manually
executed counterpart of this Amendment No. 1.
SECTION SEVEN - GOVERNING LAW. This Amendment No. 1 shall be
governed by, and construed in accordance with, the laws of the State of New York
(without giving effect to any provisions thereof relating to conflicts of law).
[Remainder of Page Intentionally Left Blank]
<PAGE>
S-1
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment No. 1 to be executed by their respective officers thereunto duly
authorized, as of the date first above written.
QUEST DIAGNOSTICS INCORPORATED
By:
---------------------------------
Name:
Title:
GUARANTORS:
SBCL, Inc. (DE)
SmithKline Beecham Clinical
Laboratories, Inc. (DE)
Quest Diagnostics Incorporated (CA)
Quest Holdings Incorporated (MD)
Quest Diagnostics Incorporated (MD)
Quest Holdings Incorporated (MI)
Quest Diagnostics LLC (IL)
Quest Diagnostics Incorporated (MI)
Quest Diagnostics
Incorporated (CT)
Quest Diagnostics Incorporated (MA)
Quest Diagnostics of Pennsylvania Inc.
(DE)
Quest Diagnostics Incorporated (OH)
MetWest Inc. (DE)
Nichols Institute Diagnostics (CA)
DPD Holdings, Inc. (DE)
Diagnostics Reference Services Inc.
(MD)
Laboratory Holding Incorporated (MA)
Quest MRL Inc. (DE)
Each as a Guarantor and Pledgor
By:
---------------------------------
Name:
Title:
<PAGE>
S-2
QUEST DIAGNOSTICS INVESTMENTS
INCORPORATED
QUEST DIAGNOSTICS FINANCE
INCORPORATED
Each as a Guarantor and Pledgor
By:
---------------------------------
Name:
Title:
PATHOLOGY BUILDING PARTNERSHIP, by
Quest Diagnostics Incorporated
(MD), as General Partner
By:
---------------------------------
Name:
Title:
<PAGE>
S-3
AGENTS:
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER &
SMITH INCORPORATED,
as Joint Lead Arranger and
Syndication Agent
By:
---------------------------------
Name:
Title:
BANC OF AMERICA SECURITIES LLC,
as Joint Lead Arranger
By:
---------------------------------
Name:
Title:
BANK OF AMERICA, N.A.,
as Administrative Agent
By:
---------------------------------
Name:
Title:
WACHOVIA BANK, N.A.,
as Co-Documentation Agent
By:
---------------------------------
Name:
Title:
THE BANK OF NEW YORK,
as Co-Documentation Agent
<PAGE>
S-4
By:
---------------------------------
Name:
Title:
---------------------------------,
as a Lender (please type)
By:
---------------------------------
Name:
Title:
<PAGE>
Exhibit 10.22
EMPLOYMENT AGREEMENT
BETWEEN
KENNETH W. FREEMAN
&
QUEST DIAGNOSTICS INCORPORATED
This EMPLOYMENT AGREEMENT (the "Agreement") is entered into as of the
date of execution (the "Effective Date"), between QUEST DIAGNOSTICS INCORPORATED
(the "Company"), a Delaware corporation having its principal place of business
at One Malcolm Avenue, Teterboro, NJ 07608, and KENNETH W. FREEMAN (the
"Executive").
WHEREAS, Executive has been employed by the Company as Chairman of
the Board and Chief Executive Officer; and
WHEREAS, the Company considers the services of the Executive to be
unique and essential to the success of the Company's business; and
WHEREAS the Company and the Executive had previously entered into an
employment agreement dated December 18, 1996, the term of which originally is to
expire as of December 31, 1999, and the parties desire that the Executive
continue as President and Chief Executive Officer of the Company; and
WHEREAS, the Company and the Executive now wish to enter into an
omnibus amendment of the current agreement of employment on the terms and
conditions set forth herein, and which shall constitute the sole and exclusive
agreement relating to the employment of Executive by the Company.
NOW, THEREFORE, in consideration of the foregoing premises, the mutual
covenants, terms and conditions set forth herein, and other valuable
consideration, the receipt and sufficiency
-1-
<PAGE>
of which are hereby acknowledged, it is hereby agreed between the Company and
the Executive that his existing agreement shall be amended and modified in its
entirety as follows:
1. EMPLOYMENT. The Company shall continue to employ the Executive in a
full-time capacity in the position set forth in this paragraph, and the
Executive shall continue to accept such employment upon the terms and
conditions set forth herein. Such employment shall be in the capacity
of Chief Executive Officer of the Company, and as a Director and
Chairman of the Board of Directors of the Company (the "Board")
reporting directly to the Board. The Company shall nominate the
Executive as a Director of the Company and shall use its best efforts
to have the Executive elected and re-elected to the Board for the
duration of the "Employment Term" (as hereinafter defined).
2. EMPLOYMENT TERM. Unless earlier terminated pursuant to Section (10)
hereof, the term of Executive's employment under this Agreement shall
commence as of the Effective Date of this Agreement and continue until
December 31, 2002 (the "Employment Term"). On or before June 1, 2002,
the Company and Executive agree to use their good faith efforts to
negotiate a renewal of this Agreement (the "Renewal Agreement"), on
mutually satisfactory terms and conditions. Subject to continued
service by the Executive through December 31, 2002 (absent any
termination by the Company without Cause, or termination by the
Executive for Good Reason, or as a result of the death or permanent
disability of the Executive, in each case giving rise to payments
pursuant to Section 11 hereof) (each individually a "Section 11
Event"), then upon the expiration of this Agreement on December 31,
2002 (a "Non-Renewal Event"), the Executive shall be entitled to the
severance benefit provided in Section 11.
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3. DUTIES. During the Employment Term, the Executive shall, subject to the
supervising powers of the Board, have those powers and duties
consistent with his position as Chief Executive Officer and Chairman,
which powers shall in all cases include, without limitation, the power
of supervision and control over, and responsibility for, the general
management and operations of the Company. Executive agrees to devote
substantially all his working time and attention to the business of the
Company. The Executive shall not, without the prior written consent of
the Company's Board of Directors, be directly or indirectly engaged in
any other trade, business or occupation for compensation requiring his
personal services during the Employment Term. Nothing in this agreement
shall preclude the Executive from (i) engaging in charitable and
community activities or from managing his personal investments, or (ii)
serving as a member of the board of directors of an unaffiliated
company not in competition with the Company, subject however, in each
such case of board membership, to approval by the Company's Board of
Directors (not to be unreasonably withheld).
4. PLACE OF PERFORMANCE. The principal place of employment of the
Executive shall be at the Company's principal executive offices in
Teterboro, New Jersey, or such other location either currently under
consideration by the Company/Executive or proposed by the Executive for
the new corporate headquarters as may be agreed to by the Board and
Executive.
5. CASH COMPENSATION. Executive shall be compensated for services rendered
during the Employment Term as follows:
(a) BASE SALARY. Executive shall be compensated at an annual base
salary of no less than $750,000 (the base salary, at the rate
in effect from time to time, is hereinafter referred to as the
"Base Salary"). The Company's Board of Directors shall review
and
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may, if appropriate, at its discretion, increase this annual
Base Salary during the Employment Term. Base Salary shall be
reviewed annually and be adjusted to reflect (among other
factors) increases generally granted to other senior
executives of the Company and CEO performance consistent with
Company pay practices. The Base Salary shall be payable in
equal bi-weekly installments.
(b) ANNUAL BONUS. In addition to the Base Salary provided for in
Section 5 (a) above, the Company will provide annual bonus
awards to Executive under its Management Incentive Plan (MIP)
in accordance with the plan and any financial performance
targets thereunder. During the Employment Term, Executive's
target incentive opportunity under the Company's MIP will be
no less than 140% of Base Salary as in effect at the time such
target incentive opportunity is established.
(i) 60% of the annual bonus award shall be delivered in
cash (at the same time other MIP awards are paid).
(ii) 40% of the annual bonus award shall be delivered in
shares of common stock of the Company at the same
time other MIP awards are paid that will be 100%
vested but will be restricted ("Restricted Shares")
in that they may not be sold, assigned, pledged,
transferred, hypothecated or otherwise be disposed of
or encumbered, voluntarily or involuntarily, by
operation of law or otherwise, except as may be
permitted, in writing, by the Board. The Board may,
in its sole discretion, permit Restricted Shares to
be exchanged in such transaction for property subject
to restrictions and conditions substantially similar
to those applicable to the Restricted Shares
exchanged. In the event of any purported sale,
transfer or other disposition to the
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Restricted Shares in contravention of the foregoing
provisions, such purported sale, transfer or other
disposition shall, to the fullest extent permitted by
law, be null, void and of no effect. The foregoing
restrictions shall be lifted as to one-third of the
Restricted Shares on each of the first, second and
third anniversaries of the cash award payment date,
subject to accelerated lifting of restrictions as
provided for in Section 11.
(c) DEFERRAL. The Executive may elect to defer from
payments of Base Salary and Annual Bonus and any
other eligible compensation as defined by the terms
of the plan such amounts as provided for under the
terms of the Company's Supplemental Deferred
Compensation Plan ("SDCP").
(d) INCENTIVE AWARD MODIFICATIONS. Any equity and option
awards made to the Executive as of the date of this
Agreement and any equity and option awards which
shall be made to the Executive during the Employment
Term shall be subject to, and shall benefit from, any
favorable amendments or revisions to the terms and
conditions of any of the Company's Incentive
Compensation Programs (including, without limitation,
any action resulting in extended exercise periods)
that may be implemented on or after the date hereof.
6. EQUITY AWARD. Executive may be awarded additional compensation (such as
stock options, shares of incentive stock, or shares of restricted
stock) pursuant to the present or any future incentive compensation or
long-term compensation program established for the senior officers of
the Company (collectively the "Incentive Compensation Programs"), in an
appropriate manner for the position occupied by Executive and his
performance therein relative to other Company senior executives and
consistent with Company pay practices.
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Compensation granted under such plans will be subject to the actual
provisions and conditions applicable to such plans.
7. EMPLOYEE BENEFITS.
(a) GENERAL PROVISIONS. Except as expressly provided in this
Agreement, Executive shall be eligible to participate in all
employee benefit and welfare plans offered by the Company
(e.g., Life Insurance, Medical & Dental Insurance, Travel,
Accident, STD & LTD, Flexible Spending Accounts, Regular and
Supplemental AD&D, Optional/Supplemental Life Insurance,
Profit Sharing [the 401(k) Plan], Employee Stock Purchase Plan
and other personal benefit plans of the Company, collectively
referred to as the "Benefit Plans") on a basis which is no
less favorable to the Executive than that made available to
other senior officers of the Company; provided that Executive
shall be reimbursed for the costs of his annual participation
in a comprehensive executive health assessment at a leading
medical institution of his choice (grossed up for tax purposes
at the present rate of 48%).
(b) TRANSFERRED EXECUTIVE SUPPLEMENTAL RETIREMENT PLAN.
(i) Executive will be eligible to participate in the
"Transferred Executive Supplemental Retirement Plan"
(the "SRP") established by the Company for certain
executives of the Company, effective upon the
Effective Date. Under the terms of such plan,
Executive will be entitled to receive a nonqualified
retirement benefit in accordance with the terms and
provisions of the plan, as administered by the
Company's Board of Directors, subject to the terms of
this Agreement.
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(ii) Notwithstanding any terms of the SRP to the contrary,
Executive shall be entitled to receive a retirement
pension benefit under this Agreement (the "Company
Non-Qualified Benefit") as provided for below. The
Company Non-Qualified Benefit shall be an annuity
commencing on the later of (i) his date of
termination or (ii) the Executive's 57th birthday
(the "SRP Commencement Date") and shall be (1) fully
equivalent in value to the pension benefits Executive
would have received under the Corning nonqualified
and qualified pension plans as in effect on December
18, 1996 (including all across-the-board plan
improvements or benefit decreases and/or successor
plans, in each case adopted after 12/18/96) and
applicable to the class of executives of which the
Executive was a part while employed by Corning, (2)
based on Executive's combined years of service with
the Company and Corning (but in any case not less
than 34 years of service), (3) computed on an
unreduced basis as if Executive were a retiree,
rather than on a deferred vested basis, and (4) based
on all compensation earned by Executive from Corning
and Company through to the SRP Commencement Date
(provided that for purposes of such computation,
Executive's benefit eligible compensation shall be
his 1999 Base Salary and Bonus including any deferred
Base Salary and bonus in the Company's Supplemental
Deferred Compensation Plan and such amount increased
at 5% per annum for subsequent years); PROVIDED THAT
if the Executive terminates his employment under this
Agreement without Good Reason or the Company
terminates the Executive's employment under this
Agreement with Cause, then the pension
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benefits payable to the Executive under the SRP shall
be determined based only on actual years of service
and compensation through to the Termination Date.
(iii) Upon execution of this Agreement, the Company shall
deliver to Executive a standby letter of credit in
the amount of $5.4 million, in form acceptable to
Executive and his counsel and with an evergreen term
of no less than eighteen (18) months, to ensure that
the Company's obligation under the SRP and the
Company Non-Qualified Benefit are fully funded and
secured on an after-tax basis to the Executive (the
"SRP LC"). As of the first day of any calendar year
thereafter (the "Adjustment Date") as of which the
Company's pension liability (on an after-tax basis)
to Executive as computed hereunder, as determined by
an actuary acceptable to Executive on or before
November I of the preceding calendar year, has a
present value that exceeds by more than $250,000 the
SRP LC (on an after-tax basis), the Company shall,
within 60 days of the Adjustment Date, increase the
amount of the SRP LC or secure and deliver to the
Executive an additional letter of credit in form
acceptable to the Executive and his counsel so that,
in the aggregate, the letter(s) of credit then in
place are not less than the present value of such
liability (on an after-tax basis).
(iv) Immediately upon (x) the termination of Executive's
employment with the Company for any reason (including
the non-renewal of this Agreement), other than a
termination of Executive's employment by the Company
for Cause or by the Executive without Good Reason;
(y) failure of the Company
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to renew the SRP LC or increase the amount of the SRP
LC or secure an additional letter of credit, as
provided herein (in each case, without the consent of
the Executive not to do so); or (z) upon the
Executive's retirement, the Executive may draw on the
SRP LC.
(v) Amounts payable to the Executive in satisfaction of
the Company NonQualified Benefit shall be reduced by
(i) any qualified plan benefits actually received by
Executive under Corning's qualified plan ("Qualified
Corning Benefits") and (ii) any non-qualified
benefits to the extent funded pursuant to Section III
(c) of the Transition Agreement, dated as of December
18, 1996 between Corning and the Executive, and
actually received by the Executive ("Section III (c)
Benefits"), and any amounts realized by the Executive
upon drawing upon the SRP LC (or any supplemental
letter of credit) shall be adjusted to take into
account such Qualified Corning Benefits and Section
III (c) Benefits.
(c) Executive shall be eligible to participate in the Supplemental
Deferred Compensation Plan on a basis which is no less
favorable than other senior officers participating in the
Transferred Executive Supplemental Retirement Plan.
(d) VACATION AND SICK LEAVE. Executive shall be entitled to
vacation and sick leave in accordance with the vacation and
sick leave policies adopted by the Company from time to time,
provided that the Executive shall be entitled to no less than
five (5) weeks of paid vacation each calendar year. Any
vacation shall be at such time and for such periods as shall
be mutually agreed upon between the Executive and the
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Company. The Executive shall be entitled to all public
holidays observed by the Company.
(e) RELOCATION. The Company acknowledges that it has provided to
the Executive an interest-free housing loan in the amount of
$400,000, which it has also agreed shall be forgiven in five
(5) annual installments at each annual anniversary of the
effective date of the original employment agreement executed
between the Company and the Executive, dated December 18,
1996. The Company acknowledges and agrees that it shall
continue to forgive the remaining annual installments of such
loan and that any compensation income to Executive resulting
from the loan forgiveness or interest-free features of the
loan will be grossed up for tax purposes at the present rate
of 48%.
8. APPLICABLE TAXES. There shall be deducted from any compensation
payments made under this Agreement any federal, state, and local taxes
or other amounts required to be withheld by any entity having
jurisdiction over the matter.
9. MISCELLANEOUS BENEFITS. During the Employment Tenn, the Company shall
provide the Executive with the following additional benefits:
(a) BUSINESS TRAVEL AND EXPENSES. Executive shall be reimbursed by
the Company for reasonable and other business expenses, as
approved by the Company, which are incurred and accounted for
in accordance with the Company's normal practices and
procedures for reimbursement of expenses.
(b) LEGAL FEES. The Company shall reimburse Executive for
reasonable legal fees and disbursements incurred in connection
with the negotiation, preparation,
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implementation and execution of this Agreement (grossed up for
tax purposes at present rate of 48%).
(c) CLUBS AND MEMBERSHIPS. The Company will reimburse Executive
for annual and one-time costs associated with memberships for
the Executive and his family in a country club and city club
(grossed-up for tax purposes at the present rate of 48%).
(d) EXECUTIVE DRIVER. In order to ensure the accessibility and
safety of the -Executive during the Employment Term, the
Company will reimburse Executive for the costs of an executive
driver comparable to the costs presently incurred on behalf of
the Executive, subject to annual COLA adjustments (grossed up
for tax purposes at the present rate of 48%).
(e) USE OF AIRCRAFT. In order to ensure the accessibility and
safety of the Executive during the Employment Term, the
Company shall reimburse Executive for all costs associated
with the Executive's use of aircraft in accordance with the
Company's policies, whether for business purposes or for
personal reasons, whether the aircraft is being chartered or
is Company-owned. Any payments under this provision which are
to be treated as taxable compensation to the Executive (in
accordance with IRS rules and regulations) shall be grossed-up
for tax purposes at the present rate of 48%.
(f) FINANCIAL COUNSELING AND LEGAL SERVICES. The Company shall
reimburse the Executive annually for all reasonable financial
counseling (not including asset management fees), tax
preparation and legal services associated with tax, financial
and estate planning (grossed-up for tax purposes at the
present rate of 48%). The Company shall continue to pay the
fees paid to John Ullman and Associates ("Ullman") consistent
with Ullman's services under the prior contract.
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(g) NON-EXCLUSIVITY. Nothing in this Agreement shall prevent the
Executive from being entitled to receive any additional
compensation or benefits as approved by the Company's Board of
Directors.
10. TERMINATION OF EMPLOYMENT. Notwithstanding any other provisions of this
Agreement to the contrary, the employment of the Executive pursuant to
this Agreement may be terminated as follows:
(a) TERMINATION BY THE COMPANY FOR CAUSE. Executive may be
terminated for "Cause" by the Company as provided below. As
used herein, the term "Cause" shall mean (i) conviction of the
Executive for a felony; or (ii) the commission by the
Executive of fraud or theft against, or embezzlement from, the
Company. For purposes of this section, no act or failure to
act on Executive's part shall be considered to be reason for
termination for Cause if done, or omitted to be done, by
Executive in good faith and with the reasonable belief that
the action or omission was in the best interests of the
Company. Cause shall not exist unless and until there shall
have been delivered to the Executive a copy of a resolution,
duly adopted by the affirmative vote of not less than two
thirds of the entire membership of the Board at a meeting of
the Board held for the purpose (after ten (10) days' prior
written notice to the Executive of such meeting and the
purpose thereof and an opportunity for him, together with his
counsel, to be heard before the Board at such meeting), of
finding that in the good faith opinion of the Board, the
Executive was guilty of the conduct set forth above in this
Section 10(a) and specifying the particulars thereof in
detail. As set forth more fully in Section 10(f) hereof, the
"Date of Termination" (which shall be no earlier than 30 days
after delivery of the written notice to the Executive) shall
be the
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date specified in the "Notice of Termination;" provided,
however, that in the case of a termination for Cause under
clauses 10(a)(i) and 10(a)(ii) above, the Date of Termination
shall be the date of delivery of the Notice of Termination.
Anything herein to the contrary notwithstanding, if, following
a termination of the Executive's employment by the Company for
Cause based upon the conviction of the Executive for a felony,
such conviction is overturned in a final determination on
appeal, the Executive shall be entitled to the payments and
the economic equivalent of the benefits the Executive would
have received if his employment had been terminated by the
Company without Cause.
(b) TERMINATION BY THE COMPANY FOR EXCESSIVE ABSENTEEISM. At the
sole discretion of the Company's Board of Directors, Executive
may be terminated if the Executive shall have been absent from
his duties with the Company on a full-time basis for one
hundred and twenty (120) consecutive days, and if within
thirty (30) days after written Notice of Termination is given
by the Company to the Executive, the Executive shall not have
resumed the performance of his duties hereunder on a full-time
basis. In this event, the Date of Termination shall be thirty
(30) days after Notice of Termination is given by the Company
(provided that the Executive shall not have returned to the
full-time performance of his duties).
(c) DEATH. The Executive's employment shall terminate upon his
death, and the date of his death shall be the Date of
Termination for purposes of this Agreement.
(d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive
may terminate his employment hereunder for "Good Reason,"
provided that the Executive shall have delivered a Notice of
Termination within ninety (90) days after the occurrence of
the
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event of Good Reason giving rise to such termination. For
purposes of this Agreement, "Good Reason" shall mean the
occurrence of one or more of the following circumstances,
without the Executive's express written consent, which are not
remedied by the Company within thirty (30) days of receipt of
the Executive's Notice of Termination except in the event of a
Change in Control:
(i) an assignment to the Executive of any duties
materially inconsistent with his position, duties,
responsibilities, and status with the Company, or any
material limitation of the powers of the Executive
not consistent with the powers of the Executive
contemplated by Section (3) hereof;
(ii) any removal of the Executive from, or any failure to
re-elect the Executive to the positions specified in
Section (1) of this Agreement;
(iii) the change of the Executive's title as specified by
Section (1) of this Agreement;
(iv) the Company's requiring the Executive without his
written consent to be based at any office or location
more than 75 miles commuting distance from the
locations referred to in Section (4) of this
Agreement;
(v) a reduction in the Executive's Base Salary or Annual
Bonus target incentive opportunity as in effect from
time to time, without his written consent;
(vi) the failure of the Company to continue in effect any
Benefit Plan that was in effect on the date hereof or
provide the Executive with equivalent benefits,
without his written consent;
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(vii) the failure of the Company to maintain the Executive
as a member of its Board of Directors at all times
thereafter, for so long as he shall serve as Chief
Executive Officer of the Company;
(viii) any other material breach by the Company of this
Agreement;
(ix) "Change in Control" as defined in Section 11(f)
of this Agreement.
(x) a failure of the Company to secure a written
assumption by any successor company as provided
for in Section 15(g) hereof, or
(xi) the failure of the Company to secure, maintain,
renew, or supplement the SRP LC (and any supplemental
letter of credit) as provided for in Section
7(b)(iii) hereof.
In the event of a termination for Good Reason, the Date of
Termination shall be the date specified in the Notice of
Termination, and shall be more than thirty (30) days after the
Notice of Termination. In the event of a termination for Good
Reason pursuant to Section 10(d)(xi) hereof, the Executive
shall retain the right to draw on the SRP LC (and any
supplemental letter of credit) as provided for in Section 7(b)
hereof.
(e) OTHER TERMINATIONS. Notwithstanding the foregoing, the
Executive may terminate his employment at any time, subject to
the provisions of Section 10(f) hereof. If the Executive's
employment is terminated hereunder for any reason other than
as set forth in Sections 10(a) through 10(d) hereof, the date
on which a Notice of Termination is given or any later date
(within 30 days) set forth in such Notice of Termination shall
be the Date of Termination.
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(f) NOTICE OF TERMINATION. Any termination of the Executive's
employment hereunder by the Company or by the Executive shall
be communicated by written Notice of Termination to the other
party hereto. For purposes of this Agreement, a "Notice of
Termination" shall mean a notice which shall indicate the
specific termination provision in this Agreement relied upon
and shall set forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination of
the Executive's employment under the provisions so indicated
and a date of termination.
11. COMPENSATION UPON TERMINATION OR DURING DISABILITY
(a) DISABILITY PERIOD. During any period during the Employment
Term that the Executive fails to perform his duties hereunder
as a result of incapacity due to physical or mental illness
("Disability Period"), the Executive shall continue to (i)
receive his full Base Salary and bonus otherwise payable for
that period of the Employment Term including the Disability
Period and (ii) participate in the Benefit Plans. Such
payments made to the Executive during the Disability Period
shall be reduced by the sum of the amounts, if any, payable to
the Executive at or prior to the time of any such payment
under disability benefit plans of the Company or under the
Social Security disability insurance program, where such
amounts were not previously applied to reduce any such
payment.
(b) DEATH. If the Executive's employment hereunder is terminated
as a result of his death, then: (i) the Company shall pay the
Executive's estate or designated beneficiary, as soon as
practicable after the Date of Termination, a lump sum payment
equal to (1) any Base Salary installments due in the month of
death and any reimbursable expenses accrued or owing the
Executive hereunder as of the Date of
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Termination, (2) a PRO RATA portion of any bonus owed to the
Executive for that portion of the Employment Term through to
the Date of Termination and any earned and unpaid bonus
relating to services performed by the Executive in the year
preceding his death, and (3) the severance benefits set forth
in Section 11(e), and (ii) all outstanding stock options,
earned shares of incentive stock, and other awards granted to
the Executive under the Incentive Compensation Programs shall
immediately become fully vested as of the Date of Termination
and all transfer restrictions shall lapse but continue to be
subject to such exercise periods as shall be provided for
under the terms of each grant.
(c) ABSENCE FROM WORK. If the Executive's employment hereunder is
terminated for excessive absenteeism as defined in Section
10(b), then (i) the Company shall pay the Executive, as soon
as practicable after the Date of Termination (1) any Base
Salary and any reimbursable expenses accrued or owing the
Executive hereunder as of the Date of Termination, (2) a PRO
RATA portion of any bonus owed to the Executive for that
portion of the Employment Term through to the Date of
Termination and any earned and unpaid bonus relating to
service performed by the Executive in the year preceding his
Date of Termination for excessive absenteeism, and (3) the
severance benefits set forth in Section 11(e); and (ii) all
outstanding stock option and Incentive Stock awards granted to
the Executive shall immediately become fully vested as of the
Date of Termination and all transfer restrictions shall lapse
but continue to be subject to such exercise periods as shall
be provided for under the terms of each grant.
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(d) TERMINATION FOR CAUSE OR BY THE EXECUTIVE OTHER THAN FOR GOOD
REASON. If the Executive's employment hereunder is terminated
by the Company for Cause or by the Executive (other than for
Good Reason), then (i) the Company shall pay the Executive, as
soon as practicable after Date of Termination, any Base Salary
and any reimbursable expenses accrued or owing the Executive
hereunder for services as of the Date of Termination; and (ii)
the Executive shall immediately forfeit any unvested career
shares and earned but unvested incentive stock shares. In the
event of termination by the Company for Cause, the Executive
shall have the right to exercise the vested unexercised
portion of all outstanding stock option and stock awards prior
to the Date of Termination, and the unexercised portion of any
such award shall be forfeited thereafter and any restricted
stock shall remain subject to the terms of each grant. In the
event of termination by the Executive other than for Good
Reason but subject to the provisions of Section 12, the
Executive shall have the right to exercise the vested
unexercised portion of all outstanding stock options and stock
awards then held by the Executive for such period following
the Date of Termination as shall be provided for under the
terms of each grant, and the unexercised portion of any such
awards shall be forfeited thereafter and any restricted stock
shall remain subject to the terms of each grant.
(e) ALL OTHER TERMINATIONS. Executive's employment may be
terminated without Cause by the Company's Board of Director's
or by the Executive for Good Reason or upon a Non-Renewal
Event, provided that in such event:
(i) Executive shall be entitled to receive three (3)
years Base Salary (at the Executive's effective
annual rate on the date of termination) to be paid in
a
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lump-sum (net of appropriate withholdings) within
sixty (60) days of the Date of Termination;
(ii) Executive shall be entitled to receive three (3)
times his average Annual Bonus Award (including the
stock and cash components) earned during the
employment term of this Contract and any earned and
unpaid bonus relating to (A) services performed by
the Executive in the year preceding his termination
by the Company without Cause or his termination for
Good Reason, and (B) services performed by the
Executive for calendar year 2002 in the event of a
Non-Renewal Event to be paid in a lump sum (net of
appropriate withholding) within sixty (60) days of
the Date of Termination provided that the bonus
payment pursuant to Section 11(e)(ii) shall not
duplicate any bonus payments previously paid to the
Executive;
(iii) Executive and his eligible dependents shall be
entitled to continue participation in the Company's
Benefit Plans at the same cost as other Company
senior executives (to the extent allowable in
accordance with the administrative provisions of
those plans and applicable federal and state law) for
a period of up to three (3) years or until Executive
and his eligible dependents are eligible to be
covered by a successor employer's comparable benefit
plans, whichever is sooner;
(iv) Any stock or stock option granted to the Executive
subject to vesting restrictions shall become vested
and fully exercisable as of the Date of Termination
but subject to the provisions of Section 12. In
addition, any
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restrictions on sale, transfer or disposition of
restricted stock will be lifted; and
(v) In the event that the Executive receives any payment
or benefit (including but not limited to the payments
or benefits pursuant to Section 11 of this Agreement
(a "Payment") that is subject to the excise tax (the
"Excise Tax") under Section 4999 of the Internal
Revenue Code of 1986, as amended (the "Code"), the
Company shall pay to the Executive, as soon
thereafter as practicable, an additional amount (a
"Gross-Up Payment") such that the net amount retained
by the Executive, after deduction of any Excise Tax
imposed upon the Payment and any federal, state, and
local income tax and Excise Tax imposed upon the
Gross-Up Payment, shall be equal to the Payment. The
determination of whether an Excise Tax is due in
respect to any payment or benefit, the amount of the
Excise Tax and the amount of the Gross-Up Payment
shall be made by an independent auditor (the
"Auditor") jointly selected by the Company and the
Executive and paid by the Company. If the Executive
and the Company cannot agree on the firm to serve as
the Auditor, then the Executive and the Company shall
each select one nationally recognized accounting firm
and those two firms shall jointly select one
nationally recognized accounting firm to serve as the
Auditor. Notwithstanding the Payment, (i) any other
payments or benefits received or to be received by
the Executive in connection with a Change in Control
or the Executive's termination of employment (whether
pursuant to the terms of this Agreement or any other
plan, arrangement, or agreement with the Company,
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any person whose actions result in a Change in
Control or any person affiliated with the Company or
such person) shall be treated as "parachute payments"
within the meaning of Section 280G(b)(2) of the Code,
and all "excess parachute payments" within the
meaning of Section 280G of the Code shall be treated
as subject to the Excise Tax, unless in the opinion
of the tax counsel selected by the Auditor, such
other payments or benefits (in whole or in part) do
not constitute parachute payments, or are otherwise
not subject to the Excise Tax, and (ii) the Executive
shall be deemed to pay federal income tax at the
highest marginal rate applicable in the calendar year
in which the Gross-Up Payment is made, and state and
local income taxes at the highest marginal rate of
taxation in the state and locality of the Executive's
residence on the Date of Termination, net of the
maximum reduction in federal income tax which could
be obtained from deduction of such state and local
taxes. In the event the actual Excise Tax or such
income tax is more or less than the amount used to
calculate the Gross-Up Payment, the Executive or the
Company, as the case may be, shall pay to the other
an amount reflecting the actual Excise Tax or such
income tax.
(f) CHANGE IN CONTROL. For purposes of this Agreement, "Change in
Control" shall mean:
(i) The Company's shareholders approve a merger (pursuant
to which the Company is not the surviving entity),
consolidation (pursuant to which the voting
shareholders of the Company cease to hold in excess
of fifty (50%) percent of the voting stock of the
consolidated entity), sale or disposition of all or
substantially all of the Company's assets or a plan
of partial or
-21-
<PAGE>
complete liquidation and such transaction is
completed substantially in accordance with the terms
approved by the shareholders; PROVIDED THAT
notwithstanding anything to the contrary, in this
subsection (f)(i), no such merger, consolidation or
sale shall be deemed to constitute a "Change in
Control" if such transaction or series of
transactions required the Executive to be identified
in any United States securities law filing as a
person or a member of any group acquiring, holding or
disposing of beneficial ownership of the Company's
securities and/or assets and effecting a "Change in
Control" as defined in this subclause (f)(i);
(ii) The majority of the Board consists of individuals
other than Incumbent Directors (a "Hostile Board"),
which term "Incumbent Directors" means the members of
the Board as of the Effective Date of this Agreement
and any other Director elected to the Board with the
consent of the Executive, PROVIDED THAT any person
becoming a director subsequent to such date whose
election or nomination for election was supported by
two-thirds of the directors who then comprised the
Incumbent Directors shall be considered to be an
Incumbent Director; PROVIDED FURTHER that the
occurrence of a Share Acquisition (as defined below)
without the prior approval of the two-thirds of the
Incumbent Directors shall be deemed to result in a
Hostile Board for all purposes hereunder; or
(iii) the acquisition by any third-party of stock
constituting at least 51% of all outstanding shares
of stock of the Company (a "Share Acquisition") and
subsequent to such acquisition either (i) the Company
no longer is a public
-22-
<PAGE>
company for U.S. securities law purposes, or (ii)
there is a material diminution of the Executive's
position or any other breach of this Agreement by the
Company or event giving rise to a Good Reason
termination by the Executive.
-23-
<PAGE>
12. NONSOLICITATION AND NONCOMPETITION
(a) During his employment with the Company and for a period of (1)
one year from the date of the Executive's termination of
employment for any reason, the Executive will not provide
services, in any capacity, whether as an employee, consultant,
independent contractor, or otherwise, to any person or entity
that provides products or services that compete with the
Business of the Company, including but not limited to:
Laboratory Corporation of America Holdings, Inc.; Mayo
Laboratory; ARUP Laboratory; LabOne; Dianon; Specialty Labs
Inc.; DynaCare; Unilab Corporation; American Medical
Laboratory; Microbiology Reference Laboratory; Physicians
Clinical Laboratory Inc.; Endocare Services Inc.; Nu-Tech
Bio-Med, Inc.; Chi Systems, Inc.; Enzon, Inc.; IMPATH Inc.;
TRIPATH, Inc. (NEOPATH); or their successors or assigns,
except that after the termination of Executive's employment
this restriction shall only apply to North America. If so
requested in writing by Executive, the Company shall advise
the Executive promptly in writing in advance (but in no case
later than 30 calendar days) as to whether, in the exercise of
its reasonable judgment, the Company views any proposed
activity contemplated by the Executive as constituting a
competing "Business," PROVIDED THAT nothing herein shall
prevent the Executive from, after the termination of his
employment, being a passive owner of not more than 5% of the
outstanding stock of any class of a corporation that is
publicly traded and that may acquire any corporation or
business that competes with the Company.
-24-
<PAGE>
(b) For a period of one (1) year following the termination of the
Executive's employment for any reason, the Executive will not
directly or indirectly solicit the Business of any customer of
the Company during the one (1) year period prior to the
termination of the employment relationship with the Company
for any purpose other than to obtain, maintain and/or service
the customer's Business for the Company.
(c) For a period of one (1) year following the termination of the
Executive's employment for any reason, the Executive agrees
not to, directly or indirectly, recruit or solicit any
employees of the Company to work for the Executive or any
other person or entity.
(d) As used in this Section, the following terms shall have their
respective definitions:
(i) "Business" shall include (A) clinical laboratory,
pathology, toxicology, pharmaceutical testing,
clinical trials, (B) Clinical Laboratory Medical
Information Services, (C) clinical laboratory testing
kits; and (D) any other product or service which the
Company planned, provided or discussed during the (1)
one year period prior to the termination of
Executive's employment.
(ii) "Clinical Laboratory Medical Information Services"
shall mean medical information services which contain
a substantial clinical laboratory data component.
(iii) "Indirectly solicit" shall include, but are not to be
limited to, providing Company's proprietary
information to another individual, or entity,
allowing the use of Executive's name by any company
(or any employees of any other company) other than
the Company, in the solicitation of the Business of
Company's customers.
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<PAGE>
(e) In the event there is a dispute under this Section, the
parties agree to hold an expedited hearing before an
arbitrator under American Arbitration Association Rules.
(f) EXCLUSIVE PROPERTY. Executive confirms that all confidential
information is and shall remain the exclusive property of the
Company. All business records, papers and documents kept or
made by Executive relating to the business of the Company, its
affiliates and subsidiaries (other than his personal records)
shall be and remain the property of the Company. Upon the
termination of his employment with the Company or upon the
request of the Company at any time, Executive shall promptly
deliver to the Company, and shall not without the consent of
the Board retain copies of, any written materials not
previously made available to the public, or records and
documents made by Executive in his possession concerning the
business or affairs of the Company or any of its affiliates or
subsidiaries (other than his personal records); provided,
however, that subsequent to any such termination, the Company
shall provide Executive with copies (the cost of which shall
be borne by Executive) of any documents which are requested by
Executive and which Executive has determined in good faith are
(i) required to establish a defense to a claim that Executive
has not complied with his duties hereunder or (ii) necessary
to Executive in order to comply with applicable law.
(g) REMEDIES.
(i) INJUNCTIVE RELIEF. Without intending to limit the
remedies available to the Company, Executive
acknowledges that a breach of any of the covenants
contained in this Section 12 may result in material
irreparable injury to the Company or its affiliates
or subsidiaries for which there is no adequate
-26-
<PAGE>
remedy at law, that it will not be possible to
measure damages for such injuries precisely and that,
in the event of such a breach or threat thereof, the
Company shall be entitled to obtain a temporary
restraining order and/or a preliminary or permanent
injunction restraining Executive from engaging in
activities prohibited by this Section 12 or such
other relief as may be required to specifically
enforce any of the covenants in this Section 12.
Without intending to limit the remedies available to
Executive, Executive shall be entitled to seek
specific performance of the Company's obligations
under this Agreement.
(ii) ADDITIONAL REMEDY. In the event of an arbitrator's
determination that Executive has breached any of the
covenants contained in this Section 12 during his
employment or within one year after termination
thereof for any reason, then (1) all of Executive's
outstanding stock options shall immediately terminate
as of the date of the breach and (2) any gains
realized by Executive from exercising all or a
portion of any stock options within three months
prior to his termination of employment or anytime
after his termination of employment, shall be paid by
Executive to the Company. The amount of the realized
gains shall be the difference between the exercise
price and the fair market value of the stock on the
day each option is exercised and the Executive agrees
to pay immediately said amounts to the Company. The
Company shall cooperate with the Executive in filing
amended tax returns required as a result of the
exercise by the Company of its rights pursuant to
this subclause (ii). Executive agrees to pay
immediately
-27-
<PAGE>
the unpaid balance to the Company. Executive may be
released from his obligations hereunder only if the
Board (or its duly appointed agent) determines in its
sole discretion that such action is in the best
interests of the Company.
13. ARBITRATION. In the event of any difference of opinion or dispute
between the Executive and the Company with respect to the construction
or interpretation of this Agreement or the alleged breach thereof,
which cannot be settled amicably by agreement of the parties, then such
dispute shall be submitted to and determined by arbitration by a single
arbiter in the city of New York, New York in accordance with the rules
then in effect of the Commercial Arbitration Panel of the American
Arbitration Association (the "AAA"), and judgment upon the award
rendered shall be final, binding and conclusive upon the parties and
may be entered in the highest court, state or federal, having
jurisdiction. The costs of the arbitration shall be borne as determined
by the arbitrator; PROVIDED, HOWEVER, that if the Company's position is
not substantially upheld, as determined by the arbitrator, the expenses
of the Executive (including, without limitation, fees and expenses
payable to the AAA and the arbitrator, fees and expenses payable to
witnesses, including expert witnesses, fees and expenses payable to
attorneys and other professionals, expenses of the Executive in
attending the hearing, costs in connection with obtaining and
presenting evidence and costs of the transcription of the proceedings),
as determined by the arbitrator, shall be reimbursed to him by the
Company.
14. CONFIDENTIALITY. During the Employment Term, and except as otherwise
required by law, the Executive shall not disclose or make accessible to
any business, person or entity, or make use of (other than in the
course of the business of the Company) any trade secrets, proprietary
-28-
<PAGE>
knowledge or confidential information, which he shall have obtained
during his employment by the Company and which shall not be generally
known to or recognized by the general public. All information regarding
or relating to any aspect of either the Company's business, including
but not limited to that relating to existing or contemplated business
plans, activities or procedures, current or prospective clients,
current or prospective contracts or other business arrangements,
current or prospective products, facilities and methods, manuals,
intellectual property, price lists, financial information (including
the revenues, costs, or profits associated with any of the Company's
products or services), or any other information acquired because of the
Executive's employment by the Company, shall be conclusively presumed
to be confidential; PROVIDED, HOWEVER, that Confidential Information
shall not include any information known generally to the public (other
than as a result of unauthorized disclosure by the Executive) or any
specific information or type of information generally not considered
information disclosed by the Company or any officer thereof to a third
party without restrictions on the disclosure of such information. The
Executive's obligations under this Section 14 shall be in addition to
any other confidentiality or nondisclosure obligations of the Executive
of the Company at law or under any other agreements.
15. OTHER MATTERS.
(a) ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement between the Company and the Executive relating to
the subject matter hereof, and supersedes any previous
agreements, commitments and understandings, written or oral,
with respect to the matters provided herein other than with
respect to the letter from the Company dated December 30,
1999. As used in this Agreement, terms such as "herein,"
"hereof," "hereto" and similar language shall be construed to
refer to this entire
-29-
<PAGE>
instrument and not merely the paragraph or sentence in which
they appear, unless so limited by express language.
(b) ASSIGNMENT. Except as set forth below, this Agreement and the
rights and obligations contained herein shall not be
assignable or otherwise transferable by either party to this
Agreement without the prior written consent of the other party
to this Agreement. Notwithstanding the foregoing, any amounts
owing to the Executive upon his death shall inure to the
benefit of his heirs, legatees, personal representatives,
executor or administrator.
(c) NOTICES. Any and all notices provided for under this Agreement
shall be in writing and hand delivered or sent by first class
registered or certified mail, postage prepaid, return receipt
requested, addressed to the Executive at his residence or to
the Company at its usual place of business, and all such
notices shall be deemed effective at the time of delivery or
at the time delivery is refused by the addressee upon
presentation.
(d) AMENDMENT/WAIVER. No provision of this Agreement may be
amended, waived, modified, extended or discharged unless such
amendment, waiver, extension or discharge is agreed to in
writing signed by both the Company and the Executive.
(e) APPLICABLE LAW. This Agreement and the rights and obligations
of the parties hereunder shall be construed, interpreted, and
enforced in accordance with the laws of the State of New York
(applicable to contracts to be performed wholly within such
State).
(f) SEVERABILITY. The Executive hereby expressly agrees that all
of the covenants in this Agreement are reasonable and
necessary in order to protect the Company and its
-30-
<PAGE>
business. If any provision or any part of any provision of
this Agreement shall be invalid or unenforceable under
applicable law, such part shall be ineffective only to the
extent of such invalidity or unenforceability and shall not
affect in any way the validity or enforceability of the
remaining provisions of this Agreement, or the remaining parts
of such provision.
(g) SUCCESSOR OF INTERESTS. In the event the Company merges or
consolidates with or into any other corporation or
corporations, or sells or otherwise transfers substantially
all of its assets to another corporation, the provisions of
this Agreement shall be binding upon and inure to the benefit
of the corporation surviving or resulting from the merger or
consolidation or to which the assets are sold or transferred
and, prior to the consummation of any such event, the Company
shall obtain the express written assumption of this Agreement
by the other corporation (other than in the case of a merger
after which the Company is the surviving entity). All
references herein to the Company refer with equal force and
effect to any corporate or other successor of the corporation
that acquires directly or indirectly by merger, consolidation,
purchase or otherwise, all or substantially all of the assets
of the Company.
(h) NO MITIGATION. The Executive shall not be required to mitigate
amounts payable pursuant to Section (11) hereof by seeking
other employment or otherwise.
16. INDEMNIFICATION. The Company shall indemnify the Executive to the full
extent permitted by law and the By-laws of the Company for all
expenses, costs, liabilities and legal fees which the Executive may
incur in the discharge of all his duties hereunder, including, without
limitation, the right to be paid in advance by the Company for his
expenses in defending a civil or criminal action, proceeding or
investigation prior to the final disposition
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<PAGE>
thereof. The Executive shall be insured under the Company's Directors'
and Officers' Liability Insurance Policy as in effect from time to
time. Notwithstanding any other provision of this Agreement to the
contrary, any termination of the Executive's employment or of this
Agreement shall have no effect on the continuing operations of this
Section (16).
17. AUTHORITY. The execution, delivery and performance of this Agreement
has been duly authorized by the Company and this Agreement represents
the valid, legal and binding obligation of the Company, enforceable
against the Company according to its terms.
IN WITNESS WHEREOF, the Company has caused this Agreement to be executed on its
own behalf and has caused its corporate seal to be affixed, and the Executive
has executed this Agreement on his own behalf intending to be legally bound, as
of the date first written above.
QUEST DIAGNOSTICS INCORPORATED
BY:_________________________________
ATTEST:
Secretary
EXECUTIVE:
---------------------------------
Kenneth W. Freeman
Dated:______________________________
-32-
<PAGE>
Exhibit 21
AS OF FEBRUARY 22, 2000
QUEST DIAGNOSTICS INCORPORATED (DE)
SUBSIDIARIES AND JOINT VENTURES
<TABLE>
<S> <C>
100% Quest Diagnostics Holdings, Inc. f/k/a SBCL, Inc. (DE)
100% Quest Diagnostics Clinical Laboratories, Inc.,
(f/k/a/ SmithKline Beecham Clinical Laboratories, Inc.)(DE)
100% Quest Diagnostics LLC (AZ)
100% Quest Diagnostics Clinical Laboratories of Missouri LLC (MO)
(33-l/3%) Compunet Clinical Laboratories (OH)
(44%) Mid America Clinical Laboratories (IN)
(49%) Diagnostic Laboratory of Oklahoma (OK)
100% Quest Diagnostics Ventures LLC (DE)
100% Quest Diagnostics Receivables Inc. (DE)
100% Quest Holdings Incorporated (DE)
51% Quest Diagnostics of Missouri LLC (MO)
100% Quest Holdings Incorporated (MD)
100% Quest Diagnostics Incorporated (MD)
100% Diagnostic Reference Services Inc. (MD)
50% Pathology Building Partnership (MD) (gnl pshp)(1)
100% Quest Holdings Inc. (MI)
100% Quest Diagnostics Incorporated (CA)
100% Quest Diagnostics LLC (IL)
100% Quest Diagnostics Incorporated (MI)
100% Laboratory Holdings Incorporated (MA)
100% Quest Diagnostics Incorporated (CT)
100% Quest Diagnostics Incorporated (MA)
100% Quest Diagnostics of Pennsylvania Inc. (DE)
100% Quest Diagnostics Incorporated (OH)
100% Medical Management Systems, Inc. (PA)
51% Quest Diagnostics Venture LLC (PA)
53.5% Associated Clinical Laboratories (PA) (gen pshp)
50% Surgical Eye Enterprise L.P. (PA) (ltd pshp)
50% Surgical Eye Institute L.P. (PA) (ltd pshp)
100% Quest Diagnostics Investments Incorporated (DE)
100% Quest Diagnostics Finance Incorporated (DE)
100% DPD Holdings Inc. (DE)
100% MetWest Inc. (DE)
100% Quest Diagnostics of Arizona Incorporated (DE)
49% Sonora Quest Laboratories LLC (AZ)
100% Quest MRL Inc. (DE)
- ----------
(1) Other 50% interest held by Quest Diagnostics Incorporated (MD)
<PAGE>
100% Nichols Institute Diagnostics (CA)
100% Nichols Institute Sales Corporation (U.S.V.I.)
100% Nichols Institute Diagnostics Limited (U. K.)
100% Nichols Institute Diagnostics Trading S.A. (Switzerland)
100% Nichols Institute Diagnostika GMBH (Germany)
100% Nichols Institute Diagnostika GMBH (Austria)
100% Nichols Institute International Holding B.V. (Netherlands)
100% Nichols Institute Diagnostics B.V. (Netherlands)
100% Nichols Institute Diagnostics SARL (France)
100% Quest Diagnostics do Brasil Ltda. S.C. (Brazil)
100% Quest Diagnostics Limited (UK)
100% Nomad-Massachusetts, Inc. (MA)
100% Quest Laboratorios Clinicos, S.A. de C.V. (Mexico)
100% Analisis, S.A. (Mexico)
100% Laboratorios Clinicos de Mexico, S.A. de C.V. (Mexico)
100% Servicios de Laboratorio, S.A. de C.V. (Mexico)
100% Laboratorios de Frontera Polanco, S.A. de C.V. (Mexico)
100% Laboratorio de Analisis Biomedicos, S.A. (Mexico)
100% New England Medical Laboratory Inc.*
100% Stat Toxicology Service of Boston Inc.*
100% MetPath Europe Limited (U.K.)*
</TABLE>
- ----------
* In process of dissolution
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-17077, 333-17079, 333-17083, 333-60477,
333-66177, 333-74103 and 333-85713) of Quest Diagnostics Incorporated of our
report dated January 24, 2000, except as to Note 17 which is as of March 13,
2000, relating to the financial statements and financial statement schedule,
which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
- --------------------------------
PricewaterhouseCoopers LLP
New York, New York
March 29, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0001022079
<NAME> QUEST DIAGNOSTICS INCORPORATED
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1999 JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1999 DEC-31-1998 DEC-31-1997
<EXCHANGE-RATE> 1 1 1
<CASH> 27,284 202,908 161,661
<SECURITIES> 0 0 0
<RECEIVABLES> 660,806 291,562 328,239
<ALLOWANCES> 121,550 70,701 89,870
<INVENTORY> 52,302 31,164 30,360
<CURRENT-ASSETS> 872,661 578,187 571,884
<PP&E> 795,445 589,530 576,418
<DEPRECIATION> 367,467 349,141 326,195
<TOTAL-ASSETS> 2,878,481 1,360,240 1,400,928
<CURRENT-LIABILITIES> 701,244 309,465 295,146
<BONDS> 1,171,442 413,426 482,161
1,000 1,000 1,000
0 0 0
<COMMON> 444 302 300
<OTHER-SE> 861,618 566,628 540,360
<TOTAL-LIABILITY-AND-EQUITY> 2,878,481 1,360,240 1,400,928
<SALES> 0 0 0
<TOTAL-REVENUES> 2,205,243 1,458,607 1,528,695
<CGS> 1,379,989 <F1> 896,793 <F1> 962,935 <F1>
<TOTAL-COSTS> 2,203,429 1,342,678 1,429,987
<OTHER-EXPENSES> 2,811 6,968 4,131
<LOSS-PROVISION> 142,333 89,428 118,223
<INTEREST-EXPENSE> 61,450 33,403 40,996
<INCOME-PRETAX> 14,384 53,861 (19,058)
<INCOME-TAX> 15,658 26,976 3,202
<INCOME-CONTINUING> (1,274) 26,885 (22,260)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> (2,139) 0 0
<CHANGES> 0 0 0
<NET-INCOME> (3,413) 26,885 (22,260)
<EPS-BASIC> (0.10) 0.90 (0.77)
<EPS-DILUTED> (0.10) 0.89 (0.77)
<FN>
<F1> During 1999, the Company reclassified certain expense items, primarily
related to a portion of occupancy costs and professional liability insurance
expense items, from selling, general and administrative expenses to cost of
services, to better reflect the cost of performing testing. All prior year
financial information has been reclassified for comparative purposes to conform
with the 1999 presentation.
</FN>
</TABLE>
