<PAGE>
Filed Pursuant to Rule 424(B)(3)
File No. 333-93967
PROSPECTUS
Offer to Exchange All 12 3/4% Senior Subordinated Notes due 2009
for 12 3/4% Senior Subordinated Notes due 2009, Which Have Been Registered
Under the Securities Act of 1933, As Amended, of
UNILAB CORPORATION
The Exchange Offer will expire at 5:00 P.M.,
New York City time, on February 17, 2000, unless extended.
[LOGO OF UNILAB APPEARS HERE]
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Terms of the Exchange Offer:
. We will exchange all outstanding Old Notes that are validly tendered and
not withdrawn prior to the expiration of the Exchange Offer.
. You may withdraw tenders of Old Notes at any time prior to the
expiration of the Exchange Offer.
. We believe that the exchange of Old Notes will not be a taxable exchange
for U.S. federal income tax purposes but you should see "Material
Federal Income Tax Considerations" beginning on page 115 for more
information.
. We will not receive any proceeds from the Exchange Offer.
. The terms of the New Notes are substantially identical to the
outstanding Old Notes, except that the New Notes are registered under
the Securities Act and the transfer restrictions and registration rights
relating to the Old Notes do not apply to the New Notes.
----------------
A discussion of risks that should be considered by holders prior to tendering
their Old Notes is set forth under "Risk Factors" beginning on page 14.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
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The date of this prospectus is January 18, 2000
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We have not authorized any dealer, salesperson or other person to give any
information or represent anything not contained in this prospectus. You must
not rely on unauthorized information. This prospectus does not offer to sell
or buy any shares in any jurisdiction where it is unlawful. The information in
this prospectus is current as of January 18, 2000. However, you should realize
that our affairs may have changed since the date of this prospectus.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Forward-Looking Statements....... ii
Prospectus Summary............... 1
Risk Factors..................... 14
The Recapitalization............. 22
Use of Proceeds.................. 24
Capitalization................... 25
Unaudited Pro Forma Financial
Statements...................... 26
Selected Historical Financial
Data............................ 35
Management's Discussion and
Analysis of Financial Condition
and Results of Operations....... 37
Business......................... 46
Management....................... 63
</TABLE>
<TABLE>
<CAPTION>
Page
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<S> <C>
Security Ownership of Certain
Beneficial Owners and
Management...................... 66
The Exchange Offer............... 67
Description of New Credit
Facility........................ 74
Description of the Notes......... 77
Book-Entry; Delivery and Form.... 110
Exchange Offer; Registration
Rights.......................... 112
Material Federal Income Tax
Considerations.................. 115
Plan of Distribution............. 119
Legal Matters.................... 119
Independent Auditors............. 119
Where to Find More Information... 120
Index to Financial Statements.... F-1
</TABLE>
i
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FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements regarding, among other
things, our financial condition and business strategy. You can identify these
statements by the fact that they do not relate strictly to historical or
current facts. They use words like "believe," "may," "will," "expect,"
"intend," "plan," "anticipate," "estimate" or "continue" and other words and
terms of similar meaning. These forward-looking statements are based on
current expectations about future events. While we believe these expectations
are reasonable, such forward-looking statements are inherently subject to
risks, uncertainties and assumptions, including the following, among other
things:
. potential adverse actions by governmental or other third-party payors,
including Medicare and Medicaid;
. the importance of managed care providers in California;
. extensive and frequently changing governmental regulation of the
clinical laboratory testing industry;
. government investigations of our marketing and billing practices;
. complexities in billing for laboratory testing services;
. difficulties in integrating any acquired businesses;
. technological changes leading to the development of cost-effective
point-of-care testing that reduces the need for independent laboratory
testing services;
. our dependence upon key members of our management team;
. intense competition in the industry; and
. our exposure to professional liability and other litigation.
ii
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PROSPECTUS SUMMARY
In this prospectus, "Unilab Finance" refers to Unilab Finance Corp., "UC
Acquisition" refers to UC Acquisition Sub, Inc. and, unless otherwise
indicated, "Unilab," "we," "our" and "us" refer to Unilab Corporation.
Currently, we do not have any subsidiaries. Unless stated otherwise, all our
pro forma information in this prospectus give effect to (1) the
recapitalization and (2) the recent acquisitions of substantially all of the
assets of Meris Laboratories, Inc. and Physicians Clinical Laboratories, Inc.,
which operated under the name Bio-Cypher Laboratories, in each case as of the
dates or at the beginning of the periods specified and as further described in
the "Unaudited Pro Forma Financial Statements" section. Both the
recapitalization and the recent acquisitions are described below in this
summary in more detail. Unless stated otherwise, aggregate employee data in
this prospectus are adjusted to reflect the number of "full-time equivalent"
employees. The number of full-time equivalent employees is calculated by
aggregating the number of payroll hours worked by all employees and dividing
the total by a standard 40-hour work week. The following summary highlights
selected information from this prospectus and may not contain all of the
information that is important to you. For a more complete understanding of this
offering, you are encouraged to read this entire document and the documents
incorporated by reference into this prospectus.
Unilab Corporation
We are the largest independent clinical laboratory testing company in
California, providing comprehensive laboratory testing services to physicians,
managed care groups, hospitals and other health care providers. We perform over
1,000 different tests which help physicians diagnose, evaluate, monitor and
treat disease by measuring the presence, concentrations or composition of
chemical and cellular components in human body fluids and tissue. These tests
range from simple tests, such as glucose monitoring, to highly specialized
ones, such as those designed to measure HIV infection. On a pro forma basis, we
believe our revenues in California for the year ended December 31, 1998
represented approximately 25% of the California independent clinical laboratory
testing market, or more than twice the annual sales of the next largest
independent clinical laboratory in California. On a pro forma basis, for the
nine months ended September 30, 1999, we would have generated revenue of $232.0
million.
We operate our fully integrated collection and processing system 365 days a
year, 24 hours a day. Patient specimens are collected daily from clients'
offices or our own collection stations known as patient service centers.
Specimens are then transported to either full-service or short turn around time
("STAT") laboratories. STAT laboratories are local facilities where we can
quickly perform an abbreviated line of routine tests for customers that require
emergency or time-sensitive testing services. Once the specimens are received
at the laboratories, each specimen and related test request form is checked for
completeness, bar coded and entered into our computer system for testing and
billing purposes. Laboratory technicians then perform the requested tests, with
results generally available to clients the next morning electronically.
The clinical laboratory testing industry is essential to America's health
care delivery system because physicians must rely on accurate testing
information to properly assess and remedy their patients' health conditions. We
believe that the U.S. clinical laboratory testing market accounts for
approximately 3%, or approximately $30 billion, of the nation's total annual
healthcare expenditures. The clinical laboratory testing industry in the United
States is composed of three segments: (1) laboratories located in hospitals,
(2) laboratories located in physicians' offices and laboratories owned by
physicians and (3) independent clinical laboratories. Management believes that
the California clinical laboratory testing market is approximately $4.0 billion
in size and is the largest in the nation. Despite significant industry
consolidation, the clinical laboratory testing market nationally, and
particularly in California, remains highly fragmented. We directly compete in
the approximately $1.2-$1.4 billion independent clinical laboratory testing
sector within California.
1
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Recent Acquisitions
We have acquired and integrated six companies in the past five years.
Recently we completed two acquisitions which have in large part served to
increase our market share from approximately 15% to approximately 25% of
California's independent clinical laboratory testing market. In reviewing the
merits of a potential acquisition, our management develops a highly detailed
integration plan by examining the target's existing operations and assessing
the ongoing requirements of the combined businesses. The actual results and
timing of an integration are closely monitored against the plan.
Meris Acquisition. In November 1998, we acquired substantially all of the
assets of Meris Laboratories, Inc., an independent laboratory which was based
in San Jose, California. Meris was one of our principal competitors in the
California clinical laboratory testing market. We acquired Meris primarily to
expand our market penetration in the Marin County, Berkeley and Newport Beach
regions, increase utilization of our existing San Jose laboratory and eliminate
redundant costs. Following the acquisition, we reduced employees formerly
employed by Meris from approximately 450 to 220. In addition, we closed Meris'
main testing center which processed approximately 3,200 specimens per day and
reduced the number of STAT laboratories and patient service centers from
approximately 85 to 55. As a result, we estimate that we were able to eliminate
over $19 million of annual expenses, generating an EBITDA margin on the
incremental revenue of approximately 32%, while retaining a substantial
majority of Meris' clients and improving service levels. Within approximately
two months of completing the acquisition, we had substantially integrated the
Meris business and realized most of the significant synergies planned in the
consolidation.
Bio-Cypher Acquisition. In May 1999, we acquired substantially all of the
assets of Physicians Clinical Laboratories, Inc., an independent laboratory
which operated under the name Bio-Cypher Laboratories and was headquartered in
Sacramento, California. Bio-Cypher was one of our principal competitors in the
California independent clinical laboratory testing market, with a majority of
Bio-Cypher's revenue being generated from the greater Sacramento area. We
acquired Bio-Cypher to increase our market share, rationalize excess capacity
and capture other synergies from the combination. We expect to realize
significant cost savings by eliminating Bio-Cypher's main testing laboratory,
which currently processes over 8,500 specimens per day, reducing employees from
approximately 855 to 350 and consolidating redundant STAT laboratories and
patient service centers from approximately 180 to 50. We have completed an
expansion program in our Sacramento laboratory to accommodate the increased
volume from the Bio-Cypher acquisition. We believe that annual cost savings
from the Bio-Cypher acquisition will exceed approximately $26 million. We fully
integrated the Bio-Cypher business in September 1999.
Through the acquisitions of Meris and Bio-Cypher, we significantly expanded
our annual specimen levels and revenues and were able to benefit from
substantial operating synergies. The following table sets forth certain
estimated statistics of our stand-alone business as of October 31, 1998 (prior
to the Meris and Bio-Cypher acquisitions), the Meris and Bio-Cypher businesses
immediately prior to their respective acquisitions and our pro forma statistics
reflecting base business growth through June 30, 1999, both acquisitions and
all acquisition-related synergies.
<TABLE>
<CAPTION>
Bio- Net Pro forma
Unilab Meris Cypher Adjustments Unilab
--------- ------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Principal laboratories..... 3 1 1 (2) 3
STAT laboratories.......... 31 9 14 (14) 40
Patient service centers.... 222 76 166 (159) 305
Employees.................. 2,320 450 855 (675) 2,950
Annual specimens........... 8,500,000 840,000 2,250,000 410,000 12,000,000
Specimens per day.......... 32,500 3,200 8,500 1,400 45,600
Specimens per employee per
day....................... 14.0 7.1 9.9 15.5
</TABLE>
2
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Competitive Strengths
We attribute our leading position in the California independent clinical
laboratory testing market and our significant opportunities for continued
profitable growth to the following competitive strengths:
Market Leader in California. We are the largest independent clinical
laboratory testing company in California with a market share of approximately
25%, more than twice that of our next largest competitor. Our strong regional
presence and reputation for superior customer service and support make us the
preferred provider of laboratory testing services to physicians and other
customers seeking superior patient access and service reliability. We currently
serve approximately 40,000 customers and have approximately 150 managed care
contracts, covering approximately 3.8 million managed care lives.
Superior Regional Infrastructure. Our fully integrated and expansive field-
service network gives us a unique competitive advantage in California's
clinical laboratory testing market by offering greater geographic coverage and
convenience to our clients and their patients. We currently operate more
client-support facilities than any of our competitors in California. We will
operate three full-service laboratories (in Los Angeles, San Jose and
Sacramento), approximately 305 conveniently located patient service centers and
40 strategically located STAT laboratories. Our 420 courier routes and 36
courier hubs will continue to provide rapid collection, processing and
distribution services to clients. We assess the characteristics of each
geographic territory to customize professional service routes that ensure
proper specimen collection and report distribution which enable us to offer
highly effective services to the different needs of rural and high traffic
urban areas in California.
Low Cost Provider. We enjoy cost advantages gained through economies of scale
and efficient processes. Our management believes our cost per specimen is the
lowest in the California market. We have created a fully integrated collection,
testing, distribution and operating system which is characterized by a high
degree of operating leverage, allowing us to expand testing capacity at a very
low incremental cost. Meris and Bio-Cypher historically had average costs per
specimen of approximately $43.00 and $27.00, respectively. Following the
acquisitions, Meris has, and Bio-Cypher is expected to have, average costs per
specimen of approximately $21.00 and $16.00, respectively. Our management
expects these average cost per specimen reductions to generate annual cost
savings of approximately $45 million. Our management believes that we have the
capacity to process approximately 60,000 specimens per day, allowing an
increase of approximately 32.0% over the current level of 45,600 specimens per
day, without the need for significant additional operating expenses or capital
expenditures. This operating leverage should enable us to experience cash flow
growth while achieving our market share growth objectives.
Comprehensive Testing Services. We are able to provide our customers with
"one-stop-shopping" by offering a full spectrum of testing services to the
medical community. We perform approximately 99% of ordered tests, including
most esoteric tests, in-house. The balance is referred to subcontracted
specialty laboratories. We maintain a policy of expanding our testing menu only
when there is sufficient volume and economic justification. Accordingly,
favorable partnering relationships with several other laboratories facilitate
our ability to optimize our in-house test menu under a "make versus buy" cost-
based analysis. We believe that new testing procedures such as amplified DNA
probes for chlamydia and gonorrhea testing and emerging cytology (PAP smear)
technology offer two examples of possible additional future revenue growth from
technology. Conversion from non-amplified to amplified probes not only provides
for more specific and definitive test results, but also provides for a higher
level of reimbursement. Conversion to the newer emerging PAP smear technology
provides similar benefits both to the patient and to us. Our management
believes that increased marketing support of both of these new technologies
will have a positive effect on future revenue.
Reputation for Quality. Clinical laboratory testing is an essential element
in the delivery of quality healthcare service because physicians use laboratory
tests to assist in detecting, diagnosing, evaluating, monitoring and treating
diseases and other medical conditions. Approximately 70% of total healthcare
3
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expenditures in the United States are determined on the basis of laboratory
test results. We employ a quality assurance program for all of our laboratories
and facilities designed to ensure that specimens are collected and tested, and
client, patient and test information is reported, billed and filed in a timely
and accurate manner. Each of our three full-service laboratories has earned
full accreditation by the College of American Pathology. Over the past four
years, our accuracy rates, as determined by the College of American Pathology,
have increased from 99.2% in 1994 to over 99.5% in 1998. Our management
believes that our accuracy rates are among the highest in the industry.
Proven and Committed Management Team with Substantial Local Market
Knowledge. We have a proven management team with extensive experience in the
California clinical laboratory testing industry, including significant
expertise in identifying, effecting and integrating acquisitions within the
California market. We have strengthened our existing management team with the
addition of Robert E. Whalen, who became our President and Chief Executive
Officer on November 23, 1999. Mr. Whalen was previously an Executive Vice
President of Laboratory Corporation of America and National Health
Laboratories. Mr. Whalen has over 20 years of experience in the clinical
laboratory testing industry, with over 10 of those years in California. David
C. Weavil, our former Chairman, President and Chief Executive Officer, is
expected to continue to have an active role in management and planning and will
remain Chairman. Our five most senior executives collectively have over 80
years of clinical laboratory testing experience. Moreover, approximately 70% of
our 200 employees in supervisory or managerial roles have been employed at our
company for five years or more. Upon completion of the recapitalization, our
management team will own or have the opportunity to acquire through a stock
option plan up to 15% of our common stock.
Business Strategy
Our overall goal is to continue to be recognized as the preeminent
independent clinical laboratory testing organization in California. To
accomplish this goal, we employ the following business strategies:
Maintain Customer Satisfaction through Superior Service Quality. We achieve a
high level of customer satisfaction through superior customer service and seek
to maintain what our management believes is our reputation as the highest
quality provider of clinical laboratory testing services in California. Our 75-
member sales and service staff is responsible for visiting existing and
prospective accounts regularly to educate them about our capabilities and
general laboratory issues and, in the case of existing accounts, to identify
ways to improve existing services. We also operate a customer service hotline
to assist customers with service issues and billing inquiries. Doctors can
receive patient test results via an automated telephone system 24 hours a day.
To ensure the integrity of our tests, we standardized and automated our
collection, testing and billing processes. Such standardized controls and
techniques include utilizing specialized pouches and preprinted requisition
forms for proper processing, as well as utilizing computer bar coding and log-
in techniques for proper testing and billing. Our goal is to remain the
provider of choice in California and to utilize our established brand name and
reputation for quality to compete on factors other than price.
Continue to Improve Terms of Contracts. We have a company-wide policy to
partner with our customers, especially managed care customers, in an effort to
effect greater correlation between price and service levels based on the
following three strategies: (1) increase "at risk" capitation rates to achieve
greater coverage of incremental testing costs; (2) reduce our incurred costs
that do not add value to patient care and (3) restructure contracts to exclude
some non-core "premium" services, such as PAP smears and esoteric tests, from
the "at risk" capitation rate. For example, we restructured a major contract in
early 1998 by increasing the capitation rate by more than 50%, with an
additional 50% step-up beginning in 1999. In addition, we passed all expenses
associated with six supporting STAT laboratories and 10 patient service centers
to the customer, expenses which would have previously been included in the
capitation rate. In 1997, we repriced over 70% of our managed care contracts
with a 50% average price increase and in 1998 we repriced 40% of our managed
care contracts with a 30% average price increase. We have established this
partnering approach as a longer-term strategy and have instituted a quarterly
contract-specific review process to achieve this goal.
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Grow Market Share through Refocused Sales and Marketing Efforts. We intend to
intensify our sales and marketing activities. We believe there are significant
opportunities to gain market share from other commercial laboratories. To
accomplish this, we intend to have a clearer delineation between sales and
service activities. We also believe there are considerable opportunities to
increase our hospital reference testing business and enter into laboratory
management agreements with hospitals, a segment which is largely unpenetrated
by us. Hospital laboratories account for approximately $2.0 billion of the
approximately $4.0 billion California clinical laboratory testing market. We
will also expand our effort to reduce client turnover through reorganized
sales, service and marketing functions. We intend to dedicate existing sales
force personnel to focus solely on these opportunities.
Maximize Operating Efficiencies. Although we have realized significant
expense reductions over the past two years, management believes there are
significant additional cost savings that can be attained over the near term.
For example, we expect to achieve further cost reductions through test menu
consolidations, continued process and workflow scheduling improvements and
consolidations of patient service centers and STAT laboratories. Our management
also expects to reduce expenses for lab subcontracting, overtime and supplies.
In addition, our management team expects to reduce our bad debt expense through
an increased emphasis on correct billing information.
Pursue Selected Acquisitions. In addition to seeking to maximize internal
growth, we will continue to opportunistically pursue selected acquisition
opportunities. We believe that independent laboratories with annual revenues of
less than $20 million make up over 40% of the California independent clinical
laboratory testing market. We believe that our expansive service network and
operating discipline effectively position us to be a logical consolidator
within the fragmented California market. In evaluating potential acquisition
targets, we will continue to focus on financially and ethically sound
businesses with one or more of the following characteristics: overlapping
field-service networks for highly synergistic "fold-in" acquisitions, such as
the Meris and Bio-Cypher acquisitions; strong geographic presence in regions
where we may desire to attain greater market share and quality customer bases
possessing favorable pricing characteristics.
The Recapitalization
On May 24, 1999, we entered into an agreement with UC Acquisition, which is
owned by affiliates of Kelso & Company, under which UC Acquisition merged with
and into our company. The merger was completed on November 23, 1999. With the
completion of the merger, 93.0% of our common stock is owned by the Kelso
affiliates and designees and management. The remaining 7.0% of our common stock
is held by a limited number of investors.
This merger was a part of our recapitalization. The other principal features
of the recapitalization included:
. the conversion into cash of approximately 44.8 million shares of our
common stock at $5.85 per share, the conversion into cash of 364,000
shares of our preferred stock at $5.75 per share and the accelerated
vesting and either the cancellation or retention of outstanding stock
options, for total cash consideration of up to $280.6 million; and
. the retirement of $144.5 million of our existing debt, consisting of
$119.5 million of 11% senior notes due 2006 and $25.0 million of 7.5%
notes.
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We financed the recapitalization with:
. a new common equity investment of $139.5 million from funds provided by
the affiliates and designees of Kelso and a $11.1 million equity
rollover from certain existing shareholders of approximately 1.9 million
shares of our currently outstanding stock into approximately 7.4% of our
post-merger common stock;
. approximately $31.3 million of cash from us;
. a new senior bank credit facility consisting of $160.0 million in term
loans and $2.0 million of borrowings under a $25.0 million revolving
credit facility; and
. $150.8 million from the issuance of the Old Notes.
In addition, if our ratio of net total debt to EBITDA (as defined in a
capital call agreement) for the year 2000 is greater than 5.0 times, the Kelso
affiliates that control us will be required, pursuant to the capital call
agreement, to make (or cause their designees to make) an equity investment of
up to $50.0 million to the extent necessary for us to reduce the ratio to 5.0
times. The indenture governing the Notes will contain a covenant requiring us
to receive such equity investment to the extent required by the new credit
facility.
The following table sets forth the expected sources and uses of funds in
connection with the recapitalization, as if it had occurred on September 30,
1999:
<TABLE>
<CAPTION>
Sources of Funds: Amount
- ----------------- -------------
(in millions)
<S> <C>
Cash(1)................... $ 31.3
Revolving credit facili-
ty(1).................... 2.0
Term loans................ 160.0
The Notes................. 150.8
Common equity invest-
ment(2).................. 150.6
------
Total sources of funds.. $494.7
======
</TABLE>
- --------
(1) Our cash on hand increased by the time our merger with UC Acquisition was
completed so that we did not have to borrow any funds under the revolving
credit facility.
<TABLE>
<CAPTION>
Use of Funds: Amount
- ------------- -------------
(in millions)
<S> <C>
Merger consideration(3)... $291.7
Repayment of existing
debt(4).................. 144.5
Estimated fees and ex-
penses................... 58.5
------
Total uses of funds..... $494.7
======
</TABLE>
(2) Includes $139.5 million from the Kelso affiliates and designees and a
retained common equity interest of $11.1 million (valued at the $5.85 per
share merger price).
(3) Includes cash merger consideration of $280.6 million and retained equity
interest of $11.1 million. The cash merger consideration will be used to
liquidate our current outstanding common and preferred stock that is not
part of the retained interest, including the shares of common stock that
were issued upon conversion of a $14.0 million 7.5% convertible
subordinated note issued in connection with the Meris acquisition.
(4) Gives effect to the tendering of 99.6% of the senior notes in a tender
offer completed on November 23, 1999.
Our common stock is currently listed on the American Stock Exchange under the
symbol "ULB." With the completion of the merger, we anticipate that our common
stock will no longer be listed.
For more information on the recapitalization, see "The Recapitalization"
section.
6
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The Exchange Offer
On September 28, 1999, Unilab Finance issued and sold $155,000,000 aggregate
principal amount of 12 3/4% Senior Subordinated Notes (the "Old Notes") in an
offering exempted from registration under the Securities Act. Concurrently with
the closing of the offering, Unilab Finance deposited the net proceeds of the
offering with an escrow agent. As part of our recapitalization, we assumed the
obligations of Unilab Finance under the Old Notes and related indenture on
November 23, 1999 and used the escrowed funds deposited by Unilab Finance to
finance our recapitalization and related transactions. In this exchange offer,
you may exchange your outstanding Old Notes for New Notes which have
substantially the same terms. You should read the discussion under the headings
"The Exchange Offer" and "Description of Notes" for further information
regarding the New Notes to be issued in the exchange offer.
Securities Offered........ We are offering up to $155,000,000 aggregate
principal amount of new 12 3/4% Senior Subordinated
Notes due 2009 which have been registered under the
Securities Act (the "New Notes"). The form and
terms of the New Notes are identical in all
material respects to those of the Old Notes. The
New Notes, however, will not contain certain
transfer restrictions, registration rights and
liquidated damages provisions relating to the Old
Notes. The Old Notes may be exchanged for New Notes
under the exchange offer described in this
prospectus under the headings "The Exchange Offer"
and "Exchange Offer; Registration Rights."
Tenders; Expiration Date;
Withdrawal of Tender.....
The Exchange Offer will expire at 5:00 p.m., New
York City time, on February 17, 2000, unless we
extend it. If you decide to exchange your Old Notes
for New Notes, you must acknowledge that you are
not engaging in, and do not intend to engage in, a
distribution of the New Notes. You may withdraw any
Old Notes that you tendered for exchange at any
time prior to 5:00 p.m., New York City time, on
February 17, 2000. If we decide for any reason not
to accept any Old Notes you have tendered for
exchange, those notes will be returned to you
without cost promptly after the expiration or
termination of the exchange offer. See "The
Exchange Offer--Terms of the Exchange Offer; Period
for Tendering Old Notes" and "The Exchange Offer--
Withdrawal Rights."
Certain Conditions to the
Exchange Offer...........
The exchange offer is subject to customary
conditions, which we may waive. Please read the
section "The Exchange Offer--Certain Conditions to
the Exchange Offer" of this prospectus for more
information regarding conditions to the exchange
offer.
Material Federal Tax
Considerations...........
Your exchange of Old Notes for New Notes to be
issued in the exchange offer will not result in any
gain or loss to you for federal income tax
purposes. See "Material Federal Income Tax
Considerations" in this prospectus.
Use of Proceeds........... We will not receive any cash proceeds from the
exchange offer.
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Exchange Agent............ HSBC Bank USA is the Exchange Agent. The address
and telephone number of the Exchange Agent appear
in "The Exchange Offer--Exchange Agent" section.
Consequences of Not
Exchanging Old Notes..... If you do not exchange your Old Notes in the
exchange offer, your Old Notes will continue to be
subject to the restrictions on transfer set forth
in the legend on the certificate for your Old
Notes. In general, you may offer or sell your Old
Notes only if they are registered under, offered or
sold under an exemption from, or offered or sold in
a transaction not subject to, the Securities Act
and applicable state securities laws. We do not
currently intend to register the Old Notes under
the Securities Act. If your Old Notes are not
tendered and accepted in the exchange offer, it may
become more difficult for you to sell or transfer
your Old Notes. Under certain circumstances,
however, certain holders of Old Notes, including
holders who are not permitted to participate in the
exchange offer or who may not freely resell New
Notes received in the exchange offer, may require
us to file and cause to become effective, a shelf
registration statement which would cover resales of
Old Notes by such holders. See "The Exchange
Offer--Consequences of Exchanging or Failing to
Exchange Old Notes" and "Exchange Offer;
Registration Rights."
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Description of the New Notes
The terms of the New Notes and the Old Notes are identical in all material
respects, except:
. the New Notes will have been registered under the Securities Act;
. the New Notes will not contain transfer restrictions and registration
rights that relate to the Old Notes; and
. the New Notes will not contain provisions relating to the payment of
liquidated damages to be made to the holders of the Old Notes under
circumstances related to the timing of the exchange offer.
Where we refer to "Notes" in this prospectus, we are referring to both Old
Notes and New Notes. The summary below describes the principal terms of the
Notes. Some of the terms and conditions described below are subject to
important limitations and exceptions. The "Description of the Notes" section of
this prospectus contains a more detailed description of the terms and
conditions of the Notes.
Securities Offered........ We are offering up to $155,000,000 aggregate
principal amount of 12 3/4% senior subordinated
notes due 2009 which have been registered under the
Securities Act.
Maturity.................. October 1, 2009.
Interest Rate............. 12 3/4% per year, calculated using a 360-day year.
Interest Payment Dates.... April 1 and October 1 beginning on April 1, 2000.
Interest will accrue from the issue date of the
Notes.
Ranking................... The Old Notes are, and the New Notes will be,
unsecured senior subordinated obligations of ours
and will rank junior to all of our existing and
future senior debt. Because the Notes are
subordinated, in the event of bankruptcy,
liquidation or dissolution, holders of Notes will
not receive any payment until holders of senior
debt have been paid in full. As of September 30,
1999, after giving effect to the recapitalization
after giving effect to the tendering of 99.6% of
the senior notes in the tender offer completed on
November 23, 1999, we estimate that we would have
had $166.6 million of senior debt, excluding
approximately $23.0 million that we expect to have
available to borrow under our new credit facility.
Optional Redemption....... We cannot redeem the Notes until October 1, 2004,
except as described below in connection with an
equity offering. At any time on or after October 1,
2004, we may redeem some or all of the Notes at the
redemption prices listed in the "Description of the
Notes" section under the heading "Optional
Redemption," plus accrued interest.
Optional Redemption After
Equity Offerings......... At any time, which may be more than once, before
October 1, 2002, we can choose to redeem up to 35%
of the outstanding Notes with money that we raise
in one or more equity offerings, as long as:
. we pay 112.75% of the face amount of the
Notes, plus accrued interest;
. we redeem the Notes within 90 days of
completing the equity offering; and
9
<PAGE>
. at least 65% of the aggregate principal
amount of Notes issued remains outstanding
afterwards.
Change of Control Offer... If a change of control of our company occurs, each
holder of the Notes will have the opportunity to
sell their Notes to us at 101% of their face
amount, plus accrued interest.
We might not be able to pay you the required price
for Notes you wish to sell at the time of a change
of control, because:
. we might not have enough funds at that time;
or
. the terms of our senior debt may prevent us
from paying.
Asset Sale Proceeds....... If we or any of our restricted subsidiaries engage
in asset sales, we generally must either re-invest
the net cash proceeds from such sales in our
business within a specified period of time, prepay
senior debt or make an offer to purchase a
principal amount of the Notes equal to the excess
net cash proceeds from such asset sales. The
purchase price of the Notes will be 100% of their
principal amount, plus accrued interest.
Certain Indenture
Provisions............... The indenture governing the Notes contains
covenants that, among other things, limit our
ability and the ability of some or all of our
subsidiaries to:
. incur additional debt;
. pay dividends or distributions on our
capital stock or repurchase our capital
stock;
. issue preferred stock of subsidiaries;
. make certain investments;
. create liens on any assets to secure debt;
. enter into transactions with affiliates;
. merge or consolidate with another company;
and
. transfer and sell assets.
These covenants are subject to a number of
important limitations and exceptions.
Risk Factors.............. Investing in the Notes involves substantial risks.
See the "Risk Factors" section for a description of
certain of the risks you should consider before
investing in the Notes.
Executive Offices
Unilab Corporation is a Delaware corporation with principal executive offices
located at 18448 Oxnard Street, Tarzana, California 91356. Our main phone
number is (818) 996-7300.
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<PAGE>
Summary Pro Forma Financial Data
The summary pro forma financial data set forth below have been derived from,
and should be read in conjunction with, the unaudited pro forma financial
statements, including the accompanying notes, appearing elsewhere in this
prospectus. See "Unaudited Pro Forma Financial Statements." The summary pro
forma statement of operations data give effect to both the recapitalization and
the Meris and Bio-Cypher acquisitions as if they had occurred on the first day
of the relevant period and the summary pro forma balance sheet gives effect to
the recapitalization as if it had occurred on September 30, 1999. The summary
unaudited pro forma financial data are presented for illustrative purposes only
and are not necessarily indicative of the operating results or financial
position that would have occurred if the recapitalization and recent
acquisitions had been consummated on the dates indicated, nor are they
necessarily indicative of future operating results or financial position.
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, 1998 September 30, 1999
----------------- ------------------
(dollars in thousands)
<S> <C> <C>
Statement of Operations Data:
Revenue................................. $296,951 $232,021
Gross profit (1)........................ 75,384 67,450
Selling, general and administrative
expense................................ 60,067 33,977
Operating income........................ 4,572 25,561
Interest, net........................... 37,468 27,930
Net income (loss)....................... $(32,616) $ 9,523
Other Financial Data:
Depreciation and amortization........... 10,745 7,912
Capital expenditures (2)................ 3,595 5,188
Gross margin (1)........................ 25.4% 29.1%
</TABLE>
<TABLE>
<CAPTION>
As of
September 30, 1999
----------------------
(dollars in thousands)
<S> <C>
Balance Sheet
Data:
Cash and cash
equivalents.. $ --
Accounts
receivable,
net......... 55,830
Total
assets...... 186,675
Total debt... 317,358
Shareholders'
equity
(deficit)... (163,132)
</TABLE>
- --------
(1) Excludes depreciation and amortization.
(2) Our historical capital expenditures were $3,005,000 and $4,903,00 for the
year ended December 31, 1998 and the nine months ended September 30, 1999,
respectively. Meris' historical capital expenditures were $21,000 for the
nine months ended September 30, 1998, during which time Meris was in
bankruptcy. Bio-Cypher's historical capital expenditures were $569,000 and
$285,000 for the year ended December 31, 1998 and the approximate four-
month period ended May 9, 1999, respectively. Pro forma capital
expenditures are presented for illustrative purposes only and are not
necessarily indicative of the capital expenditures that would have been
incurred if the recapitalization and recent acquisitions had been
consummated on the dates indicated. For further information on capital
expenditures, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources--
Following the Recapitalization."
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<PAGE>
Summary Historical Financial Data
The summary financial data for each of the fiscal years in the three-year
period ended December 31, 1998 have been derived from our audited financial
statements. Such information is contained in and should be read in conjunction
with the audited financial statements and accompanying notes included in this
prospectus.
The summary financial data for the nine months ended September 30, 1998 and
1999 have been derived from our unaudited interim financial statements, which
in the opinion of management include all adjustments, consisting only of normal
recurring adjustments, which we consider necessary for a fair presentation of
our financial position and results of operations for these periods. Operating
results for the nine months ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the full year. The nine
month data should be read in conjunction with our unaudited financial
statements for the nine months ended September 30, 1998 and 1999 included
elsewhere in this prospectus.
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
---------------------------- --------------------------
1996 1997 1998 1998 1999
-------- -------- -------- ------------ ------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue............... $205,217 $214,001 $217,370 $ 162,046 $ 213,496
Direct laboratory and
field expenses....... 154,172 155,942 152,007 111,634 147,133
Legal, acquisition and
restructuring related
charges.............. 70,595 -- -- -- 600
Selling, general and
administrative
expense.............. 41,801 34,570 33,530 24,990 29,323
Operating income
(loss)............... (72,842) 14,604 24,241 19,648 29,251
Third party interest,
net.................. (13,401) (14,068) (13,538) (10,068) (11,244)
Related party
interest, net........ 1,279 -- -- -- --
Loss on sale of
promissory note...... 4,529 -- -- -- --
Income (loss) before
income taxes and
extraordinary item... (89,493) 536 10,703 9,580 18,007
Income tax benefit.... -- -- -- -- 11,904
Income (loss) before
extraordinary item... (89,493) 536 10,703 9,580 29,911
Extraordinary item.... 3,451 -- -- -- --
Net income (loss)..... $(92,944) $ 536 $ 10,703 $ 9,580 $ 29,911
Other Financial Data:
EBITDA(1)............. $ 9,244 $ 23,489 $ 31,833 $ 25,422 $ 37,040
Depreciation and
amortization......... 11,491 8,885 7,592 5,774 7,189
Capital expenditures.. 3,948 1,935 3,005 2,335 4,903
Ratio of earnings to
fixed charges(2)..... --(3) 1.03x 1.60x 1.73x 2.17x
<CAPTION>
As of September 30, 1999
--------------------------
(dollars in thousands)
<S> <C>
Balance Sheet Data:
Cash, cash equivalents and restricted cash....... $ 31,250
Accounts receivable, net......................... 55,830
Total assets..................................... 213,400
Total debt....................................... 162,541
Shareholders' equity............................. 12,036
</TABLE>
- --------
(1) "EBITDA" is defined as net income (loss) before interest expense, income
taxes, depreciation and amortization, non-recurring charges and
extraordinary items. EBITDA is not a measure of performance under GAAP.
While EBITDA should not be considered in isolation or as a substitute for
net income, cash
12
<PAGE>
flows from operating activities and other income or cash flow statement data
prepared in accordance with GAAP, or as a measure of profitability or
liquidity, management understands that EBITDA is customarily used as a
criteria in evaluating health care companies. Moreover, substantially all of
our financing agreements contain covenants in which EBITDA is used as a
measure of financial performance. Excludes non-recurring charges of $70.6
million for 1996 and $0.6 million for the first nine months of 1999.
(2) For purposes of determining the ratio of earnings to fixed charges,
earnings are defined as income before income taxes plus fixed charges.
Fixed charges include interest expense on all debt, amortization of
deferred financing costs and one-third of rental expense on operating
leases representing that portion of rental expense deemed to be
attributable to interest.
(3) Earnings were insufficient to cover fixed charges in 1996 by $89,493.
13
<PAGE>
RISK FACTORS
You should carefully consider the following factors in addition to the other
information in this prospectus before investing in the Notes.
Our substantial debt could adversely affect our financial health and prevent
us from fulfilling the obligations under the New Notes.
As a result of the recapitalization, we will have a significant amount of
debt. After giving effect to the recapitalization as if it had occurred on
September 30, 1999, we would have had approximately $317.4 million of debt
(excluding unused commitments of approximately $23.0 million under the new
credit facility). See "The Recapitalization" and the "Unaudited Pro Forma
Financial Statements" sections for more information on the recapitalization and
its pro forma effects on our financial condition and results of operations.
Our substantial debt could have important consequences to you. For example,
it could:
. make it more difficult for us to satisfy our obligations with respect to
the New Notes;
. increase our vulnerability to general adverse economic and industry
conditions;
. limit our ability to obtain additional financing for future working
capital, capital expenditures, acquisitions and other general corporate
requirements;
. increase our vulnerability to interest rate fluctuations because the
interest on the debt under the new credit facility will be at variable
rates;
. require us to dedicate a substantial portion of our cash flow from
operations to payments on our debt, thereby reducing the availability of
our cash flow for operations and other purposes;
. limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate; and
. place us at a competitive disadvantage compared to our competitors that
have less debt.
Despite substantial levels of debt, we may still be able to incur even more
debt. This could further exacerbate the risks described above.
We may be able to incur substantial additional debt in the future. The terms
of the indenture do not fully prohibit us from doing so, and our new credit
facility will likely permit additional borrowings. In particular, we expect
that at least $23.0 million of the revolving credit facility under the new
credit facility will be undrawn on the date of the merger. If new debt is added
to our current debt levels, the related risks that we now face could intensify.
We will require a significant amount of cash to service our debt. Our ability
to generate cash depends on many factors, many of which are beyond our control.
Our ability to make payments on and to refinance our debt, including the New
Notes, and to fund planned capital expenditures and acquisitions will depend on
our ability to generate cash in the future. This, to some extent, is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond our control. We cannot assure you that our business
will generate sufficient cash flow from operations, that currently anticipated
cost savings and operating improvements will be realized on schedule or that
future borrowings will be available to us under the new credit facility in an
amount sufficient to enable us to service our debt, including the Notes, or to
fund our other liquidity needs. In order to pay the principal amount of the
Notes at maturity, we may need to refinance all or a portion of our debt,
including the New Notes, on or before maturity. We cannot assure you that we
will be able to refinance any of our debt, including the new credit facility
and the New Notes, on commercially reasonable terms or at all.
14
<PAGE>
Your right to receive payments on the Notes is junior to our existing debt
and possibly to all of our future borrowings.
The New Notes will rank behind all of our existing senior debt including all
borrowings under the new credit facility and all other future debt, except any
future debt that expressly provides that it is not senior in right of payment
to the New Notes. As a result, upon any distribution to our creditors in a
bankruptcy, liquidation or reorganization or similar proceeding relating to us
or our property, the holders of our senior debt will be entitled to be paid in
full in cash before any payment may be made with respect to the Notes.
In addition, all payments on the Notes can be blocked in the event of a
payment default on senior debt and may be blocked for up to 180 of 360
consecutive days in the event of certain non-payment defaults on senior debt.
In the event of a bankruptcy, liquidation or reorganization or similar
proceeding relating to us, holders of the Notes will participate with trade
creditors and holders of our other obligations that are not senior debt in the
assets remaining after we have paid all of the senior debt. However, because
the indenture requires that amounts otherwise payable to holders of the Notes
in a bankruptcy or similar proceedings be paid to holders of senior debt
instead, holders of the Notes may receive less, ratably, than holders of trade
payables and other obligations that are not senior debt in any such
proceedings. In any of these cases, we may not have sufficient funds to pay all
of our creditors, and holders of Notes may receive less, ratably, than the
holders of senior debt.
Assuming the recapitalization had been completed on September 30, 1999, the
Notes would have been junior to approximately $166.6 million of senior debt and
approximately $23.0 million would have been available for borrowing as
additional senior debt under the new credit facility. We will be permitted to
borrow substantial additional debt, including senior debt, in the future under
the terms of the indenture.
Our new credit facility and the indenture governing the New Notes will
contain various covenants which limit the discretion of our management in the
operations of our business.
Our new credit facility and the indenture governing the New Notes will
contain various provisions that limit our management's discretion by
restricting our ability to:
. incur additional debt;
. pay dividends or distributions on our capital stock or repurchase our
capital stock;
. issue preferred stock of subsidiaries;
. make certain investments;
. create liens to secure debt;
. enter into transactions with affiliates;
. merge or consolidate with another company; and
. transfer and sell assets.
In addition, the new credit facility will require us to meet specified
financial ratios.
If we fail to comply with the restrictions of the new credit facility or the
indenture governing the New Notes or any other subsequent financing agreements,
a default may occur. This default may allow the creditors, if the agreements so
provide, to accelerate the related debt as well as any other debt to which a
cross-acceleration or cross-default provision applies. In addition, the lenders
may be able to terminate any commitments they had made to supply us with
further funds. See "Description of New Credit Facility" and "Description of the
Notes".
15
<PAGE>
Federal and state laws allow courts, under specific circumstances, to void
debts and require creditors to return payments received from debtors.
Our incurrence of debt, including the New Notes and borrowings under the new
credit facility, and the subsequent transfer of a portion of those proceeds to
our shareholders to pay the cash consideration in our merger with UC
Acquisition, may be subject to review under relevant federal and state
fraudulent conveyance statutes in the case of either:
. a bankruptcy, reorganization or rehabilitation case or similar
proceeding; or
. a lawsuit by or on behalf of any of our creditors that are not paid on
time.
Under these fraudulent conveyance statutes, a court could invalidate some or
all of the debt related to our recapitalization, including the Notes, as a
fraudulent conveyance, or could render the Notes junior to our debt to
existing or future creditors, if the court found that, at the time of the
recapitalization, either (1) we incurred the debt and paid the cash
consideration in the merger with the intent of hindering, delaying or
defrauding current or future creditors or (2) we both:
. received less than reasonably equivalent value or fair consideration in
the recapitalization; and
. were found to be one or more of the following:
(1) insolvent or rendered insolvent by reason of the recapitalization,
including the incurrence of the related debt;
(2) a company engaged in a business or transaction for which its assets
constituted unreasonably small capital;
(3) a company intending to incur, or believing that it would incur,
obligations beyond its ability to pay as these obligations matured;
or
(4) a defendant in an action for money damages, or a company that had a
judgment for money damages docketed against it, if, in either case,
after final judgment the judgment is unsatisfied.
As a condition to the consummation of the merger of our company and UC
Acquisition, our directors are entitled to receive an independent opinion as
to the solvency of the company after the recapitalization. Such opinion is
not, however, binding on a court.
Governmental and other third-party payors have been taking steps to lower
the cost of health care services. As a result, we have received reduced
payments from them for our services and other changes which reduce our
revenues and profitability.
The health care industry has been undergoing significant change as third
party payors, such as Medicare, Medicaid and insurers, increase their efforts
to control the cost of health care services. We have historically derived
approximately 25%-30% of our revenue from tests performed for beneficiaries of
Medicare and Medicaid. As a result of payors' cost-cutting efforts, the
amounts we receive through reimbursements for our testing services have been
reduced. In addition, payors have limited the number and types of tests that
they will fully reimburse in particular medical circumstances. We expect
additional efforts in the future by payors to reduce health care costs.
Because the law generally requires clinical laboratories to accept Medicare
and Medicaid reimbursement amounts as payment in full, when these payors
unilaterally reduce the fees they are willing to pay for our services, we
usually have no choice but to accept the reduced payments. Cost-cutting
efforts by Medicare, Medicaid, insurers and other payors have had and may
continue to have a material adverse effect on our revenues and profitability.
The importance of the managed care sector could have a negative impact on
our profitability.
We believe that California has the highest enrollment rate in managed care
plans of any state in the United States with approximately 40% of the
population covered at the end of 1998. As a result, delivery of health care
16
<PAGE>
to participants in managed care plans has become integral to the healthcare
delivery system throughout the state. We may experience declines in average
revenue per patient specimen processed as managed care organizations maintain
or strengthen their presence in the California health care insurance market.
The importance of the managed care sector presents challenges that could have a
material adverse effect on our financial condition, results of operations and
cash flow. These challenges include:
. Shift Toward Capitated Payment Contracts. Managed care organizations
generally negotiate for capitated payment contracts for a substantial
portion of their business. Under these contracts, 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 additional
testing from the managed care organization to the clinical laboratory.
Approximately 30%-35% of our volume and approximately 10%-15% of our
revenue in 1998 were generated from capitated agreements with managed
care organizations.
. 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 testing
services provided to the members of the managed care organization. Under
these arrangements, the principal laboratory provider is responsible for
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.
. History of Aggressive Pricing. Agreements with managed care
organizations have historically been priced aggressively due to the
expectation that a laboratory will capture not only the testing covered
under the contract, but also additional higher priced fee-for-service
business from non-managed care patients of participating physicians. As
the number of patients under managed care organizations increases,
however, there is less fee-for-service business available to potentially
offset the lower margin 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 higher priced fee-for-service testing from
them.
We cannot assure you that we will be able to maintain our arrangements with
managed care providers or that even if such arrangements are maintained they
will not be negotiated in a manner that would have a material adverse effect
upon our financial condition, results of operations and cash flow.
The clinical laboratory testing industry is subject to extensive, complex and
frequently changing governmental regulation, which can have adverse effects
upon us.
The clinical laboratory testing industry is subject to extensive and complex
governmental regulation, which is frequently changing. We are subject to
extensive governmental regulation at both the federal and state levels in the
following areas, among others:
. reimbursements from government payors;
. licensing/certification requirements and quality assurance for clinical
laboratories and personnel;
. health care billing and fraud and abuse;
. environmental protection; and
. occupational safety.
We expect that in some of these areas governmental regulation will increase
or become more burdensome. Generally, increased governmental regulation raises
costs. Adverse consequences of our failure to meet governmental requirements in
these areas include civil and criminal penalties, exclusion from participation
in government health care programs such as Medicare and Medicaid and
prohibitions or restrictions on the use of our laboratories. Existing or future
governmental regulation could have a material adverse effect on our business,
financial condition, results of operations or prospects. For more information
on governmental
17
<PAGE>
regulation of California's clinical laboratory testing industry, see the
"Business" section under the heading "Governmental Regulation".
Some of our marketing and billing practices have been subject to federal and
state investigations and related legal claims, which can result in civil and
criminal penalties and changes in the conduct of our business.
Over the past several years, some of our marketing and billing practices have
been the subject of federal and California investigations which resulted in
agreements by us with federal and California governmental agencies to pay two
settlements in an aggregate amount of $6.7 million since 1993. Although we were
not required to change our practices as a result of these government
settlements, we voluntarily implemented a more formal compliance program to
review our billing procedures and other compliance matters. Since 1993, we also
have entered into settlements with three insurance companies for an aggregate
amount of $825,000.
In November 1999, we reached a settlement with a group of thirteen insurance
companies regarding claims by the insurance companies that we over-billed them
in the early to mid-1990s in connection with several chemistry profile tests
that were previously the subject of a settlement agreement with the government.
We paid $600,000 in the settlement. Such amount has been reflected as a charge
in the statement of operations for the second quarter of 1999.
In May 1999, we learned of a new federal investigation under the False Claims
Act relating to our billing practices for four types of medical tests we
perform. We are in the process of gathering and voluntarily submitting
documentation to the Department of Justice regarding the two tests with respect
to which they have requested information. We cannot at this time assess what
the result of the investigation might be. Remedies available to the government
include civil and criminal penalties and exclusion from participation in
federal health care programs such as Medicare and Medicaid. Application of
these remedies could have a material adverse effect upon our business,
financial condition, results of operations or prospects. For more information
about governmental investigations, see the "Business" section under the heading
"Legal Proceedings" and "Governmental Investigations."
The complexities of billing may affect our revenues and cash flow.
Billing for laboratory testing services is complicated. Laboratories must
bill various payors, such as patients, insurance companies, Medicare, Medicaid,
doctors and employer groups, all of which have different requirements. Most of
our bad debt expense is the result of several non-credit related issues,
primarily missing or incorrect billing information on requisitions.
Among many other factors complicating billing are:
. pricing differences between our fee schedules and those of the payors;
. disputes between payors as to which party is responsible for payment;
. disparity in coverage among various carriers; and
. assuring adherence to specific compliance and procedures.
Difficulties with the integration of any new acquisitions may impose
substantial costs and delays and cause other problems for us.
As a part of our business strategy, we will continue to pursue selected
acquisition opportunities that will enable us to generate revenue growth as
well as additional operating efficiencies. Acquisitions involve a number of
risks, including:
. the assimilation of new operations and personnel;
. integration of each company's respective equipment, service offerings,
networks and technologies and financial and information systems;
. coordination of geographically separated facilities and work forces;
18
<PAGE>
. coordination of the company's respective sales, marketing and service
development efforts; and
. maintenance of standards, controls, procedures and policies.
The process of integrating the operations of the acquired companies,
including their personnel, could cause the interruption of our business and
operations activities, including those of the acquired companies. Employees who
may be key to the integration effort or our ongoing operations may choose not
to continue to work for us following the closing of the acquisitions. Further,
the process of integration may require a disproportionate amount of the time
and attention of our management, which may distract management's attention from
the day to day responsibilities of running the business, and financial and
other resources.
Any interruption or deterioration in services may result in a customer's
decision to stop using us for clinical laboratory testing. Most clinical
laboratory testing is performed under arrangements that are terminable at will
or on short notice. It is possible that we may not realize all or any of the
anticipated benefits of an acquisition, either at all or in a timely manner. If
that happens and we incur significant costs, it could have a material adverse
impact on our business.
Technology changes may lead to the development of cost-effective point-of-
care testing equipment and product that will negatively impact our testing
volume and revenues.
The clinical laboratory testing industry is faced with changing technology
and introduction of new products. Technology changes may lead to the
development of more cost-effective point-of-care testing equipment and product
that can be performed by physicians in their offices without requiring the
services of clinical laboratories. Development of such technology could
negatively impact our testing volume and revenues.
With the completion of the recapitalization, affiliates of Kelso control our
company.
With the completion of the recapitalization, affiliates and designees of
Kelso own approximately 93% of our outstanding common stock. The Kelso
affiliates are able to elect all of our directors, appoint new management and
approve any action requiring the approval of our shareholders, including
amendment of our certificate of incorporation and mergers or sales of
substantially all of the company's assets. The directors elected by the Kelso
affiliates are able to make decisions affecting our capital structure,
including decisions to issue additional capital stock, implement stock
repurchase programs and declare dividends. The interests of Kelso and its
affiliates could conflict with your interests. For example, if we encounter
financial difficulties or are unable to pay our debts as they mature, the
interests of our equity holders might conflict with your interests as a
Noteholder. In addition, our equity holders may have an interest in pursuing
acquisitions, divestitures, financings or other transactions, that, in their
judgment, could enhance their equity investments, even though such transactions
might involve risks to the holders of the New Notes. For information concerning
the composition of our management team following the recapitalization, see the
"Management" section.
Loss of key members of our management team could negatively impact our
business prospects.
Our success is dependent in part on the efforts of some key members of our
management team. The loss of their services could materially adversely affect
our business, financial condition, results of operations or prospects. We do
not currently maintain key person life insurance on any of our key employees.
We operate in an intensively competitive environment which could cause us to
lower prices and could result in reduced revenues and profit margins.
The independent clinical laboratory testing industry in the United States and
in California is highly fragmented and is characterized by intense competition.
According to government data, there are about 4,500 independent clinical
laboratories in the United States, approximately 600 of which we believe are
located in California. These independent clinical laboratories fall into two
categories. The first are the smaller, local
19
<PAGE>
laboratories that generally offer fewer tests and services and have less
capital than the larger laboratories. These laboratories seek to differentiate
themselves by maintaining a close working relationship with their physician
clients by providing a high level of personal and localized services.
The second group, which includes laboratories such as Unilab, consists of the
larger regional or national laboratories that provide a broader range of tests
and services. In California, our two largest independent clinical laboratory
competitors are Quest Diagnostics Incorporated and Laboratory Corporation of
America. Quest recently acquired SmithKline Beecham Clinical Laboratories,
Inc., which had been one of our principal competitors.
We compete primarily on the basis of the following: (1) service capability
and convenience offered by our facilities, including accessibility of PSCs and
local STAT testing availability; (2) size and scope of testing services
performed; (3) accuracy, timeliness and consistency in reporting test results;
(4) reputation in the medical community and (5) pricing of the laboratory's
testing services. To successfully compete in the California clinical testing
market, we may be required to increase our operating costs, cut prices and take
other measures that could have an adverse effect on our financial condition,
results of operations and cash flow, which in turn could cause covenant
breaches under the terms of our debt. See the "Business" section under the
heading "The Clinical Laboratory Industry" and "Competition" for more
information on competition in the California clinical testing industry.
Professional liability litigation can be costly to defend and result in large
damage awards which our insurance may not adequately cover or which may make it
more expensive or difficult for us to insure in the future.
As a provider of clinical laboratory testing services, we are subject to
lawsuits involving negligence and other similar legal claims. These lawsuits
could be costly to defend and involve claims for substantial damages. These
kinds of suits could also have an adverse effect on our client base. We
maintain insurance which we believe to be adequate to cover our exposure to
professional liability claims. However, we cannot assure you that our current
insurance is adequate or that in the future we will be able to adequately
insure at an acceptable cost.
Our failure or the failure by third-parties to successfully address the Year
2000 problem could adversely affect us.
There is a widespread concern that many existing computer programs that use
only the last two digits to refer to a year will not properly recognize a year
that begins with the digits "20" instead of "19." If not corrected, many
computer applications could fail, create erroneous results, or cause
unanticipated systems failures, among other problems. Our failure or the
failure by one or more of our significant vendors, government payors or
insurance company payors to address successfully year 2000 issues could have a
material adverse effect on our results of operations and financial condition.
In September 1998, the General Accounting Office reported that "the Health Care
Financing Administration and its contractors are severely behind schedule in
repairing, testing and implementing the mission-critical systems supporting
Medicare" and concluded that "it is highly unlikely that all of the Medicare
systems will be compliant in time to ensure the delivery of uninterrupted
benefits and services into the Year 2000." If Medicare or other payor systems
do not become Year 2000 compliant in time, our cash collections could be
significantly delayed. See the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section under the heading "Year
2000" for more information about our Year 2000 compliance efforts.
The original issue discount may present unfavorable tax and other legal
consequences to you.
The Notes will be deemed to have been issued to you at a discount for federal
income tax purposes. Original issue discount, which is the difference between
the stated redemption price of the Notes at maturity
20
<PAGE>
and the issue price of the Notes, will accrue from the issue date of the Notes
and be includable in a holder's gross income as it accrues. See "Material
Federal Income Tax Considerations."
If a bankruptcy case under the U.S. Bankruptcy Code were commenced by or
against us after the issuance of the Notes, the claim of a holder of Notes
could be limited to exclude the amount of unamortized original issue discount,
as of the relevant date, if the bankruptcy court determined that it was
"unmatured interest."
We may not have the ability to raise the funds necessary to finance the
change of control offer required by the indenture.
Upon the occurrence of specific kinds of change of control events, we will be
required to offer to repurchase all outstanding New Notes. However, the new
credit facility will not allow such repurchase. In any event, it is possible
that we will not have sufficient funds at the time of the change of control to
make the required repurchase of New Notes. In addition, some important
corporate events would not constitute a "Change of Control" under the
indenture. See "Description of the Notes--Repurchase at the Option of Holders".
21
<PAGE>
THE RECAPITALIZATION
On May 24, 1999 UC Acquisition, a Delaware corporation owned by Kelso
Investment Associates VI, L.P. and KEP VI, LLC, affiliates of Kelso, entered
into a merger agreement providing for, among other things, the merger of UC
Acquisition with and into our company. The merger was part of the
recapitalization. Both the merger and the recapitalization were consummated on
November 23, 1999. The principal features of the recapitalization, including
the merger of UC Acquisition and our company, are described in this section.
Merger Agreement
Under the terms of the merger agreement, all but approximately 1.9 million
shares of our common stock, approximately 7.4% of our post-merger shares
outstanding, were converted into the right to receive $5.85 per share in cash.
In addition to the conversion of our common stock in the merger, the vesting of
all our options was accelerated and either cancelled in exchange for the value
of such options determined with reference to the $5.85 merger price or
converted into options for post-merger shares of our common stock. The 364,000
outstanding shares of our convertible preferred stock were converted into cash
at the liquidation preference of $5.75 per share. The aggregate cash
consideration in the merger is $280.6 million, assuming that the 1.9 million
shares remain outstanding at UC Acquisition's election and that all our options
are cancelled for cash value.
Holders of approximately 4.1% of our previously outstanding shares of common
stock agreed to retain their equity interest in the company. As a result, these
holders now own the remaining 7.4% of our post-merger shares.
Debt Repayment
As part of the recapitalization, we repaid $144.5 million of debt, consisting
of $119.5 million of the senior notes and $25.0 million of 7.5% notes issued in
connection with the recently completed acquisition of Bio-Cypher. We retired
the senior notes through a cash tender offer for them which was commenced on
September 1, 1999 and which we completed on the same date as the consummation
of UC Acquisition's merger with our company. In the tender offer, we offered to
purchase senior notes at a premium over their face amount plus accrued and
unpaid interest to the date of payment.
Fees and Expenses
Fees and expenses associated with the recapitalization were approximately
$58.5 million. That amount includes accrued interest; severance costs; fees and
expenses relating to the financings; financial advisory fees; fees, expenses
and purchase premium for the senior notes tender; legal and accounting
expenses; and printing costs.
Sources of Funds
In addition to the net proceeds from the sale of the Old Notes offered, we
financed the recapitalization with:
. a new common equity investment of $139.5 million from funds provided by
the Kelso affiliates and designees of Kelso;
. approximately $31.3 million of cash from us; and
. $162.0 million of borrowings under the new credit facility, consisting
of a six year $50.0 million A term loan, a seven year $110.0 million B
term loan and borrowings of $2.0 million under a six year $25.0 million
revolving credit facility.
22
<PAGE>
Equity Commitment
Under a capital call agreement, if our ratio of net total debt to EBITDA (as
defined in the capital call agreement) for the year 2000 is greater than 5.0
times, the Kelso affiliates that control us after the recapitalization will be
required to make (or cause their designees to make) an equity investment of up
to $50.0 million to the extent necessary for us to reduce the ratio to 5.0
times. The indenture governing the Notes contains a covenant requiring us to
receive such equity investment to the extent required by the new credit
facility. For a more detailed description of the new credit facility and the
capital call agreement, see "Description of New Credit Facility."
The following table sets forth the expected sources and uses of funds in
connection with the recapitalization, as if it had occurred on September 30,
1999:
<TABLE>
<CAPTION>
Sources of Funds: Amount
- ----------------- -------------
(in millions)
<S> <C>
Cash(1)................... $ 31.3
Revolving credit
facility(1).............. 2.0
Term loans................ 160.0
The Notes................. 150.8
Common equity
investment(2)............ 150.6
------
Total sources of funds.. $494.7
======
- --------
</TABLE>
<TABLE>
<CAPTION>
Uses of Funds: Amount
- -------------- -------------
(in millions)
<S> <C>
Merger consideration(3)... $291.7
Repayment of existing
debt(4).................. 144.5
Estimated fees and
expenses................. 58.5
------
Total uses of funds..... $494.7
======
</TABLE>
(1) Our cash on hand increased by the time our merger with UC Acquisition was
completed so that we did not have to borrow any funds under the revolving
credit facility.
(2) Includes $139.5 million from the Kelso affiliates and designees and a
retained common equity interest of $11.1 million (valued at the $5.85 per
share merger price).
(3) Includes cash merger consideration of $280.6 million and retained equity
interest of $11.1 million. The cash merger consideration will be used to
liquidate our current outstanding common and preferred stock that is not
part of the retained interest, including the shares of common stock that
were issued upon conversion of a $14.0 million 7.5% convertible
subordinated note issued in connection with the Meris acquisition.
(4) Gives effect to the tendering of 99.6% of the senior notes in a tender
offer completed on November 23, 1999.
23
<PAGE>
USE OF PROCEEDS
We will not receive any proceeds from the exchange offer. The proceeds from
the offering of the Old Notes were approximately $150.8 million, before
deducting commissions and expenses related to the offering. The proceeds from
the offering of the Old Notes were released to us. We have used and will use
the net proceeds from the offering to fund a portion of the financing for our
recapitalization and related transactions, including:
. payments in respect of our capital stock and options for our common
stock;
. repayment of most of our existing debt; and
. payment of transaction-related fees and expenses.
For further discussion of the estimated sources and uses of funds related to
our recapitalization, see "The Recapitalization."
24
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999 on
a historical basis and on a pro forma basis after giving effect to our
recapitalization. This table should be read in conjunction with "Use of
Proceeds," "Unaudited Pro Forma Financial Statements," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our
financial statements and the related notes included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
As of September 30,
1999
----------------------
Historical As Adjusted
---------- -----------
(dollars in thousands)
<S> <C> <C>
Cash, cash equivalents and restricted cash............... $ 31,250 $ --
======== ========
Debt:
New credit facility (1)................................ $ -- $161,977
Capital lease obligations.............................. 4,128 4,128
11% senior notes due 2006 (2).......................... 119,413 488
The Notes, net of discount............................. -- 150,765
7.5% notes (3)......................................... 25,000 --
7.5% convertible subordinated note (4)................. 14,000 --
-------- --------
Total debt........................................... 162,541 317,358
-------- --------
Shareholders' equity (deficit):
Convertible preferred stock............................ 4 --
Common stock........................................... 420 257
Additional paid-in capital............................. 231,973 149,614
Accumulated deficit.................................... (220,361) (313,003)
-------- --------
Total shareholders' equity (deficit)................. 12,036 (163,132)
-------- --------
Total capitalization................................. $174,577 $154,226
======== ========
</TABLE>
- --------
(1) Consists of a six year $50.0 million A term loan, a seven year $110.0
million B term loan and approximately $2.0 million of borrowings under a
six year $25.0 million revolving credit facility. Our cash on hand
increased by the time our merger with UC Acquisition was completed so that
we did not have to borrow any funds under the revolving credit facility. If
our ratio of net total debt to EBITDA (as defined in a capital call
agreement) for the year 2000 is greater than 5.0 times, the Kelso
affiliates that will control us after the recapitalization will be
required, pursuant to the capital call agreement, to make (or cause their
designees to make) an equity investment of up to $50.0 million to the
extent necessary for us to reduce the ratio to 5.0 times. For a more
detailed description of the new credit facility and the capital call
agreement, see "Description of New Credit Facility."
(2) Assumes that 99.6% of the senior notes are tendered.
(3) Issued in connection with the Bio-Cypher acquisition.
(4) Issued in connection with the Meris acquisition.
25
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The following unaudited pro forma financial statements have been derived by
the application of pro forma adjustments to our historical financial statements
included in this prospectus. The pro forma statements of operations for the
nine months ended September 30, 1999 and the year ended December 31, 1998 give
effect to the merger of UC Acquisition and our company and related transactions
constituting our recapitalization, including our assumption of Unilab Finance's
obligations under the Old Notes and related indenture and our receipt of the
proceeds from the offering of the Old Notes, and the Meris and Bio-Cypher
acquisitions as if such transactions had been consummated on the first day of
the relevant period. The pro forma balance sheet gives effect to the
recapitalization as if such transaction had occurred on September 30, 1999. The
adjustments are described in the accompanying notes. The pro forma financial
statements should not be considered indicative of actual results that would
have been achieved had the recapitalization and the acquisitions of Meris and
Bio-Cypher been consummated on the dates indicated and do not purport to
indicate balance sheet data or results of operations as of any future date or
for any future period. The pro forma financial statements should be read in
conjunction with our, Meris', and Bio-Cypher's historical financial statements
and the notes thereto included elsewhere in this prospectus.
On November 23, 1999, UC Acquisition Sub, Inc. merged with and into our
company, and our company continued as the surviving corporation. UC Acquisition
Sub, Inc. was organized for the purposes of the merger and has not carried on
any activities to date other than those incident to its formation and the
transactions contemplated by the related merger agreement. Also upon closing of
the merger, we assumed Unilab Finance's obligations under the Old Notes and
related indenture and received the proceeds from the offering of the Old Notes
held in escrow.
Because the pro forma adjustments to our historical financial statements to
reflect and account for the merger of UC Acquisition and our company and
related transactions were applied as a recapitalization, the historical basis
of assets and liabilities were not affected by the transaction. The pro forma
financial data gives effect to the tendering of 99.6% of the senior notes in
the tender offer that was completed on November 23, 1999 at a repurchase price
of approximately $1,128.0 per $1,000 principal amount of senior notes plus
accrued and unpaid interest.
26
<PAGE>
UNILAB CORPORATION UNAUDITED PRO FORMA BALANCE SHEET
(dollars in thousands)
September 30, 1999
<TABLE>
<CAPTION>
Historical Pro Forma Pro Forma
Unilab Adjustments Unilab
---------- ----------- ---------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 25,753 $ (25,753)(a) $ --
Restricted cash......................... 5,497 (5,497)(a) --
Accounts receivable, net................ 55,830 55,830
Inventory of supplies................... 3,970 3,970
Prepaid expenses and other current
assets................................. 2,346 2,346
--------- --------- ---------
Total current assets.................. 93,396 (31,250) 62,146
Property and equipment, net............... 13,009 13,009
Deferred tax asset........................ 16,558 16,558
Goodwill, net............................. 83,347 83,347
Other intangible assets, net.............. 1,922 1,922
7,761 (a)
(3,036)(d)
Other assets.............................. 5,168 (200)(e) 9,693
--------- --------- ---------
$ 213,400 $ (26,725) $ 186,675
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......... $ 1,763 $ 1,100 (f) $ 2,863
Accounts payable and accrued liabilities.. 23,236 (7,775)(a) 15,461
Accrued payroll and benefits.............. 10,336 10,336
--------- --------- ---------
Total current liabilities............. 35,335 (6,675) 28,660
(143,925)(a)
312,742 (a)
(14,000)(b)
Long-term debt, net of current portion.... 160,778 (1,100)(f) 314,495
(727)(a)
Other liabilities......................... 5,251 2,128 (e) 6,652
--------- --------- ---------
201,364 148,443 349,807
Shareholders' Equity (Deficit):
Convertible preferred stock............... 4 (4)(b) --
(401)(b)
Common stock.............................. 420 238 (c) 257
(221,621)(b)
Additional paid-in capital................ 231,973 139,262 (c) 149,614
(24,900)(a)
(17,818)(a)
(44,560)(b)
(3,036)(d)
Accumulated deficit....................... (220,361) (2,328)(e) (313,003)
--------- --------- ---------
Total shareholders' equity (deficit).. 12,036 (175,168) (163,132)
--------- --------- ---------
$ 213,400 $ (26,725) $ 186,675
========= ========= =========
</TABLE>
See accompanying notes to unaudited pro forma balance sheet.
27
<PAGE>
UNILAB CORPORATION
NOTES TO UNAUDITED PRO FORMA BALANCE SHEET
(a) The recapitalization provides and utilizes the following sources and uses
of funds (dollars in thousands):
Sources of Funds:
<TABLE>
<S> <C>
Borrowings under the revolving credit facility...................... $ 1,977
Borrowings under the term loan facilities........................... 160,000
The Notes........................................................... 150,765
--------
Total debt...................................................... 312,742
Cash equity investment.............................................. 139,500
--------
Total sources of funds.......................................... $452,242
========
Uses of Funds:
Payment for historical common stock for $5.85 per share(1) ......... $262,009
Payment for outstanding Unilab stock options(2)..................... 16,484
Payment of historical preferred stock, 364,000 shares outstanding,
for $5.75 per share................................................ 2,093
--------
Total merger consideration...................................... 280,586
Repurchase of existing 99.6% of senior notes at book value.......... 118,925
Repurchase of existing note issued in connection with the Bio-Cypher
acquisition at book value.......................................... 25,000
--------
Total repurchase of existing debt at book value................. 143,925
Debt retirement premium(3).......................................... 17,818
Payment of accrued interest......................................... 7,775
Payment of deferred compensation liabilities........................ 727
New credit facility deferred fees................................... 3,238
The Notes deferred fees............................................. 4,523
--------
Total deferred financing fees(4)................................ 7,761
Estimated transaction costs(5)...................................... 24,900
Decrease in balance sheet cash and cash equivalents................. (25,753)
Decrease in balance sheet restricted cash........................... (5,497)
--------
Total uses of funds............................................. $452,242
========
</TABLE>
- --------
(1) The amount associated with the conversion to cash of the common stock is
calculated as follows:
<TABLE>
<S> <C>
Total common shares outstanding.............................. 42,016,236
Conversion of $14.0 million convertible subordinated note
into common shares.......................................... 4,666,667
------------
46,682,903
Rollover equity interest..................................... (1,895,000)
------------
Common shares converted to cash.............................. 44,787,903
Cash purchase price per share................................ $ 5.85
------------
$262,009,233
============
</TABLE>
(2) The pro forma financial statements have been prepared on the basis that the
holders of our stock options will have the vesting of all options
accelerated and will receive the excess of $5.85 over the exercise price of
the stock options multiplied by the total number of shares of common stock
subject to such options. The total cost consideration to be paid to holders
of our stock options will be approximately $16.5 million. Alternatively, it
may be determined by UC Acquisition and such holders of our stock options
that such options may remain outstanding, possibly on amended terms but
with the same aggregate spread.
28
<PAGE>
(3) To reflect estimated debt retirement premium and the write-off of
unamortized original issue discount of $17.8 million, comprised of $13.5
million related to our currently outstanding $120.0 million (face value)
senior notes (assuming 99.6% of noteholders tender their notes in the
tender offer) and $3.8 million related to the $25.0 million 7.5% notes
issued in connection with the Bio-Cypher acquisition.
(4) To reflect the estimated financing fees associated with the new credit
facility and the Notes. Such amount will be recorded as debt issuance costs
and will be amortized over the expected life of the debt to be issued.
(5) Estimated costs associated with the recapitalization, including financial
advisory fees, other financing fees and expenses, the dealer manager fee on
the senior notes tender offer, legal and accounting fees and severance
costs.
(b) To reflect our payments for historical common and preferred stock in
accordance with the merger agreement (in thousands):
<TABLE>
<S> <C>
Payment for common and preferred stock (including
consideration for Unilab stock options)..................... $ 280,586
=========
Purchase price is allocated as follows:
Convertible preferred stock.................................. $ (4)
Common stock................................................. (401)
Conversion of $14.0 million convertible subordinated note.... (14,000)
Additional paid-in capital................................... (221,621)
Accumulated deficit.......................................... (44,560)
---------
$(280,586)
=========
</TABLE>
(c) To reflect an equity contribution to UC Acquisition by the Kelso
affiliates, Kelso Investment Associates VI, L.P. and KEP VI, LLC, and
designees of Kelso in the amount of $139.5 million in respect of which they
will receive 23,846,154 shares of recapitalized common stock. A portion of
such investment may instead be made by third parties, subject to the Kelso
affiliates retaining a 75% ownership interest on a primary basis.
(d) To reflect the write-off of $3.0 million of deferred financing costs
associated with the repurchase of the senior notes.
(e) The aggregate adjustment of $2.3 million is comprised of the following:
. Compensation expense of $2.1 million related to the immediate vesting,
at a change of control, of phantom common stock units under our
supplemental executive retirement plan; and
. compensation expense of $200,000 related to the forgiveness of a
$150,000 loan by us to one of our directors in connection with his
efforts in effecting the recapitalization and forgiveness of a loan for
$50,000 to an executive, effective upon a change of control.
(f) To reclassify borrowings under the new credit facility to short term debt
for scheduled principal repayments due within the first year.
29
<PAGE>
UNILAB CORPORATION
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
(dollars in thousands, except per share amounts)
Year Ended December 31, 1998
<TABLE>
<CAPTION>
Historical Historical
Meris Bio-Cypher
Jan 1- Dec 1, 1997- Pro
Historical Nov 5, Nov 30, Pro Forma Forma
Unilab 1998 (a) 1998 (b) Adjustments (c) Unilab (r)
---------- ---------- ------------ --------------- ----------
<S> <C> <C> <C> <C> <C>
Revenue................. $217,370 $22,008 $ 57,573 $ -- $296,951
Cost of services........ 152,007 21,745 47,815 -- 221,567
(473)(g)
624 (i)
(3,357)(l)
Depreciation and amorti-
zation................. 7,592 -- 4,667 1,692 (m) 10,745
Selling, general and ad-
ministrative expense... 33,530 9,386 16,551 600 (e) 60,067
Writedown of intangi-
bles................... -- -- 44,727 (44,727)(p) --
-------- ------- -------- -------- --------
Total operating ex-
penses............... 193,129 31,131 113,760 (45,641) 292,379
-------- ------- -------- -------- --------
Operating income
(loss)................. 24,241 (9,123) (56,187) 45,641 4,572
868 (d)
20,298 (f)
(427)(j)
889 (k)
Other expenses: (9,529)(n)
Interest, net........... 13,538 427 9,529 1,875 (o) 37,468
Other................... -- -- (280) -- (280)
-------- ------- -------- -------- --------
Income (loss) before in-
come taxes............. 10,703 (9,550) (65,436) 31,667 (32,616)
Tax provision........... -- -- -- -- --
-------- ------- -------- -------- --------
Net income (loss)....... 10,703 (9,550) (65,436) 31,667 (32,616)
======== ======= ======== ======== ========
Preferred stock divi-
dends.................. 131 -- -- (131)(h) --
Net income (loss)
available to common
stockholders........... $ 10,572 $(9,550) $(65,436) $ 31,798 $(32,616)
======== ======= ======== ======== ========
Ratio of earnings to
fixed charges (r)...... 1.60x --
======== ========
</TABLE>
See accompanying notes to unaudited pro forma statements of operations.
30
<PAGE>
UNILAB CORPORATION
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
(dollars in thousands, except per share amounts)
Nine Months Ended September 30, 1999
<TABLE>
<CAPTION>
Historical Bio- Pro Forma
Cypher Jan. 1- Pro Forma Unilab
Historical Unilab May 9, 1999 (b) Adjustments (c) (r)
----------------- --------------- --------------- ---------
<S> <C> <C> <C> <C>
Revenue................. $213,496 $18,525 $ -- $232,021
Cost of services........ 147,133 17,438 -- 164,571
Legal charge............ 600 -- (600)(q) --
(355)(g)
(848)(l)
Depreciation and
amortization........... 7,189 1,315 611 (m) 7,912
Selling, general and
administrative
expense................ 29,323 4,204 450 (e) 33,977
Writedown of fixed
assets................. -- 1,331 (1,331)(p) --
-------- ------- -------- --------
Total operating
expenses........... 184,245 24,288 (2,073) 206,460
-------- ------- -------- --------
Operating income
(loss)................. 29,251 (5,763) 2,073 25,561
920 (d)
15,090 (f)
Other expenses: (3,682)(n)
Interest, net......... 11,244 3,682 676 (o) 27,930
Other................. -- 12 -- 12
-------- ------- -------- --------
Income (loss) before
income taxes......... 18,007 (9,457) (10,931) (2,381)
Tax benefit........... 11,904 -- -- 11,904
-------- ------- -------- --------
Net income (loss)..... 29,911 (9,457) (10,931) 9,523
======== ======= ======== ========
Preferred stock
dividends.............. 99 -- (99)(h) --
Net income (loss)
available to common
stockholders........... $ 29,812 $(9,457) $(10,832) $ 9,523
======== ======= ======== ========
Ratio of earnings to
fixed charge (r)....... 2.17x --
======== ========
</TABLE>
See accompanying notes to unaudited pro forma statements of operations
31
<PAGE>
UNILAB CORPORATION
NOTES TO UNAUDITED PRO FORMA STATEMENTS OF OPERATIONS
(a) On September 16, 1998, we signed an asset purchase agreement with Meris
for us to acquire substantially all the assets of Meris. The agreement was
approved on October 28, 1998 by the United States Bankruptcy Court in Los
Angeles, California, and we completed the acquisition of Meris on November 5,
1998. The results of operations of Meris for the period from January 1 through
November 5, 1998 have been included in our pro forma statement of operations
for the year ended December 31, 1998. The results of operations of Meris since
November 5, 1998 have been included in our historical results of operations.
(b) On April 5, 1999, we signed an asset purchase agreement with Bio-Cypher
for us to acquire substantially all of the assets of Bio-Cypher. The
acquisition of Bio-Cypher was completed on May 10, 1999. Bio-Cypher's results
for the period from January 1, 1999 through May 9, 1999 and for the twelve
months ended November 30, 1998 have been included in our pro forma statements
of operations for the nine months ended September 30, 1999 and the year ended
December 31, 1998, respectively. The results of Bio-Cypher since May 9, 1999
have been included in our historical results of operations.
(c) The pro forma adjustments to the statements of operations exclude:
. $24.9 million of estimated fees and expenses to be incurred in
connection with the recapitalization transaction;
. the write-off of $3.0 million of deferred financing costs associated
with the repurchase of our existing senior notes;
. the estimated $17.8 million of fees payable for the early retirement of
existing debt;
. $16.5 million of employee compensation expenses relating to the exercise
of stock options; and
. $2.3 million of deferred compensation expenses and forgiveness of loans
either effective upon a change of control or payable due to certain
individual's efforts in connection with effecting the recapitalization.
Such amounts represent non-recurring expenses which we anticipate will be
recorded in the statement of operations for the period including the
recapitalization.
(d) Represents the elimination of interest income on overnight deposits.
(e) Represents annual financial advisory fees paid to Kelso.
32
<PAGE>
(f) The pro forma adjustments to interest expense reflect the following:
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, 1998 September 30, 1999
----------------- ------------------
(dollars in thousands)
<S> <C> <C>
New credit facility:
Revolving credit facility(1)........... $ 180 $ 135
A term loan(2)......................... 4,562 3,422
B term loan(3)......................... 10,862 8,146
The Notes(4)........................... 19,763 14,822
Commitment fee(5)...................... 115 86
Capital lease obligations.............. 819 502
------- -------
Cash interest expense.................. 36,301 27,113
Amortization of debt financing
costs(6).............................. 946 710
Amortization of discount on Notes(7)... 221 107
------- -------
Pro forma interest expense............. 37,468 27,930
Less: historical interest expense on
debt repaid(8)........................ (14,406) (12,164)
Less: pro forma interest expense on
debt related to the Meris acquisition
(see footnote (k) below).............. (889) --
Less: pro forma interest expense on
debt related to the Bio-Cypher
acquisition (see footnote (o) below).. (1,875) (676)
------- -------
Total adjustment....................... $20,298 $15,090
======= =======
</TABLE>
- --------
(1) Represents interest on the drawn portion of the $25.0 million revolving
credit facility using an assumed interest rate of 9.125%.
(2) Represents interest on the $50.0 million A term loan using an assumed
interest rate of 9.125%.
(3) Represents interest on the $110.0 million B term loan using an interest
rate of 9.875%.
(4) Represents interest on $155.0 million of the Notes at an interest rate of
12.75%.
(5) Represents a 0.5% commitment fee on the unused portion of the revolving
credit facility.
(6) Represents amortization of deferred financing costs of $7.8 million over
the term of the related debt.
(7) Represents amortization of original issue discount of $4.2 million over the
term of the Notes using the effective interest rate method.
(8) Represents the elimination of historical interest expense paid or payable
in cash.
A 0.125% increase or decrease in the assumed weighted average interest rate
applicable to the new credit facility would change the pro forma interest
expense and income before taxes as follows:
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, 1998 September 30, 1999
----------------- ------------------
(dollars in thousands)
<S> <C> <C>
Revolving credit facility............... $ 2 $ 2
A term loan............................. 63 47
B term loan............................. 138 103
---- ----
Total................................. $203 $152
==== ====
</TABLE>
(g) Represents the elimination of the historical deferred financing
amortization expense associated with our existing senior notes.
(h) To eliminate dividends on preferred stock redeemed as part of the
recapitalization.
(i) To reflect additional amortization expense for the period from January 1
through November 5, 1998 associated with the goodwill and other intangible
assets recorded in connection with the acquisition of Meris.
(j) To reflect the elimination of the historical interest expense incurred by
Meris.
33
<PAGE>
(k) To reflect interest expense for the period from January 1 through
November 5, 1998 associated with the issuance of a $14.0 million convertible
subordinated note, bearing interest on the outstanding balance at a rate of
7.5% per annum, in connection with the acquisition of Meris.
(l) To reflect the elimination of the historical amortization expense
incurred by Bio-Cypher.
(m) To reflect additional amortization expense associated with the goodwill
and other intangible assets recorded in connection with the acquisition of Bio-
Cypher.
(n) To reflect the elimination of the historical interest expense incurred by
Bio-Cypher.
(o) To reflect the interest expense associated with the issuance of the $25.0
million notes, bearing interest on the outstanding balance at a rate of 7.5%
per annum, in connection with the acquisition of Bio-Cypher.
(p) To reflect the elimination of the non-recurring charges recorded by Bio-
Cypher to write-down intangible assets and goodwill for the permanent decline
in value below Bio-Cypher's previous unamortized historical cost and the write-
down of fixed assets to fair market value.
(q) To reflect the elimination of a non-recurring legal charge of $0.6
million recorded by us for the estimated settlement amount regarding claims by
a group of insurance companies in connection with our billing practices.
(r) For purposes of determining the pro forma ratio of earnings to fixed
charges, earnings are defined as income before income taxes plus fixed charges.
Fixed charges include interest expense on all debt, amortization of deferred
financing costs and one-third of rental expense on operating leases
representing that portion of rental expense deemed to be attributable to
interest. Earnings would have been insufficient to cover fixed charges by
$32,616 and $2,381 for year ended December 31, 1998 and the nine months ended
September 30, 1999, respectively.
34
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
The selected historical financial data for each of the fiscal years in the
five-year period ended December 31, 1998 have been derived from our audited
financial statements. Such information is contained in and should be read in
conjunction with the audited financial statements and accompanying notes
included in this prospectus or incorporated by reference in our Annual Reports
on Form 10-K, as amended, for such years.
The selected financial data for the nine months ended September 30, 1998 and
1999 have been derived from our unaudited interim financial statements, which
in the opinion of management include all adjustments, consisting only of normal
recurring adjustments, which we consider necessary for a fair presentation of
our financial position and results of operations for these periods. Operating
results for the nine months ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the full year. The nine
month data should be read in conjunction with our unaudited financial
statements for the nine months ended September 30, 1998 and 1999 included
elsewhere in this prospectus.
The variations in the year-to-year and nine-month period to nine-month period
comparisons are due primarily to the acquisition of substantially all of the
assets of Bio-Cypher Laboratories, effective May 10, 1999, the acquisition of
substantially all of the assets of Meris Laboratories, effective November 5,
1998, the acquisition of MLN Holding Acquisition Co., effective May 16, 1995
and the acquisition of Premier Laboratory Services, Inc., effective January 24,
1994. In addition, see notes 4, 5 and 7 of the notes to the audited financial
statements included elsewhere in this prospectus for a more detailed discussion
of the legal and acquisition related charges, restructuring charges and loss on
sale of promissory note recorded in 1996. In addition, see note 5 to our
unaudited nine-month financial statements included elsewhere in this prospectus
for a more detailed discussions of the legal charge recorded during the nine
months ended September 30, 1999.
<TABLE>
<CAPTION>
December 31, September 30,
------------------------------------------------------ ------------------
1994 1995 1996 1997 1998 1998 1999
-------- -------- -------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data:
Revenue................ $151,820 $189,042 $205,217 $214,001 $217,370 $162,046 $213,496
Direct laboratory and
field expenses........ 102,715 132,877 154,172 155,942 152,007 111,634 147,133
Legal, acquisition and
restructuring related
charges............... 1,282(1) 4,400(2) 70,595 -- -- -- 600
Selling, general and
administrative
expense............... 31,187 37,612 41,801 34,570 33,530 24,990 29,323
Operating income
(loss)................ 9,137 4,539 (72,842) 14,604 24,241 19,648 29,251
Third party interest,
net................... (5,059) (8,994) (13,401) (14,068) (13,538) (10,068) (11,244)
Related party interest,
net................... (133) 661 1,279 -- -- -- --
Loss on sale of equity
investment/promissory
note.................. -- 36,499(3) 4,529 -- -- -- --
Income (loss) before
income taxes and
extraordinary item.... 4,515 (40,043) (89,493) 536 10,703 9,580 18,007
Income tax benefit..... -- -- -- -- -- -- 11,904
Income (loss) before
extraordinary item.... 4,515 (40,043) (89,493) 536 10,703 9,580 29,911
Extraordinary item..... -- 1,732 3,451 -- -- -- --
Net income (loss)...... $ 4,515 $(41,775) $(92,944) $ 536 $ 10,703 $ 9,580 $ 29,911
Other Financial Data:
EBITDA(4).............. $ 17,918 $ 18,553 $ 9,244 $ 23,489 $ 31,833 $ 25,422 $ 37,040
Depreciation and
amortization.......... 7,499 9,614 11,491 8,885 7,592 5,774 7,189
Capital expenditures... 2,879 4,435 3,948 1,935 3,005 2,335 4,903
Net cash provided
(used) by operating
activities............ 4,299 (7,400) (5,128) 3,715 13,996 12,590 25,301
Net cash provided
(used) by financing
activities............ 30,483 29,055 13,786 (1,384) (1,836) (1,387) (681)
Net cash provided
(used) by investing
activities............ (34,558) (23,076) 4,352 (3,759) (3,675) (2,954) (13,507)
Ratio of earnings to
fixed charges(5)...... 1.48x -- (6) -- (6) 1.03x 1.60x 1.73x 2.17x
Balance Sheet Data:
Cash, cash equivalents
and restricted cash... $ 1,491 $ 70 $ 12,176 $ 11,652 $ 20,137 $ 19,901 $ 31,250
Accounts receivable,
net................... 27,348 40,334 37,279 36,583 41,326 40,395 55,830
Total assets........... 196,407 196,174 125,919 118,700 142,460 127,643 213,400
Total debt............. 74,119 109,154 127,872 126,096 138,376 124,794 162,541
Shareholders' equity
(deficiency).......... 95,334 56,330 (34,688) (32,283) (21,367) (22,545) 12,036
</TABLE>
35
<PAGE>
- --------
(1) Represents acquisition related charges arising from the closure of our
patient service centers and related facilities and a reduction in our
workforce in connection with the Premier acquisition.
(2) Represents a legal charge related to a settlement and legal fees paid in
connection with a lawsuit regarding our sales, marketing and distribution
of a product designed for use in connection with pap smears.
(3) Represents a loss on the sale of equity investment relating to the sale of
our 40% equity interest in a European laboratory company.
(4) "EBITDA" is defined as net income (loss) before interest expense, income
taxes, depreciation and amortization, non-recurring charges and
extraordinary items. EBITDA is not a measure of performance under generally
accepted accounting principles ("GAAP"). While EBITDA should not be
considered in isolation or as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared
in accordance with GAAP, or as a measure of profitability or liquidity,
management understands that EBITDA is customarily used as a criteria in
evaluating health care companies. Moreover, substantially all of our
financing agreements contain covenants in which EBITDA is used as a measure
of financial performance. Excludes non-recurring charges and extraordinary
items of $1.3 million, $42.6 million, $70.6 million and $0.6 million for
1994, 1995 and 1996 and the nine months ended September 30, 1999,
respectively.
(5) For purposes of determining the ratio of fixed charges, earnings are
defined as income before income taxes plus fixed charges. Fixed charges
include interest expense on all debt, amortization of deferred financing
costs and one-third of rental expense on operating leases representing that
portion of rental expense deemed to be attributable to interest.
(6) Earnings were insufficient to cover fixed charges in 1995 and 1996 by
$40,293 and $89,493, respectively.
36
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are the largest clinical laboratory testing company in California,
providing comprehensive laboratory testing services to physicians, managed care
groups, hospitals and other health care providers. Our predecessor began
operations in California in the 1970s. We were originally structured as a
public company in 1988 for the purpose of receiving the Western United States
laboratory services assets (California, Colorado, Texas, Arizona) of MetPath,
Inc., a subsidiary of Corning Incorporated, in exchange for approximately 50%
of our outstanding shares. We initially operated under the name "MetWest."
Subsequently, in 1993, we completed a reorganization transaction with Corning,
in which we sold to Corning effectively all of our non-California operations in
exchange for substantially all of Corning's equity ownership in us. As a result
of this reorganization, we began operating under the name "Unilab Corporation,"
became a widely held public company, severed our relationship with Corning and
focused almost exclusively on the California marketplace.
In the early 1990s, the clinical laboratory testing industry in California
was affected by changes in government regulation, price competition and the
increased penetration of managed care. As a result of these factors, our
profitability was negatively impacted both by changes in testing volume and
reimbursement levels and the mix of payors for our services. Government
regulation focusing on health care cost containment has historically reduced
testing volumes and reimbursement rates and added costs to clinical
laboratories by increasing the complexity of billing and adding new regulatory
requirements. In response to these changes, in 1997 we implemented a strategy
to maintain testing volumes, increase prices and decrease costs. Once these
strategies were in place, we began to implement an in-market acquisition
strategy to leverage our fixed costs by increasing capacity utilization.
We derive our revenues from payments for clinical laboratory testing services
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 payors of health care costs
aggressively move the populations they control into lower cost plans. The
growth and consolidation of the managed care industry have 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 negotiate for capitated payment contracts, under which clinical
laboratories receive a fixed monthly fee per individual enrolled with the
managed care organization for all testing directed from the managed care
organization to the clinical laboratory. Some services, such as various
esoteric tests and anatomic pathology services, may be excluded from a
capitated rate and, if excluded, would be charged on a fee-for-service basis.
We expect the use of capitated agreements to continue for the foreseeable
future. We maintain an active account management process to evaluate the
profitability of our existing and new business, including capitated agreements.
Since 1997, we have sought to adjust the prices of managed care contracts,
where appropriate, to better correlate reimbursement rates with the level of
service provided.
The clinical laboratory testing industry is labor intensive given the high
degree of manual labor required in collecting, transporting and testing
specimens. In 1998, salaries, wages and benefits constituted approximately 45%
of our direct laboratory and field expenses. Supplies expenses in collecting,
transporting and testing specimens constituted approximately 20% of our direct
laboratory and field expenses in 1998. Other operating expenses accounted for
approximately 35% of our direct laboratory and field expenses in 1998. Selling,
general and administrative expenses consist principally of the costs of the
sales force, billing operations and general management and administrative
support. Costs to address Year 2000 issues have been principally included in
selling, general and administrative expenses.
37
<PAGE>
Recent Acquisitions
Meris Acquisition
On September 16, 1998, we signed a definitive agreement to acquire
substantially all of the assets of Meris Laboratories, Inc., one of the leading
regional independent laboratories in Northern California, for approximately
$16.5 million, consisting of a $14.0 million 7.5% convertible subordinated note
and the assumption of $2.5 million in additional liabilities to be paid in
equal installments of $35,000 per month over 72 months. In addition to Meris'
customer list, we acquired approximately $3.5 million of net assets, the
majority of which were trade accounts receivable. The agreement was approved on
October 28, 1998 by the United States Bankruptcy Court and we took possession
of the acquired net assets on November 5, 1998. Within approximately two months
after completing the acquisition, we had substantially integrated the Meris
business and realized much of the significant synergies available in the
consolidation.
Bio-Cypher Acquisition
On April 5, 1999, we signed a definitive agreement to acquire substantially
all of the assets of Physicians Clinical Laboratories, Inc., which operated
under the name Bio-Cypher Laboratories for approximately $37 million. Bio-
Cypher had been one of our principal competitors. The purchase price for Bio-
Cypher consisted of one million shares of our common stock, approximately $8.6
million in cash, $25 million of notes and the assumption of $4 million in
additional liabilities. In addition to Bio-Cypher's customer list, we acquired
approximately $9.6 million of assets, the majority of which were trade accounts
receivable. The transaction closed on May 10, 1999 and we have completed the
integration of the acquisition.
Results of Operations
The following table sets forth certain components of our consolidated
statement of operations data as a percentage of revenue.
<TABLE>
<CAPTION>
Nine Months
Ended
September
Year Ended December 31, 30,
------------------------- ------------
1996 1997 1998 1998 1999
------- ------- ------- ----- -----
<S> <C> <C> <C> <C> <C>
Revenue........................... 100.0% 100.0% 100.0% 100.0% 100.0%
Direct laboratory and field ex-
penses:
Salaries, wages and benefits.... 34.5% 32.3% 31.2% 30.6% 29.6%
Supplies........................ 14.0% 14.0% 14.1% 13.9% 14.4%
Other operating expenses........ 26.6% 26.6% 24.7% 24.3% 24.9%
Depreciation and amortization..... 5.6% 4.2% 3.5% 3.6% 3.4%
Selling, general and administra-
tive expenses.................... 20.4% 16.2% 15.4% 15.4% 13.7%
EBITDA(1)......................... 4.5% 11.0% 14.6% 15.7% 17.3%
</TABLE>
- --------
(1) Excludes certain non-recurring charges and extraordinary items.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Revenue. Revenue increased to $213.5 million for the nine month period ended
September 30, 1999 from $162.0 million for the comparable prior year period,
representing an increase of $51.5 million or 31.8%. Approximately $36.4 million
of the increase for the nine month period ended September 30, 1999 was
attributable to revenue generated from the acquisitions of Meris, effective
November 5, 1998 and Bio-Cypher, effective May 10, 1999. Exclusive of the
acquired Meris and Bio-Cypher businesses, revenue increased $15.1 million for
the period, primarily the result of increases in reimbursement levels of $8.5
million and additional specimen volume generating $6.6 million.
38
<PAGE>
We experienced a 5.1% increase, exclusive of the acquired Meris and BCL
businesses, in the average reimbursement received for each specimen processed
during the nine month period ended September 30, 1999 versus the comparable
prior year period. The increase in reimbursement levels is primarily due to
increases in rates charged to managed care clients, replacement of our most
unprofitable accounts with other better priced business and changes in test mix
to more sophisticated testing procedures for HIV and sexually transmitted and
other infectious diseases. Exclusive of the acquired Meris and Bio-Cypher
businesses, we experienced a 4.0% increase in the number of specimens processed
in the core business during the nine month period ended September 30, 1999
versus the comparable prior year period. In addition, while we have experienced
increases in volume over the prior year through acquisitions and growth in the
core business, we have experienced over the last several months greater
seasonal softness than anticipated and we have purged more business (primarily
lower priced and less profitable accounts) from the Bio-Cypher acquisition than
originally forecasted.
Salaries, Wages and Benefits. Salaries, wages and benefits increased to $63.2
million for the nine month period ended September 30, 1999 from $49.6 million
for the comparable prior year period. As a percentage of revenue, salaries,
wages and benefits decreased to 29.6% for the nine month period ended September
30, 1999 from 30.6% for the comparable prior year period. The decrease
primarily reflects the economies of scale associated with processing a
significantly higher specimen volume (25.3% volume increase during the first
nine months of 1999 including the effect of the Meris and Bio-Cypher
acquisitions) without the same corresponding increase in headcount.
Supplies. Supplies expense increased to $30.7 million for the nine month
period ended September 30, 1999 from $22.6 million for the comparable prior
year period. As a percentage of revenue, supplies expense increased to 14.4%
for the nine month period ended September 30, 1999 from 13.9% for the
comparable prior year period. The increase is attributable to bringing certain
more costly testing in-house, mandated use of more costly safety needles and
inefficiencies of running two laboratories in the Sacramento area during the
integration period of Bio-Cypher. We closed the Bio-Cypher laboratory in mid-
August, 1999.
Other Operating Expenses. Other operating expenses increased to $53.3 million
for the nine month period ended September 30, 1999 from $39.4 million for the
comparable prior year period. As a percentage of revenue, other operating
expenses increased to 24.9% for the nine month period ended September 30, 1999
from 24.3% for the comparable prior year period. The increases are attributable
to inefficiencies of running two laboratories in the Sacramento area during the
integration period of Bio-Cypher and a higher volume of testing being processed
by outside reference laboratories.
Legal Charge. We have recently settled with a group of thirteen insurance
companies regarding claims by the insurance companies that we over-billed them
in the mid-1990s in connection with several chemistry profile tests that were
previously the subject of a settlement agreement with the government. We paid
$600,000 to settle these claims, and such amount has been reflected as a charge
in the statement of operations for the second quarter of 1999.
Depreciation and Amortization. Depreciation and amortization increased to
$7.2 million for the nine month period ended September 30, 1999 from $5.8
million for the comparable prior year period. The increase was primarily due to
the additional amortization expense incurred from the goodwill recorded in
connection with the Meris and Bio-Cypher acquisitions offset by a decrease in
depreciation expense due to certain laboratory computer equipment becoming
fully depreciated in 1998.
In addition, based upon the final review of certain assets acquired in the
Meris and Bio-Cypher acquisitions, we have changed our estimate of goodwill
amortization arising from those acquisitions to a 10-year period effective July
1, 1999. The effect of the change was to increase amortization expense by $0.6
million for the nine month period ended September 30, 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $29.3 million for the nine month period
ended September 30, 1999 from $25.0 million for the comparable prior
39
<PAGE>
year period. As a percentage of revenue, selling, general and administrative
expenses decreased to 13.7% for the nine month period ended September 30, 1999
from 15.4% for the comparable prior year period. Such decrease continued the
trend realized by us throughout 1998 and 1999 from cost reduction efforts and
also reflected the economies of scale and efficiencies gained from the Meris
and Bio-Cypher acquisitions.
EBITDA. EBITDA were $36.4 million for the nine month period ended September
30, 1999, compared to $25.4 million for the comparable prior year period.
Without the effect of the $0.6 million legal charge recorded in the second
quarter of 1999, EBITDA for the nine month period ended September 30, 1999
would have been $37.0 million or 17.3% of sales, and would have represented an
increase of approximately 46% over the comparable prior year period.
Interest Expense. Third party interest, net increased to $11.2 million for
the nine month period ended September 30, 1999 compared to $10.1 million for
the comparable prior year period. The increase was primarily due to the
additional interest expense incurred on the $14.0 million convertible
subordinated note issued in connection with the Meris acquisition and the $25.0
million subordinated note issued in connection with the Bio-Cypher acquisition.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue increased to $217.4 million for the year ended December 31,
1998 from $214.0 million for the comparable prior year period, representing an
increase of $3.4 million or 1.6%. Approximately $2.9 million of the increase
was attributable to revenue generated from the acquisition of Meris, which was
effective as of November 5, 1998. Exclusive of the acquired Meris business,
revenue increased $0.5 million, primarily the result of increases in
reimbursement levels of $6.3 million offset by decreases in specimen volume of
approximately $5.8 million.
We experienced a 3.1% increase, exclusive of the acquired Meris business, in
the average reimbursement received for each specimen processed during the year
ended December 31, 1998 versus the comparable prior year period. The increase
in reimbursement levels is primarily due to increases in rates charged to
managed care clients as we continue our strategy to only work with managed care
clients who are willing to adequately pay for the levels of service they
request and the elimination and replacement of our most unprofitable accounts
with other reasonably priced business. Exclusive of the acquired Meris
business, we experienced a 2.8% decrease in the number of specimens processed
during the year ended December 31, 1998 versus the comparable prior year
period. The decrease in volume was the effect of Medicare requirements for new
test panels which led to changes in ordering patterns among physicians, the
elimination of some under-performing accounts and the exit from small
geographical areas where we couldn't achieve significant economies of scale.
Salaries, Wages and Benefits. Salaries, wages and benefits decreased to $67.7
million for the year ended December 31, 1998 from $69.1 million for the
comparable prior year period. As a percentage of revenue, salaries, wages and
benefits were 31.2% and 32.3% for the years ended December 31, 1998 and 1997,
respectively. Such decrease primarily reflects a reduction in headcount and
tight control over the growth in wage increases.
Supplies. Supplies expense remained consistent at approximately 14.0% of
revenue for the years ended December 31, 1998 and 1997. However, supplies
expense per specimen processed increased slightly in 1998 as we started to
perform certain more costly tests in-house in late 1997 that were previously
sent to outside reference laboratories. Although we experienced a slight
increase in supplies expense related to bringing this testing in-house, we had
a positive net benefit as lab subcontracting expenses decreased by more than
10% in the year ended December 31, 1998 from the comparable prior year period.
Other Operating Expenses. Other operating expenses decreased to $53.6 million
for the year ended December 31, 1998 from $57.0 million for the comparable
prior year period. As a percentage of revenue, other operating expenses were
24.7% and 26.6% for the years ended December 31, 1998 and 1997, respectively.
Such decrease was primarily due to reductions in lab subcontracting expenses
(see explanation in preceding
40
<PAGE>
paragraph) and reductions in outside courier, automobile, telecommunication and
insurance expenses, as we evaluated all expense line items throughout 1997 and
1998 and streamlined expenses as necessary to achieve cost efficiencies.
Depreciation and Amortization. Depreciation and amortization expense
decreased to $7.6 million for the year ended December 31, 1998 from $8.9
million for the comparable prior year period primarily due to certain non-
compete agreements and laboratory computer equipment becoming fully amortized
or depreciated in late 1997 and early 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $33.5 million for the year ended December
31, 1998 from $34.6 million for the comparable prior year period. As a
percentage of revenue, selling, general and administrative expenses were 15.4%
and 16.2% for the years ended December 31, 1998 and 1997, respectively. Such
decrease continued the trend realized by us throughout 1997 and relates to a
reduction in corporate managerial and administrative positions and streamlining
of all operating support services.
EBITDA. EBITDA was $31.8 million for the year ended December 31, 1998
compared to $23.5 million for the comparable prior year period. Without the
effect of a $1.2 million impact on EBITDA resulting from the integration period
between November 5, 1998 and late December 1998 of the Meris acquisition,
EBITDA for the year ended December 31, 1998 would have been $33.0 million.
Interest Expense. Third party interest expense, net decreased to $13.5
million for the year ended December 31, 1998 from $14.1 million for the
comparable prior year period primarily due to the repayment of capital lease
obligations.
The Company has not recognized an income tax provision for the years ended
December 31, 1998 and 1997. In 1998, the Company reduced the valuation
allowance against its deferred tax assets by $3.9 million, which offset any
potential income tax provision. In 1997, the Company did not have taxable
income. The Company has provided a valuation allowance against the entire
deferred tax asset balance of $34.8 million at December 31, 1998. The Company
believes that the valuation allowance is required since the Company has a
recent history of operating and taxable losses, had cumulative losses of $11.1
million (excluding legal, acquisition-related and restructuring charges) for
the past three years, has historically fallen short of its projected operating
results and is still integrating and has not yet fully realized the benefits
from the Meris acquisition. Based on these factors, the Company does not
believe the weight of the evidence would support the Company having sufficient
future book and taxable income to release some or all of the valuation
allowance at December 31, 1998.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue. Revenue increased to $214.0 million for the year ended December 31,
1997 from $205.2 million for the comparable prior year period, representing an
increase of $8.8 million or 4.3%. The increase was primarily the result of
additional specimen volume generating approximately $17.6 million offset by
changes in payor mix and decreases in reimbursement levels of approximately
$8.8 million.
The $17.6 million increase in specimen volume was due to a 8.6% increase in
the number of specimens processed during the year ended December 31, 1997
versus the comparable prior year period. Such increase was primarily
attributable to growth in our core business.
We experienced a 3.9% decline in the average reimbursement received for each
specimen processed during the year ended December 31, 1997 versus the
comparable prior year period. Such decrease was primarily due to an increase in
managed care business and a general softening in reimbursement levels across
most payor groups, most notably from insurance carriers.
41
<PAGE>
While average reimbursement was down over the prior year, the average
reimbursement over the last six months of 1997 increased approximately 2.5%
over the average reimbursement in the first six months of 1997, the first time
in over two years that average reimbursement has increased over a comparable
prior period.
Salaries, Wages and Benefits. Salaries, wages and benefits decreased to $69.1
million for the year ended December 31, 1997 from $70.9 million for the
comparable prior year period. As a percentage of revenue, salaries, wages and
benefits were 32.3% and 34.5% for the years ended December 31, 1997 and 1996,
respectively. Such decrease primarily reflects a reduction in headcount,
control over the growth in wage increases and economies of scale associated
with fewer employees processing a significantly higher specimen volume.
Supplies. Supplies expense increased to $29.9 million for the year ended
December 31, 1997 from $28.6 million for the comparable prior year period. As a
percentage of revenue, supplies expense were consistent at 14.0% for the years
ended December 31, 1997 and 1996. However, on a per specimen basis, supplies
costs actually decreased 4.2% as a result of economies of scale associated with
an increased specimen volume.
Other Operating Expenses. Other operating expenses increased to $57.0 million
for the year ended December 31, 1997 from $54.7 million for the comparable
prior year period. As a percentage of revenue, other operating expenses were
consistent at 26.6% for the years ended December 31, 1997 and 1996.
During the third quarter of 1996, we recorded charges of approximately $4.9
million, primarily related to settlements reached with the U.S. Government and
certain other entities in connection with our sales, marketing and billing
practices. We agreed to pay the U.S. Government approximately $4.0 million to
conclude an investigation of certain of our billings to Medicare and certain
other governmental entities for hematology indices being billed in conjunction
with complete blood counts. We also paid the California MediCal program
approximately $160,000 in October 1996 to settle all their claims concerning
the same issue.
During the fourth quarter of 1996, we recorded charges of $65.7 million,
consisting of the write-off of goodwill and customer lists of $61.7 million and
a reserve for managerial restructuring expenses of $4.0 million. The write-off
of goodwill and customer lists principally related to two of our laboratory
operations, which had seen decreasing operating results and cash flows
throughout 1996. The $4.0 million managerial restructuring expenses related to
a reduction in headcount of approximately 25 employees, including the
resignation of our then Chairman, President and Chief Executive Officer in
January 1997.
Depreciation and Amortization. Depreciation and amortization expense
decreased to $8.9 million for the year ended December 31, 1997 from $11.5
million for the comparable prior year period. Such decrease was primarily due
to a reduction in amortization expense from the write-off of goodwill and
customer lists of $61.7 million in the fourth quarter of 1996 offset by
increased depreciation expense from approximately $4.1 million of laboratory
computer equipment and software placed into service at one of our laboratory
locations in the first quarter of 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $34.6 million for the year ended December
31, 1997 from $41.8 million for the comparable prior year period. As a
percentage of revenue, selling, general and administrative expenses were 16.2%
and 20.4% for the years ended December 31, 1997 and 1996, respectively. Such
decrease related primarily to a reduction in the level of expenditures incurred
in the sales and marketing area, including revisions in incentive programs and
reduction in staffing levels and organizational and support services, and
reduction in corporate managerial and administrative positions.
EBITDA. EBITDA was $23.5 million for the year ended December 31, 1997
compared to $9.2 million for the comparable prior year period (excluding legal
and acquisition related and restructuring charges, loss on sale of promissory
note and extraordinary item).
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Interest Expense. Third party interest expense, net increased to $14.1
million for the year ended December 31, 1997 from $13.4 million for the
comparable prior year period. The increase was primarily due to the full year
effect of increased debt incurred by us under an offering of $120.0 million of
11% senior notes due 2006 in March 1996.
Related party interest income of $1.3 million for the year ended December 31,
1996 reflects interest income on a $15.0 million promissory note we received
upon the sale, effective June 30, 1995, of an equity investment. In November
1996, we sold a 100% participation interest in our rights under the $15.0
million promissory note to a third party for $11.0 million. We recorded a $4.5
million loss upon the sale, which reflected the $4.0 million loss in principal
plus the write-off of accrued and unpaid interest of $0.5 million from July 1,
1996 through the sale date.
Upon completion of the senior notes offering, we wrote off $3.5 million of
deferred financing costs related to our previous credit agreements.
Liquidity and Capital Resources
Following the Recapitalization
Our principal liquidity requirements are for working capital, consisting
primarily of accounts receivable and inventories, capital expenditures and debt
service. We will fund our liquidity needs primarily with internally generated
funds from operations and, to the extent necessary, through borrowings under
the new $25.0 million revolving credit facility.
For more information on our capital structure, including our debt
obligations, following the recapitalization, see "The Recapitalization,"
"Unaudited Pro Forma Financial Statements" and "Description of New Credit
Facility."
Capital expenditures were approximately $3.0 million and $4.9 million for the
year ended December 31, 1998 and the nine months ended September 30, 1999,
respectively, and were primarily for information technology, laboratory
equipment and expansion of our Sacramento laboratory. We expect to make
approximately $6.0 million of capital expenditures for the year ending December
31, 1999. Significant investments are expected for laboratory expansion,
information technology and laboratory equipment. We anticipate that on-going
maintenance capital expenditures will approximate 1% of revenue.
Historical
Net cash provided by operating activities was $25.3 million for the nine
months ended September 30, 1999 and reflects an improvement of $12.7 million
over the comparable prior year period when net cash provided by operating
activities was $12.6 million. The improvement in 1999 was primarily due to an
improvement in the Company's operating performance and timing of payments for
accounts payable.
Net cash used by financing activities was $0.7 million for the nine months
ended September 30, 1999, resulting primarily from scheduled principal
repayments under capital lease obligations.
Net cash used by investing activities was $13.5 million for the nine months
ended September 30, 1999, resulting from an $8.6 million cash payment in
partial consideration of the purchase price for the Bio-Cypher acquisition and
$4.9 million of fixed asset additions. We had $25.8 million of unrestricted
cash and cash equivalents at September 30, 1999.
Net cash provided by operating activities during the year ending December 31,
1998 was $14.0 million and reflects an improvement of $10.3 million over the
comparable prior year period when net cash provided by operating activities was
$3.7 million. The increase in 1998 was primarily due to the improvement in our
operating performance.
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Net cash used by financing activities was $1.8 million for the year ending
December 31, 1998, primarily resulting from scheduled principal repayments
under capital lease obligations of $1.7 million and the issuance of preferred
dividends of $0.1 million.
Net cash used by investing activities was $3.7 million for the year ended
December 31, 1998, resulting from capital expenditures of $3.0 million and
payments made on acquisitions completed in 1996 and 1995 of $0.7 million. We
expect that our capital expenditure requirements, excluding any amounts related
to acquisitions, will approximate $4.0 million in 1999.
In March 1996, we completed the offering of $120.0 million of 11% senior
notes due 2006. The proceeds from the senior notes offering were used to retire
outstanding borrowings under our then existing bank term loan and revolving
line of credit facility in the principal amount of $102.1 million, plus accrued
interest. We have not been required to make any mandatory redemption or sinking
fund payment with respect to the senior notes prior to maturity. The senior
notes are not redeemable prior to April 1, 2001, after which the senior notes
will be redeemable at any time at our option, in whole or in part, at various
redemption prices as set forth in the indenture covering such senior notes,
plus accrued and unpaid interest, if any, to the date of redemption. The
indenture governing the senior notes limits our ability to incur additional
debt, under certain circumstances.
As part of the recapitalization, on September 1, 1999 we commenced a tender
offer to repurchase and retire the senior notes. We have close the tender offer
on November 23, 1999, the same date as the closing of our merger with UC
Acquisition and other recapitalization transactions.
In connection with the acquisition of Meris, we issued a $14.0 million
convertible subordinated note, bearing interest at the rate of 7.5% and payable
on May 5 and November 5 of each year. The note is subordinated to the senior
notes and is due in November 2006. The note is convertible into our common
stock at a conversion price of $3.00 per share, subject to certain
restrictions. In addition, subject to certain restrictions, the note may be
redeemed by us. At the completion of the merger, the note was converted into
approximately 4.7 million shares of our common stock, which was then cashed out
at the $5.85 per share merger price.
In connection with the acquisition of Bio-Cypher, we issued $25.0 million of
notes bearing interest at the rate of 7.5%. As part of the recapitalization, we
have redeemed the notes.
In July 1996, we entered into an agreement with a financial institution
whereby we can sell accounts receivable up to a maximum of $20.0 million. As
collections reduce accounts receivables which have been sold, we may sell new
receivables to bring the amount sold up to a maximum of $20.0 million. As of
December 31, 1998, we had not sold any accounts receivable under this
agreement. Sales of receivables, if any, under the facility are subject to a
liquidity and debt service coverage ratio. We were in compliance with such
covenants in 1998. We allowed the agreement to terminate in July 1999.
We had $20.1 million of cash and cash equivalents on hand at December 31,
1998.
Year 2000
We have substantially completed the upgrading and modification of all our
laboratory, billing and accounting systems in order for such systems to
properly recognize and perform date calculations in the year 2000. We spent
approximately $400,000 in 1998 and another $100,000 in 1999 for additional
hardware, upgraded software and consulting time to enable us to properly
address the year 2000 issue. The total cost to fix the year 2000 issue is in
line with our original estimates. While the consequences of an incomplete or
untimely resolution of the year 2000 issue could have a significant impact on
finalizing laboratory results, properly billing the numerous different payor
groups and gathering and reporting payroll, accounting and other employee and
financial information, we believe that we have adequately resolved the year
2000 issue for our internal systems. There can be no assurance, however, that
our year 2000 compliance efforts will adequately address all year 2000-related
contingencies.
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As part of our contingency planning, we have standardized the platform and
software used to process and report laboratory results during the last several
years. In addition, we converted the last billing system not on our standard
billing platform in 1998. If a problem occurred with the laboratory hardware or
software, we might have to rely on outside reference laboratories to process
specimens until year 2000 problems were fixed. If we had to rely on another
location or outside reference laboratory to process specimens, turn-around time
on test results would be diminished and billings and cash collections from
payor groups could be significantly delayed.
We are relying upon the ability of numerous payor groups, primarily insurance
companies and government payors, to solve their year 2000 issues in order to
process our billings and make appropriate cash remittances. If such payor
groups do not properly resolve their year 2000 issues, cash collections could
be significantly delayed. In September 1998, the General Accounting Office
reported that "the Health Care Financing Administration and its contractors are
severely behind schedule in repairing, testing and implementing the mission-
critical systems supporting Medicare" and concluded that "it is highly unlikely
that all of the Medicare systems will be compliant in time to ensure the
delivery of uninterrupted benefits and services into the Year 2000." There can
be no assurance that payors or other third parties upon which we depend will
successfully address the year 2000 issue.
We send approximately 1% of our specimens to outside reference laboratories
for testing and do not believe we would have difficulty finding another
reference laboratory to perform such tests if our current main vendor
encounters difficulties with the year 2000 issue. We have asked all significant
vendors to report in writing to us on the status of their year 2000 readiness
and whether their systems will be compliant in sufficient time to satisfy our
current requirements and workflow. We review such reports regularly and makes
modifications to our own planning process, if necessary, based on the reports
received from vendors.
Seasonality
Our operations experience seasonal trends that we believe affect all clinical
laboratory companies. Testing volume generally tends to be lower during the
holiday seasons and, to a lesser extent, inclement weather. As a result,
because a substantial portion of our expenses are relatively fixed over the
short term, our operating income as a percentage of revenue tends to decrease
during the fourth quarter of each year, mainly due to the Christmas and
Thanksgiving holidays. Excluding $2.9 million of additional revenue in the
fourth quarter from the Meris acquisition, as a percentage of total 1998
revenue, we generated approximately 25.4% in the first quarter, 25.4% in the
second quarter, 24.8% in the third quarter and 24.4% in the fourth quarter.
Bad Debt Expense
Our bad debt expense as a percentage of revenue has remained stable over the
past several years, after accounting for acquisitions. The following table sets
forth our bad debt expense for each of the past three fiscal years and the nine
months ended September 30, 1998 and 1999.
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
------------------------- ------------------
1996 1997 1998 1998 1999
------- ------- ------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Bad debt expense.............. $14,180 $15,663 $15,662 $ 11,697 $ 15,376
% of revenue................. 6.9% 7.3% 7.2% 7.2% 7.2%
</TABLE>
Inflation
Inflation was not a material factor in either revenue or operating expenses
during the periods presented.
45
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BUSINESS
General
We are the largest independent clinical laboratory testing company in
California, providing comprehensive laboratory testing services to physicians,
managed care groups, hospitals and other health care providers. We perform over
1,000 different tests which help physicians diagnose, evaluate, monitor and
treat disease by measuring the presence, concentrations or composition of
chemical and cellular components in human body fluids and tissue. These tests
range from simple tests, such as glucose monitoring, to highly specialized
ones, such as those designed to measure HIV infection. On a pro forma basis, we
believe our revenues in California for the year ended December 31, 1998
represented approximately 25% of the California independent clinical laboratory
testing market, or more than twice the annual sales of the next largest
independent clinical laboratory in California. On a pro forma basis, for the
nine months ended September 30, 1999, we would have generated revenue of $232.0
million.
We operate our fully integrated collection and processing system 365 days a
year, 24 hours a day. Patient specimens are collected daily from clients'
offices or our own collection stations known as patient service centers.
Specimens are then transported to either full-service or short turn around time
("STAT") laboratories. STAT laboratories are local facilities where we can
quickly perform an abbreviated line of routine tests for customers that require
emergency or time-sensitive testing services. Once the specimens are received
at the laboratories, each specimen and related test request form is checked for
completeness, bar coded and entered into our computer system for testing and
billing purposes. Laboratory technicians then perform the requested tests, with
results generally available to clients the next morning electronically.
The clinical laboratory testing industry is essential to America's health
care delivery system because physicians must rely on accurate testing
information to properly assess and remedy their patients' health conditions. We
believe that the U.S. clinical laboratory testing market accounts for
approximately 3%, or approximately $30 billion, of the nation's total annual
healthcare expenditures. The clinical laboratory testing industry in the United
States is composed of three segments: (1) laboratories located in hospitals,
(2) laboratories located in physicians' offices and laboratories owned by
physicians and (3) independent clinical laboratories. Our management believes
that the California clinical laboratory testing market is approximately $4.0
billion in size and is the largest in the nation. Despite significant industry
consolidation, the clinical laboratory testing market nationally, and
particularly in California, remains highly fragmented. We directly compete in
the approximately $1.2-$1.4 billion independent clinical laboratory testing
sector within California.
Competitive Strengths
We attribute our leading position in the California independent clinical
laboratory testing market and our significant opportunities for continued
profitable growth to the following competitive strengths:
Market Leader in California. We are the largest independent clinical
laboratory testing company in California with a market share of approximately
25%, more than twice that of our next largest competitor. Our strong regional
presence and reputation for superior customer service and support make us the
preferred provider of laboratory testing services to physicians and other
customers seeking superior patient access and service reliability. We currently
serve approximately 40,000 customers and has approximately 150 managed care
contracts, covering approximately 3.8 million managed care lives.
Superior Regional Infrastructure. Our fully integrated and expansive field-
service network gives us a unique competitive advantage in California's
clinical laboratory testing market by offering greater geographic coverage and
convenience to our clients and their patients. We currently operate more
client-support facilities than any of our competitors in California. Now that
the integration of Bio-Cypher is substantially completed, we operate three
full-service laboratories (in Los Angeles, San Jose and Sacramento),
approximately 305 conveniently located patient service centers and 40
strategically located STAT laboratories. Our 420 courier routes and 36 courier
hubs will continue to provide rapid collection, processing and distribution
services to clients. We assess the characteristics of each geographic territory
to customize professional service routes that
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ensure proper specimen collection and report distribution which enable us to
offer highly effective services to the different needs of rural and high
traffic urban areas in California.
Low Cost Provider. We enjoy cost advantages gained through economies of scale
and efficient processes. Our management believes our cost per specimen is the
lowest in the California market. We have created a fully integrated collection,
testing, distribution and operating system which is characterized by a high
degree of operating leverage, allowing us to expand testing capacity at a very
low incremental cost. Meris and Bio-Cypher historically had average costs per
specimen of approximately $43.00 and $27.00, respectively. Following the
acquisitions, Meris has, and Bio-Cypher is expected to have, average costs per
specimen of approximately $21.00 and $16.00, respectively. Our management
expects these average cost per specimen reductions to generate annual cost
savings of approximately $45 million. Our management believes that we have the
capacity to process approximately 60,000 specimens per day, allowing an
increase of approximately 32.0% over the current level of 45,600 specimens per
day, without the need for significant additional operating expenses or capital
expenditures. This operating leverage should enable us to experience cash flow
growth while achieving our market share growth objectives.
Comprehensive Testing Services. We are able to provide our customers with
"one-stop-shopping" by offering a full spectrum of testing services to the
medical community. We perform approximately 99% of ordered tests, including
most esoteric tests, in-house. The balance is referred to subcontracted
specialty laboratories. We maintain a policy of expanding our testing menu only
when there is sufficient volume and economic justification. Accordingly,
favorable partnering relationships with several other laboratories facilitate
our ability to optimize our in-house test menu under a "make versus buy" cost-
based analysis. We believe that new testing procedures such as amplified DNA
probes for chlamydia and gonorrhea testing and emerging cytology (PAP smear)
technology offer two examples of possible additional future revenue growth from
technology. Conversion from non-amplified to amplified probes not only provides
for more specific and definitive test results, but also provides for a higher
level of reimbursement. Conversion to the newer emerging PAP smear technology
provides similar benefits both to the patient and to us. Our management
believes that increased marketing support of both of these new technologies
will have a positive effect on future revenue.
Reputation for Quality. Clinical laboratory testing is an essential element
in the delivery of quality healthcare service because physicians use laboratory
tests to assist in detecting, diagnosing, evaluating, monitoring and treating
diseases and other medical conditions. Approximately 70% of total healthcare
expenditures in the United States are determined on the basis of laboratory
test results. We employ a quality assurance program for all of our laboratories
and facilities designed to ensure that specimens are collected and tested, and
client, patient and test information is reported, billed and filed in a timely
and accurate manner. Each of our three full-service laboratories has earned
full accreditation by the College of American Pathology. Over the past four
years, our accuracy rates, as determined by the College of American Pathology,
have increased from 99.2% in 1994 to over 99.5% in 1998. Our management
believes that our accuracy rates are among the highest in the industry.
Proven and Committed Management Team with Substantial Local Market
Knowledge. We have a proven management team with extensive experience in the
California clinical laboratory testing industry, including significant
expertise in identifying, effecting and integrating acquisitions within the
California market. We have strengthened our existing management team with the
addition of Robert E. Whalen, who became our President and Chief Executive
Officer on November 23, 1999. Mr. Whalen was previously an Executive Vice
President of Laboratory Corporation of America and National Health
Laboratories. Mr. Whalen has over 20 years of experience in the clinical
laboratory testing industry, with over 10 of those years in California. David
C. Weavil, our former Chairman, President and Chief Executive Officer, is
expected to continue to have an active role in management and planning and will
remain Chairman. Our five most senior executives collectively have over 80
years of clinical laboratory testing experience. Moreover, approximately 70% of
our 200 employees in supervisory or managerial roles have been employed at our
company for five years or more. With the completion of the recapitalization,
our management team owns or have the opportunity to acquire through a stock
option plan up to 15% of our common stock.
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Business Strategy
Our overall goal is to continue to be recognized as the preeminent
independent clinical laboratory testing organization in California. To
accomplish this goal, we employ the following business strategies:
Maintain Customer Satisfaction through Superior Service Quality. We achieve a
high level of customer satisfaction through superior customer service and seek
to maintain what management believes our reputation as the highest quality
provider of clinical laboratory testing services in California. Our 75-member
sales and service staff is responsible for visiting existing and prospective
accounts regularly to educate them about our capabilities and general
laboratory issues and, in the case of existing accounts, to identify ways to
improve existing services. We also operate a customer service hotline to assist
customers with service issues and billing inquiries. Doctors can receive
patient test results via an automated telephone system 24 hours a day. To
ensure the integrity of our tests, we standardized and automated our
collection, testing and billing processes. Such standardized controls and
techniques include utilizing specialized pouches and preprinted requisition
forms for proper processing, as well as utilizing computer bar coding and log-
in techniques for proper testing and billing. Our goal is to remain the
provider of choice in California and to utilize our established brand name and
reputation for quality to compete on factors other than price.
Continue to Improve Terms of Contracts. We have a company-wide policy to
partner with our customers, especially managed care customers, in an effort to
effect greater correlation between price and service levels based on the
following three strategies: (1) increase "at risk" capitation rates to achieve
greater coverage of incremental testing costs; (2) reduce our incurred costs
that do not add value to patient care and (3) restructure contracts to exclude
some non-core "premium" services, such as PAP smears and esoteric tests, from
the "at risk" capitation rate. For example, we restructured a major contract in
early 1998 by increasing the capitation rate by more than 50%, with an
additional 50% step-up beginning in 1999. In addition, we passed all expenses
associated with six supporting STAT laboratories and 10 patient service centers
to the customer, expenses which would have previously been included in the
capitation rate. In 1997, we repriced over 70% of our managed care contracts
with a 50% average increase in pricing and in 1998 repriced 40% of our managed
care contracts with a 30% average increase in pricing. We have established this
partnering approach as a longer-term strategy and have instituted a quarterly
contract-specific review process to achieve this goal.
Grow Market Share through Refocused Sales and Marketing Efforts. We intend to
intensify our sales and marketing activities. We believe there are significant
opportunities to gain market share from other commercial laboratories. To
accomplish this, we intend to have a clearer delineation between sales and
service activities. We also believe there are considerable opportunities to
increase our hospital reference testing business and enter into laboratory
management agreements with hospitals, a segment which is largely unpenetrated
by us. Hospital laboratories account for approximately $2.0 billion of the
approximately $4.0 billion California clinical laboratory testing market. We
will also expand our effort to reduce client turnover through reorganized
sales, service and marketing functions. We intend to dedicate existing sales
force personnel to focus solely on these opportunities.
Maximize Operating Efficiencies. Although we have realized significant
expense reductions over the past two years, management believes there are
significant additional cost savings that can be attained over the near term.
For example, we expect to achieve further cost reductions through test menu
consolidations, continued process and workflow scheduling improvements and
consolidations of patient service centers and STAT laboratories. Our management
also expects to reduce expenses for lab subcontracting, overtime and supplies.
In addition, our management team expects to reduce our bad debt expense through
an increased emphasis on correct billing information.
Pursue Selected Acquisitions. In addition to seeking to maximize internal
growth, we will continue to opportunistically pursue selected acquisition
opportunities. We believes that independent laboratories with annual revenues
of less than $20 million make up over 40% of the California independent
clinical laboratory testing market. We believe that our expansive service
network and operating discipline effectively position us to
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be a logical consolidator within the fragmented California market. In
evaluating potential acquisition targets, we will continue to focus on
financially and ethically sound businesses with one or more of the following
characteristics: overlapping field-service networks for highly synergistic
"fold-in" acquisitions, such as the Meris and Bio-Cypher acquisitions; strong
geographic presence in regions where we may desire to attain greater market
share and quality customer bases possessing favorable pricing characteristics.
The Clinical Laboratory Testing Industry
Overview and Trends
We believe the U.S. clinical laboratory testing market accounts for roughly
3% of the nation's total annual healthcare expenditures, and represents an
estimated $30 billion in annual revenue. The clinical laboratory testing
industry is essential to America's health care delivery system because
physicians must rely on accurate testing information to properly assess and
remedy their patients' health conditions. We believe the California clinical
laboratory testing market is approximately $4.0 billion in size and is the
largest in the nation. We directly compete in the approximately $1.2-$1.4
billion independent laboratory sector within California.
Even after years of industry consolidation, the clinical laboratory testing
market nationally, and particularly in California, is highly fragmented. The
market is composed of three segments: (1) laboratories located in hospitals;
(2) laboratories located in physicians' offices and physician-owned
laboratories; and (3) independent clinical laboratories. Industry sources
estimate that there are currently fewer than 4,500 independent clinical labs
in the United States, with as many as 600 located in California. We believe
that approximately 55% of clinical laboratory testing revenues in California
result from tests performed by hospitals, 15% from tests performed by
physicians in their offices and physician-owned laboratories and 30% from
tests performed by independent laboratories. We believe that the consolidation
trend of the last several years is likely to continue, resulting in fewer
independent clinical labs both nationally and in California. We also believe
that large independent clinical laboratories may be able to increase their
share of the overall clinical laboratory testing market due to their scale,
large service networks and lower cost structure. These advantages should
enable larger clinical laboratories to more effectively serve managed care
organizations and more effectively manage the costs of more stringent
regulatory requirements and more complex billing practices.
Clinical laboratory testing continues to be an integral part of the delivery
of health care services in the United States due to a number of factors,
including:
. the aging of the U.S. population, resulting in increased utilization of
testing services;
. an increase in the number of routine tests and esoteric tests due to
advances in technology and scientific knowledge;
. increased automation in testing procedures due to the development of
highly automated laboratory testing equipment which has resulted in
greater efficiencies in testing operations;
. increased awareness among physicians and the general public concerning
the importance of preventive medicine and early detection; and
. increased use of tests by physicians as protection against potential
malpractice suits.
We believe that there will be further opportunities for independent
laboratories to capture additional market share from hospital and physician
office laboratories because of the cost and service advantages which large
independent laboratories like us have with respect to high volume, non-
emergency testing. The number of clinical laboratories has declined as
physicians have exited the clinical laboratory testing business and
consolidation has occurred in the independent laboratory segment. Also,
certain recent required changes in the billing and collection of Medicare and
Medicaid payments have complicated the billing and collection process and made
such processes more expensive.
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California Market
California is the single largest state clinical laboratory testing market in
the U.S., accounting for approximately 12% of the country's laboratory testing
revenues. We believe that consolidation in California has occurred and will
continue for reasons similar to those which have caused the industry
nationwide to consolidate, such as:
. the cost of compliance with increasingly stringent regulatory
requirements;
. the cost efficiencies afforded by large-scale automation of routine
testing;
. legislative developments, such as restrictions on physician self-
referrals and ownership of laboratories;
. reductions in Medicare and other third-party reimbursements;
. the growth of HMOs and other managed care groups which require efficient
testing services from high-capacity laboratories;
. the increasing demand for sophisticated equipment and management
information systems that tend to be prohibitively expensive for small
laboratories; and
. the competition for a limited supply of qualified laboratory personnel.
We have focused on the California clinical laboratory testing market because
of: (1) its size and density, (2) the high degree of fragmentation and
prospects of continued consolidation and (3) our current leadership position
in the market and the prospects of leveraging this status across the state.
Facilities and Testing
We currently operate three full-service clinical laboratories in San Jose,
Tarzana (Los Angeles) and Sacramento, California which offer over 1,000
clinical testing procedures, ranging from routine screening to advanced
technical procedures, used in the diagnosis, monitoring and treatment of
diseases and other medical conditions. We operate 24 hours a day, 365 days a
year, utilizing a fully integrated collection and processing system. Patient
specimens are collected from client offices or our own collecting stations and
transported to full-service or STAT laboratories, where each specimen and
related test request form is checked for completeness, bar coded and entered
into our computer system for testing and billing purposes. Laboratory
technicians then perform the requested tests, with results generally available
to clients the next morning electronically. Our clinical computer program
keeps track of patients' samples, reports test results and maintains records
and billing information.
Tests performed by us measure the levels of, and analyze chemical and
cellular components in, human body fluids and tissue and are used in the
diagnosis, monitoring and treatment of disease. They include procedures in the
areas of blood chemistry, hematology, urine chemistry, tissue pathology and
cytology, among others. Commonly ordered individual tests include red and
white blood cell counts, PAP smears, blood cholesterol level tests, urinalysis
and procedures to measure blood sugar levels and to determine pregnancy.
Routine test groups include tests to determine the function of the kidney,
heart, liver and thyroid, as well as other organs, and a general health screen
that measures several important body health parameters. Many of the routine
tests are performed by automated equipment and are capable of being performed
and reported within a 24-hour period. Approximately 85% of the tests conducted
by us are considered to be routine. Laboratory technicians perform requested
tests, with results generally available to clients the next morning
electronically. We perform approximately 99% of the tests requested by our
clients, with the remaining 1% performed by third party reference laboratories
with whom we contract. On a revenue basis, approximately 6% of testing fees
collected by us are paid to third party reference laboratories or pathology
services.
We also conduct esoteric testing services. Esoteric tests generally require
complex manual techniques, a higher degree of technical skill and knowledge
and sophisticated equipment. As a consequence, esoteric tests are priced
higher than routine tests. Two examples of esoteric tests provided by us
include immunoelectrophoresis, used for the diagnosis of autoimmune disorders
and myelomas, and hepatitis markers, used for the diagnosis of acute hepatitis
A and B and for identification of chronic carriers of these diseases. The
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number of esoteric tests performed by us has been increasing as new medical
discoveries are made and testing procedures developed.
Now that the integration of Bio-Cypher is substantially completed, we will
operate an extensive distribution and collection system of approximately 420
collection routes, approximately 305 PSCs and approximately 36 courier hubs.
Courier routes are logically designed based on lab location, geographic density
and specimen volume. Strategically located full service labs and satellite
courier "hubs" serve as control centers to ensure courier routing is efficient
and tightly controlled. In addition, PSCs act as initial specimen processing
centers, effectively putting control of the specimen in our possession earlier
in the process. We believe this distribution infrastructure is integral to
providing efficient, convenient and reliable service to our clients.
Customers
We provide testing services to a broad range of health care providers. The
following factors, among others, are often used by health care providers in
selecting a laboratory: (1) service capability and convenience offered by our
facilities, including accessibility of PSCs and local STAT testing
availability; (2) size and scope of testing services performed; (3) accuracy,
timeliness and consistency in reporting test results; (4) reputation in the
medical community and (5) pricing of the laboratory's testing services. Our
primary customer types are described below:
. Physicians and Physician Groups. Physicians performing testing for their
patients who are unaffiliated with a pre-paid health plan are the
principal source of our clinical laboratory testing business. These
physicians often participate in independent physician associations
("IPAs") to achieve greater local recognition and contracting leverage.
When we provide contracted testing services to physicians who belong to
IPAs, we bill the IPA, usually under a capitated arrangement. Otherwise,
services rendered for physicians' non-managed care patients are billed
to various other payors such as insurance, client bill, Medicare or
Medicaid.
. Health Maintenance Organizations and Other Managed Care Groups. HMOs and
other managed care payors, which designate the laboratory to be used for
tests ordered by the physician, represent a substantial portion of our
business. HMOs generally select an independent laboratory based on
competitive pricing offered to high volume customers, capability of the
laboratory to effectively service incremental blocks of business, field
distribution system, including couriers and PSCs to service their
networks of physician providers, and the reputation of the laboratory in
the medical community. We believe that our services more managed care
contracts than any other lab in the California marketplace, and that we
have become a preferred lab services provider to managed care for
several reasons. First, we have a state-wide presence, which gives
managed care clients the ability to partner with one lab subcontractor
that has state-wide coverage, instead of several subcontractors with
limited geographic coverage. Second, our internal cost-efficiencies
allow us to offer competitive pricing to the cost-conscious managed care
community. Third, we possess considerable expertise in addressing the
needs and issues of managed care payors.
. Hospitals. We provide both esoteric testing for hospitals, which often
are not equipped to perform such sophisticated tests, and general
reference testing for hospitals which have reduced or eliminated their
in-hospital laboratory testing in an attempt to reduce their cost of
delivering patient care. The selection of an independent laboratory by
hospitals is usually based on reputation of the laboratory in the
medical community, type of services offered, accuracy, timeliness and
consistency of test results and competitive pricing.
. Independent Laboratories. We also provide reference testing services to
independent clinical laboratories which do not have the full range of
our testing capabilities.
. Clinics. We have arrangements with a broad network of community health
clinics across the state of California that provide preventive health
care and/or medical attention for the lower-income and indigent patient
population (frequently MediCal recipients). Under these arrangements, we
are the primary provider of testing services for patients who choose to
use these clinics.
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We believe that California has the highest enrollment rate--approximately 40%
of the population--in managed care plans of any state in the country and, as a
result, delivery of health care to participants in such plans has become
integral to the health care delivery system throughout the state. The
proliferation of managed care providers in the healthcare industry has altered
the customer base of healthcare service providers, especially in California.
From 1993 to 1994, we more than doubled our number of covered lives--i.e.,
individuals covered by contracts between pre-paid health plans and our company
for the provision of laboratory services--to over 2 million lives. During 1995,
we continued to serve a similar number of covered lives, and during the first
half of 1996, increased our managed care coverage to over 2.5 million lives.
Today, we serve approximately 3.8 million managed care lives. This business had
historically been viewed as having substantial value, in large part because of
the economies of scale inherent in its considerable volume. It was also viewed
as a competitive advantage in obtaining additional non-managed care business
generated from many of the same offices which were serving managed care
patients. Increasingly, like other major laboratory companies, we came to
recognize that the pricing received in relation to the cost of services
provided to managed care patients was disproportionately low, and we undertook
a concerted effort in 1997 to improve the situation. To this end, we
renegotiated contracts with respect to over 70% of the covered lives and
received an average price increase in excess of 50% on those renegotiated
contracts. By year-end 1998, we had once again repriced the capitation rates on
approximately 40% of our managed care lives at an average increase of greater
than 30%. For the first six months of 1999, we have repriced approximately 12%
of our managed care lives at an average increase of approximately 50%. Some of
these contracts have been restructured to exclude some non-core "premium"
services, such as PAP smears and esoteric tests from the "at risk" capitation
rate.
Payors
Tests in the clinical laboratory industry are often billed to a party other
than the physician or patient. We receive reimbursement for our services from
five sources including third party payors such as insurance companies, managed
care providers and Medicare and MediCal as well as direct payors such as
physicians, hospitals, employers and patients.
The following table set forth ranges indicating the estimated contribution of
each of our principal payor categories to our total specimen volume and our
total clinical laboratory revenue for the year ended December 31, 1998, after
giving effect to the Meris and Bio-Cypher acquisitions.
<TABLE>
<S> <C>
Specimen Volume as % of Total Volume:
Managed care-capitated............................................. 30%-35%
Medicare and Medicaid.............................................. 20%-25%
Monthly bill (physician, hospital, employer, other)................ 20%-25%
Third party fee-for-service........................................ 15%-20%
Patients........................................................... 1%-5%
Revenue as % of Total:
Managed care-capitated............................................. 10%-15%
Medicare and Medicaid.............................................. 25%-30%
Monthly bill (physician, hospital, employer, other)................ 10%-15%
Third party fee-for-service........................................ 30%-35%
Patients........................................................... 10%-15%
</TABLE>
Quality Assurance
We believe that our procedures meet or exceed the highest standards in the
industry. We have established comprehensive quality assurance programs for all
of our laboratories and other facilities to ensure that specimens are collected
and transported properly, tests are performed accurately, and client, patient
and test information are reported, billed and filed correctly. Our quality
assurance programs include:
. preventive maintenance of laboratory testing equipment;
. maintenance of high personnel standards and training which require that
only qualified personnel perform testing;
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. rigorous utilization of control specimens in order to ensure accuracy
and precision of test equipment; and
. a tightly managed collection and distribution network.
In addition, all laboratories certified by the Health Care Financing
Administration ("HCFA") for participation in the Medicare program under the
Clinical Laboratory Improvement Amendments of 1988 ("CLIA"), such as our, must
participate in basic quality assurance programs. Each of our laboratories is
licensed or has licensure pending with its respective state authorities and is
also certified by HCFA for participation in the Medicare program under CLIA.
In addition, we participate in a number of independent proficiency testing
programs. Participation in a federally recognized proficiency testing program
is a requirement of CLIA. Under these programs, an independent testing
authority submits pre-tested samples to a laboratory. These tests measure the
laboratory's test results against known proficiency test values. We also
participate in a number of proficiency programs conducted both by us on our own
and in conjunction with groups such as the College of American Pathologists
("CAP"), and state and Federal government regulatory agencies. CAP is an
independent non-governmental organization of board certified pathologists which
offers an accreditation program to which laboratories can voluntarily
subscribe. The CAP accreditation program involves both on-site inspections of
the laboratory and participation in CAP's proficiency testing program for all
categories in which the laboratory is accredited by CAP. Each of our full-
service laboratories in Sacramento, San Jose and Tarzana has earned full
accreditation by CAP. In the 1998 External Proficiency Testing Program
conducted by CAP at our three primary laboratories, the total accuracy rate for
all sections of the laboratories was 99.5%, consistent with the 1997 accuracy
rate of 99.5%, which has increased steadily since the 1994 cumulative accuracy
rate of 99.2%.
Regional Operations, Sales, Service and Marketing
As of September 30, 1999 our sales and service organization was comprised of
approximately 75 full-time sales and service employees. Sales representatives
are primarily responsible for executing focused sales initiatives established
within their regions, while service representatives are primarily responsible
for account retention and enhancing client relations, although they also have
defined selling responsibilities. We intend to more clearly delineate between
the sales and service functions. In addition, incentive compensation will be
aligned to more closely reflect either sales or service responsibilities so
that sales and service employees will specialize in their respective
disciplines. Incentive compensation paid on new sales generation, achieved by
either sales or service representatives, is designed to recognize the cost of
supporting new business and reward dedication to client support and client
retention.
Our marketing department is committed to promoting our mission of maintaining
high quality and cost-effective laboratory services that are responsive to the
values and needs of patients and physicians. We promote this mission and our
other initiatives through the creation and targeted dissemination of marketing
materials to clients and prospects by our sales and service representatives (as
well as our couriers). More specifically, our marketing initiatives and
materials address four distinct objectives:
. Enhance medical community awareness of our full spectrum of services;
. Promote and sell new services and technological advances;
. Educate clients on regulatory and compliance issues that will affect the
medical community; and
. Address customer needs and concerns about new testing procedures.
These marketing initiatives are prioritized through a collaborative effort
among senior management, sales and service employees and other relevant
departments.
Acquisitions
We have had a history of successfully acquiring and integrating companies in
the clinical laboratory testing industry in California. Over the past five
years, we have successfully acquired and integrated five
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companies in the clinical laboratory industry, including Meris in the past
year. We completed the integration of our most recently acquired company, Bio-
Cypher, in the third quarter of 1999. These acquisitions have accounted for a
substantial portion of our growth. We believe our acquisitions of substantially
all of the assets of Meris and Bio-Cypher have increased our market share from
approximately 15% to approximately 25% of California's independent clinical
laboratory testing market.
Competition
The independent clinical laboratory testing industry in the United States and
in California is highly fragmented and is characterized by intense competition.
According to HCFA, there are approximately 4,500 independent clinical
laboratories in the United States, approximately 600 of which we believe are
located in California. These independent clinical laboratories fall into two
separate categories. The first are the smaller, local laboratories that
generally offer fewer tests and services and have less capital than the larger
laboratories. These laboratories seek to differentiate themselves by
maintaining a close working relationship with their physician clients by
providing a high level of personal and localized services.
The second group, which includes laboratories such as our, consists of the
larger regional or national laboratories that provide a broader range of tests
and services. In California, our two largest independent clinical laboratory
competitors are Quest Diagnostics Incorporated and Laboratory Corporation of
America. Quest recently acquired SmithKline Beecham Clinical Laboratories,
Inc., which had been one of our principal competitors. We believe that we
currently have approximately a 25% share of the California independent clinical
laboratory testing market, more than twice that of our nearest competitor. We
expect to gain market share from hospital laboratories in the coming years. The
hospital laboratory segment accounts for approximately one half of the $4.0
billion California clinical laboratory testing market and is characterized by a
large number of primarily cost center laboratories that operate with low
volumes and quick turn around times.
We compete primarily on the basis of the following: (1) service capability
and convenience offered by our facilities, including accessibility of PSCs and
local STAT testing availability; (2) size and scope of testing services
performed; (3) accuracy, timeliness and consistency in reporting test results;
(4) reputation in the medical community and (5) pricing of the laboratory's
testing services. Competition for qualified personnel is also intensifying as
statutory requirements for the licensing of personnel become more stringent. We
believe that our extensive California facilities provide easy access to our
clients and quick reporting of results at competitive prices. It is expected
that we will be able to continue to provide the full range of required testing,
either through our own testing capabilities or by utilizing outside reference
testing services contracted from third parties.
Information Systems
Effective information systems are a key component of our continued growth and
success. The clinical laboratory testing industry has embraced technology to
continually improve the level of service to our clients. The complexity of our
business requires that we constantly evaluate our systems to ensure that they
provide the tools required to deliver laboratory results and bills in a timely
manner.
We are a company that evolved from a series of mergers and acquisitions. We
realized early on that disparate systems for core business processes across our
three regional laboratories would be a barrier to consistent client service. In
the mid-1990s, we undertook a strategy to establish a standard platform for
both the laboratory and billing systems in the company. All our regional
laboratories have been running the Antrim Lab Information System since 1996.
Antrim is a specimen tracking, test result and instrument interface laboratory
system which is prevalent throughout the industry and provides a flexible
platform to interface current and future laboratory instruments. In addition,
the Antrim system provides our clients with the tools they require to deliver
the best quality medicine for patients. We believe that Antrim offers us the
flexibility to address new technologies and features as improved testing and
new delivery options become available in the market.
We have selected the SYS billing system. In October 1998, we converted the
last regional laboratory to SYS and now all regions are running versions of
this system. By selecting this system, we can now better
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control bill submission and compliance-related issues and now has the ability
to produce programs and make changes that can be run at all locations. We are
confident that billing policies are consistent across the company.
We are running year 2000 compliant software for both the Antrim and SYS
systems. For more information on our year 2000 issues, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000."
We recently signed an agreement with Healtheon Corp., a company that provides
medical information over the Internet. We believe this contract will put us in
the forefront of the clinical laboratory testing market by allowing clients to
order lab work over the Internet. We expect that this contract will ultimately
increase the volume of work ordered electronically, increase the accuracy of
billing information, and thereby have a positive impact on our profitability.
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 whom have different requirements.
Most of our bad debt expense is the result of several non-credit related
issues, primarily missing or incorrect billing information on requisitions. We
perform the requested tests and reports test results regardless of incorrect or
missing billing information. We subsequently attempt to obtain any missing
information and rectify incorrect billing information received from the health
care provider. Missing or incorrect information on requisitions slows the
billing process, creates backlogs of unbilled requisitions and generally
increases the aging of accounts receivable. Among many other factors
complicating billing are:
. pricing differences between our fee schedules and those of the payers;
. disputes between payers as to which party is responsible for payment;
. disparity in coverage among various carriers; and
. 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.
Employees
As of September 30, 1999, we employed approximately 3,215 employees, none of
whom were under union contract. We believe that our relations with employees
are good.
Properties
Our corporate headquarters are located in leased offices at 18448 Oxnard
Street, Tarzana, California 91356. Our major regional laboratories are located
in the following metropolitan areas: Los Angeles (Tarzana), California; San
Jose, California; and Sacramento, California. In May 1999, we acquired the
lease for Bio-Cypher's main laboratory facility in Sacramento. Similar to
Meris, we recently closed that facility and integrated the testing from that
facility into one of our existing laboratories.
We lease our laboratory facilities and PSCs. All of the major laboratory
facilities have been built or improved for the purpose of providing clinical
laboratory testing services. We believe our facilities are suitable, adequate
and have sufficient production capacity for our operations as currently
conducted and as anticipated to be conducted. We believe that if we lost the
lease on any of our PSCs or STAT laboratories, we could find alternate space at
competitive market rates and relocate our operations to such new locations
without disruption.
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However, if we lost our lease on any of our three main laboratory facilities,
we could experience a temporary disruption in our operations until such time as
we relocate to a new facility.
Now that the integration of the Bio-Cypher acquisition is substantially
completed, we operate approximately 305 PSCs and 40 STAT laboratories. PSCs are
typically approximately 900 square feet in size and accommodate one to two
phlebotomists (technicians who draw blood), draw chairs, supplies and other
office materials. STAT laboratories are typically 3,000 square feet in size.
STAT laboratories typically accommodate about 8 personnel and contain a limited
amount of equipment to perform high volume, low cost and quick turn around time
tests such as glucose monitoring, pregnancy and complete blood count ("CBC")
blood tests, among others.
Governmental Regulation
Numerous aspects of our operations, including our testing processes, business
practices and in some instances, the amount and methods by which we are paid,
are subject to governmental regulation at the Federal, state and/or local
levels.
Federal and State Clinical Laboratory Licensing
All clinical laboratories operating in the United States, with limited
exceptions, are required to obtain Federal certification pursuant to CLIA and
its implementing regulations. The law and its implementing regulations impose,
as conditions for such certification, requirements relating to test processes,
personnel qualifications, facilities and equipment, record keeping, quality
control, quality assurance and participation in proficiency testing. The same
regulatory requirements also apply as conditions for participation in the
Medicare and Medicaid programs. CLIA regulations vary depending on the
complexity of the methodologies performed by the laboratory. Compliance is
verified by periodic on-site inspections. Sanctions for failure to meet
CLIA/Medicare certification requirements include suspension or revocation of
certification, criminal penalties, injunctive actions to close the laboratory,
civil penalties or imposition of specific plans of correction to remedy alleged
deficiencies.
Licensing requirements similar to those imposed pursuant to CLIA also apply
at the state level, with similar sanctions for noncompliance. In 1999
California received deemed equivalency status under CLIA, which is formal
recognition by the federal government that California quality requirements meet
or exceed CLIA levels. Notwithstanding compliance costs, we regard these
licensing requirements as beneficial to the industry and favorable to our
business because the CLIA certification requirements apply not only to
independent laboratories but to all clinical laboratories, with only narrow
exceptions for those facilities performing a limited number of simple
procedures. Additionally, in California specific proficiency testing
participation is required for those laboratories, like us, that perform testing
to detect the presence of the human immunodeficiency virus ("HIV").
Federal and State Billing and Fraud and Abuse Laws
General. The Federal Medicare laws impose specific billing requirements on
clinical laboratories and a wide array of Medicare/Medicaid fraud and abuse
provisions apply to those clinical laboratories participating in these
programs, including us. These laws prohibit, among other things, the submission
of false claims or false information to the programs, deceptive or fraudulent
conduct, the provision of excessive or unnecessary services or services at
excessive prices and the offer or receipt of broadly defined inducements for
the referral of Medicare, Medicaid or other federal health care program
patients or business. Penalties for violations of these Federal laws include
exclusion from participation in the Medicare/Medicaid programs, asset
forfeitures, civil penalties and criminal penalties. Civil penalties for a wide
range of offenses may be up to $10,000 per item and treble the amount claimed.
In the case of certain severe offenses, exclusion from participation in
Medicare and Medicaid is a mandatory penalty. These fraud and abuse provisions
are interpreted liberally and enforced aggressively by the various enforcing
agencies of the federal government.
Governmental Oversight. Several Federal agencies are charged with the
responsibility of investigating allegations of fraudulent and abusive conduct
by health care providers. These agencies include, without
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limitation, the Department of Justice ("DOJ"), Federal Bureau of Investigation
("FBI") and the Office of Inspector General ("OIG") of the Department of Health
and Human Services ("HHS"). Additionally, Medicare carriers and Medicaid state
agencies now have certain fraud and abuse control authority. According to
public statements by the DOJ, health care fraud has been elevated to the
second-highest priority of the DOJ, and FBI agents have been transferred from
investigating counterintelligence activities to health care provider fraud. The
OIG has been and continues to be actively involved in such investigations and
has targeted certain laboratory practices for study, investigation and
prosecution. These practices include, without limitation, (1) offering packages
of tests to physicians (referred to as "panels" or "profiles" of tests) and
"unbundling" them into several tests to obtain higher reimbursement; (2)
"upcoding" tests to realize higher reimbursement than appropriate; (3) offering
inducements to physicians (for example, providing free fax machines or
computers, free lab services to the physician, his family and staff, and the
collection of hazardous waste from the physician's office without charge) in
order to induce the physician to refer testing business (including business for
Medicare or Medicaid patients) to the lab; (4) charging for tests not actually
performed and (5) duplicate billing. Such projects culminated during the 1990's
in the industry-wide governmental "LabScam" investigations that have resulted
in approximately $800 million of aggregate settlement payments being made by a
number of independent clinical labs in the past several years. The LabScam
investigation appears to be ongoing and HHS and HCFA have announced several
anti-fraud initiatives in 1999. The 1999 HCFA anti-fraud initiative responds in
part to a recent OIG report estimating that, in 1998, 7% of Medicare claims
were billed improperly or erroneously.
Federal Legislation and Regulation. A Federal "self-referral" law commonly
referred to as the "Stark" law prohibits Medicare payments for laboratory tests
referred by physicians who, personally or through a family member, have a
financial interest, including "ownership interests" and "compensation
arrangements," in the testing laboratory. Sanctions for laboratory violations
of the prohibition include denial of Medicare payment, refunds, civil money
penalties of up to $15,000 for each service billed in violation of the
prohibition and exclusion from the Medicare program. Legislations relating to
Stark law have been proposed in Congress, but not yet adopted, which could
narrow the scope of the law's applicability.
In 1996, Congress passed and the President signed into law HIPAA, frequently
referred to as the "Kennedy-Kassebaum Act", after its principal Senatorial
sponsors. The law made major changes in federal fraud and abuse laws applicable
to health care providers. It established a new federal program designed to
coordinate federal, state and local fraud and abuse control programs. The law
permitted the DOJ and the OIG to conduct audits and investigations relating to
the delivery of health care in the United States, without limitation to
Medicare and Medicaid, and established a Fraud and Abuse Trust Fund. In May
1999, HCFA announced the engagement of a number of non-governmental health care
audit organizations to assist the government in tracking and collecting
fraudulent billings for healthcare services. HIPAA also expanded the federal
anti-kickback law so that it applies not only to situations involving Medicare
and Medicaid, but to almost all federally funded health care programs. In
addition, the law for the first time permits providers to obtain advisory
opinions from the government concerning the legality of certain contemplated
practices under the anti-kickback law; the OIG published regulations
implementing this advisory opinion mandate in February 1997 and amended those
regulations in 1998. The Kennedy-Kassebaum law also significantly increased the
penalties for certain civil violations of the Medicare law and increased the
types of offenses for which a provider could be excluded from
Medicare/Medicaid. Finally, the law established a number of new criminal
provisions applicable to health care fraud.
The Balanced Budget Act of 1997 ("BBA '97") contains numerous changes in
Medicare/Medicaid fraud and abuse provisions. BBA '97 requires permanent
exclusion from Medicare and Medicaid for persons convicted of three health
care-related crimes and a 10-year exclusion period for persons convicted of
certain offenses who have one previous conviction. The statute permits the
Secretary of HHS to refuse to enter into Medicare participation agreements with
individuals or entities that have been convicted of felonies. In addition, BBA
'97 expands the reach of Medicare/Medicaid civil money penalties to apply to
persons who arrange or contract with excluded persons for the provision of
covered services. Further, the statute includes a provision
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permitting civil money penalties of up to $50,000 per violation for certain
specified types of violations, plus damages equal to three times the total
amount offered, paid, solicited or received, for violations of the
Medicare/Medicaid anti-kickback statute. Finally, BBA '97 requires the
Secretary of HHS to issue advisory opinions regarding potential violations of
the Stark law prohibiting Medicare/Medicaid physician self-referral for
designated health services other than laboratory testing services.
It should be noted that, among the many federal provisions available to
enforcement authorities in connection with health care offenses, an especially
potent remedy is exclusion from Medicare, Medicaid and other federal health
care programs. Particularly significant is the permissive exclusion authority
of the OIG, the principal threat that has brought many clinical laboratories to
the settlement table in the LabScam operation. In December 1997, the OIG
released non-binding guidelines indicating the criteria it will use in making
permissive exclusion decisions. These criteria address the circumstances and
seriousness of the offense, the defendant's response to allegations, the
likelihood of reoccurrences of the same or similar offenses, and whether the
provider can continue participating in federal health care programs without a
real threat of bankruptcy or to its ability to provide quality care.
State Legislation and Regulation. At the state level, laboratory operations
are affected by billing requirements applicable to all laboratory testing
services and state fraud and abuse and anti-inducement laws that similarly
apply to all laboratory testing services. California, where we conduct almost
all of our business, has adopted especially stringent laws of this type,
including an expansive anti-referral law that is even broader than the federal
law (Ca. Bus. Prof. Code ss.650) and the Physician Ownership and Referral Act,
known as the "Speier Bill", which became effective January 1, 1995 and which
prohibits, under most circumstances, referrals of clinical laboratory testing
business by physicians to laboratories in which the physician has a "financial
interest". Penalties for violation of these provisions can include fines,
criminal penalties and disciplinary action against referring physicians. In
addition, California has adopted the "Calderon" law, which prohibits physicians
from "marking up" laboratory bills for lab services the physician did not
perform. We believe the Calderon law benefits independent laboratories by
reducing the financial incentives for physician-owned laboratories.
Governmental Investigations of Unilab. In August 1993, we received a subpoena
from HHS in connection with an investigation and internal review relating to
the possible submission of false or improper claims under the Medicare and
Medicaid programs. The HHS subpoena required production of a broad range of
documents, including those relating to our selling, pricing and billing
practices. The HHS subpoena concerned fourteen tests, including five tests that
were the subject of our civil claims settlements. See "Legal Proceedings--
Department of Justice Settlement". We completed production of these documents
in February 1994. We did not hear anything further on the matter thereafter.
In August 1995, we received a subpoena from HHS requesting certain
information with respect to our marketing and billing practices for CBC, a
diagnostic test which was not included in any prior subpoena of any of the
settlements entered into by us in September 1993 (the "Settlements"). See,
"Legal Proceedings--Department of Justice Settlement". We promptly completed
production of all documents in response to the HHS subpoena and cooperated
fully in the HHS investigation. We reached an agreement with the Federal
government in September 1996 to pay $4.0 million to conclude this
investigation. In addition, in October 1996, we paid the California MediCal
program approximately $160,000 to settle all their claims regarding the same
issue. The settlements did not constitute an admission by us with respect to
any allegation, issue of law or fact arising from the investigation and we
received a full civil and administrative release from all claims by the
government with respect to these billings through the date of the settlement
agreement.
In May 1999 we learned of a new federal investigation under the False Claims
Act relating to our billing practices for the following four test procedures:
(1) apolipoprotein in conjunction with coronary risk panel assessments; (2)
microscopic evaluation in conjunction with urinalysis; (3) performance of T7
index in conjunction with T3 and T4 tests; and (4) fragmenting billing of
unlisted panel codes. We are in the process of gathering and voluntarily
submitting documentation to the DOJ regarding the two tests with respect to
which the
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DOJ has requested information about. We cannot at this time assess what the
result of the investigation might be. Remedies available to the government
include civil and criminal penalties and exclusion from participation in
federal health care programs such as Medicare and Medicaid. Application of
these remedies could have a material adverse effect upon our business,
financial condition, results of operations or prospects.
Our Compliance Program. In recent years, it has been OIG's practice to
require labs that enter into government settlements with respect to marketing
and billing practices to enter into corporate integrity agreements ("CIA").
Under the CIA, the lab is required to adopt and comply with various procedures
for implementing a compliance program, including training programs, preparation
of policy and procedure manuals and dissemination of educational materials to
the workforce. OIG in 1997 proposed and publicly disseminated a Model
Compliance Plan, which it revised slightly in 1998, to serve as guidance for
laboratory compliance programs.
We were not required to enter into a CIA when we reached two government
settlements in 1993 and 1996. However, we have voluntarily adopted a compliance
program that substantially meets the guidelines described in the Model
Compliance Plan. We have established a Compliance Committee, comprised of our
senior officers. The Compliance Program is run under the supervision of the
Chief Compliance Officer, who reports directly to the Chief Executive Officer.
The Chief Compliance Officer updates the Board of Directors on compliance
matters on a regular basis.
In November 1998, we acquired substantially all of the assets of Meris
Laboratories, Inc. At that time, Meris had a CIA with the OIG arising from the
settlement of claims against Meris asserted by the United States in connection
with its LabScam investigations. As part of our purchase of the Meris assets
and in lieu of assuming the Meris CIA, we voluntarily entered into an agreement
with the OIG entitled "Compliance Program Disclosure Agreement" (the "Unilab-
Meris/OIG Agreement"). Pursuant to this Agreement we will maintain our hotline,
undertake special billing audits of the former Meris facilities, obtain new
CLIA certifications and provider numbers for the former Meris facilities, and
provide certain information to the OIG. The Unilab-Meris/OIG Agreement will
last until February 28, 2000.
In May 1999, we acquired substantially all of the assets of Bio-Cypher
Laboratories. Bio-Cypher, like Meris, was party to a CIA with the OIG,
resulting from a prior settlement of claims against Bio-Cypher arising from the
LabScam investigation. In connection with our acquisition of Bio-Cypher's
assets, and in lieu of assuming Bio-Cypher's CIA obligations, in June 1999, we
again voluntarily entered into a Compliance Program Disclosure Agreement (the
"Unilab-Bio-Cypher/OIG Agreement"). The Unilab-Bio-Cypher/OIG Agreement is
substantially similar to the Unilab-Meris/OIG Agreement and will last until
August 9, 2001.
Reimbursement
Medicare reimbursement for clinical laboratory testing services is made
pursuant to Medicare fee schedules, subject to a national limitation amount
("cap") that is based upon the median of all the Medicare fee schedules. From
the late 1980s to the 1990s, the cap on Medicare reimbursement dropped from
115% to 74% of the median of all the Medicare fee schedules. BBA '97 provides
for a freeze on fee schedule payments for 1998 through 2002. The President's
FY2000 budget proposed a reduction of the Medicare fee schedule caps to 72% of
the laboratory fee schedule medians, beginning January 1, 2000, but Congress
did not accept this proposal. In addition, an expert panel considering changes
in Medicare has proposed reinstatement of beneficiary cost sharing for
diagnostic clinical laboratory services provided to Medicare patients, although
it is not known whether the full Medicare Commission will agree to this
proposal or whether any congressional action will be taken with regard to it.
To date, Congress has not adopted any proposed legislation regarding
beneficiary cost sharing.
CPT Coding. Current Procedural Terminology ("CPT") codes form the basis for
the coding of tests billed to Medicare and Medicaid, as well as to some third-
party payors, and, thus, coding changes may substantially affect reimbursement
levels. CPT codes are periodically revised by the AMA. One of the areas of the
CPT code revision that has most affected laboratory reimbursement levels is a
change in the codes that designate panel and profile tests, so that numerous
panel codes have been eliminated entirely and those
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remaining have been given specific definitions for constituent tests for the
first time. This coding change reduced our laboratory reimbursement and the
clinical laboratory testing industry generally. Other codes have been
eliminated or superseded by new codes, and codes have been added for new,
previously uncoded procedures.
A substantial CPT revision effective as of April 1, 1998 included numerous
new and revised individual and panel test codes affecting several laboratory
specialties. The most significant changes again concern panel codes. The 1998
CPT revision replaced the 19 pre-existing multichannel chemistry profile codes
with four "clinically relevant" test panels. Effective April 1, 1998, HCFA
directed that laboratories could no longer bill Medicare for the multichannel
chemistry profiles, but must use the new "clinically relevant" panels
exclusively. This change appears to have had an adverse effect on revenues and
operating costs of the clinical laboratory testing industry, including our
company. Further changes were made in the CPT manual for 1999, including an
expansion by one test of one of the "clinically relevant" panels. It is
currently unclear what affect, if any, this change will have on us.
Environmental Compliance
As with all clinical laboratories, each of our laboratories must comply with
the provisions of numerous federal, state and local statutes and regulations
relating to public health and the environment, including: practices and
procedures regarding the proper storage and labeling of hazardous and toxic
materials or other substances associated with the operation of clinical
laboratories and the proper management of medical waste, hazardous waste and
low-level radioactive waste generated by operation of clinical laboratories;
public disclosure requirements regarding certain hazardous and toxic materials
or other substances associated with the operation of clinical laboratories;
employee training and notification; environmental protection requirements, such
as standards relating to the discharge of pollutants into the air, water and
land; emergency response and remediation or cleanup in connection with
hazardous and toxic materials or other substances associated with operation of
clinical laboratories; operation and remediation, if necessary, of underground
storage tank sites; the removal, encapsulation or disturbance of asbestos-
containing materials when such materials are in poor condition or in the event
of construction, remodeling, renovation or demolition of a building; and other
safety and health standards.
As regulated entities, our facilities are subject to compliance
investigations from numerous governmental agencies. From time to time, such
inspections have resulted in a notice of violation being issued to a laboratory
in connection with certain regulatory requirements, e.g. labeling of regulated
substances. In each such case, we have responded to the inspecting agency and
the alleged violation has been addressed without the imposition of substantial
fines or penalties. We are not aware of any past or present violation which we
believe could have a material adverse effect on us or our financial conditions
or results of operations.
Legal Proceedings
We are a party to various legal proceedings arising in the ordinary course of
our business. Although the ultimate disposition of these proceedings is not
determinable, management does not believe that adverse determinations in any or
all of such proceedings will have a material adverse effect upon our financial
condition, liquidity or results of operations.
In November 1999, we reached a settlement with a group of thirteen insurance
companies regarding claims by the insurance companies that we over-billed them
in the early to mid-1990s in connection with several chemistry profile tests
that were previously the subject of a settlement agreement with the government.
We paid $600,000 in the settlement. Such amount has been reflected as a charge
in the statement of operations for the second quarter of 1999. Since 1993, we
also have entered into settlements with three insurance companies for an
aggregate amount of $825,000.
In May of 1999 we learned of a new federal investigation under the False
Claims Act relating to our billing practices for the following four test
procedures: (1) apolipoprotein in conjunction with coronary risk panel
assessments; (2) microscopic evaluation in conjunction with urinalysis; (3)
performance of T7 index in
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conjunction with T3 and T4 tests and (4) fragmenting billing of unlisted panel
codes. We are in the process of gathering and voluntarily submitting
documentation to the DOJ regarding the two tests with respect to which the DOJ
has requested information. We cannot at this time assess what the result of the
investigation might be. Remedies available to the government include civil and
criminal penalties and exclusion from participation in federal health care
programs such as Medicare and Medicaid. Application of these remedies could
have a material adverse effect upon our business, financial condition, results
of operations or prospects.
Department of Justice Settlement
In 1991, the DOJ contacted us concerning an investigation of certain of our
sales, marketing, pricing and billing practices. During 1993, we learned that a
qui tam (whistle blower) complaint had been filed approximately two years
earlier by a former employee.
A qui tam action, under the Federal "whistle blower" statute, is a private
action brought on behalf of the U.S. government in connection with claims for
payments submitted to the U.S. The private individual(s) bringing the qui tam
action may be entitled to 15% to 30% of any amounts recovered as a consequence
of the qui tam action. By law, the DOJ is required to investigate the matters
raised by the qui tam complaint to determine whether to "intervene" (i.e.,
pursue the action itself) or to permit the private plaintiff to pursue the
action.
In September 1993, we entered into settlements pursuant to which we made
payments to the DOJ (the "DOJ Settlement") and to the State of California (the
"California Settlement" and, together with the DOJ Settlement, the
"Settlements") to settle certain civil claims relating to the investigation.
Our portion of the Settlements was approximately $2.7 million, which included
approximately $2.2 million of the DOJ Settlement and the entire $0.5 million
amount of the California Settlement.
By their terms, the Settlements reserved the rights of the government
agencies involved to pursue criminal prosecutions in connection with certain
related claims. Criminal convictions in these matters could have resulted in
mandatory exclusion of our company from Medicare and state health programs,
including Medicaid. In May 1995, we were informed by the DOJ that its criminal
investigation concerning the allegations at issue in the 1993 investigation and
in the Settlements had been closed without prosecution.
The Settlements did not constitute an admission of wrongdoing with respect to
any issue of law or fact arising from the civil action brought on behalf of the
United States, that gave rise to the DOJ investigation. The DOJ Settlement
addressed the U.S. government's contention that we submitted improper Medicare
claims for unnecessary blood tests with respect to five tests (HDL, LDL, TIBC,
PBG and serum ferritin) offered in conjunction with basic blood chemistry
profiles. The California Settlement addressed the State of California's
contention that improper Medicaid claims were submitted with respect to the
same five tests.
The government's allegations involved a series of laboratory tests conducted
at the time on a "sequential multiple analysis computer" ("SMAC") for which
Medicare reimbursed laboratories on a flat fee basis for any 19 or more blood
chemistry tests. The government alleged that some or all of the five tests that
were the subject of the investigation were added routinely to the SMAC for a
"nominal" additional price or as part of annual across-the-board price
increases to the physicians, while the fact that Medicare and Medicaid would be
billed separately for each test at retail prices often was not revealed to the
doctors. The government contended that as a result of this marketing approach,
some doctors ordered blood chemistry profiles (which covered the SMAC plus the
additional tests) even if they needed only the SMAC, not realizing that the
additional tests were being billed to Medicare and Medicaid.
We have historically made available to our clients test profiles which
provide the choice of incorporating as few or as many of these additional tests
in the basic blood chemistry profile as our physician-clients feel appropriate
for a full diagnostic evaluation. Notwithstanding such policy, the government
contended that it was not made sufficiently clear to physician-clients the
financial consequences to the Medicare program of their
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choice in ordering such tests as "add-ons" to the basic blood chemistry
profile, thereby resulting in physicians' ordering certain of these tests, and
Medicare or Medical, as the case may be, being billed for such tests, when not
medically necessary.
While the Settlements did not require any specific changes to policies or
practices with regard to these tests, we nevertheless have re-emphasized to our
clients the financial consequences to them and to third party payors of their
laboratory test choices.
CHAMPUS Settlement
In February 1994, as part of a joint settlement with MetPath related to the
same activities that were the subject of the 1993 DOJ Settlement, a payment of
$1.1 million was made by MetPath to the Office of Civilian Health and Medical
Program of the Uniformed Services ("CHAMPUS") to settle all civil claims of
CHAMPUS against MetPath and our company with respect to the same issues and
same five tests that were the subject of the DOJ Settlement and California
Settlement. Our portion of such payment was approximately $25,000, with the
remainder being paid by MetPath. As with the DOJ Settlement and California
Settlement, the CHAMPUS settlement included a reservation of rights with
respect to certain criminal prosecutions which could result in mandatory
exclusion of our company from Medicare and State health programs should any
criminal convictions result. The CHAMPUS settlement, however, does not
constitute an admission by us of any wrongdoing with respect to any issue of
law or fact arising from the civil action brought by the U.S. government that
gave rise to CHAMPUS' inquiry. We were informed in May 1995 of the government's
closure of its criminal inquiry without prosecution.
HHS Subpoenas
In August 1993, we received a subpoena from HHS in connection with an
investigation and internal review relating to the possible submission of false
or improper claims under the Medicare and Medicaid programs. The HHS subpoena
required production of a broad range of documents, including those relating to
our selling, pricing and billing practices. The HHS subpoena concerned fourteen
tests, including the five tests that were the subject of the civil claims
Settlements. We completed production of these documents in February 1994. Other
independent clinical laboratories received similar requests for production as
part of the industry-wide LabScam investigation of certain practices in the
clinical laboratory testing industry. In July 1994, we were informed that
jurisdiction for this investigation had been transferred to the United States
Attorney's Office in Newark, New Jersey. In May 1995, we were informed by the
DOJ that its criminal investigation concerning the allegations at issue in the
1993 HHS subpoena and in the Settlements had been closed without prosecution.
In August 1995, we received a subpoena from HHS requesting certain
information with respect to our marketing and billing practices for a CBC, a
diagnostic test which was not included in any prior subpoena or the subject of
any of the Settlements. We promptly completed production of all documents in
response to the HHS subpoena and cooperated fully in the HHS investigation. We
reached an agreement with the Federal government in September 1996 to pay $4.0
million to conclude this investigation. In addition, in October 1996 we paid
the California Medical program approximately $160,000 to settle all their
claims regarding the same CBC issue. The settlement did not constitute an
admission by us with respect to any allegation, issue of law or fact arising
from the investigation and we received a full civil and administrative release
from all claims by the government with respect to these billings through the
date of the settlement agreement.
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MANAGEMENT
The following table sets forth certain information regarding the directors,
executive officers and key management personnel of our company.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
David C. Weavil......... 48 Chairman of the Board
Robert E. Whalen........ 57 President, Chief Executive Officer and Director
Brian D. Urban.......... 37 Executive Vice President, Chief Financial Officer and Treasurer
Mark L. Bibi............ 41 Executive Vice President, Secretary and General Counsel
Ian J. Brotchie......... 59 Executive Vice President and Division President, Unilab Northern California
R. Jeffrey Lanzolatta... 46 Executive Vice President and Division President, Unilab Southern California
C. Michael Hanbury...... 35 Senior Vice President, Chief Scientific Officer
Paul T. Wertlake........ 63 Vice President, Chief Medical Officer
Michael B. Goldberg..... 52 Director
David I. Wahrhaftig..... 42 Director
</TABLE>
David C. Weavil served as Chairman, President and Chief Executive Officer of
Unilab from January 1997 to November 1999. Effective as of the
recapitalization, Mr. Weavil serves only as Chairman of the Board. He served
as Executive Vice President of Laboratory Corporation of America Holdings
("LabCorp") from the April 1995 merger of Roche Biomedical Laboratories, Inc.
("RBL") and National Health Laboratories, Inc. ("NHL"), which created LabCorp,
until December 1996. He was additionally appointed Chief Operating Officer of
LabCorp in September 1995. Previously, Mr. Weavil served as Senior Vice
President and Chief Operating Officer of RBL from 1989 to April 1995. From
1988 through 1989, Mr. Weavil was Regional Senior Vice President-Mid-Atlantic
of RBL. Prior to that, he served as Senior Vice President and Chief Financial
Officer of RBL from 1982 to 1988.
Robert E. Whalen was appointed President, Chief Executive Officer and a
director of Unilab effective as of the recapitalization. From May 1997 to
September 3, 1999, Mr. Whalen served as Executive Vice President and, from
September 1998 to September 3, 1999, as Chief Operating Officer of Scripps's
Clinic, a 320-physician multi-specialty medical group located in Southern
California. From the April 1995 merger of RBL and NHL until August 1996, Mr.
Whalen served as Executive Vice President of LabCorp. Prior to his employment
at LabCorp, Mr. Whalen held various senior level positions with NHL, which he
joined in 1976. He served as Executive Vice President of NHL from 1993 to
1995, as Senior Vice President from 1991 to 1993 and as Vice President--
Administration from 1985 to 1993. From 1979 to 1985, he was Vice President--
Division Manager of NHL. At NHL and later LabCorp, Mr. Whalen oversaw human
resources, client service and major regional laboratories in California,
Washington, Nevada and Utah. Mr. Whalen was a member of the management
committee at NHL and LabCorp.
Brian D. Urban has been Executive Vice President, Chief Financial Officer
and Treasurer of Unilab since May 1998. He served as Vice President, Chief
Financial Officer and Treasurer from September 1997 to April 1998. He was Vice
President and Controller of Unilab from November 1993 to September 1997. Mr.
Urban served as Assistant Controller of Unilab from October 1992 to November
1993. He was Manager of External Reporting of MetPath from July 1992 to
October 1992. Prior thereto, Mr. Urban was senior audit manager at Price
Waterhouse where he worked from November 1986 to July 1992.
Mark L. Bibi has been Executive Vice President, Secretary and General
Counsel of Unilab since May 1998. He served as Vice President, Secretary and
General Counsel from June 1993 through April 1998. Mr. Bibi was with the New
York City law firm of Schulte Roth & Zabel from May 1989 through June 1993.
Prior thereto, he was with the law firm of Sullivan & Cromwell, New York, New
York, from August 1985 to April 1989.
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Ian J. Brotchie has been Executive Vice President and Division President of
Unilab Northern California since May 1998. He served as Division President of
Unilab Northern California from August 1997 to April 1998. He was Division
President of Unilab San Jose from February 1994 to August 1997. He was
President of Associated Laboratories, Inc. from November 1991 to September
1995. Mr. Brotchie served as President of Lab Concepts Inc. from February 1990
to November 1991. Prior thereto, Mr. Brotchie served as Business Development
Director with SmithKline Bio-Science Laboratories in Dublin, California from
January 1989 to February 1990.
R. Jeffrey Lanzolatta has been Executive Vice President and Division
President of Unilab Southern California since May 1998. He served as Division
President of Unilab Southern California from July 1996 to April 1998. He was
Senior Vice President, Sales and Marketing of Unilab Southern California from
December 1994 to July 1996. He served as Vice President, Sales and Marketing
for Unilab from November 1993 to December 1994. He served as Vice President,
Sales and Marketing of MetWest from January 1993 to November 1993. Prior
thereto Mr. Lanzolatta served as Regional Vice President and General Manager of
MetWest's Southern California operations from July 1990 to December 1992. From
April 1990 to June 1990, Mr. Lanzolatta served as Director of Sales and
Marketing for MetWest's Northern California operations. Mr. Lanzolatta was Vice
President, Business Development of International Clinical Laboratories' Western
Operations from July 1985 through January 1989.
C. Michael Hanbury, Ph.D., Senior Vice President and Chief Scientific
Officer, has been with Unilab since April 1998. Prior to joining Unilab, from
April 1996 to April 1998, Dr. Hanbury managed Regulatory Affairs for Roche
Diagnostics, Inc., an international diagnostic company representing their
interests to the US Food and Drug Administration for a variety of molecular
diagnostic tests for infectious disease. Prior thereto, Dr. Hanbury served from
September 1994 to March 1996 as National Technical Director of an international
clinical diagnostic manufacturer and as a clinical chemist for Roche Biomedical
Labs from April 1988 to September 1994. Dr. Hanbury is a registered clinical
pathologist with over 14 years experience in laboratory testing services and in
vitro diagnostic manufacturing.
Paul T. Wertlake, M.D., has been Vice President and Chief Medical Officer of
Unilab since January 1994. Since October 1989, Dr. Wertlake has served as the
Senior Medical Officer for Southern California and Medical Director of our
Tarzana laboratory. Prior thereto, Dr. Wertlake has served in the academic,
hospital and reference laboratory sectors.
Michael B. Goldberg has been a Managing Director of Kelso since October 1991
and became a director of Unilab effective as of the recapitalization. Mr.
Goldberg served as a Managing Director and jointly managed the merger and
acquisitions department at The First Boston Corporation from 1989 to May 1991.
Mr. Goldberg was a partner at the law firm of Skadden, Arps, Slate, Meagher &
Flom from 1980 to 1989. Mr. Goldberg is a director of Consolidated Vision
Group, Inc., Endo Pharmaceuticals, Inc., Hosiery Corporation of America, Inc.
and Netspeak Corporation. Mr. Goldberg is also a director of the Phoenix House
Foundation and the Woodrow Wilson Council.
David I. Wahrhaftig has been a Managing Director of Kelso since April 1998.
Mr. Wahrhaftig has been affiliated with Kelso since 1987, and became a director
of Unilab effective as of the recapitalization. Mr. Wahrhaftig also serves as a
director of Consolidated Vision Group, Inc., Endo Pharmaceuticals, Inc. and
Humphreys, Inc.
Arrangements with Messrs. Whalen and Weavil
Whalen Employment Agreement. We expect to enter into an employment agreement
with Robert E. Whalen effective as of the time of his appointment as President
and Chief Executive Officer.
Weavil Employment Agreement and Consulting Agreement. We entered into an
employment agreement with David C. Weavil on January 20, 1997 to serve as
Chairman of the Board, President and Chief Executive Officer of Unilab.
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With the completion of the UC Acquisition merger, Mr. Weavil's employment
agreement was terminated and we entered into a five-year consulting agreement
with Mr. Weavil. Pursuant to this agreement, Mr. Weavil is entitled to an
annual consulting fee of $220,000, a seat on the board of directors and
options to purchase common stock of our company on terms that are
substantially similar to the options granted to our management and our other
employees following the merger. Mr. Weavil also received a bonus of $400,000.
We also entered into a non-competition agreement pursuant to which we
compensated Mr. Weavil for limiting his ability to compete with our company
following the completion of the merger with UC Acquisition.
We have entered into employment agreements with certain other members of our
management team.
Stock Option Plan
Following the recapitalization, we intend to grant to our management and
employees options to purchase shares of our post-merger common stock pursuant
to a new stock option plan. Although the terms of the plan have not been
finalized, we anticipate that options granted initially will have an exercise
price of $5.85 per share, will cover approximately 15% of the post-merger
shares on a primary basis and will consist of two tranches, one of which will
vest over time and one of which will vest subject to various performance
criteria which we will establish.
Other Transactions with Kelso
Under the terms of the merger agreement covering the merger of UC
Acquisition and our company we paid to Kelso a one-time fee of $6 million upon
the completion of the merger. In addition, under the merger agreement, we are
required to do the following:
. pay to Kelso annual financial advisory fees of $600,000;
. reimburse Kelso for its expenses incurred in providing us with financial
advisory services; and
. indemnify Kelso and certain related parties with respect to the
transactions contemplated by the merger, including the financing of the
merger and any services to be provided by Kelso or any related party to
us going forward.
We have already begun paying financial advisory fees to Kelso and have
already reimbursed Kelso for some expenses.
Following the recapitalization, our directors that are affiliated with Kelso
will not receive any compensation for serving on the board.
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<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information concerning each person believed to
be a beneficial owner of more than 5% of the outstanding shares of our common
stock and beneficial ownership of our common stock by each director, named
executive officer and all directors and executive officers as a group.
<TABLE>
<CAPTION>
Shares Percentage
---------- ----------
<S> <C> <C>
Kelso Investment Associates VI, L.P.(1).............. 18,743,590 72.8%
KEP VI, LLC(1)....................................... 2,901,709 11.3%
Frank T. Nickell(1).................................. (2) (2)
Thomas R. Wall IV(1)................................. (2) (2)
George E. Matelich(1)................................ (2) (2)
Michael B. Goldberg(1)(3)............................ (2) (2)
David I. Wahrhaftig(1)(3)............................ (2) (2)
Frank K. Bynum, Jr.(1)............................... (2) (2)
Philip E. Berney(1).................................. (2) (2)
Robert E. Whalen(4)(5)............................... 50,000 0.2%
Brian D. Urban(4)(6)................................. 50,000 0.2%
All Directors and Executive Officers of Unilab as a
Group (10 persons).................................. 100,000 0.4%
</TABLE>
- --------
(1) The business address for these persons is c/o Kelso & Company, 320 Park
Avenue, 24th Floor, New York, New York 10022.
(2) Messrs. Nickell, Wall, Matelich, Goldberg, Wahrhaftig, Bynum and Berney
may be deemed to share beneficial ownership of shares of common stock
owned of record by Kelso Investment Associates VI, L.P. and KEP VI, LLC,
by virtue of their status as managing members of KEP VI, LLC and the
general partner of Kelso Investment Associates VI, L.P. Messrs. Nickell,
Wall, Matelich, Goldberg, Wahrhaftig, Bynum and Berney share investment
and voting power with respect to the shares of common stock owned by Kelso
Investment Associates VI, L.P. and KEP VI, LLC but disclaim beneficial
ownership of such shares.
(3) Messrs. Goldberg and Wahrhaftig are directors.
(4) Business address: 18448 Oxnard Street, Tarzana, California 91356.
(5) Mr. Whalen is our President and Chief Executive Officer and one of our
directors.
(6) Mr. Urban is our Executive Vice President, Chief Financial Officer and
Treasurer.
Stockholders Agreement
Upon completion of our merger with UC Acquisition, we entered into a
stockholders agreement with the Kelso affiliates which now control us, EOS
Partners, L.P., an affiliate of Pequot Capital LLC, certain additional
investors and members of management. The stockholders agreement contains
various rights and restrictions, including tag-along and drag-along rights,
rights of first refusal and restrictions on transfer, in connection with such
parties' ownership of our equity securities. Under the stockholders agreement,
management and Unilab will also have put and call rights, respectively, with
respect to shares of stock and options held by members of management in event
of termination of employment, including in the event of death, disability or
resignation. Depending on the circumstances of termination, these put and call
rights are exercisable at fair market value, based on an annual appraisal of
our stock, or at cost plus 6% annual interest.
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THE EXCHANGE OFFER
Terms of the Exchange Offer; Period for Tendering Old Notes
Upon the terms and subject to the conditions set forth in this prospectus and
in the accompanying letter of transmittal, which together constitute the
exchange offer, we will accept for exchange Old Notes which are properly
tendered on or prior to the Expiration Date and not withdrawn as permitted
below. As used in this prospectus, the term "Expiration Date" means 5:00 p.m.,
New York City time, on February 17, 2000. However, if we, in our sole
discretion, have extended the period of time for which the exchange offer is
open, the term "Expiration Date" means the latest time and date to which we
extend the exchange offer.
As of the date of this prospectus, $155,000,000 aggregate principal amount of
the Old Notes is outstanding. This prospectus, together with the letter of
transmittal, is first being sent on or about January 18, 2000, to all holders
of Old Notes known to us. Our obligation to accept Old Notes for exchange
pursuant to the exchange offer is subject to certain conditions as set forth
under "--Certain Conditions to the Exchange Offer" below.
We expressly reserve the right, at any time or from time to time, to extend
the period of time during which the exchange offer is open, and thereby delay
acceptance for exchange of any Old Notes, by giving oral or written notice of
such extension to the holders of Old Notes as described below. During any such
extension, all Old Notes previously tendered will remain subject to the
exchange offer and may be accepted for exchange by us. Any Old Notes not
accepted for exchange for any reason will be returned without expense to the
tendering holder as promptly as practicable after the expiration or termination
of the exchange offer.
Old Notes tendered in the exchange offer must be in denominations of
principal amount of $1,000 and any integral multiple thereof.
We expressly reserve the right to amend or terminate the exchange offer, and
not to accept for exchange any Old Notes not previously accepted for exchange,
upon the occurrence of any of the conditions of the exchange offer specified
below under "--Certain Conditions to the Exchange Offer." We will give oral or
written notice of any (1) extension, (2) amendment, (3) non-acceptance or (4)
termination to the holders of the Old Notes as promptly as practicable on the
next business day after the previously scheduled Expiration Date. Such notice
in the case of any extension is to be issued by means of a press release or
other public announcement no later than 9:00 a.m., New York City time, on such
date.
Procedures for Tendering Old Notes
The tender to us of Old Notes by a holder of Old Notes as set forth below and
acceptance of such tender by us will constitute a binding agreement between the
tendering holder and us upon the terms and subject to the conditions set forth
in this prospectus and in the accompanying letter of transmittal. Except as set
forth below, a holder who wishes to tender Old Notes for exchange pursuant to
the exchange offer must transmit a properly completed and duly executed letter
of transmittal, including all other documents required by such letter of
transmittal, to HSBC Bank USA (the "Exchange Agent") at the address set forth
below under "--Exchange Agent" on or prior to the Expiration Date. In addition,
the Exchange Agent must receive:
. certificates for such Old Notes along with the letter of transmittal; or
. prior to the Expiration Date, a timely confirmation of book-entry
transfer (a "Book-Entry Confirmation") of such Old Notes, if such
procedure is available, into the Exchange Agent's account at The
Depository Trust Company (the "Book-Entry Transfer Facility"), pursuant
to the procedure for book-entry transfer described below; or
. the holder must comply with the guaranteed delivery procedures described
below.
The method of delivery of Old Notes, letters of transmittal and all other
required documents is at your election and risk. If such delivery is by mail,
we recommend that you use registered mail, properly insured, with return
receipt requested. In all cases, you should allow sufficient time to assure
timely delivery. You should not send letters of transmittal or Old Notes to us.
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Any beneficial owner whose Old Notes are registered in the name of a broker,
dealer, commercial bank, trust company or other nominee, and who wishes to
tender, should contact the registered holder promptly and instruct such
registered holder to tender on such beneficial owner's behalf. If such
beneficial owner wishes to tender on such owner's own behalf, such owner must,
prior to completing and executing the letter of transmittal and delivering such
owner's Old Notes, either (1) make appropriate arrangements to register
ownership of the Old Notes in such owner's name or (2) obtain a properly
completed bond power from the registered holder. The transfer of registered
ownership may take considerable time.
Signatures on a letter of transmittal or a notice of withdrawal, as the case
may be, must be guaranteed unless the Old Notes surrendered for exchange are
tendered:
. by a registered holder of the Old Notes who has not completed the box
entitled "Special Issuance Instructions" or "Special Delivery
Instructions" on the letter of transmittal or
. for the account of an Eligible Institution (as defined below).
In the event that signatures on a letter of transmittal or a notice of
withdrawal, as the case may be, are required to be guaranteed, such guarantees
must be by a firm which is a financial institution--including most banks,
savings and loan associations and brokerage houses--that is a participant in
the Securities Transfer Agents Medallion Program, the New York Stock Exchange
Medallion Signature Program or the Stock Exchanges Medallion Program
(collectively, "Eligible Institutions"). If Old Notes are registered in the
name of a person other than a signer of the letter of transmittal, the Old
Notes surrendered for exchange must be endorsed by, or be accompanied by a
written instrument or instruments of transfer or exchange, in satisfactory form
as determined by us in our sole discretion, duly executed by the registered
holder with the signature on such Old Notes guaranteed by an Eligible
Institution.
All questions as to the validity, form, eligibility (including time of
receipt) and acceptance of Old Notes tendered for exchange will be determined
by us in our sole discretion. This determination shall be final and binding. We
reserve the absolute right to reject any and all tenders of any particular Old
Notes not properly tendered or to not accept any particular Old Note which
acceptance might, in our judgment or our counsel's judgment, be unlawful. We
also reserve the absolute right to waive any defects or irregularities or
conditions of the exchange offer as to any particular Old Notes either before
or after the Expiration Date, including the right to waive the ineligibility of
any holder who seeks to tender Old Notes in the exchange offer. The
interpretation of the terms and conditions of the exchange offer as to any
particular Old Notes either before or after the Expiration Date, including the
letter of transmittal and the instructions to such letter of transmittal, by us
shall be final and binding on all parties. Unless waived, any defects or
irregularities in connection with tenders of Old Notes for exchange must be
cured within such reasonable period of time as we shall determine. Neither we,
the Exchange Agent nor any other person shall be under any duty to give
notification of any defect or irregularity with respect to any tender of Old
Notes for exchange, nor shall any of them incur any liability for failure to
give such notification.
If the letter of transmittal is signed by a person or persons other than the
registered holder or holders of Old Notes, such Old Notes must be endorsed or
accompanied by appropriate powers of attorney. In either case, such Old Notes
must be signed exactly as the name or names of the registered holder or holders
appear on the Old Notes.
If the letter of transmittal or any Old Notes or powers of attorney are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity, such persons should so indicate when signing, and, unless waived by
us, proper evidence satisfactory to us of their authority to so act must be
submitted.
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By tendering, each holder will represent to us that, among other things, (1)
the New Notes acquired pursuant to the exchange offer are being obtained in the
ordinary course of business of the person receiving such New Notes, (2) whether
or not such person is the holder, and (3) that neither the holder nor such
other person has any arrangement or understanding with any person to
participate in the distribution of the New Notes. In the case of a holder that
is not a broker-dealer, each such holder, by tendering, will also represent to
us that such holder is not engaged in and does not intend to engage in a
distribution of the New Notes. If any holder or any such other person is an
"affiliate," as defined under Rule 405 of the Securities Act, of ours, or is
engaged in, or intends to engage in, or has an arrangement or understanding
with any person to participate in, a distribution of such New Notes to be
acquired pursuant to the exchange offer, such holder or any such other person
(1) could not rely on the applicable interpretations of the staff of the
Commission and (2) must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale transaction.
Each broker-dealer that receives New Notes for its own account in exchange
for Old Notes, where such Old Notes were acquired by such broker-dealer as a
result of market-making activities or other trading activities, must
acknowledge that it will deliver a prospectus that meets the requirements of
the Securities Act in connection with any resale of such New Notes. The letter
of transmittal states that by so acknowledging and by delivering such a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. See "Plan of
Distribution."
Acceptance of Old Notes for Exchange; Delivery of New Notes
Upon satisfaction or waiver of all of the conditions to the exchange offer,
we will accept, promptly after the Expiration Date, all Old Notes properly
tendered, and will issue the New Notes promptly after acceptance of the Old
Notes. See "--Certain Conditions to the Exchange Offer" below. For purposes of
the exchange offer, we shall be deemed to have accepted properly tendered Old
Notes for exchange when, as and if we have given oral or written notice to the
Exchange Agent, with written confirmation of any oral notice to be given
promptly after giving such notice.
For each Old Note accepted for exchange, the holder of such Old Note will
receive a New Note having a principal amount equal to that of the surrendered
Old Note. The New Notes will bear interest from the most recent date to which
interest has been paid on the Old Notes or, if no interest has been paid on the
Old Notes, from November 20, 1998. Accordingly, registered holders of New Notes
on the relevant record date for the first interest payment date following the
consummation of the exchange offer will receive interest accruing from the most
recent date to which interest has been paid or, if no interest has been paid,
from September 28, 1999. Old Notes accepted for exchange will cease to accrue
interest from and after the date of consummation of the exchange offer. Holders
of Old Notes whose Old Notes are accepted for exchange will not receive any
payment in respect of accrued interest on such Old Notes otherwise payable on
any interest payment date the record date for which occurs on or after
consummation of the exchange offer.
In all cases, issuance of New Notes for Old Notes that are accepted for
exchange pursuant to the exchange offer will be made only after timely receipt
by the Exchange Agent of (1) certificates for such Old Notes, or a timely Book-
Entry Confirmation of such Old Notes, into the Exchange Agent's account at the
Book-Entry Transfer Facility, (2) a properly completed and duly executed letter
of transmittal and (3) all other required documents.
If any tendered Old Notes are not accepted for any reason set forth in the
terms and conditions of the exchange offer, or if Old Notes are submitted for a
greater principal amount than the holder desires to exchange, such unaccepted
or non-exchanged Old Notes will be returned without expense to the tendering
holder of such Old Notes, or, in the case of Old Notes tendered by book-entry
transfer into the Exchange Agent's account at the Book-Entry Transfer Facility
pursuant to the book-entry procedures described below, such non-exchanged Old
Notes will be credited to an account maintained with such Book-Entry Transfer
Facility, as promptly as practicable after the expiration or termination of the
exchange offer.
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Book-Entry Transfer
The Exchange Agent will make a request to establish an account with respect
to the Old Notes at the Book-Entry Transfer Facility for purposes of the
exchange offer within two business days after the date of this prospectus. Any
financial institution that is a participant in the Book-Entry Transfer
Facility's systems may make book-entry delivery of Old Notes by causing the
Book-Entry Transfer Facility to transfer such Old Notes into the Exchange
Agent's account at the Book-Entry Transfer Facility in accordance with such
Book-Entry Transfer Facility's procedures for transfer. However, although
delivery of Old Notes may be effected through book-entry transfer at the Book-
Entry Transfer Facility, the letter of transmittal or a facsimile of such
letter of transmittal, with any required signature guarantees and any other
required documents, must, in any case, be transmitted to, and received by, the
Exchange Agent at the address set forth below under "--Exchange Agent" on or
prior to the Expiration Date or there has been compliance with the guaranteed
delivery procedures described below.
Guaranteed Delivery Procedures
If a registered holder of the Old Notes desires to tender such Old Notes and
(1) the Old Notes are not immediately available, or time will not permit such
holder's Old Notes, or (2) other required documents to reach the Exchange Agent
before the Expiration Date, or (3) the procedure for book-entry transfer cannot
be completed on a timely basis, a tender may be effected if:
. the tender is made through an Eligible Institution;
. prior to the Expiration Date, the Exchange Agent received from such
Eligible Institution a properly completed and duly executed letter of
transmittal, or a facsimile of such letter of transmittal, and Notice of
Guaranteed Delivery, substantially in the form provided by us, by
facsimile transmission, mail or hand delivery, (a) setting forth the
name and address of the holder of Old Notes and the amount of Old Notes
tendered, (b) stating that the tender is being made thereby, and (c)
guaranteeing that within three New York Stock Exchange ("NYSE") trading
days after the Expiration Date, the certificates for all physically
tendered Old Notes, in proper form for transfer, or a Book-Entry
Confirmation, as the case may be, and any other documents required by
the letter of transmittal will be deposited by the Eligible Institution
with the Exchange Agent; and
. the certificates for all physically tendered Old Notes, in proper form
for transfer, or a Book-Entry Confirmation, as the case may be, and all
other documents required by the letter of transmittal, are received by
the Exchange Agent within three NYSE trading days after the Expiration
Date.
Withdrawal Rights
Tenders of Old Notes may be withdrawn at any time prior to 5:00 p.m., New
York City time, on the Expiration Date.
For a withdrawal to be effective, a written notice of withdrawal must be
received by the Exchange Agent at the address or, in the case of Eligible
Institutions, at the facsimile number, set forth below under""--Exchange Agent"
prior to 5:00 p.m., New York City time, on the Expiration Date. Any such notice
of withdrawal must:
. specify the name of the person having tendered the Old Notes to be
withdrawn (the "Depositor");
. identify the Old Notes to be withdrawn, including the certificate number
or numbers and principal amount of such Old Notes;
. contain a statement that such holder is withdrawing his election to have
such Old Notes exchanged;
. be signed by the holder in the same manner as the original signature on
the letter of transmittal by which such Old Notes were tendered,
including any required signature guarantees, or be accompanied by
documents of transfer to have the Trustee with respect to the Old Notes
register the transfer of such Old Notes in the name of the person
withdrawing the tender; and
. specify the name in which such Old Notes are registered, if different
from that of the Depositor.
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If Old Notes have been tendered pursuant to the procedure for book-entry
transfer described above, any notice of withdrawal must specify the name and
number of the account at the Book-Entry Transfer Facility to be credited with
the withdrawn Old Notes and otherwise comply with the procedures of such
facility. All questions as to the validity, form and eligibility, including
time of receipt, of such notices will be determined by us, whose determination
shalt be final and binding on all parties. Any Old Notes so withdrawn will be
deemed not to have been validly tendered for exchange for purposes of the
exchange offer. No New Notes will be issued with respect to the exchange offer
unless the Old Notes so withdrawn are validly retendered. Any Old Notes that
have been tendered for exchange, but which are not exchanged for any reason,
will be returned to the holder of such Old Notes without cost to such holder,
or, in the case of Old Notes tendered by book-entry transfer into the Exchange
Agent's account at the Book-Entry Transfer Facility pursuant to the book-entry
transfer procedures described above, such Old Notes will be credited to an
account maintained with the Book-Entry Transfer Facility for the Old Notes, as
soon as practicable after withdrawal, rejection of tender or termination of the
exchange offer. Properly withdrawn Old Notes may be retendered by following the
procedures described under "--Procedures for Tendering Old Notes" above at any
time on or prior to 5:00 p.m., New York City time, on the Expiration Date.
Certain Conditions to the Exchange Offer
Notwithstanding any other provision of the exchange offer, we shall not be
required to accept for exchange, or to issue New Notes in exchange for, any Old
Notes and may terminate or amend the exchange offer, if at any time before the
acceptance of such Old Notes for exchange or the exchange of the New Notes for
such Old Notes, any of the following events shall occur:
. there shall be threatened, instituted or pending any action or
proceeding before, or any injunction, order or decree shall have been
issued by, any court or governmental agency or other governmental
regulatory or administrative agency or commission (1) seeking to
restrain or prohibit the making or consummation of the exchange offer or
any other transaction contemplated by the exchange offer, or assessing
or seeking any damages as a result of such transaction, or (2) resulting
in a material delay in our ability to accept for exchange or exchange
some or all of the Old Notes pursuant to the exchange offer; or any
statute, rule, regulation, order or injunction shall be sought,
proposed, introduced, enacted, promulgated or deemed applicable to the
exchange offer or any of the transactions contemplated by the exchange
offer by any government or governmental authority, domestic or foreign,
or any action shall have been taken, proposed or threatened, by any
government, governmental authority, agency or court, domestic or
foreign, that in our sole judgment might directly or indirectly result
in any of the consequences referred to in clauses (1) or (2) above or,
in our sole judgment, might result in the holders of New Notes having
obligations with respect to resales and transfers of New Notes which are
greater than those described in the interpretation of the Commission
referred to above, or would otherwise make it inadvisable to proceed
with the exchange offer; or
. there shall have occurred:
(1) any general suspension of or general limitation on prices for, or
trading in, securities on any national securities exchange or in
the over-the-counter market;
(2) any limitation by a governmental agency or authority which may
adversely affect our ability to complete the transactions
contemplated by the exchange offer;
(3) a declaration of a banking moratorium or any suspension of payments
in respect of banks in the United States or any limitation by any
governmental agency or authority which adversely affects the
extension of credit; or
(4) a commencement of a war, armed hostilities or other similar
international calamity directly or indirectly involving the United
States, or, in the case of any of the foregoing existing at the
time of the commencement of the exchange offer, a material
acceleration or worsening of such calamities; or
. any change, or any development involving a prospective change, shall
have occurred or be threatened in our business, properties, assets,
liabilities, financial condition, operations, results of operations or
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prospects and those of our subsidiaries taken as a whole that, in our sole
judgment, is or may be adverse to us, or we shall have become aware of
facts that, in our sole judgment, have or may have adverse significance
with respect to the value of the Old Notes or the New Notes; which in our
sole judgment in any case, and regardless of the circumstances, including
any action by us, giving rise to any such condition, makes it inadvisable
to proceed with the exchange offer and/or with such acceptance for exchange
or with such exchange.
The foregoing conditions are for our sole benefit and may be asserted by us
regardless of the circumstances giving rise to any such condition, or may be
waived by us in whole or in part at any time and from time to time in its sole
discretion. Our failure at any time to exercise any of the foregoing rights
shall not be deemed a waiver of any such right and each such right shall be
deemed an ongoing right which may be asserted at any time and from time to
time.
In addition, we will not accept for exchange any Old Notes tendered, and no
New Notes will be issued in exchange for any such Old Notes, if at such time
any stop order shall be threatened or in effect with respect to the
Registration Statement of which this prospectus constitutes a part or the
qualification of the Indenture under the Trust Indenture Act of 1939.
Exchange Agent
HSBC Bank USA has been appointed as the Exchange Agent for the exchange
offer. All executed letters of transmittal should be directed to the Exchange
Agent at the address set forth below. Questions and requests for assistance,
requests for additional copies of this prospectus or of the letter of
transmittal and requests for Notices of Guaranteed Delivery should be directed
to the Exchange Agent addressed as follows:
HSBC Bank USA, Exchange Agent
By Mail: By Hand or By Overnight Courier:
HSBC Bank USA HSBC Bank USA
140 Broadway, level A 140 Broadway, level A
New York, NY 10005 New York, NY 10005
Attention: Paulette Shaw Attention: Paulette Shaw
For Information Call:
(212) 658-5931
By Facsimile Transmission (for Eligible Institutions only):
(212) 658-2292
Attention: Corporate Trust Operations
Confirm by Telephone:
(212) 658-5931
If you deliver the letter of transmittal to an address other than as set
forth above or transmission of instructions via facsimile other than as set
forth above, then such delivery or transmission does not constitute a valid
delivery of such letter of transmittal.
Fees and Expenses
We will not make any payment to brokers, dealers, or others soliciting
acceptances of the exchange offer. The estimated cash expenses to be incurred
in connection with the exchange offer will be paid by us. We estimate these
expenses in the aggregate to be approximately $500,000.
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Transfer Taxes
Holders who tender their Old Notes for exchange will not be obligated to pay
any related transfer taxes, except that holders who instruct us to register New
Notes in the name of, or request that Old Notes not tendered or not accepted in
the exchange offer be returned to, a person other than the registered tendering
holder will be responsible for the payment of any applicable transfer taxes.
Consequences of Exchanging or Failing to Exchange Old Notes
Holders of Old Notes who do not exchange their Old Notes for New Notes
pursuant to the exchange offer will continue to be subject to the provisions in
the Indenture regarding transfer and exchange of the Old Notes and the
restrictions on transfer of such Old Notes as set forth in the legend on such
Notes as a consequence of the issuance of the Old Notes pursuant to exemptions
from, or in transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws. In general, the Old Notes
may not be offered or sold, unless registered under the Securities Act, except
pursuant to an exemption from, or in a transaction not subject to, the
Securities Act and applicable state securities laws. As discussed below in
"Exchange offer; Registration Rights," we do not currently anticipate that we
will register Old Notes under the Securities Act.
Based on interpretations by the staff of the Commission, as set forth in no-
action letters issued to third parties, we believe that New Notes issued
pursuant to the exchange offer in exchange for Old Notes may be offered for
resale, resold or otherwise transferred by holders of such Old Notes, other
than any such holder which is an "affiliate" of ours within the meaning of Rule
405 under the Securities Act, without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that such New
Notes are acquired in the ordinary course of such holders' business and such
holders have no arrangement or understanding with any person to participate in
the distribution of such New Notes. However, the Commission has not considered
the exchange offer in the context of a no-action letter. There can be no
assurance that the staff of the Commission would make a similar determination
with respect to the exchange offer as in such other circumstances. Each holder,
other than a broker-dealer, must acknowledge that it is not engaged in, and
does not intend to engage in, a distribution of New Notes and has no
arrangement or understanding to participate in a distribution of New Notes. If
any holder is an affiliate of ours, is engaged in or intends to engage in or
has any arrangement or understanding with respect to the distribution of the
New Notes to be acquired pursuant to the exchange offer, such holder (1) could
not rely on the applicable interpretations of the staff of the Commission and
(2) must comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any resale transaction. Each broker-
dealer that receives New Notes for its own account in exchange for Old Notes
must acknowledge that such Old Notes were acquired by such broker-dealer as a
result of market-making activities or other trading activities and that it will
deliver a prospectus in connection with any resale of such New Notes. In
addition, to comply with the securities laws of certain jurisdictions, if
applicable, the New Notes may not be offered or sold unless they have been
registered or qualified for sale in such jurisdiction or an exemption from
registration or qualification, with which there has been compliance, is
available. See "Plan of Distribution."
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DESCRIPTION OF NEW CREDIT FACILITY
The new credit facility provides for the following:
(1) a six year $50.0 million A term loan to be drawn at closing to
finance in part the recapitalization and certain related costs and
expenses, and to refinance certain existing debt of our company
(2) a seven year $110.0 million B term loan to be drawn at closing to
finance in part the recapitalization and certain related costs and
expenses, and to refinance certain existing debt of our company; and
(3) a six year $25.0 million revolving credit facility, of which $2.9
million may be drawn at closing to finance part of the recapitalization and
which may include letters of credit (subject to a sub-limit to be
determined), to be used for, among other things, general corporate purposes
including working capital.
The A and B term loans will amortize in quarterly amounts based on the annual
amounts shown below:
<TABLE>
<CAPTION>
A Term Loan B Term Loan
----------- -----------
(dollars in thousands)
<S> <C> <C>
Fiscal Year 1999..................................... $ -- $ 275
Fiscal Year 2000..................................... 1,250 1,100
Fiscal Year 2001..................................... 5,625 1,100
Fiscal Year 2002..................................... 8,125 1,100
Fiscal Year 2003..................................... 10,625 1,100
Fiscal Year 2004..................................... 13,125 1,100
Fiscal Year 2005..................................... 11,250 26,675
Fiscal Year 2006..................................... -- 77,550
------- --------
Total.............................................. $50,000 $110,000
======= ========
</TABLE>
Deutsche Bank Securities Inc. has acted as lead arranger, Bankers Trust
Company has acted as administrative agent and Merrill Lynch Capital Corporation
has acted as co-arranger and syndication agent for the syndicate of lenders
providing the new credit facility.
Subject to certain limited exceptions, the new credit facility requires
mandatory repayments and mandatory reductions thereunder with the proceeds from
(1) assets sales, (2) the issuance of debt and preferred stock, (3) insurance
and condemnation claims, (4) annual excess cash flow and (5) any payments from
the Kelso affiliates and other investors pursuant to the equity investment
described in the penultimate paragraph of this section. Voluntary prepayments
of the new credit facility are permitted at any time, subject to certain notice
requirements and to the payment of certain losses and expenses suffered by the
lenders as a result of the prepayment of Eurodollar Loans (as defined in the
new credit facility) prior to the end of the applicable interest period.
The new credit facility bears interest at the sum of the (1) applicable
margin and (2) at our option, either the "Base Rate" (as defined in the new
credit facility) or the "Eurodollar Rate" (as defined in the new credit
facility). The Base Rate is the higher of (1) the rate that Bankers Trust
Company announces from time to time as its prime lending rate, as in effect
from time to time and (2) one-half of 1% in excess of the overnight federal
funds effective rate as published by the Federal Reserve Bank of New York. The
applicable interest margin is initially a percentage per annum equal to (1) in
the case of the A term loan and revolving loans maintained as (a) Base Rate
Loans (as defined in the new credit facility), 2.125%, and (b) Eurodollar
Loans, 3.125% and (2) in the case of the B term loan maintained as (a) Base
Rate Loans, 2.875%, and (b) Eurodollar Loans, 3.875%, in each case subject to
adjustments to be determined based on certain levels of financial performance.
With respect to Eurodollar Loans, (1) we may elect interest periods of 1, 2,
3 or 6 months and (2) interest is payable in arrears at the earlier of (a) the
end of an applicable interest period and (b) quarterly. With respect to Base
Rate Loans, interest is payable quarterly on the last business day of each
fiscal quarter. In each case,
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calculations of interest is based on a 360-day year and actual days elapsed.
Additionally, we are to pay a commitment fee in an amount equal to 0.50% per
annum on the daily average unused portion of the new credit facility, subject
to adjustments to be determined based on certain levels of financial
performance.
The new credit facility contains certain covenants, including, without
limitation, restrictions on:
. debt and liens;
. the sale of assets;
. mergers, acquisitions and other business combinations;
. voluntary prepayment of certain of our debt (including the Notes);
. transactions with affiliates;
. capital expenditures; and
. loans and investments, as well as prohibitions on the payment of cash
dividends to, or the repurchase on redemption of stock from,
stockholders, and various financial covenants.
The new credit facility contains customary events of default, including
payment defaults, breaches of representations and warranties, covenant
defaults, cross-default and cross-acceleration to certain other debt, certain
events of bankruptcy and insolvency, certain events under the Employee
Retirement Income Security Act of 1974, as amended, material judgments, actual
or asserted failure of any guaranty or security document supporting the new
credit facility to be in full force and effect and change of control of our
company. If such a default occurs, the lenders under the new credit facility
would be entitled to take various actions, including all actions permitted to
be taken by a secured creditor, the acceleration of amounts due under the new
credit facility and requiring that all such amounts to be immediately paid in
full.
All obligations under the new credit facility are jointly and severally
guaranteed by any of our direct and indirect domestic subsidiaries. The debt
under the new credit facility is secured by a pledge of the capital stock of
our subsidiaries, if any (but not to exceed 66 2/3 of the voting stock of
foreign subsidiaries), and a perfected lien and security interest in
substantially all of our assets (tangible and intangible) and those of our
direct and indirect subsidiaries. Our future domestic subsidiaries will be
required to guarantee the new credit facility and to secure such guarantee with
their real property and substantially all of their tangible and intangible
personal property.
If our ratio of net total debt to EBITDA (as defined in a capital call
agreement) for the year 2000 is greater than 5.0 times, the Kelso affiliates
that control our company will be required, pursuant to the capital call
agreement, to make (or cause their designees to make) an equity investment in
our company. The proceeds from the equity investment will be used to retire the
term loans under the new credit facility. To the extent all such proceeds are
not fully used to repay the term loans, the commitment under the revolving
credit facility will be reduced by an amount equal to the remaining proceeds.
The equity investment will be in an amount equal to the lesser of (a) the
amount necessary to cause the ratio of net total debt to EBITDA, after giving
effect to the equity investment, to equal 5.0 times and (b) $50.0 million.
For the purposes of the capital call agreement, net total debt is expected to
consist of our consolidated debt (net of cash and cash equivalents) plus any
debt of another person secured by our assets or those of any of our
subsidiaries and any of our contingent obligations or those of any of our
subsidiaries for debt of another person.
For the purposes of the capital call agreement, EBITDA consists of the sum of
net income; provisions for income taxes; interest expense (including all
commissions, discounts and other fees and charges owed with respect to certain
debt); depreciation expense; amortization expense; extraordinary, unusual or
nonrecurring gains, losses, income or expense and the related tax effects;
other non-cash expenses and certain acquisition-related expenses; less
extraordinary gains. Each of these items is calculated on a consolidated basis.
Under the capital call agreement the ratio of net total debt to EBITDA is
calculated on a pro forma basis in a similar manner to the calculation of the
"Consolidated Fixed Charge Coverage Ratio" in the indenture
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governing the Notes, except that in the case of the pro forma calculation under
the capital call agreement pro forma effect is also given to the closure or
discontinuation of operations of any of our facility as if it had occurred on
the first date of the test period.
The new credit facility and the capital call agreement, including the terms
and conditions described above, is subject to modification, amendment and
waiver by the parties to the respective agreements.
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DESCRIPTION OF THE NOTES
The New Notes will be issued under an indenture (the "Indenture"), dated as
of September 28, 1999, between Unilab Finance Corp. and HSBC Bank USA, as
trustee (the "Trustee"), as supplemented by the supplemental indenture thereto,
dated as of November 23, 1999 (the "Supplemental Indenture"), among Unilab
Finance, the Trustee and Unilab. Pursuant to the Supplemental Indenture, the
obligations of Unilab Finance under the Old Notes and Indenture were assumed by
Unilab upon the consummation of the recapitalization, which occurred on
November 23, 1999. References to the Notes include the New Notes unless the
context otherwise requires.
The following is a summary of the material provisions of the Indenture. It
does not include all of the provisions of the Indenture. We urge you to read
the Indenture because it defines your rights. The terms of the Notes include
those stated in the Indenture and those made part of the Indenture by reference
to the Trust Indenture Act of 1939, as amended (the "TIA"). A copy of the
Indenture may be obtained upon request from us and which is filed as an exhibit
to the registration statement to which this prospectus forms a part. You can
find definitions of certain capitalized terms used in this description under
"--Certain Definitions."
The New Notes will be our unsecured obligations, ranking subordinate in right
of payment to all our Senior Debt to the extent set forth in the Indenture.
The Trustee will authenticate and deliver the New Notes for original issue
only in exchange for a like principal amount of Old Notes.
The New Notes will be issued in fully registered form only in denominations
of $1,000 and integral multiples thereof. The Trustee will initially act as
Paying Agent and Registrar for the New Notes. The New Notes may be presented
for registration of transfer and exchange at the offices of the Registrar,
which initially will be the Trustee's corporate trust office. We may change any
Paying Agent and Registrar without notice to holders of the New Notes (the
"Holders"). We will pay principal (and premium, if any) on the New Notes at the
Trustee's corporate office in New York, New York. At our option, interest may
be paid at the Trustee's corporate trust office or by check mailed to the
registered address of Holders.
No service charge will be made for any transfer, exchange or redemption of
New Notes, except in certain circumstance for any tax or other governmental
charge that may be impose in connection therewith.
For each Old Note accepted for exchange, the holder of such Old Note will
receive a New Note having a principal amount equal to that of the surrendered
Notes.
Any Notes that remain outstanding after the completion of the exchange offer,
together with the New Notes issued in connection with the exchange offer, will
be treated as a single class of securities under the Indenture.
Holders of such Additional Notes will have the right to vote together with
Holders of Old Notes and New Notes as one class. No offering of any such
Additional Notes is being or shall be deemed to be made by this prospectus.
Interest on the New Notes will accrue at the rate of 12 3/4% per annum and will
be payable semiannually in cash on each April 1 and October 1 commencing on
April 1, 2000, to the persons who are registered Holders at the close of
business on the and immediately preceding the applicable interest payment date.
Interest on the New Notes will accrue from the most recent date to which
interest has been paid or, if no interest has been paid, from and including the
date of issuance. Old Notes accepted for exchange will cease to accrue interest
from and after the date of consummation of the exchange offer. Holders of the
Old Notes whose Old Notes are accepted for exchange will not receive any
payment in respect of interest on such Old Notes otherwise payable on any
interest payment date and record date which occurs on or after the consummation
of the exchange offer.
The Notes will not be entitled to the benefit of any mandatory sinking fund.
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Redemption
Optional Redemption. Except as described below, the Notes are not redeemable
before October 1, 2004. Thereafter, we may redeem the Notes at our option, in
whole or in part, upon not less than 30 nor more than 60 days' notice, at the
following redemption prices (expressed as percentages of the principal amount
thereof) if redeemed during the twelve-month period commencing on October 1 of
the year set forth below:
<TABLE>
<CAPTION>
Year Percentage
---- ----------
<S> <C>
2004.............................................................. 106.375%
2005.............................................................. 104.250%
2006.............................................................. 102.125%
2007 and thereafter............................................... 100.000%
</TABLE>
In addition, we must pay accrued and unpaid interest on the Notes redeemed.
Optional Redemption Upon Equity Offerings. At any time, or from time to
time, on or prior to October 1, 2002, we may, at our option, use the net cash
proceeds of one or more Equity Offerings (as defined below) to redeem up to
35% of the aggregate principal amount of the Notes issued under the Indenture
(including any Additional Notes) at a redemption price equal to 112.75% of the
principal amount thereof plus accrued and unpaid interest thereon, if any, to
the date of redemption; provided that:
(1) at least 65% of the principal amount of Notes issued under the
Indenture (including any Additional Notes) remains outstanding immediately
after any such redemption; and
(2) We make such redemption not more than 90 days after the
consummation of any such Equity Offering.
"Equity Offering" means a sale of our Qualified Capital Stock, other than
any of our Capital Stock required to be purchased pursuant to the terms of the
Capital Call Agreement.
Selection and Notice of Redemption
In the event that we choose to redeem less than all of the Notes, selection
of the Notes for redemption will be made by the Trustee either:
(1) in compliance with the requirements of the principal national
securities exchange, if any, on which the Notes are listed; or,
(2) on a pro rata basis, by lot or by such method as the Trustee shall
deem fair and appropriate.
No Notes of a principal amount of $1,000 or less shall be redeemed in part.
If a partial redemption is made with the net cash proceeds of an Equity
Offering, the Trustee will select the Notes only on a pro rata basis or on as
nearly a pro rata basis as is practicable (subject to DTC procedures). Notice
of redemption will be mailed by first-class mail at least 30 but not more than
60 days before the redemption date to each Holder of Notes to be redeemed at
its registered address. On and after the redemption date, interest will cease
to accrue on Notes or portions thereof called for redemption as long as we
have deposited with the Paying Agent funds in satisfaction of the applicable
redemption price.
Escrow of Proceeds and Other Amounts
On September 28, 1999, Unilab Finance entered into an escrow agreement (the
"Escrow Agreement") with HSBC Bank USA, as escrow agent (the "Escrow Agent"),
pursuant to which Unilab Finance deposited with the Escrow Agent the net
proceeds of the offering of the Old Notes and cash or Treasury Securities (as
defined in the Escrow Agreement) (the "Escrowed Property") in an aggregate
amount sufficient to redeem in cash the Old Notes at a redemption price equal
to 101% of the offering price (i.e., 97.268% of the principal amount at
maturity) of the Old Notes plus accrued and unpaid interest to the date of
redemption (the "Initial Deposit").
Upon consummation of our recapitalization, the Escrow Agent released all
Escrowed Property to us.
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Subordination
The payment of all Obligations on or relating to the Notes is subordinated in
right of payment, to the extent described below and in the Indenture, to the
prior payment in full in cash or Cash Equivalents of all Obligations on Senior
Debt (including the Obligations with respect to the New Credit Facility).
Notwithstanding the foregoing, payments and distributions made relating to the
Notes pursuant to the trust described under "Legal Defeasance and Covenant
Defeasance" shall not be so subordinated in right of payment.
The holders of Senior Debt will be entitled to receive payment in full in
cash or Cash Equivalents of all Obligations due in respect of Senior Debt
(including interest after the commencement of any bankruptcy or other like
proceeding at the rate specified in the applicable Senior Debt whether or not
such interest is an allowed claim in any such proceeding) before the Holders of
Notes will be entitled to receive any payment or distribution of any kind or
character with respect to any Obligations on, or relating to, the Notes in the
event of any distribution to our creditors:
(1) in a liquidation or dissolution of our company;
(2) in a bankruptcy, reorganization, insolvency, receivership or
similar proceeding relating to the our company or our property;
(3) in an assignment for the benefit of creditors; or
(4) in any marshalling of our assets and liabilities.
We also may not make any payment or distribution of any kind or character
with respect to any Obligations on, or relating to, the Notes or acquire any
Notes for cash or property or otherwise if:
(1) a payment default on any Senior Debt occurs and is continuing; or
(2) any other default occurs and is continuing on Designated Senior
Debt that permits holders of the Designated Senior Debt to accelerate its
maturity and the Trustee receives a notice of such default (a "Payment
Blockage Notice") from the Representative of any Designated Senior Debt.
Payments on and distributions with respect to any Obligations on, or with
respect to, the Notes may and shall be resumed:
(1) in the case of a payment default, upon the date on which such
default is cured or waived; and
(2) in case of a nonpayment default, the earliest of (x) the date on
which all nonpayment defaults are cured or waived (so long as no other
event of default exists), (y) 180 days after the date on which the
applicable Payment Blockage Notice is received or (z) the date on which the
Trustee receives notice from the Representative for such Designated Senior
Debt rescinding the Payment Blockage Notice, unless the maturity of any
Designated Senior Debt has been accelerated.
No new Payment Blockage Notice may be delivered unless and until 360 days
have elapsed since the effectiveness of the immediately prior Payment Blockage
Notice.
No nonpayment default that existed or was continuing on the date of delivery
of any Payment Blockage Notice to the Trustee shall be, or be made, the basis
for a subsequent Payment Blockage Notice unless such default shall have been
cured or waived for a period of not less than 90 consecutive days (it being
acknowledged that any subsequent action, or any breach of any financial
covenants for a period commencing after the date of delivery of such initial
Payment Blockage Notice that in either case would give rise to a default
pursuant to any provisions under which a default previously existed or was
continuing shall constitute a new default for this purpose).
We must promptly notify holders of Senior Debt if payment of the Notes is
accelerated because of an Event of Default.
As a result of the subordination provisions described above in the event of
our bankruptcy, liquidation or reorganization, Holders of the Notes may recover
less ratably than our creditors who are holders of Senior Debt.
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After giving effect to the Recapitalization and the financing therefor, on a
pro forma basis, and after giving effect to the tendering of 99.6% of the
senior notes in the tender offer, at September 30, 1999, the aggregate amount
of Senior Debt outstanding would have been approximately $166.6 million
(excluding unused commitments of $23.0 million under the New Credit Facility).
Change of Control
Upon the occurrence of a Change of Control, each Holder will have the right
to require that we purchase all or a portion of such Holder's Notes pursuant to
the offer described below (the "Change of Control Offer"), at a purchase price
equal to 101% of the principal amount thereof plus accrued interest to the date
of purchase.
Within 30 days following the date upon which we obtain actual knowledge that
a Change of Control occurred, we must send, by first class mail, a notice to
each Holder, with a copy to the Trustee, which notice shall govern the terms of
the Change of Control Offer. Such notice shall state, among other things, the
purchase date, which must be no earlier than 30 days nor later than 45 days
from the date such notice is mailed, other than as may be required by law or
stock exchange rule (the "Change of Control Payment Date"). Holders electing to
have a Note purchased pursuant to a Change of Control Offer will be required to
surrender the Note, with the form entitled "Option of Holder to Elect Purchase"
on the reverse of the Note completed, to the Paying Agent at the address
specified in the notice prior to the close of business on the third business
day prior to the Change of Control Payment Date.
Prior to the mailing of the notice referred to above, but in any event within
30 days following the date upon which we obtain actual knowledge of any Change
of Control, we covenant to:
(1) repay in full and terminate all commitments under Indebtedness
under the New Credit Facility and all other Senior Debt the terms of which
require repayment upon a Change of Control or offer to repay in full and
terminate all commitments under all Indebtedness under the New Credit
Facility and all other such Senior Debt and to repay the Indebtedness owed
to each lender which has accepted such offer; or
(2) obtain the requisite consents under the New Credit Facility and
all other Senior Debt to permit the repurchase of the Notes as provided
below.
We shall first comply with the covenant in the immediately preceding
paragraph before we shall be required to repurchase Notes pursuant to the
provisions described below. Our failure to comply with the covenant described
in the immediately preceding paragraph may (with notice and lapse of time)
constitute an Event of Default described in clause (3) but shall not constitute
an Event of Default described in clause (2) under "Events of Default" below.
If a Change of Control Offer is made, there can be no assurance that we will
have available funds sufficient to pay the Change of Control purchase price for
all the Notes that might be delivered by Holders seeking to accept the Change
of Control Offer. In the event that we are required to purchase outstanding
Notes pursuant to a Change of Control Offer, we expect that we would seek third
party financing to the extent we do not have available funds to meet our
purchase obligations. However, there can be no assurance that we would be able
to obtain such financing.
The definition of Change of Control includes a phrase relating to the sale,
lease, exchange or other transfer of "all or substantially all" of our assets.
Although there is a developing body of case law interpreting the phrase
"substantially all," there is no precise definition of the phrase under
applicable law. Accordingly, in certain circumstances there may be a degree of
uncertainty in ascertaining whether a particular transaction would involve a
disposition of "all or substantially all" of the our assets, and therefore it
may be unclear as to whether a Change of Control has occurred and whether the
Holders have the right to require us to repurchase such Notes.
Neither our Board of Directors nor the Trustee may waive the covenant
relating to a Holder's right to redemption upon a Change of Control.
Restrictions in the Indenture described herein on our ability and our
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Restricted Subsidiaries to incur additional Indebtedness, to grant liens on its
property, to make Restricted Payments and to make Asset Sales may also make
more difficult or discourage a takeover of our company, whether favored or
opposed by our management. Consummation of any such transaction in certain
circumstances may require redemption or repurchase of the Notes, and there can
be no assurance that we or the acquiring party will have sufficient financial
resources to effect such redemption or repurchase. Such restrictions and the
restrictions on transactions with Affiliates may, in certain circumstances,
make more difficult or discourage any leveraged buyout of our company or any of
our Subsidiaries by our management. While such restrictions cover a wide
variety of arrangements which have traditionally been used to effect highly
leveraged transactions, the Indenture may not afford the Holders protection in
all circumstances from the adverse aspects of a highly leveraged transaction,
reorganization, restructuring, merger or similar transaction.
We will comply with the requirements of Rule 14e-1 under the Exchange Act and
any other securities laws and regulations thereunder to the extent such laws
and regulations are applicable in connection with the repurchase of Notes
pursuant to a Change of Control Offer. To the extent that the provisions of any
securities laws or regulations conflict with the "Change of Control" provisions
of the Indenture, we shall comply with the applicable securities laws and
regulations and shall not be deemed to have breached our obligations under the
"Change of Control" provisions of the Indenture by virtue thereof.
Certain Covenants
The Indenture will contain, among others, the following covenants:
Limitation on Restricted Payments. We will not, and will not cause or permit
any of our Restricted Subsidiaries to, directly or indirectly:
(1) declare or pay any dividend or make any distribution (other than
dividends or distributions payable in Qualified Capital Stock) on or in
respect our shares of our Capital Stock to holders of such Capital Stock;
(2) purchase, redeem or otherwise acquire or retire for value any of
our Capital Stock or any warrants, rights or options to purchase or acquire
shares of any class of such Capital Stock, other than the exchange of such
Capital Stock for Qualified Capital Stock; or
(3) make any Investment (other than Permitted Investments) in any
other Person (each of the foregoing actions set forth in clauses (1), (2)
and (3) (other than the exceptions thereto) being referred to as a
"Restricted Payment");
if at the time of such Restricted Payment or immediately after giving
effect thereto:
(i) a Default or an Event of Default shall have occurred and be
continuing; or
(ii) we are not able to incur at least $1.00 of additional
Indebtedness (other than Permitted Indebtedness) in compliance with the
"Limitation on Incurrence of Additional Indebtedness" covenant; or
(iii) the aggregate amount of Restricted Payments made subsequent to
the Issue Date shall exceed the sum of:
(w) 50% of our cumulative Consolidated Net Income (or if
cumulative Consolidated Net Income shall be a loss, minus 100% of such
loss) earned subsequent to the Issue Date and on or prior to the date
the Restricted Payment occurs (the "Reference Date") (treating such
period as a single accounting period); plus
(x) 100% of the aggregate net cash proceeds received by us from
any Person (other than our Subsidiary) from the issuance and sale
subsequent to November 23, 1999 and on or prior to the Reference Date
of our Qualified Capital Stock (including Capital Stock issued upon the
conversion of convertible Indebtedness or in exchange for outstanding
Indebtedness but excluding (A) aggregate net cash proceeds from the
sale of our Capital Stock to the extent used to repurchase or acquire
shares of our Capital Stock pursuant to clause (2)(ii) of the next
succeeding paragraph and (B) aggregate net cash proceeds from the sale
of our Capital Stock required by the terms of the Capital Call
Agreement); plus
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(y) without duplication of any amounts included in clause (iii)
(x) above, 100% of the aggregate net cash proceeds of any equity
contribution received by us (excluding any equity contribution required
to be made pursuant to the terms of the Capital Call Agreement) from a
holder of our Capital Stock subsequent to November 23, 1999; plus
(z) to the extent that any Investment (other than a Permitted
Investment) that was made after November 23, 1999 is sold for cash or
otherwise liquidated or repaid for cash, the lesser of:
(a) the net cash proceeds received with respect to such sale,
liquidation or repayment of such Investment (less the cost of such
sale, liquidation or repayment, if any) and
(b) the initial amount of such Investment, but only to the
extent not included in the calculation of Consolidated Net Income.
Any net cash proceeds included in the foregoing clauses (iii)(x) or
(iii)(y) shall not be included in clause (10)(a) or clause (10)(b)
of the definition of "Permitted Investments" to the extent actually
utilized to make a Restricted Payment under this paragraph.
Notwithstanding the foregoing, the provisions set forth in the immediately
preceding paragraph do not prohibit:
(1) the payment of any dividend or the consummation of any irrevocable
redemption within 60 days after the date of declaration of such dividend or
notice of such redemption if the dividend or payment of the redemption
price, as the case may be, would have been permitted on the date of
declaration or notice;
(2) if no Event of Default shall have occurred and be continuing as a
consequence thereof, the acquisition of any shares our Capital Stock,
either (i) solely in exchange for shares of our Qualified Capital Stock, or
(ii) through the application of net proceeds of a substantially concurrent
sale (other than to our Subsidiary) of shares of our Qualified Capital
Stock;
(3) payments for the purpose of and in an amount equal to the amount
required to permit us to redeem or repurchase shares of our Capital Stock
or options in respect thereof, in each case in connection with the
repurchase provisions under employee stock option or stock purchase
agreements or other agreements to compensate management employees or
payments in respect of any redemption, repurchase, acquisition,
cancellation or other retirement for value of shares of our Capital Stock
or options, stock appreciation or similar securities, in each case held by
our then current or former officers, directors or employees or any of our
Subsidiaries (or their estates or beneficiaries under their estates) or by
an employee benefit plan, upon death, disability, retirement or termination
of employment; provided that such redemptions, repurchases, acquisitions,
cancellations or other retirements pursuant to this clause (3) shall not
exceed $10.0 million in the aggregate after the Issue Date (which amount
shall be increased by the amount of any cash proceeds to us from (x) sales
of our Capital Stock to management employees subsequent to November 23,
1999 and (y) any "key-man" life insurance policies which are used to make
such redemptions or repurchases);
(4) the payment of fees and compensation as permitted under clauses
(1), (14) or (15) of paragraph (c) of the "Limitation on Transactions with
Affiliates" covenant;
(5) so long as no Default or Event of Default shall have occurred and
be continuing, payments not to exceed $100,000 in the aggregate, to enable
us to make payments to holders of our Capital Stock in lieu of issuance of
fractional shares of our Capital Stock;
(6) repurchases of Capital Stock deemed to occur upon the exercise of
stock options if such Capital Stock represents a portion of the exercise
price thereof;
(7) Restricted Payments made pursuant to the Merger Agreement; and
(8) the distribution of Capital Stock of any of our Unrestricted
Subsidiary to holders of our Capital Stock.
In determining the aggregate amount of Restricted Payments made subsequent to
November 23, 1999 in accordance with clause (3) of the immediately preceding
paragraph:
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(1) amounts expended (to the extent such expenditure is in the form of
cash or other property other than Qualified Capital Stock) pursuant to
clauses (1) and (3) shall be included in such calculation, provided that
such expenditures pursuant to clause (3) shall not be included to the
extent of cash proceeds received by us from any "key man" life insurance
policies; and
(2) amounts expended pursuant to clauses (2), (4), (5), (6) and (7)
shall be excluded from such calculation.
Limitation on Incurrence of Additional Indebtedness. From and after November
23, 1999, we will not, and will not permit any of our Restricted Subsidiaries
to, directly or indirectly, create, incur, assume, guarantee, acquire, become
liable, contingently or otherwise, with respect to, or otherwise become
responsible for payment of (collectively, "incur") any Indebtedness (other than
Permitted Indebtedness); provided, however, that if no Default or Event of
Default shall have occurred and be continuing at the time or as a consequence
of the incurrence of any such Indebtedness, we or any Guarantor may incur
Indebtedness if on the date of the incurrence of such Indebtedness, after
giving effect to the incurrence thereof, our Consolidated Fixed Charge Coverage
Ratio is greater than 2.0 to 1.0 if such incurrence is on or prior to October
1, 2001 and 2.25 to 1 if such incurrence is thereafter.
Limitation on Transactions with Affiliates. (a) From and after November 23,
1999, we will not, and will not permit any of our Restricted Subsidiaries to,
directly or indirectly, enter into or permit to exist any transaction or series
of related transactions (including, without limitation, the purchase, sale,
lease or exchange of any property or the rendering of any service) with, or for
the benefit of, any of our Affiliates (an "Affiliate Transaction"), other than
(x) Affiliate Transactions permitted under paragraph (c) below and (y)
Affiliate Transactions entered into on terms that are fair and reasonable to,
and in the best interests of, our company or such Restricted Subsidiary, as the
case may be, as determined in good faith by our Board of Directors; provided,
however, that for a transaction or series of related transactions with an
aggregate value of $5.0 million or more, at our option (i) such determination
shall be made in good faith by a majority of the disinterested members of our
Board of the Directors or (ii) our Board of Directors or any such Restricted
Subsidiary party to such Affiliate Transaction shall have received a favorable
opinion from a nationally recognized investment banking firm that such
Affiliate Transaction is fair from a financial point of view to us or such
Restricted Subsidiary; provided, further, that for a transaction or series of
related transactions with an aggregate value of $15.0 million or more, our
Board of Directors shall have received a favorable opinion from a nationally
recognized investment banking firm that such Affiliate Transaction is fair from
a financial point of view to us or such Restricted Subsidiary.
(b) The foregoing restrictions shall not apply to:
(1) reasonable fees and compensation paid to, and indemnity provided
on behalf of, our officers, directors, employees or consultants or those of
our Subsidiary as determined in good faith by our Board of Directors;
(2) transactions exclusively between or among us and any of our
Restricted Subsidiaries or exclusively between or among such Restricted
Subsidiaries, provided such transactions are not otherwise prohibited by
the Indenture;
(3) transactions effected as part of a Qualified Receivables
Transaction;
(4) any agreement as in effect as of November 23, 1999 or any
amendment thereto or any transaction contemplated thereby (including
pursuant to any amendment thereto) in any replacement agreement thereto so
long as any such amendment or replacement agreement is not more
disadvantageous to the Holders in any material respect than the original
agreement as in effect on November 23, 1999;
(5) Restricted Payments permitted by the Indenture;
(6) any Permitted Investment;
(7) transactions permitted by, and complying with, the provisions of
the covenant described under "Merger, Consolidation and Sale of Assets";
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(9) the grant of stock options or similar rights to our employees and
directors and those of our Subsidiaries pursuant to Plans and employment
contracts approved by our Board of Directors;
(10) loans or advances to our officers, directors or employees or
those of our Restricted Subsidiaries not in excess of $5.0 million at any
one time outstanding;
(11) the granting or performance of registration rights under a
written registration rights agreement approved by our Board of Directors;
(12) transactions with Persons solely in their capacity as holders of
our Indebtedness or Capital Stock or the Indebtedness of our Restricted
Subsidiaries, where such Persons are treated no more favorably than holders
of our Indebtedness or Capital Stock or the Indebtedness of our Restricted
Subsidiary generally;
(13) any agreement to do any of the foregoing;
(14) the payment of fees, reimbursements, indemnifications and other
amounts pursuant to any agreements between Unilab and Kelso & Co., L.P.
with respect to the payment of investment banking and annual financial
advisory fees; and
(15) transactions entered into on November 23, 1999 in connection with
the Recapitalization and the financing therefor.
Limitation on Liens. From and after November 23, 1999, we will not, and will
not permit any of our Restricted Subsidiaries to, create, incur, assume or
suffer to exist any Liens (other than Permitted Liens) of any kind against or
upon any of their respective property or assets, or any proceeds, income or
profit therefrom which secure Senior Subordinated Indebtedness or Subordinated
Obligations, unless:
(1) in the case of Liens securing Subordinated Obligations, the Notes
are secured by a Lien on such property, assets, proceeds, income or profit
that is senior in priority to such Liens at least to the same extent that
the Notes are subordinated to Senior Debt; and
(2) in the case of Liens securing Senior Subordinated Indebtedness,
the Notes are equally and ratably secured by a Lien on such property,
assets, proceeds, income or profit.
Prohibition on Incurrence of Senior Subordinated Debt. Neither we nor any
Guarantor will incur or suffer to exist Indebtedness that is senior in right of
payment to the Notes or such Guarantor's Guarantee and subordinate in right of
payment to any other of our Indebtedness or such Guarantor, as the case may be.
Limitation on Dividend and Other Payment Restrictions Affecting
Subsidiaries. From and after November 23, 1999, we will not, and will not
permit any of our Restricted Subsidiaries to, directly or indirectly, create or
otherwise cause or permit to exist or become effective any consensual
encumbrance or restriction on the ability of any Restricted Subsidiary to:
(1) pay dividends or make any other distributions on or in respect of
our Capital Stock;
(2) make loans or advances or to pay any Indebtedness or other
obligation owed to us or any of our other Restricted Subsidiary; or
(3) transfer any of its property or assets to us or any of our other
Restricted Subsidiary, except for such encumbrances or restrictions
existing under or by reason of:
(a) applicable law;
(b) the Indenture or encumbrances or restrictions substantially
similar to the encumbrances and restrictions contained in the Indenture
taken as a whole;
(c) non-assignment provisions of any contract or any lease entered
into in the ordinary course of business;
(d) any instrument governing Acquired Indebtedness, which
encumbrance or restriction is not applicable to us or any of our
Restricted Subsidiary, or the properties or assets of any such
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Person, other than the Person or the properties or assets of the Person
so acquired; provided, however, that such Acquired Indebtedness was not
incurred in connection with, or in anticipation or contemplation of an
acquisition by us or any of our Restricted Subsidiary;
(e) agreements existing on November 23, 1999;
(f) the New Credit Facility;
(g) restrictions on the transfer of assets subject to any Lien
permitted under the Indenture imposed by the holder of such Lien;
(h) restrictions imposed by any agreement to sell assets permitted
under the Indenture to any Person pending the closing of such sale;
(i) any agreement or instrument governing Capital Stock of any
Person that is acquired after the Issue Date;
(j) Indebtedness or other contractual requirements of a Receivables
Entity in connection with a Qualified Receivables Transaction; provided
that such restrictions apply only to such Receivables Entity; or
(k) an agreement effecting a refinancing, replacement or
substitution of Indebtedness issued, assumed or incurred pursuant to an
agreement referred to in clause (b), (d), (e) or (f) above; provided,
however, that the provisions relating to such encumbrance or restriction
contained in any such refinancing, replacement or substitution agreement
are no less favorable to us or the Holders in any material respect as
determined by our Board of Directors than the provisions relating to
such encumbrance or restriction contained in agreements referred to in
such clause (b), (d), (e) or (f).
Limitation on Preferred Stock of Subsidiaries. From and after November 23,
1999, we will not permit any of our Restricted Subsidiaries to issue any
Preferred Stock (other than to us or to a Restricted Subsidiary) or permit any
Person (other than us or a Restricted Subsidiary) to own any Preferred Stock
of any of our Restricted Subsidiary.
Merger, Consolidation and Sale of Assets. We will not, in a single
transaction or a series of related transactions, consolidate with or merge
with or into, or sell, assign, transfer, lease, convey or otherwise dispose of
all or substantially all of its assets to, another Person or Persons.
From and after November 23, 1999, we will not, in a single transaction or a
series of related transactions, consolidate with or merge with or into, or
sell, assign, transfer, lease, convey or otherwise dispose of (or cause or
permit any of our Restricted Subsidiary to sell, assign, transfer, lease,
convey or otherwise dispose of) all or substantially all of our assets to,
another Person or Persons unless:
(1) either:
(a) we shall be the surviving or continuing corporation of such
merger or consolidation; or
(b) the surviving Person is a corporation existing under the laws
of the United States, any state thereof or the District of Columbia and
such surviving Person shall expressly assume all of our obligations
under the Notes and the Indenture;
(2) immediately after giving effect to such transaction (on a pro
forma basis, including any Indebtedness incurred or anticipated to be
incurred in connection with such transaction and the other adjustments that
are referred to in the definition of "Consolidated Fixed Charge Coverage
Ratio"), we are or the surviving Person is able to incur at least $1.00 of
additional Indebtedness (other than Permitted Indebtedness) in compliance
with the "Limitation on Incurrence of Additional Indebtedness" covenant;
(3) immediately before and immediately after giving effect to such
transaction (including any Indebtedness incurred or anticipated to be
incurred in connection with the transaction), no Default or Event of
Default shall have occurred and be continuing; and
(4) we have or the surviving entity has, as the case may be, delivered
to the Trustee an officers' certificate and opinion of counsel, each
stating that such consolidation, merger or transfer complies with
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the Indenture, that the surviving Person agrees to be bound thereby and by
the Notes and the Registration Rights Agreement, and that all conditions
precedent in the Indenture relating to such transaction have been
satisfied.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all of the properties and assets of one or more of our
Subsidiaries, the Capital Stock of which constitutes all or substantially all
of our properties and assets, shall be deemed to be the transfer of all or
substantially all of our properties and assets.
Notwithstanding the foregoing clauses (1), (2) and (3):
(a) any of our Restricted Subsidiary may consolidate with, merge into
or transfer all or part of its properties and assets to us and
(b) we may merge with an Affiliate that is (x) a corporation that has
no material assets or liabilities and which was incorporated solely for the
purpose of reincorporating us in another jurisdiction or (y) our Restricted
Subsidiary so long as all of our assets and those of our Restricted
Subsidiaries immediately prior to such transaction are owned by such
Restricted Subsidiary and its Restricted Subsidiaries immediately after the
consummation thereof.
The Indenture will provide that upon any consolidation, combination or merger
or any transfer of all or substantially all of our assets in accordance with
the foregoing, the surviving entity shall succeed to, and be substituted for,
and may exercise every right and power of, our company under the Indenture and
the Notes with the same effect as if such surviving entity had been named as
such.
Limitation on Asset Sales. From and after November 23, 1999, we will not, and
will not permit any of our Restricted Subsidiaries to, consummate an Asset Sale
unless:
(1) we or the applicable Restricted Subsidiary, as the case may be,
receive consideration at the time of such Asset Sale at least equal to the
fair market value of the assets sold or otherwise disposed of (as
determined in good faith by our Board of Directors);
(2) at least 75% of the consideration received by us or such
Restricted Subsidiary, as the case may be, from such Asset Sale shall be
cash or Cash Equivalents and is received at the time of such disposition;
provided that the amount of (x) any of our or such Restricted Subsidiary's
liabilities (as shown on our or such Restricted Subsidiary's most recent
balance sheet or in the notes thereto) (other than liabilities that are by
their terms subordinated to the Notes and other than liabilities consisting
of Disqualified Capital Stock) (i) that are assumed by the transferee of
any such assets and from which we and a Restricted Subsidiaries are
unconditionally released or (ii) in respect of which neither we nor any of
our Restricted Subsidiary following such sale has any obligation and (y)
any notes or other obligations received by us or such Restricted Subsidiary
from such transferee that are promptly, but in no event more than 60 days
after receipt, converted by us or such Restricted Subsidiary into cash or
Cash Equivalents (to the extent of the cash or Cash Equivalents received),
shall be deemed to be cash for purposes of this provision; and
(3) upon the consummation of an Asset Sale, we shall apply, or cause
such Restricted Subsidiary to apply, the Net Cash Proceeds relating to such
Asset Sale within 365 days of receipt thereof either:
(a) to prepay any Senior Debt or Guarantor Senior Debt and, in the
case of any Senior Debt or Guarantor Senior Debt under any revolving
credit facility, effect a permanent reduction in the availability under
such revolving credit facility;
(b) to reinvest in Productive Assets; or
(c) a combination of prepayment and investment permitted by the
foregoing clauses (3)(a) and (3)(b).
On the 366th day after an Asset Sale or such earlier date, if any, as our or
such Restricted Subsidiary's Board of Directors determines not to apply the Net
Cash Proceeds relating to such Asset Sale as set forth in clauses (3)(a),
(3)(b) and (3)(c) of the immediately preceding sentence (each, a "Net Proceeds
Offer Trigger
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Date"), such aggregate amount of Net Cash Proceeds which have not been applied
on or before such Net Proceeds Offer Trigger Date as permitted in clauses
(3)(a), (3)(b) and (3)(c) of the immediately preceding sentence (each a "Net
Proceeds Offer Amount") shall be applied by us or such Restricted Subsidiary to
make an offer to purchase for cash (the "Net Proceeds Offer") on a date (the
"Net Proceeds Offer Payment Date") not less than 30 nor more than 45 days
following the applicable Net Proceeds Offer Trigger Date, from all Holders on a
pro rata basis, that amount of Notes equal to the Net Proceeds Offer Amount at
a price in cash equal to 100% of the principal amount of the Notes to be
purchased, plus accrued and unpaid interest thereon, if any, to the date of
purchase; provided, however, that if at any time any non-cash consideration
received by us or any of our Restricted Subsidiary, as the case may be, in
connection with any Asset Sale is converted into or sold or otherwise disposed
of for cash (other than interest, dividends or other earnings received with
respect to any such non-cash consideration), then such conversion or
disposition shall be deemed to constitute an Asset Sale hereunder and the Net
Cash Proceeds thereof shall be applied in accordance with this covenant.
Notwithstanding the foregoing, if a Net Proceeds Offer Amount is less than
$10.0 million, the application of the Net Cash Proceeds constituting such Net
Proceeds Offer Amount to a Net Proceeds Offer may be deferred until such time
as such Net Proceeds Offer Amount plus the aggregate amount of all Net Proceeds
Offer Amounts arising subsequent to the Net Proceeds Offer Trigger Date
relating to such initial Net Proceeds Offer Amount from all Asset Sales by us
and our Restricted Subsidiaries aggregates at least $10.0 million, at which
time we or such Restricted Subsidiary shall apply all Net Cash Proceeds
constituting all Net Proceeds Offer Amounts that have been so deferred to make
a Net Proceeds Offer (the first date the aggregate of all such deferred Net
Proceeds Offer Amounts is equal to $10.0 million or more shall be deemed to be
a "Net Proceeds Offer Trigger Date").
Notwithstanding the immediately preceding paragraphs of this covenant, we and
our Restricted Subsidiaries will be permitted to consummate an Asset Sale
without complying with such paragraphs to the extent that:
(1) at least 75% of the consideration for such Asset Sale constitutes
Productive Assets; and
(2) such Asset Sale is for at least fair market value (as determined
in good faith by our Board of Directors); provided that any consideration
not constituting Productive Assets received by us or any of our Restricted
Subsidiaries in connection with any Asset Sale permitted to be consummated
under this paragraph shall constitute Net Cash Proceeds and shall be
subject to the provisions of the two preceding paragraphs; provided, that
at the time of entering into such transaction or immediately after giving
effect thereto, no Default or Event of Default shall have occurred or be
continuing or would occur as a consequence thereof.
Each Net Proceeds Offer will be mailed to the record Holders as shown on the
register of Holders within 25 days following the Net Proceeds Offer Trigger
Date, with a copy to the Trustee, and shall comply with the procedures set
forth in the Indenture. Upon receiving notice of the Net Proceeds Offer,
Holders may elect to tender their Notes in whole or in part in integral
multiples of $1,000 in exchange for cash. To the extent Holders properly tender
Notes in an amount exceeding the Net Proceeds Offer Amount, Notes of tendering
Holders will be purchased on a pro rata basis (based on amounts tendered). A
Net Proceeds Offer shall remain open for a period of 20 business days or such
longer period as may be required by law. To the extent that the aggregate
amount of Notes tendered pursuant to a Net Proceeds Offer is less than the Net
Proceeds Offer Amount, we may use any remaining Net Proceeds Offer Amount for
general corporate purposes. Upon completion of any such Net Proceeds Offer, the
Net Proceeds Offer Amount shall be reset at zero.
We will comply with the requirements of Rule 14e-1 under the Exchange Act and
any other securities laws and regulations thereunder to the extent such laws
and regulations are applicable in connection with the repurchase of Notes
pursuant to a Net Proceeds Offer. To the extent that the provisions of any
securities laws or regulations conflict with the "Asset Sale" provisions of the
Indenture, we shall comply with the applicable securities laws and regulations
and shall not be deemed to have breached its obligations under the "Asset Sale"
provisions of the Indenture by virtue thereof.
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Limitation of Guarantees by Restricted Subsidiaries. We will not permit any
of our Restricted Subsidiaries, directly or indirectly, by way of the pledge of
any intercompany note or otherwise, to assume, guarantee or in any other manner
become liable with respect to any of our Indebtedness (other than: (1)
Permitted Indebtedness of our Restricted Subsidiary; (2) Indebtedness under
Currency Agreements in reliance on clause (5) of the definition of Permitted
Indebtedness; or (3) Interest Swap Obligations incurred in reliance on clause
(4) of the definition of Permitted Indebtedness), unless, in any such case:
(1) such Restricted Subsidiary executes and delivers a supplemental
indenture to the Indenture, providing a guarantee of payment of the Notes
by such Restricted Subsidiary, and
(2) (a) if any such assumption, guarantee or other liability of such
Restricted Subsidiary is provided in respect of Senior Debt, the guarantee
or other instrument provided by such Restricted Subsidiary in respect of
such Senior Debt may be superior to such guarantee of the Notes pursuant to
subordination provisions no less favorable to the Holders of the Notes than
those contained in the Indenture and (b) if such assumption, guarantee or
other liability of such Restricted Subsidiary is provided in respect of
Indebtedness that is expressly subordinated to the Notes, the guarantee or
other instrument provided by such Restricted Subsidiary in respect of such
subordinated Indebtedness shall be subordinated to such guarantee at least
to the same extent that the Notes are subordinated to Senior Debt.
Notwithstanding the foregoing, any such Guarantee by a Restricted Subsidiary
of the Notes shall provide by its terms that it shall be automatically and
unconditionally released and discharged, without any further action required on
the part of the Trustee or any Holder, upon:
(1) the unconditional release of such Restricted Subsidiary from its
liability in respect of the Indebtedness in connection with which such
Guarantee was executed and delivered pursuant to the preceding paragraph;
(2) any sale or other disposition (by merger or otherwise) to any
Person which is not our Restricted Subsidiary of all of our Capital Stock
in, or all or substantially all of the assets of, such Restricted
Subsidiary; provided that (a) such sale or disposition of such Capital
Stock or assets is otherwise in compliance with the terms of the Indenture
and (b) such assumption, guarantee or other liability of such Restricted
Subsidiary has been released by the holders of our other Indebtedness so
guaranteed.
(3) the Legal Defeasance of the Notes as described under "Legal
Defeasance and Covenant Defeasance;"
(4) such Restricted Subsidiary being designated as an Unrestricted
Subsidiary in compliance with the provisions of the Indenture.
Conduct of Business. From and after November 23, 1999, we and our Restricted
Subsidiaries will not engage in any businesses which are not the same, similar,
related or ancillary to the businesses in which we and our Restricted
Subsidiaries are engaged on the Issue Date.
Reports to Holders. The Indenture will provide that, whether or not required
by the rules and regulations of the Commission, so long as any Notes are
outstanding, we will furnish the Holders of Notes:
(1) all quarterly and annual financial information that would be
required to be contained in a filing with the Commission on Forms 10-Q and
10-K if we were required to file such Forms; and
(2) all current reports that would be required to be filed with the
Commission on Form 8-K if we were required to file such reports, in each
case within the time periods specified in the Commission's rules and
regulations.
Whether or not required by the rules and regulations of the Commission, we
will file a copy of all such information and reports with the Commission for
public availability within the time periods specified in the Commission's rules
and regulations (unless the Commission will not accept such a filing) and make
such information available to securities analysts and prospective investors
upon request. In addition, we have has agreed that, for a period of two years
after the Issue Date, we will furnish to the Holders and to securities analysts
and prospective investors, upon their request, the information required to be
delivered pursuant to
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Rule 144A(d)(4) under the Securities Act if at the time of such request we are
not subject to Section 13 or 15(d) of the Exchange Act.
Capital Call Agreement. We shall have received the net cash proceeds from the
equity contribution or purchase of our Capital Stock, as the case may be, to
the extent required by, and upon the terms of, the Capital Call Agreement as in
effect on November 23, 1999.
Events of Default
The following events are defined in the Indenture as "Events of Default":
(1) the failure to pay interest on any Notes when the same becomes due
and payable and the default continues for a period of 30 days (whether or
not such payment shall be prohibited by the subordination provisions of the
Indenture);
(2) the failure to pay the principal on any Notes, when such principal
becomes due and payable, at maturity, upon redemption or otherwise
(including the failure to make a payment to purchase Notes tendered
pursuant to a Change of Control Offer or a Net Proceeds Offer) (whether or
not such payment shall be prohibited by the subordination provisions of the
Indenture);
(3) a default in the observance or performance of any other covenant
or agreement contained in the Indenture which default continues for a
period of 30 days after we receive written notice specifying the default
(and demanding that such default be remedied) from the Trustee or the
Holders of at least 25% of the outstanding principal amount of the Notes
(except in the case of a default with respect to the "Merger, Consolidation
and Sale of Assets" covenant, which will constitute an Event of Default
with such notice requirement but without such passage of time requirement);
(4) the failure to pay at final stated maturity (giving effect to any
applicable grace periods and any extensions thereof) the principal amount
of any of our or any of our Restricted Subsidiary's Indebtedness (other
than a Receivables Entity), or the acceleration of the final stated
maturity of any such Indebtedness (which acceleration is not rescinded,
annulled or otherwise cured within 20 days of receipt by us or such
Restricted Subsidiary of notice of any such acceleration) if the aggregate
principal amount of such Indebtedness, together with the principal amount
of any other such Indebtedness in default for failure to pay principal at
final maturity or which has been accelerated (in each case with respect to
which the 20-day period described above has elapsed), aggregates $15.0
million or more at any time;
(5) one or more judgments in an aggregate amount in excess of $15.0
million shall have been rendered against us or any of our Significant
Subsidiaries and such judgments remain undischarged, unpaid or unstayed for
a period of 60 days after such judgment or judgments become final and non-
appealable; and
(6) certain events of bankruptcy affecting us or any of our
Significant Subsidiaries.
If an Event of Default (other than an Event of Default specified in clause
(6) above with respect to us) shall occur and be continuing, the Trustee or the
Holders of at least 25% in principal amount of outstanding Notes may declare
the principal of and accrued interest on all the Notes to be due and payable by
notice in writing to us and the Trustee specifying the respective Event of
Default and that it is a "notice of acceleration" (the "Acceleration Notice"),
and the same:
(1) shall become immediately due and payable; or
(2) if there are any amounts outstanding under the New Credit
Facility, shall become immediately due and payable upon the first to occur
of an acceleration under the New Credit Facility or 5 business days after
receipt by us and the Representative under the New Credit Facility of such
Acceleration Notice but only if such Event of Default is then continuing.
If an Event of Default specified in clause (6) above with respect to us
occurs and is continuing, then all unpaid principal of, and premium, if any,
and accrued and unpaid interest on all of the outstanding Notes shall
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ipso facto become and be immediately due and payable without any declaration or
other act on the part of the Trustee or any Holder.
The Indenture will provide that, at any time after a declaration of
acceleration with respect to the Notes as described in the preceding paragraph,
the Holders of a majority in principal amount of the Notes may rescind and
cancel such declaration and its consequences:
(1) if the rescission would not conflict with any judgment or decree;
(2) if all existing Events of Default have been cured or waived except
nonpayment of principal or interest that has become due solely because of
the acceleration;
(3) to the extent the payment of such interest is lawful, interest on
overdue installments of interest and overdue principal, which has become
due otherwise than by such declaration of acceleration, has been paid;
(4) if we have paid the Trustee its reasonable compensation and
reimbursed the Trustee for its expenses, disbursements and advances; and
(5) in the event of the cure or waiver of an Event of Default of the
type described in clause (6) of the description above of Events of Default,
the Trustee shall have received an officers' certificate to the effect that
such Event of Default has been cured or waived. No such rescission shall
affect any subsequent Default or impair any right consequent thereto.
The Holders of a majority in principal amount of the Notes may waive any
existing Default or Event of Default under the Indenture, and its consequences,
except a default in the payment of the principal of or interest on any Notes.
Holders of the Notes may not enforce the Indenture or the Notes except as
provided in the Indenture and under the TIA. Subject to the provisions of the
Indenture relating to the duties of the Trustee, the Trustee is under no
obligation to exercise any of its rights or powers under the Indenture at the
request, order or direction of any of the Holders, unless such Holders have
offered to the Trustee reasonable indemnity. Subject to all provisions of the
Indenture and applicable law, the Holders of a majority in aggregate principal
amount of the then outstanding Notes have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Trustee
or exercising any trust or power conferred on the Trustee.
Under the Indenture, we are required to provide an officers' certificate to
the Trustee promptly upon any such officer obtaining knowledge of any Default
or Event of Default (provided that such officers shall provide such
certification at least annually whether or not they know of any Default or
Event of Default) that has occurred and, if applicable, describe such Default
or Event of Default and the status thereof.
No Personal Liability of Directors, Officers, Employees and Stockholders
No of our director, officer, employee, incorporator or stockholder shall have
any liability for any of our obligations under the Notes or the Indenture or
for any claim based on, in respect of, or by reason of, such obligations or
their creation. Each Holder by accepting a Note waives and releases all such
liability.
Legal Defeasance and Covenant Defeasance
We may, at our option and at any time, elect to have its obligations and the
obligations of the Guarantors discharged with respect to the outstanding Notes
("Legal Defeasance"). Such Legal Defeasance means that we shall be deemed to
have paid and discharged the entire indebtedness represented by the outstanding
Notes, except for:
(1) our obligations with respect to the Notes concerning issuing
temporary Notes, registration of Notes, mutilated, destroyed, lost or
stolen Notes and the maintenance of an office or agency for payments;
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(2) the rights, powers, trust, duties and immunities of the Trustee
and our obligations in connection therewith; and
(3) the Legal Defeasance provisions of the Indenture.
In addition, we may, at our option and at any time, elect to have our
obligations released with respect to certain covenants that are described in
the Indenture ("Covenant Defeasance") and thereafter any omission to comply
with such obligations shall not constitute a Default or Event of Default with
respect to the Notes. In the event Covenant Defeasance occurs, certain events
(not including non-payment, bankruptcy, receivership, reorganization and
insolvency events) described under "Events of Default" will no longer
constitute an Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance:
(1) we must irrevocably deposit with the Trustee, in trust, for the
benefit of the Holders cash in U.S. dollars, non-callable U.S. government
obligations, or a combination thereof, in such amounts as will be
sufficient, in the opinion of a nationally recognized firm of independent
public accountants, to pay the principal of, premium, if any, and interest
on the Notes on the stated date for payment thereof or on the applicable
redemption date, as the case may be;
(2) in the case of Legal Defeasance, we shall have delivered to the
Trustee an opinion of counsel in the United States reasonably acceptable to
the Trustee confirming that:
(a) we have received from, or there has been published by, the
Internal Revenue Service a ruling; or
(b) since the date of the Indenture, there has been a change in
the applicable federal income tax law,
in either case to the effect that, and based thereon such opinion of
counsel shall confirm that, the Holders will not recognize income, gain or
loss for federal income tax purposes as a result of such Legal Defeasance
and will be subject to federal income tax on the same amounts, in the same
manner and at the same times as would have been the case if such Legal
Defeasance had not occurred;
(3) in the case of Covenant Defeasance, we shall have delivered to the
Trustee an opinion of counsel in the United States reasonably acceptable to
the Trustee confirming that the Holders will not recognize income, gain or
loss for federal income tax purposes as a result of such Covenant
Defeasance and will be subject to federal income tax on the same amounts,
in the same manner and at the same times as would have been the case if
such Covenant Defeasance had not occurred;
(4) no Default or Event of Default shall have occurred and be
continuing on the date of such deposit (other than a Default or Event of
Default with respect to the Indenture resulting from the incurrence of
Indebtedness, all or a portion of which will be used to defease the Notes
concurrently with such incurrence);
(5) such Legal Defeasance or Covenant Defeasance shall not result in a
breach or violation of, or constitute a default under the Indenture or any
other material agreement or instrument to which we or any of our
Subsidiaries is a party or by which we or any of our Subsidiaries is bound;
(6) we shall have delivered to the Trustee an officers' certificate
stating that the deposit was not made by us with the intent of preferring
the Holders over any of our other creditors or with the intent of
defeating, hindering, delaying or defrauding any of our other creditors or
others;
(7) we shall have delivered to the Trustee an officers' certificate
and an opinion of counsel, each stating that all conditions precedent
provided for or relating to the Legal Defeasance or the Covenant Defeasance
have been complied with;
(8) we shall have delivered to the Trustee an opinion of counsel to
the effect that:
(a) the trust funds will not be subject to any rights of holders
of Senior Debt, including, without limitation, those arising under the
Indenture; and
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(b) assuming we have no intervening bankruptcy between the date of
deposit and the 91st day following the date of deposit and that no Holder
is our insider, after the 91st day following the date of deposit, the trust
funds will not be subject to the effect of any applicable bankruptcy,
insolvency, reorganization or similar laws affecting creditors' rights
generally; and
(9) certain other customary conditions precedent are satisfied.
Notwithstanding the foregoing, the opinion of counsel required by clause (2)
above with respect to a Legal Defeasance need not be delivered if all Notes not
theretofore delivered to the Trustee for cancellation (1) have become due and
payable or (2) will become due and payable on the maturity date within one year
under arrangements satisfactory to the Trustee for the giving of notice of
redemption by the Trustee in our name and at our expense.
Satisfaction and Discharge
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of the
Notes, as expressly provided for in the Indenture) as to all outstanding Notes
when:
(1) either:
(a) all the Notes theretofore authenticated and delivered (except
lost, stolen or destroyed Notes which have been replaced or paid and
Notes for whose payment money has theretofore been deposited in trust
or segregated and held in trust by us and thereafter repaid to us or
discharged from such trust) have been delivered to the Trustee for
cancellation; or
(b) all Notes not theretofore delivered to the Trustee for
cancellation have become due and payable and we have irrevocably
deposited or caused to be deposited with the Trustee funds in an amount
sufficient to pay and discharge the entire Indebtedness on the Notes
not theretofore delivered to the Trustee for cancellation, for
principal of, premium, if any, and interest on the Notes to the date of
deposit together with irrevocable instructions from us directing the
Trustee to apply such funds to the payment thereof at maturity or
redemption, as the case may be;
(2) we have paid all other sums payable under the Indenture by us; and
(3) we have delivered to the Trustee an officers' certificate and an
opinion of counsel stating that all conditions precedent under the
Indenture relating to the satisfaction and discharge of the Indenture have
been complied with.
Modification of the Indenture
From time to time, we and the Trustee, without the consent of the Holders,
may amend the Indenture for certain specified purposes, including curing
ambiguities, defects or inconsistencies, so long as such change does not, in
the opinion of the Trustee, adversely affect the rights of any of the Holders
in any material respect. In formulating its opinion on such matters, the
Trustee will be entitled to rely on such evidence as it deems appropriate,
including, without limitation, solely on an opinion of counsel. Other
modifications and amendments of the Indenture may be made with the consent of
the Holders of a majority in principal amount of the then outstanding Notes
issued under the Indenture, except that, without the consent of each Holder
affected thereby, no amendment may:
(1) reduce the amount of Notes whose Holders must consent to an
amendment, supplement or waiver;
(2) reduce the rate of or change or have the effect of changing the
time for payment of interest, including defaulted interest, on any Notes;
(3) reduce the principal of or change or have the effect of changing
the fixed maturity of any Notes, or change the date on which any Notes may
be subject to redemption or reduce the redemption price therefor;
(4) make any Notes payable in money other than that stated in the
Notes;
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(5) make any change in provisions of the Indenture protecting the
right of each Holder to receive payment of principal of and interest on
such Note on or after the due date thereof or to bring suit to enforce such
payment, or permitting Holders of a majority in principal amount of Notes
to waive Defaults or Events of Default;
(6) amend, change or modify in any material respect our obligation to
make and consummate a Change of Control Offer in the event of a Change of
Control or make and consummate a Net Proceeds Offer with respect to any
Asset Sale that has been consummated or, after such Change of Control has
occurred or such Asset Sale has been consummated, modify any of the
provisions or definitions with respect thereto; or
(7) modify or change any provision of the Indenture or the related
definitions affecting the subordination or ranking of the Notes or any
Guarantee in a manner which adversely affects the Holders.
Governing Law
The Indenture will provide that it, the Notes and any Guarantees will be
governed by, and construed in accordance with, the laws of the State of New
York but without giving effect to applicable principles of conflicts of law to
the extent that the application of the law of another jurisdiction would be
required thereby.
The Trustee
The Indenture will provide that, except during the continuance of an Event of
Default, the Trustee will perform only such duties as are specifically set
forth in the Indenture. During the existence of an Event of Default, the
Trustee will exercise such rights and powers vested in it by the Indenture, and
use the same degree of care and skill in its exercise as a prudent man would
exercise or use under the circumstances in the conduct of his own affairs.
The Indenture and the provisions of the TIA contain certain limitations on
the rights of the Trustee, should it become our creditor, to obtain payments of
claims in certain cases or to realize on certain property received in respect
of any such claim as security or otherwise. Subject to the TIA, the Trustee
will be permitted to engage in other transactions; provided that if the Trustee
acquires any conflicting interest as described in the TIA, it must eliminate
such conflict or resign.
Certain Definitions
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any other terms used herein for which no definition is
provided.
"Acquired Indebtedness" means Indebtedness (1) of a Person or any of its
Subsidiaries existing at the time such Person becomes our Restricted Subsidiary
or (2) assumed in connection with the acquisition of assets from such Person,
in each case whether or not incurred by such Person in connection with, or in
anticipation or contemplation of, such Person becoming our Restricted
Subsidiary or such acquisition. Acquired Indebtedness shall be deemed to have
been incurred, with respect to clause (1) of the preceding sentence, on the
date such Person becomes our Restricted Subsidiary and, with respect to clause
(2) of the preceding sentence, on the date of consummation of such acquisition
of assets.
"Affiliate" means, with respect to any specified Person, any other Person who
directly or indirectly through one or more intermediaries controls, or is
controlled by, or is under common control with, such specified Person. The term
"control" means the possession, directly or indirectly, of the power to direct
or cause the direction of the management and policies of a Person, whether
through the ownership of voting securities, by contract or otherwise; and the
terms "controlling" and "controlled" have meanings correlative of the
foregoing. Notwithstanding the foregoing, no Person (other than us or any of
our Subsidiary) in whom a Receivables Entity makes an Investment in connection
with a Qualified Receivables Transaction shall be deemed to be our Affiliate or
any of our Subsidiaries solely by reason of such Investment.
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"Asset Acquisition" means (1) an Investment by us or any of our Restricted
Subsidiary in any other Person pursuant to which such Person shall become our
Restricted Subsidiary or a Restricted Subsidiary of any of our Restricted
Subsidiary, or shall be merged with or into our company or any of our
Restricted Subsidiary, or (2) the acquisition by us or any of our Restricted
Subsidiary of the assets of any Person (other than our Restricted Subsidiary)
which constitute all or substantially all of the assets of such Person or
comprises any division or line of business of such Person or any other
properties or assets of such Person other than in the ordinary course of
business.
"Asset Sale" means any direct or indirect sale, issuance, conveyance,
transfer, lease (other than operating leases entered into in the ordinary
course of business), assignment or other transfer for value by us or any of our
Restricted Subsidiaries (including any Sale and Leaseback Transaction) to any
Person other than us or our Restricted Subsidiary of: (1) any Capital Stock of
any of our Restricted Subsidiary or (2) any of our or our Restricted
Subsidiaries' other property or assets other than in the ordinary course of
business; provided, however, that asset sales or other dispositions shall not
include:
(a) any transaction or series of related transactions for which we or
our Restricted Subsidiaries receive aggregate consideration of less than
$1.0 million;
(b) the sale, lease, conveyance, disposition or other transfer of all
or substantially all of our assets as permitted under "Merger,
Consolidation and Sale of Assets";
(c) the sale or discount, in each case without recourse, of accounts
receivable arising in the ordinary course of business, but only in
connection with the compromise or collection thereof;
(d) the factoring of accounts receivable arising in the ordinary
course of business pursuant to arrangements customary in the industry;
(e) the licensing of intellectual property;
(f) disposals or replacements of obsolete equipment in the ordinary
course of business;
(g) the sale, lease, conveyance, disposition or other transfer by us
or any if our Restricted Subsidiary of assets or property in transactions
constituting Investments that are not prohibited under the "Limitation on
Restricted Payments" covenant;
(h) sales of accounts receivable and related assets of the type
specified in the definition of "Qualified Receivables Transaction" to a
Receivables Entity (for the purposes of this clause (h), Purchase Money
Notes shall be deemed to be cash);
(i) transfers of accounts receivable and related assets of the type
specified in the definition of "Qualified Receivables Transaction" (or a
fractional undivided interest therein) by a Receivables Entity in a
Qualified Receivables Transaction; and
(j) leases or subleases to third persons not interfering in any
material respect with our business or the business of any of ours
Restricted Subsidiaries.
"Board of Directors" means, as to any Person, the board of directors of such
Person or any duly authorized committee thereof.
"Board Resolution" means, with respect to any Person, a copy of a resolution
certified by the Secretary or an Assistant Secretary of such Person to have
been duly adopted by the Board of Directors of such Person and to be in full
force and effect on the date of such certification, and delivered to the
Trustee.
"Borrowing Base" means the sum (determined as of the end of the most recently
ended fiscal quarter for which our consolidated financial statements are
available) of (1) 60% of our and our Restricted Subsidiaries' Inventory and (2)
80% of our and our Restricted Subsidiaries' Receivables.
"Capital Call Agreement" means the Capital Call Agreement to be dated as of
November 23, 1999 by and among Kelso & Company, L.P., our company and Bankers
Trust Company, as agent for the lenders under the New Credit Facility.
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"Capital Stock" means:
(1) with respect to any Person that is a corporation, any and all
shares, interests, participations or other equivalents (however designated
and whether or not voting) of corporate stock, including each class of
Common Stock and Preferred Stock of such Person; and
(2) with respect to any Person that is not a corporation, any and all
partnership, membership or other equity interests of such Person.
"Capitalized Lease Obligation" means, as to any Person, the obligations of
such Person under a lease that are required to be classified and accounted
for as capital lease obligations under GAAP and, for purposes of this
definition, the amount of such obligations at any date shall be the
capitalized amount of such obligations at such date, determined in accordance
with GAAP.
"Cash Equivalents" means:
(1) marketable direct obligations issued by, or unconditionally
guaranteed by, the United States Government or issued by any agency thereof
and backed by the full faith and credit of the United States, in each case
maturing within one year from the date of acquisition thereof;
(2) marketable direct obligations issued by any state of the United
States of America or any political subdivision of any such state or any
public instrumentality thereof maturing within one year from the date of
acquisition thereof and, at the time of acquisition, having one of the two
highest ratings obtainable from either Standard & Poor's Ratings Group
("S&P") or Moody's Investors Service, Inc. ("Moody's");
(3) commercial paper maturing no more than one year from the date of
creation thereof and, at the time of acquisition, having a rating of at
least A-1 from S&P or at least P-1 from Moody's;
(4) certificates of deposit or bankers' acceptances (or with respect
to foreign banks, similar instruments) maturing within one year from the
date of acquisition thereof issued by any bank organized under the laws of
the United States of America or any state thereof or the District of
Columbia or any U.S. branch of a foreign bank having at the date of
acquisition thereof combined capital and surplus of not less than $200.0
million;
(5) certificates of deposit or bankers' acceptances or similar
instruments maturing within one year from the date of acquisition thereof
issued by any foreign bank that is a lender under the New Credit Facility
having at the date of acquisition thereof combined capital and surplus of
not less than $500 million;
(6) repurchase obligations with a term of not more than seven days for
underlying securities of the types described in clause (1) above entered
into with any bank meeting the qualifications specified in clause (4)
above; and
(7) investments in money market funds which invest substantially all
their assets in securities of the types described in clauses (1) through
(6) above.
"Change of Control" means the occurrence of one or more of the following
events:
(1) any sale, lease, exchange or other transfer (in one transaction or
a series of related transactions) of all or substantially all of our assets
to any Person or group of related Persons (other than one or more Permitted
Holders) for purposes of Section 13(d) of the Exchange Act (a "Group"),
together with any Affiliates thereof (whether or not otherwise in
compliance with the provisions of the Indenture);
(2) the approval by the holders of our Capital Stock of any plan or
proposal for the liquidation or dissolution of our company (whether or not
otherwise in compliance with the provisions of the Indenture);
(3) any Person or Group (other than one or more Permitted Holders)
shall become the beneficial owner, directly or indirectly, of shares
representing 50% or more of the aggregate ordinary voting power represented
by the issued and outstanding our Capital Stock; or
(4) the first day on which a majority of our Board of Directors are
not Continuing Directors.
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"Common Stock" of any Person means any and all shares, interests or other
participations in, and other equivalents (however designated and whether voting
or non-voting) of such Person's common stock, whether outstanding on the Issue
Date or issued after the Issue Date, and includes, without limitation, all
series and classes of such common stock.
"Consolidated EBITDA" means, with respect to any Person, for any period, the
sum (without duplication) of:
(1) Consolidated Net Income; and
(2) to the extent Consolidated Net Income has been reduced thereby:
(a) all income taxes of such Person and its Restricted
Subsidiaries paid or accrued in accordance with GAAP for such period
(other than income taxes attributable to extraordinary, unusual or
nonrecurring gains or losses or taxes attributable to sales or
dispositions outside the ordinary course of business);
(b) Consolidated Interest Expense; and
(c) charges attributable to the exercise of employee options
vesting upon the consummation of the Recapitalization; and
(d) Consolidated Non-cash Charges less any non-cash items
increasing Consolidated Net Income for such period, all as determined
on a consolidated basis for such Person and its Restricted Subsidiaries
in accordance with GAAP.
"Consolidated Fixed Charge Coverage Ratio" means, with respect to any Person,
the ratio of Consolidated EBITDA of such Person during the four full fiscal
quarters (the "Four Quarter Period") ending prior to the date of the
transaction giving rise to the need to calculate the Consolidated Fixed Charge
Coverage Ratio for which financial statements are available (the "Transaction
Date") to Consolidated Fixed Charges of such Person for the Four Quarter
Period. In addition to and without limitation of the foregoing, for purposes of
this definition, "Consolidated EBITDA" and "Consolidated Fixed Charges" shall
be calculated after giving effect on a pro forma basis for the period of such
calculation to:
(1) the incurrence or repayment of any Indebtedness of such Person or
any of its Restricted Subsidiaries (and the application of the proceeds
thereof) giving rise to the need to make such calculation and any
incurrence or repayment of other Indebtedness (and the application of the
proceeds thereof), other than the incurrence or repayment of Indebtedness
in the ordinary course of business for working capital purposes pursuant to
working capital facilities, occurring during the Four Quarter Period or at
any time subsequent to the last day of the Four Quarter Period and on or
prior to the Transaction Date, as if such incurrence or repayment, as the
case may be (and the application of the proceeds thereof), occurred on the
first day of the Four Quarter Period; and
(2) any Asset Sales or Asset Acquisitions (including, without
limitation, any Asset Acquisition giving rise to the need to make such
calculation as a result of such Person or one of its Restricted
Subsidiaries (including any Person who becomes a Restricted Subsidiary as a
result of the Asset Acquisition) incurring, assuming or otherwise being
liable for Acquired Indebtedness and also including any Consolidated EBITDA
(including pro forma adjustments for cost savings ("Cost Savings
Adjustments") that we reasonably believe in good faith could have been
achieved during the Four Quarter Period as a result of such acquisition or
disposition (provided that both (i) such cost savings were identified and
quantified in an Officers' Certificate delivered to the Trustee at the time
of the consummation of the acquisition or disposition and (ii) with respect
to each acquisition or disposition completed prior to the 90th day
preceding such date of determination, actions were commenced or initiated
by us within 90 days of such acquisition or disposition to effect such cost
savings identified in such Officers' Certificate and with respect to any
other acquisition or disposition, such Officers' Certificate sets forth the
specific steps to be taken within the 90 days after such acquisition or
disposition to accomplish such cost savings) attributable to the assets
which are the subject of the Asset Acquisition or
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Asset Sale during the Four Quarter Period) occurring during the Four
Quarter Period or at any time subsequent to the last day of the Four
Quarter Period and on or prior to the Transaction Date, as if such Asset
Sale or Asset Acquisition (including the incurrence, assumption or
liability for any such Indebtedness or Acquired Indebtedness) occurred on
the first day of the Four Quarter Period;
(3) with respect to any such Four Quarter Period commencing prior to
the Recapitalization, the Recapitalization (including any Cost Savings
Adjustments) shall be deemed to have taken place on the first day of such
Four Quarter Period; and
(4) any asset sales or asset acquisitions (including any Consolidated
EBITDA (including any Cost Savings Adjustments) attributable to the assets
which are the subject of the asset acquisition or asset sale during the
Four Quarter Period) that have been made by any Person that has become our
Restricted Subsidiary or has been merged with or into our company or any of
our Restricted Subsidiary during the Four Quarter Period or at any time
subsequent to the last day of the Four Quarter Period and on or prior to
the Transaction Date that would have constituted Asset Sales or Asset
Acquisitions had such transactions occurred when such Person was our
Restricted Subsidiary or subsequent to such Person's merger into our
company, as if such asset sale or asset acquisition (including the
incurrence, assumption or liability for any Indebtedness or Acquired
Indebtedness in connection therewith) occurred on the first day of the Four
Quarter Period;
provided that to the extent that clause (2) or (4) of this sentence requires
that pro forma effect be given to an asset sale or asset acquisition, such pro
forma calculation shall be based upon the four full fiscal quarters immediately
preceding the Transaction Date of the Person, or division or line of business
of the Person, that is acquired or disposed for which financial information is
available. If such Person or any of its Restricted Subsidiaries directly or
indirectly guarantees Indebtedness of a third Person, the preceding sentence
shall give effect to the incurrence of such guaranteed Indebtedness as if such
Person or any Restricted Subsidiary of such Person had directly incurred or
otherwise assumed such guaranteed Indebtedness.
Furthermore, in calculating "Consolidated Fixed Charges" for purposes of
determining the denominator (but not the numerator) of this "Consolidated Fixed
Charge Coverage Ratio":
(1) interest on outstanding Indebtedness determined on a fluctuating
basis as of the Transaction Date and which will continue to be so
determined thereafter shall be deemed to have accrued at a fixed rate per
annum equal to the rate of interest on such Indebtedness in effect on the
Transaction Date;
(2) if interest on any Indebtedness actually incurred on the
Transaction Date may optionally be determined at an interest rate based
upon a factor of a prime or similar rate, a eurocurrency interbank offered
rate, or other rates, then the interest rate in effect on the Transaction
Date will be deemed to have been in effect during the Four Quarter Period;
and
(3) notwithstanding clause (1) above, interest on Indebtedness
determined on a fluctuating basis, to the extent such interest is covered
by agreements relating to Interest Swap Obligations, shall be deemed to
accrue at the rate per annum resulting after giving effect to the operation
of such agreements.
"Consolidated Fixed Charges" means, with respect to any Person for any
period, the sum, without duplication, of:
(1) Consolidated Interest Expense (excluding amortization or write-off
of debt issuance costs relating to the Recapitalization and the financing
therefor or relating to retired or existing Indebtedness and amortization
or write-off of customary debt issuance costs relating to future
Indebtedness incurred in the ordinary course of business); plus
(2) the product of (x) the amount of all dividend payments on any
series of Preferred Stock of such Person (other than dividends paid in
Qualified Capital Stock) paid, accrued or scheduled to be paid or accrued
during such period times (y) a fraction, the numerator of which is one and
the denominator of which is one minus the then current effective
consolidated federal, state and local tax rate of such Person, expressed as
a decimal.
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"Consolidated Interest Expense" means, with respect to any Person for any
period, the sum of, without duplication:
(1) the aggregate of all cash and non-cash interest expense with
respect to all outstanding Indebtedness of such Person and its Restricted
Subsidiaries, including the net costs associated with Interest Swap
Obligations for such period determined on a consolidated basis in
conformity with GAAP; and
(2) the interest component of Capitalized Lease Obligations paid,
accrued and/or scheduled to be paid or accrued by such Person and its
Restricted Subsidiaries during such period as determined on a consolidated
basis in accordance with GAAP.
"Consolidated Net Income" of ours means, for any period, the aggregate net
income (or loss) of our and our Restricted Subsidiaries for such period on a
consolidated basis, determined in accordance with GAAP; provided that there
shall be excluded therefrom:
(1) gains and losses from Asset Sales (without regard to the $1.0
million limitation set forth in the definition thereof) or abandonments or
reserves relating thereto and the related tax effects according to GAAP;
(2) gains and losses due solely to fluctuations in currency values and
the related tax effects according to GAAP;
(3) extraordinary, unusual or nonrecurring gains, losses, income or
expense, and the related tax effects;
(4) the net income (or loss) of any Person acquired in a "pooling of
interests" transaction accrued prior to the date it becomes our Restricted
Subsidiary or is merged or consolidated with us or any of our Restricted
Subsidiary;
(5) the net income of any of our Restricted Subsidiary to the extent
that the declaration of dividends or similar distributions by that
Restricted Subsidiary of that income is restricted by a contract, operation
of law or otherwise;
(6) the net loss of any Person other than our Restricted Subsidiary;
(7) the net income of any Person, other than our Restricted
Subsidiary, except to the extent of cash dividends or distributions paid to
us or to our Restricted Subsidiary by such Person unless, in the case of
any of our Restricted Subsidiary who receives such dividends or
distributions, such Restricted Subsidiary is subject to clause (5) above;
(8) non-cash compensation charges, including any arising from existing
stock options resulting from any merger or recapitalization transition; and
(9) any fees, expenses or charges related to the Recapitalization or
the transactions contemplated by the Recapitalization.
"Consolidated Non-cash Charges" means, with respect to any Person, for any
period, the aggregate depreciation, amortization and other non-cash expenses of
such Person and its Restricted Subsidiaries reducing Consolidated Net Income of
such Person and its Restricted Subsidiaries for such period, determined on a
consolidated basis in accordance with GAAP (excluding any such charges
constituting an extraordinary item or loss or any such charge which requires an
accrual of or a reserve for cash charges for any future period).
"Continuing Directors" means, as of any date of determination, any member of
our Board of Directors who:
(1) was a member of such Board of Directors on November 23, 1999;
(2) was nominated for election or elected to such Board of Directors
with, or whose election to such Board of Directors was approved by, the
affirmative vote of a majority of the Continuing Directors who were members
of such Board of Directors at the time of such nomination or election; or
(3) is any designee of a Permitted Holder or was nominated by a
Permitted Holder or any designees of a Permitted Holder on the Board of
Directors.
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"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement designed to protect us or
any of our Restricted Subsidiary against fluctuations in currency values.
"Default" means an event or condition the occurrence of which is, or with the
lapse of time or the giving of notice or both would be, an Event of Default.
"Designated Senior Debt" means (1) Indebtedness under or in respect of the
New Credit Facility and (2) any other Indebtedness constituting Senior Debt
which, at the time of determination, has an aggregate principal amount
outstanding of, or under which, at the date of determination, the holders
thereof, are committed to lend up to, at least $30.0 million and is
specifically designated in the instrument evidencing such Senior Debt as
"Designated Senior Debt" by us.
"Disqualified Capital Stock" means that portion of any Capital Stock which,
by its terms (or by the terms of any security into which it is convertible or
for which it is exchangeable at the option of the holder thereof), or upon the
happening of any event (other than an event which would constitute a Change of
Control), matures (excluding any maturity as the result of an optional
redemption by the issuer thereof) or is mandatorily redeemable, pursuant to a
sinking fund obligation or otherwise, or is redeemable at the sole option of
the holder thereof (except, in each case, upon the occurrence of a Change of
Control) on or prior to the final maturity date of the Notes.
"Exchange Act" means the Securities Exchange Act of 1934, as amended, or any
successor statute or statutes thereto.
"Fair market value" means, with respect to any asset or property, the price
which could be negotiated in an arm's-length, free market transaction, for
cash, between a willing seller and a willing and able buyer, neither of whom is
under undue pressure or compulsion to complete the transaction. Fair market
value shall be determined by our Board of Directors acting reasonably and in
good faith and shall be evidenced by a Board Resolution of our Board of
Directors delivered to the Trustee.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States, which are in effect as of the Issue Date.
"Guarantor" means each of our Restricted Subsidiaries that in the future
executes a supplemental indenture in which such Restricted Subsidiary agrees to
be bound by the terms of the Indenture as a Guarantor; provided that any Person
constituting a Guarantor as described above shall cease to constitute a
Guarantor when its respective Guarantee is released in accordance with the
terms of the Indenture.
"Guarantor Senior Debt" means, with respect to any Guarantor: the principal
of, premium, if any, and interest (including any interest accruing subsequent
to the filing of a petition of bankruptcy at the rate provided for in the
documentation with respect thereto, whether or not such interest is an allowed
claim under applicable law) on any Indebtedness of a Guarantor, whether
outstanding on the Issue Date or thereafter created, incurred or assumed,
unless, in the case of any particular Indebtedness, the instrument creating or
evidencing the same or pursuant to which the same is outstanding expressly
provides that such Indebtedness shall not be senior in right of payment to the
Guarantee of such Guarantor. Without limiting the generality of the foregoing,
"Guarantor Senior Debt" shall also include the principal of, premium, if any,
interest (including any interest accruing subsequent to the filing of a
petition of bankruptcy at the rate provided for in the documentation with
respect thereto, whether or not such interest is an allowed claim under
applicable law) on, and all other amounts owing in respect of:
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(x) all monetary obligations of every nature of such Guarantor under,
or with respect to, the New Credit Facility, including, without limitation,
obligations to pay principal and interest, reimbursement obligations under
letters of credit, fees, expenses and indemnities (and guarantees thereof);
(y) all Interest Swap Obligations of such Guarantor (and guarantees
thereof by such Guarantor); and
(z) all obligations of such Guarantor (and guarantees thereof by such
Guarantor) under Currency Agreements;
in each case whether outstanding on the Issue Date or thereafter incurred.
Notwithstanding the foregoing, "Guarantor Senior Debt" shall not include:
(1) any Indebtedness of such Guarantor to a Subsidiary of such
Guarantor;
(2) Indebtedness to, or guaranteed on behalf of, any shareholder,
director, officer or employee of such Guarantor or any Subsidiary of such
Guarantor (including, without limitation, amounts owed for compensation)
other than a shareholder who is also a lender (or an Affiliate of a lender)
under the New Credit Facility;
(3) Indebtedness to trade creditors and other amounts incurred in
connection with obtaining goods, materials or services;
(4) Indebtedness represented by Disqualified Capital Stock;
(5) any liability for federal, state, local or other taxes owed or
owing by such Guarantor;
(6) that portion of any Indebtedness incurred in violation of the
Indenture provisions set forth under "Limitation on Incurrence of
Additional Indebtedness" (but, as to any such obligation, no such violation
shall be deemed to exist for purposes of this clause (6) if the holder(s)
of such obligation or their representative shall have received an officers'
certificate of our company to the effect that the incurrence of such
Indebtedness does not (or, in the case of revolving credit indebtedness,
that the incurrence of the entire committed amount thereof at the date on
which the initial borrowing thereunder is made would not) violate such
provisions of the Indenture);
(7) Indebtedness which, when incurred and without respect to any
election under Section 1111(b) of Title 11, United States Code, is without
recourse to us; and
(8) any Indebtedness which is, by its express terms, subordinated in
right of payment to any other Indebtedness of such Guarantor.
"Indebtedness" means with respect to any Person, without duplication:
(1) all Obligations of such Person for borrowed money;
(2) all Obligations of such Person evidenced by bonds, debentures,
notes or other similar instruments;
(3) all Capitalized Lease Obligations of such Person;
(4) all Obligations of such Person issued or assumed as the deferred
purchase price of property, all conditional sale obligations and all
Obligations under any title retention agreement (but excluding trade
accounts payable and other accrued liabilities arising in the ordinary
course of business);
(5) all Obligations for the reimbursement of any obligor on any letter
of credit, banker's acceptance or similar credit transaction;
(6) guarantees and other contingent obligations in respect of
Indebtedness referred to in clauses (1) through (5) above and clause (8)
below;
(7) all Obligations of any other Person of the type referred to in
clauses (1) through (6) which are secured by any lien on any property or
asset of such Person, but which Obligations are not assumed by such Person,
the amount of such Obligation being deemed to be the lesser of the fair
market value of such property or asset or the amount of the Obligation so
secured;
(8) all Obligations under currency agreements and interest swap
agreements of such Person; and
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(9) all Disqualified Capital Stock issued by such Person with the
amount of Indebtedness represented by such Disqualified Capital Stock being
equal to the greater of its voluntary or involuntary liquidation preference
and its maximum fixed repurchase price, but excluding accrued dividends, if
any.
For purposes hereof, (x) the "maximum fixed repurchase price" of any
Disqualified Capital Stock which does not have a fixed repurchase price shall
be calculated in accordance with the terms of such Disqualified Capital Stock
as if such Disqualified Capital Stock were purchased on any date on which
Indebtedness shall be required to be determined pursuant to the Indenture, and
if such price is based upon, or measured by, the fair market value of such
Disqualified Capital Stock, such fair market value shall be determined
reasonably and in good faith by the Board of Directors of the issuer of such
Disqualified Capital Stock and (y) any transfer of accounts receivable or other
assets which constitute a sale for purposes of GAAP shall not constitute
Indebtedness hereunder.
"Interest Swap Obligations" means the obligations of any Person, pursuant to
any arrangement with any other Person, whereby, directly or indirectly, such
Person is entitled to receive from time to time periodic payments calculated by
applying either a floating or a fixed rate of interest on a stated notional
amount in exchange for periodic payments made by such other Person calculated
by applying a fixed or a floating rate of interest on the same notional amount.
"Inventory" means goods held for sale or lease by a Person in the ordinary
course of business, net of any reserve for goods that have been segregated by
such Person to be returned to the applicable vendor for credit, as determined
in accordance with GAAP.
"Investment" by any Person in any other Person means, with respect to any
Person, any direct or indirect loan or other extension of credit (including,
without limitation, a guarantee) or capital contribution to (by means of any
transfer of cash or other property to others or any payment for property or
services for the account or use of others), or any purchase or acquisition by
such Person of any Capital Stock, bonds, notes, debentures or other securities
or evidences of Indebtedness issued by, such other Person. "Investment" shall
exclude extensions of trade credit by us and our Restricted Subsidiaries on
commercially reasonable terms in accordance with normal trade practices of our
company or such Restricted Subsidiary, as the case may be. For the purposes of
the "Limitation on Restricted Payments" covenant:
(1) we shall be deemed to have made an "Investment" equal to the fair
market value of the net assets of any Restricted Subsidiary at the time
that such Restricted Subsidiary is designated an Unrestricted Subsidiary
and the aggregate amount of Investments made subsequent to the Issue Date
shall exclude (to the extent the designation as an Unrestricted Subsidiary
was included as a Restricted Payment) the fair market value of the net
assets of any Unrestricted Subsidiary at the time that such Unrestricted
Subsidiary is designated a Restricted Subsidiary, not to exceed the amount
of the Investment deemed made at the date of designation thereof as an
Unrestricted Subsidiary; and
(2) the amount of any Investment shall be the original cost of such
Investment plus the cost of all additional Investments by us or any of our
Restricted Subsidiaries, without any adjustments for increases or decreases
in value, or write-ups, write downs or write-offs with respect to such
Investment, reduced by the payment of dividends or distributions (including
tax sharing payments) in connection with such Investment or any other
amounts received in respect of such Investment; provided that no such
payment of dividends or distributions or receipt of any such other amounts
shall reduce the amount of any Investment if such payment of dividends or
distributions or receipt of any such amounts would be included in
Consolidated Net Income. If we or any of our Restricted Subsidiary sells or
otherwise disposes of any Common Stock of any of our direct or indirect
Restricted Subsidiary such that, after giving effect to any such sale or
disposition, we no longer own, directly or indirectly, more than 50% of the
outstanding Common Stock of such Restricted Subsidiary, we shall be deemed
to have made an Investment on the date of any such sale or disposition
equal to the fair market value of the Common Stock of such Restricted
Subsidiary not sold or disposed of.
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"Issue Date" means the date of original issuance of the Notes.
"Joint Venture" means a corporation, partnership or other business entity,
other than our Subsidiary, engaged or proposed to be engaged in the same or a
similar line of business as us in which we own, directly or indirectly, not
less than 30% of the total voting power of shares of Capital Stock or other
interests (including partnership interests) entitled (without regard to the
occurrence of any contingency) to vote in the election of directors, managers
and trustees thereof, with the balance of the ownership interests being held by
one or more third parties.
"Lien" means any lien, mortgage, deed of trust, pledge, security interest,
charge or encumbrance of any kind (including any conditional sale or other
title retention agreement, any lease in the nature thereof and any agreement to
give any security interest).
"Merger Agreement" means the Agreement and Plan of Merger dated as of May 24,
1999 by and between our company and UC Acquisition Sub, Inc., as amended or
supplemented from time to time.
"Net Cash Proceeds" means, with respect to any Asset Sale, the proceeds in
the form of cash or Cash Equivalents including payments in respect of deferred
payment obligations when received in the form of cash or Cash Equivalents
(other than the portion of any such deferred payment constituting interest)
received by us or any of our Restricted Subsidiaries from such Asset Sale net
of:
(1) out-of-pocket expenses and fees relating to such Asset Sale
(including, without limitation, legal, accounting and investment banking
fees and sales commissions);
(2) taxes paid or payable after taking into account any reduction in
consolidated tax liability due to available tax credits or deductions and
any tax sharing arrangements;
(3) repayment of Senior Debt or Guarantor Senior Debt that is required
to be repaid in connection with such Asset Sale; and
(4) any portion of cash proceeds which we determine in good faith
should be reserved for post-closing adjustments, it being understood and
agreed that on the day that all such post-closing adjustments have been
determined, the amount (if any) by which the reserved amount in respect of
such Asset Sale exceeds the actual post-closing adjustments payable by us
or any of our Subsidiaries shall constitute Net Cash Proceeds on such date;
provided that, in the case of the sale by us of an asset constituting an
Investment made after the Issue Date (other than a Permitted Investment),
the "Net Cash Proceeds" in respect of such Asset Sale shall not include the
lesser of (x) the cash received with respect to such Asset Sale and (y) the
initial amount of such Investment, less, in the case of clause (y), all
amounts (up to an amount not to exceed the initial amount of such
Investment) received by us with respect to such Investment, whether by
dividend, sale, liquidation or repayment, in each case prior to the date of
such Asset Sale.
"New Credit Facility" means the credit agreement dated as of November 23,
1999, between our company, the lenders party thereto in their capacities as
lenders thereunder, Deutsche Bank Securities Inc., as lead arranger, Bankers
Trust Company, as administrative agent, and Merrill Lynch Capital Corporation,
as co-arranger and syndication agent, together with the related documents
thereto (including, without limitation, any guarantee agreements and security
documents), in each case as such agreements may be amended (including any
amendment and restatement thereof), supplemented or otherwise modified from
time to time, including any agreement extending the maturity of, refinancing,
replacing or otherwise restructuring (whether with the original agents and
lenders or other agents and lenders or otherwise) and whether provided under
the original New Credit Facility or one or more other credit agreements or
otherwise) (including increasing the amount of available borrowings thereunder
or adding our Subsidiaries as additional borrowers or guarantors thereunder)
all or any portion of the Indebtedness under such agreement or any successor or
replacement agreement and whether by the same or any other agent, lender or
group of lenders.
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"Obligations" means all obligations for (a) principal, premium, interest,
penalties, fees, and (b) to the extent liquidated and quantifiable at the time
of determination, indemnifications, reimbursements, damages and other
liabilities payable under the documentation governing any Indebtedness.
"Permitted Holders" means Kelso & Company, Kelso Investment Associates VI
L.P., KEP VI LLC and their respective Affiliates.
"Permitted Indebtedness" means, without duplication, each of the following:
(1) Indebtedness under the Notes and the Indenture in an aggregate
principal amount not to exceed $155.0 million;
(2) Indebtedness incurred pursuant to the New Credit Facility
(including but not limited to Indebtedness in respect of letters of credit
or bankers' acceptances issued or created thereunder) in a maximum
principal amount not to exceed in the aggregate the amount equal to $185.0
million plus the amount, if any, by which the Borrowing Base exceeds the
Borrowing Base on November 23, 1999 less the amount of all repayments of
term loans and permanent commitment reductions in the revolving credit
portion of the New Credit Facility with Net Cash Proceeds of Asset Sales
applied thereto as required by the "Limitation on Asset Sales" covenant;
(3) other Indebtedness of ours and our Restricted Subsidiaries
outstanding on November 23, 1999 reduced by the amount of any scheduled
amortization payments or mandatory prepayments when actually paid or
permanent reductions thereon;
(4) our Interest Swap Obligations or that of Restricted Subsidiary
covering our Indebtedness or any of our Restricted Subsidiaries; provided
that any Indebtedness to which any such Interest Swap Obligations
correspond is otherwise permitted to be incurred under the Indenture;
provided, further, that such Interest Swap Obligations are entered into, in
our judgment, to protect us and our Restricted Subsidiaries from
fluctuations in interest rates on their respective outstanding
Indebtedness;
(5) our Indebtedness or any of our Restricted Subsidiaries under
Currency Agreements entered into, in our judgment, to protect us or such
Restricted Subsidiary from foreign currency exchange rates;
(6) intercompany Indebtedness owed by any of our Restricted Subsidiary
to us or any of our Restricted Subsidiary or by us to any of our Restricted
Subsidiary;
(7) Acquired Indebtedness of any of our Restricted Subsidiary that is
not a Guarantor to the extent we could have incurred such Indebtedness in
accordance with the Consolidated Fixed Charge Coverage Ratio of the
"Limitation on Incurrence of Additional Indebtedness" covenant on the date
such Indebtedness became Acquired Indebtedness; provided that such Acquired
Indebtedness was not incurred in connection with, or in anticipation or
contemplation of, such Person becoming our Restricted Subsidiary;
(8) Indebtedness arising from the honoring by a bank or other
financial institution of a check, draft or similar instrument inadvertently
drawn against insufficient funds in the ordinary course of business;
provided, however, that such Indebtedness is extinguished within five
business days of incurrence;
(9) any refinancing, modification, replacement, renewal, restatement,
refunding, deferral, extension, substitution, supplement, reissuance or
resale of existing or future Indebtedness (other than pursuant to clauses
(2), (4), (5), (6), (8), (10), (11), (12), (13), (14), (15) and (16) of
this definition), including any additional Indebtedness incurred to pay
interest or premiums required by the instruments governing such existing or
future Indebtedness as in effect at the time of issuance thereof ("Required
Premiums") and fees in connection therewith; provided that any such event
shall not (1) result in an increase in the aggregate principal amount of
Permitted Indebtedness (except to the extent such increase is a result of a
simultaneous incurrence of additional Indebtedness (A) to pay Required
Premiums and related fees or (B) otherwise permitted to be incurred under
the Indenture) and (2) create Indebtedness with a Weighted Average Life to
Maturity at the time such Indebtedness is incurred that is less than the
Weighted
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Average Life to Maturity at such time of the Indebtedness being refinanced,
modified, replaced, renewed, restated, refunded, deferred, extended,
substituted, supplemented, reissued or resold; provided that none of our
Restricted Subsidiary may refinance any Indebtedness pursuant to this
clause (9) other than its own Indebtedness;
(10) Indebtedness (including Capitalized Lease Obligations) incurred
by us to finance the purchase, lease or improvement of property (real or
personal) or equipment (whether through the direct purchase of assets or
the Capital Stock of any Person owning such assets) in an aggregate
principal amount outstanding not to exceed $15.0 million at the time of any
incurrence thereof (which amount shall be deemed not to include such
Indebtedness incurred in whole or in part under the New Credit Facility to
the extent permitted under clause (a) above);
(11) the incurrence by a Receivables Entity of Indebtedness in a
Qualified Receivables Transaction that is not recourse to us or any of our
Restricted Subsidiary (except for Standard Securitization Undertakings);
(12) Indebtedness incurred by us or any of our Restricted Subsidiaries
constituting reimbursement obligations with respect to letters of credit
issued in the ordinary course of business, including, without limitation,
letters of credit in respect of workers' compensation claims or self-
insurance, or other Indebtedness with respect to reimbursement type
obligations regarding workers' compensation claims;
(13) Indebtedness arising from our or our Restricted Subsidiary's
agreements providing for indemnification, adjustment of purchase price,
earn out or other similar obligations, in each case, incurred or assumed in
connection with the disposition of any business, assets or our Restricted
Subsidiary, other than guarantees of Indebtedness incurred by any Person
acquiring all or any portion of such business, assets or Restricted
Subsidiary for the purpose of financing such acquisition, provided that the
maximum assumable liability in respect of all such Indebtedness shall at no
time exceed the gross proceeds actually received by us and our Restricted
Subsidiaries in connection with such disposition;
(14) obligations in respect of performance and surety bonds and
completion guarantees provided by us or any of our Restricted Subsidiary in
the ordinary course of business;
(15) Indebtedness consisting of guarantees (i) by us of Indebtedness
and any other obligation or liability permitted to be incurred under the
Indenture by our Restricted Subsidiaries, and (ii) subject to the
provisions of "Limitation on Guarantees by Restricted Subsidiaries," by our
Restricted Subsidiaries of Indebtedness and any other obligation or
liability permitted to be incurred by us or our other Restricted
Subsidiaries; and
(16) our or any Restricted Subsidiary's additional Indebtedness in an
aggregate principal amount not to exceed $20.0 million at any one time
outstanding (which amount may, but need not be incurred in whole or in part
under the New Credit Facility).
"Permitted Investments" means:
(1) Investments by us or any of our Restricted Subsidiary in any or
our Restricted Subsidiary (whether existing on the Issue Date or created
thereafter) and Investments in us by any of our Restricted Subsidiary;
(2) cash and Cash Equivalents;
(3) Investments existing on November 23, 1999 and Investments made on
November 23, 1999 pursuant to the Merger Agreement;
(4) loans and advances to our and our Restricted Subsidiaries'
employees, officers and directors not in excess of $1.0 million at any one
time outstanding;
(5) accounts receivable owing to us any of our Restricted Subsidiary
created or acquired in the ordinary course of business and payable or
dischargeable in accordance with customary trade terms; provided, however,
that such trade terms may include such concessionary trade terms as the
customary trade terms;
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(6) Currency Agreements and Interest Swap Obligations entered into by
us or any of our Restricted Subsidiaries for bona fide business reasons and
not for speculative purposes, and otherwise in compliance with the
Indenture;
(7) Investments in securities of trade creditors or customers received
pursuant to any plan of reorganization or similar arrangement upon the
bankruptcy or insolvency of such trade creditors or customers;
(8) guarantees by us or any of our Restricted Subsidiaries of
Indebtedness otherwise permitted to be incurred by us or any of our
Restricted Subsidiaries under the Indenture;
(9) Investments by us or any of our Restricted Subsidiary in a Person,
if as a result of such Investment (a) such Person becomes our Restricted
Subsidiary or (b) such Person is merged, consolidated or amalgamated with
or into, or transfers or conveys all or substantially all of its assets to,
or is liquidated into, our company or our Restricted Subsidiary;
(10) additional Investments having an aggregate fair market value,
taken together with all other Investments made pursuant to this clause (10)
that are at the time outstanding, not exceeding $15.0 million at the time
of such Investment (with the fair market value of each Investment being
measured at the time made and without giving effect to subsequent changes
in value), plus an amount equal to (a) 100% of the aggregate net cash
proceeds received by us from any Person (other than our Subsidiary) from
the issuance and sale subsequent to the Issue Date of our Qualified Capital
Stock (including Qualified Capital Stock issued upon the conversion of
convertible Indebtedness or in exchange for outstanding Indebtedness) and
(b) without duplication of any amounts included in clause (10)(a) above,
100% of the aggregate net cash proceeds of any equity contribution received
by us from a holder of our Capital Stock, that in the case of amounts
described in clause (10)(a) or (10)(b) are applied by us within 180 days
after receipt, to make additional Permitted Investments under this clause
(10) (such additional Permitted Investments being referred to collectively
as "Stock Permitted Investments");
(11) any Investment by us or our Restricted Subsidiary in a
Receivables Entity or any Investment by a Receivables Entity in any other
Person in connection with a Qualified Receivables Transaction; provided
that any Investment in a Receivables Entity is in the form of a Purchase
Money Note or an equity interest;
(12) Investments received by us or our Restricted Subsidiaries as
consideration for asset sales, including Asset Sales; provided in the case
of an Asset Sale, (a) such Investment does not exceed 25% of the
consideration received for such Asset Sale and (b) such Asset Sale is
otherwise effected in compliance with the "Limitation on Asset Sales"
covenant;
(13) Investments by us or our Restricted Subsidiaries in Joint
Ventures in an aggregate amount not in excess of $5.0 million; and
(14) that portion of any Investment where the consideration provided
by us is our Capital Stock (other than Disqualified Capital Stock).
Any net cash proceeds that are used by us or any of our Restricted
Subsidiaries to make Stock Permitted Investments pursuant to clause (10) of
this definition shall not be included in subclauses (x) and (y) of clause (iii)
of the first paragraph of the "Limitation on Restricted Payments" covenant.
"Permitted Liens" means the following types of Liens:
(1) Liens securing the Notes and the Guarantees;
(2) Liens securing Acquired Indebtedness incurred in reliance on
clause (7) of the definition of Permitted Indebtedness; provided that such
Liens do not extend to or cover any property or assets of our company or of
any of our Restricted Subsidiaries other than the property or assets that
secured the Acquired Indebtedness prior to the time such Indebtedness
became our Restricted Subsidiary Acquired Indebtedness or a Restricted
Subsidiary;
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(3) Liens existing on November 23, 1999, together with any Liens
securing Indebtedness incurred in reliance on clause (9) of the definition
of Permitted Indebtedness in order to refinance the Indebtedness secured by
Liens existing on the Issue Date; provided that the Liens securing the
refinancing Indebtedness shall not extend to property other than that
pledged under the Liens securing the Indebtedness being refinanced;
(4) Liens in favor of us on the property or assets, or any proceeds,
income or profit therefrom, of any of our Restricted Subsidiary; and
(5) other Liens securing Senior Subordinated Indebtedness; provided
that the maximum aggregate amount of outstanding obligations secured
thereby shall not at any time exceed $5.0 million.
"Person" means an individual, partnership, corporation, unincorporated
organization, trust or joint venture, or a governmental agency or political
subdivision thereof or any other entity.
"Plan" means any of our or our Subsidiary's employee benefit plan, retirement
plan, deferred compensation plan, restricted stock plan, health, life,
disability or other insurance plan or program, employee stock purchase plan,
employee stock ownership plan, pension plan, stock option plan or similar plan
or arrangement, or other successor plan thereof, and "Plans" shall have a
correlative meaning.
"Preferred Stock" of any Person means any Capital Stock of such Person that
has preferential rights to any other Capital Stock of such Person with respect
to dividends or redemptions or upon liquidation.
"Productive Assets" means assets (including Capital Stock) of a kind used or
usable in our and our Restricted Subsidiaries' businesses as, or related to
such business, conducted on the date of the relevant Asset Sale.
"Purchase Money Note" means a promissory note of a Receivables Entity
evidencing a line of credit, which may be irrevocable, from us or any of our
Subsidiary in connection with a Qualified Receivables Transaction to a
Receivables Entity, which note shall be repaid from cash available to the
Receivables Entity, other than amounts required to be established as reserves
pursuant to agreements, amounts paid to investors in respect of interest,
principal and other amounts owing to such investors and amounts owing to such
investors and amounts paid in connection with the purchase of newly generated
receivables.
"Qualified Capital Stock" means any Capital Stock that is not Disqualified
Capital Stock.
"Qualified Receivables Transaction" means any transaction or series of
transactions that may be entered into by us or any of our Subsidiaries pursuant
to which we or any of our Subsidiaries may sell, convey or otherwise transfer
to (a) a Receivables Entity (in the case of a transfer by us or any of our
Subsidiaries) and (b) any other Person (in the case of a transfer by a
Receivables Entity), or may grant a security interest in, any accounts
receivable (whether now existing or arising in the future) of ours or any of
our Subsidiaries, and any assets related thereto including, without limitation,
all collateral securing such accounts receivable, all contracts and all
guarantees or other obligations in respect of such accounts receivable,
proceeds of such accounts receivable and other assets which are customarily
transferred or in respect of which security interests are customarily granted
in connection with asset securitization transactions involving accounts
receivable.
"Recapitalization" means the transactions contemplated by the Merger
Agreement, together with the financings therefor.
"Receivable" means a right to receive payment arising from a sale or lease of
goods or services by a Person pursuant to an arrangement with another Person
pursuant to which such other Person is obligated to pay for goods or services
under terms that permit the purchase of such goods and services on credit, as
determined in accordance with GAAP.
"Receivables Entity" means our Wholly Owned Subsidiary (or another Person in
which we or any of our Subsidiary make an Investment and to which we or any of
our Subsidiary transfer accounts receivable and
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related assets) which engages in no activities other than in connection with
the financing of accounts receivable, all proceeds thereof and all rights
(contractual or other), collateral and other assets relating thereto, and any
business or activities incidental or related to such business, and which is
designated by our Board of Directors (as provided below) as a Receivables
Entity:
(1) no portion of the Indebtedness or any other Obligations
(contingent or otherwise) of which:
(i) is guaranteed by us or any of our Subsidiary (excluding
guarantees of Obligations (other than the principal of, and interest on,
Indebtedness) pursuant to Standard Securitization Undertakings);
(ii) is recourse to or obligates us or any of our Subsidiary in any
way other than pursuant to Standard Securitization Undertakings; or
(iii) subjects any of our or our Subsidiaries' property or asset,
directly or indirectly, contingently or otherwise, to the satisfaction
thereof, other than pursuant to Standard Securitization Undertakings;
(2) with which neither we nor any of our Subsidiary has any material
contract, agreement, arrangement or understanding other than on terms no
less favorable to us or such Subsidiary than those that might be obtained
at the time from Persons that are not our Affiliates, other than fees
payable in the ordinary course of business in connection with servicing
accounts receivable; and
(3) to which neither we nor any of our Subsidiary have any obligation
to maintain or preserve such entity's financial condition or cause such
entity to achieve certain levels of operating results other than through
the contribution of additional Receivables, related security and
collections thereto and proceeds of the foregoing.
Any such designation by our Board of Directors shall be evidenced to the
Trustee by filing with the Trustee a certified copy of the resolution of our
Board of Directors giving effect to such designation and an Officers'
Certificate certifying that such designation complied with the foregoing
conditions.
"Representative" means the indenture trustee or other trustee, agent or
representative in respect of any Designated Senior Debt; provided that if, and
for so long as, any Designated Senior Debt lacks such a representative, then
the Representative for such Designated Senior Debt shall at all times
constitute the holders of a majority in outstanding principal amount of such
Designated Senior Debt in respect of any Designated Senior Debt.
"Restricted Subsidiary" of any Person means any Subsidiary of such Person
which at the time of determination is not an Unrestricted Subsidiary.
"Sale and Leaseback Transaction" means any direct or indirect arrangement
with any Person or to which any such Person is a party, providing for the
leasing to us or our Restricted Subsidiary of any property, whether owned by
us or any of our Restricted Subsidiary at the Issue Date or later acquired,
which has been or is to be sold or transferred by us or such Restricted
Subsidiary to such Person or to any other Person from whom funds have been or
are to be advanced by such Person on the security of such Property.
"Senior Debt" means the principal of, premium, if any, and interest
(including any interest accruing subsequent to the filing of a petition of
bankruptcy at the rate provided for in the documentation with respect thereto,
whether or not such interest is an allowed claim under applicable law) on any
of our Indebtedness, whether outstanding on the Issue Date or thereafter
created, incurred or assumed, unless, in the case of any particular
Indebtedness, the instrument creating or evidencing the same or pursuant to
which the same is outstanding expressly provides that such Indebtedness shall
not be senior in right of payment to the Notes. Without limiting the
generality of the foregoing, "Senior Debt" shall also include the principal
of, premium, if any, interest (including any interest accruing subsequent to
the filing of a petition of bankruptcy at the rate provided for in the
documentation with respect thereto, whether or not such interest is an allowed
claim under applicable law) on, and all other amounts owing in respect of:
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(1) all of our monetary obligations of every nature under, or with
respect to, the New Credit Facility, including, without limitation,
obligations to pay principal and interest, reimbursement obligations under
letters of credit, fees, expenses and indemnities (and guarantees thereof);
(2) all of our Interest Swap Obligations (and guarantees thereof by
us); and
(3) all of our obligations (and guarantees thereof by us) under
Currency Agreements;
in each case whether outstanding on the Issue Date or thereafter incurred.
Notwithstanding the foregoing, "Senior Debt" shall not include:
(1) any of our Indebtedness to our Subsidiary;
(2) Indebtedness to, or guaranteed on behalf of, any of our or our
Subsidiary's shareholder, director, officer or employee (including, without
limitation, amounts owed for compensation) other than a shareholder who is
also a lender (or an Affiliate of a lender) under the New Credit Facility;
(3) Indebtedness to trade creditors and other amounts incurred in
connection with obtaining goods, materials or services;
(4) Indebtedness represented by Disqualified Capital Stock;
(5) any liability for federal, state, local or other taxes owed or
owing by us;
(6) that portion of any Indebtedness incurred in violation of the
Indenture provisions set forth under "Limitation on Incurrence of
Additional Indebtedness" (but, as to any such obligation, no such violation
shall be deemed to exist for purposes of this clause (6) if the holder(s)
of such obligation or their representative shall have received an officers'
certificate of our company to the effect that the incurrence of such
Indebtedness does not (or, in the case of revolving credit indebtedness,
that the incurrence of the entire committed amount thereof at the date on
which the initial borrowing thereunder is made would not) violate such
provisions of the Indenture);
(7) Indebtedness which, when incurred and without respect to any
election under Section 1111(b) of Title 11, United States Code, is without
recourse to us; and
(8) any Indebtedness which is, by its express terms, subordinated in
right of payment to any of our other Indebtedness.
"Senior Subordinated Indebtedness" means the Notes and any of our other
Indebtedness that specifically provides that such Indebtedness is to rank pari
passu with the Notes and is not by its express terms subordinate in right of
payment to any of our Indebtedness which is not Senior Debt.
"Significant Subsidiary", with respect to any Person, means any Restricted
Subsidiary of such Person that satisfies the criteria for a "significant
subsidiary" set forth in Rule 1.02(w) of Regulation S-X under the Exchange Act.
"Standard Securitization Undertakings" means representations, warranties,
covenants and indemnities entered into by us or any of our Subsidiary which are
reasonably customary in an accounts receivable transaction.
"Subordinated Obligation" means any of our Indebtedness (whether outstanding
on the Issue Date or thereafter incurred) which is expressly subordinate in
right of payment to the Notes pursuant to a written agreement.
"Subsidiary", with respect to any Person, means:
(1) any corporation of which the outstanding Capital Stock having at
least a majority of the votes entitled to be cast in the election of
directors under ordinary circumstances shall at the time be owned, directly
or indirectly, by such Person; or
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(2) any other Person of which at least a majority of the voting
interest under ordinary circumstances is at the time, directly or
indirectly, owned by such Person.
"Unrestricted Subsidiary" of any Person means:
(1) any Subsidiary of such Person that at the time of determination
shall be or continue to be designated an Unrestricted Subsidiary by the
Board of Directors of such Person in the manner provided below; and
(2) any Subsidiary of an Unrestricted Subsidiary.
The Board of Directors may designate any Subsidiary (including any newly
acquired or newly formed Subsidiary) to be an Unrestricted Subsidiary unless
such Subsidiary owns any of our Capital Stock of, or owns or holds any Lien on
any of our property or the property of any of our other Subsidiary that is not
a Subsidiary of the Subsidiary to be so designated; provided that:
(1) we certify to the Trustee that such designation complies with the
"Limitation on Restricted Payments" covenant; and
(2) each Subsidiary to be so designated and each of its Subsidiaries
has not at the time of designation, and does not thereafter, create, incur,
issue, assume, guarantee or otherwise become directly or indirectly liable
with respect to any Indebtedness pursuant to which the lender has recourse
to any of our assets or any assets of our Restricted Subsidiaries.
The Board of Directors may designate any Unrestricted Subsidiary to be a
Restricted Subsidiary only if:
(1) immediately after giving effect to such designation, we are able
to incur at least $1.00 of additional Indebtedness (other than Permitted
Indebtedness) in compliance with the "Limitation on Incurrence of
Additional Indebtedness" covenant; and
(2) immediately before and immediately after giving effect to such
designation, no Default or Event of Default shall have occurred and be
continuing. Any such designation by the Board of Directors shall be
evidenced to the Trustee by promptly filing with the Trustee a copy of the
Board Resolution giving effect to such designation and an officers'
certificate certifying that such designation complied with the foregoing
provisions.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (a) the then outstanding
aggregate principal amount of such Indebtedness into (b) the sum of the total
of the products obtained by multiplying (i) the amount of each then remaining
installment, sinking fund, serial maturity or other required payment of
principal, including payment at final maturity, in respect thereof, by (ii) the
number of years (calculated to the nearest one-twelfth) which will elapse
between such date and the making of such payment.
"Wholly Owned Restricted Subsidiary" of any Person means any Wholly Owned
Subsidiary of such Person which at the time of determination is a Restricted
Subsidiary of such Person.
"Wholly Owned Subsidiary" means any of our Restricted Subsidiary all the
outstanding voting securities of which (other than directors' qualifying shares
or an immaterial amount of shares required to be owned by other Persons
pursuant to applicable law) are owned, directly or indirectly, by us.
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BOOK-ENTRY; DELIVERY AND FORM
The certificates representing the Notes will be issued in fully registered
form without interest coupons. Except as described below, the New Notes
initially will be represented by a single, global Note, in definitive, fully
registered form without interest coupons (the "Global Note") and will be
deposited with the Trustee as custodian for the Depositary Trust Company
("DTC") and registered in the name of a nominee of such depositary.
DTC has advised us as follows.
. DTC is a limited purpose trust company organized under the laws of the
State of New York, a "banking organization" within the meaning of the
New York Banking Law, a member of the Federal Reserve System, a
"clearing corporation" within the meaning of the Uniform Commercial Code
and a "clearing agency" registered pursuant to the provision of Section
17A of the Exchange Act.
. DTC was created to hold securities for its participants and to
facilitate the clearance and settlement of securities transactions
between participants through electronic book-entry changes in accounts
of its participants, thereby eliminating the need for physical movement
of certificates. Participants include securities brokers and dealers,
banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others
such as banks, brokers, dealers and trust companies that clear through
or maintain a custodial relationship with a participant, either directly
or indirectly.
. Upon the issuance of the Global Note, DTC or its custodian will credit,
on its internal system, the respective principal amounts of the New
Notes represented by such Global Note to the accounts of persons who
have accounts with DTC. Ownership of beneficial interests in the Global
Note will be limited to persons who have accounts with DTC
("participants") or persons who hold interests through participants.
Ownership of beneficial interests in the Global Note will be shown on,
and the transfer of that ownership will be effected only through,
records maintained by DTC or its nominee, with respect to interests of
participants, and the records of participants, with respect to interests
of persons other than participants.
So long as DTC or its nominee is the registered owner or holder of the Global
Note, DTC or such nominee, as the case may be, will be considered the sole
owner or holder of the New Notes represented by such Global Note for all
purposes under the Indenture and the New Notes. No beneficial owner of an
interest in the Global Note will be able to transfer that interest except in
accordance with DTC's applicable procedures, in addition to those provided for
under the Indenture. Owners of beneficial interests in the Global Note will not
(1) be entitled to have the New Notes represented by such Global Note
registered in their names, (2) receive or be entitled to receive physical
delivery of certificated Notes in definitive form and (3) be considered to be
the owners or holders of any New Notes under the Global Note. Accordingly, each
person owning a beneficial interest in the Global Note must rely on the
procedures of DTC and, if such person is not a participant, on the procedures
of the participant through which such person owns its interests, to exercise
any right of a holder of New Notes under the Global Note. We understand that
under existing industry practice, in the event an owner of a beneficial
interest in the Global Note desires to take any action that DTC, as the holder
of the Global Note, is entitled to take, DTC would authorize the participants
to take such action, and that the participants would authorize beneficial
owners owning through such participants to take such action or would otherwise
act upon the instructions of beneficial owners owning through them.
Payments of the principal of, premium, if any, and interest on the New Notes
represented by the Global Note will be made to DTC or its nominee, as the case
may be, as the registered owner thereof the Global Note. Neither we, the
Trustee, nor any Paying Agent will have any responsibility or liability for any
aspect of the records relating to or payments made on account of beneficial
ownership interests in the Global Note or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
We expect that DTC or its nominee, upon receipt of any payment of principal,
premium, if any, or interest on the Global Note will credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of the Global Note, as shown on the records
of DTC or its nominee.
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We also expect that payments by participants to owners of beneficial interests
in the Global Note held through such participants will be governed by standing
instructions and customary practice, as is now the case with securities held
for the accounts of customers registered in the names of nominees for such
customers. Such payments will be the responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules. If a holder requires physical delivery of Notes
in certificated form ("Certificated Notes") for any reason, including to sell
Notes to persons in states which require physical delivery of the Notes, or to
pledge such securities, such holder must transfer its interest in a Global
Note, in accordance with the normal procedures of DTC and with the procedures
set forth in the Indenture.
Unless and until they are exchanged in whole or in part for certificated New
Notes in definitive form, the Global Note may not be transferred except as a
whole by DTC to a nominee of DTC or by a nominee of DTC to DTC or another
nominee of DTC.
Beneficial owners of New Notes registered in the name of DTC or its nominee
will be entitled to be issued, upon request, New Notes in definitive
certificated form.
DTC has advised us that DTC will take any action permitted to be taken by a
holder of Notes--including the presentation of Notes for exchange as described
below--only at the direction of one or more participants to whose account the
DTC interests in the Global Note are credited and only in respect of such
portion of the aggregate principal amount of Notes as to which such
participant or participants has or have given such direction.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global Note among participants of DTC, it is
under no obligation to perform such procedures, and such procedures may be
discontinued at any time. Neither we nor the Trustee will have any
responsibility for the performance by DTC or its participants or indirect
participants of their respective obligations under the rules and procedures
governing their operations.
Subject to certain conditions, any person having a beneficial interest in
the Global Note may, upon request to the Trustee, exchange such beneficial
interest for New Notes in the form of Certificated Notes. Upon any such
issuance, the Trustee is required to register such Certificated Notes in the
name of, and cause the same to be delivered to, such person or persons, or the
nominee of any such persons. In addition, if DTC is at any time unwilling or
unable to continue as a depositary for the Global Note, and a successor
depositary is not appointed by us within 90 days, we will issue Certificated
Notes in exchange for the Global Note.
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EXCHANGE OFFER; REGISTRATION RIGHTS
Holders of the New Notes are not entitled to any registration rights with
respect to the New Notes. Unilab Finance and the initial purchasers entered
into a registration rights agreement for the benefit of the holders of the Old
Notes. As part of the recapitalization, we entered into an assumption
agreement, dated as of November 23, 1999, with Unilab Finance whereby we
assumed the obligations of Unilab Finance under the registration rights
agreement. Pursuant to the registration rights agreement, we agreed, for the
benefit of the holders of the Old Notes, at our cost, to us our best efforts:
. to file with the SEC the exchange offer registration statement with
respect to the exchange offer for the New Notes by January 7, 2000;
. cause the exchange offer registration statement to be declared effective
under the Securities Act by May 1, 2000;
. to keep the exchange offer registration statement effective until the
closing of the exchange offer; and
. to cause the exchange offer to be consummated by June 5, 2000.
Upon the exchange offer registration statement being declared effective, we
will offer the New Notes in exchange for surrender of the Old Notes. We will
keep the exchange offer open for not less than 30 days, or longer if required
by applicable law, after the date notice of the exchange offer is mailed to
the holders of the Old Notes. For each Old Notes tendered to us pursuant to
the exchange offer and not withdrawn by the holder of such Old Note, such
holder will receive a New Note having a principal amount equal to that of the
tendered Old Note. Interest on each New Note will accrue
. from the later of (1) the last interest payment date on which interest
was paid on the Old Note surrendered in exchange therefor, or (2) if the
Old Note is surrendered for exchange on a date in a period which
includes the record date for an interest payment date to occur on or
after the date of such exchange and as to which interest will be paid,
the date of such interest payment date; or
. if no interest has been paid on such Old Note, from the issue date.
Under existing interpretations of the SEC contained in several no-action
letters to third parties, we believe that the New Notes will be freely
transferable by holders thereof (other than our affiliates) after the exchange
offer without further registration under the Securities Act, so long as each
holder that wishes to exchange its Notes for Exchange Notes represents:
. that any New Notes to be received by it will be acquired in the ordinary
course of its business;
. that at the time of the commencement of the exchange offer it has no
arrangement or understanding with any person to participate in the
distribution (within the meaning of Securities Act) of the New Notes in
violation of the Securities Act;
. that it is not an "affiliate," as defined in Rule 405 promulgated under
the Securities Act, of our company;
. if such holder is not a broker-dealer, that it is not engaged in, and
does not intend to engage in, the distribution of New Notes; and
. if such holder is a broker-dealer (a "Participating Broker-Dealer"),
that will receive New Notes for its own account in exchange for Notes
that were acquired as a result of market-making or other trading
activities, that it will deliver a prospectus in connection with any
resale of such New Notes.
We agree to make available, during the period required by the Securities
Act, a prospectus meeting the requirements of the Securities Act for use by
Participating Broker-Dealers and other persons, if any, with similar
prospectus delivery requirements for use in connection with any resale of New
Notes.
In the event that (1) any change in law or in currently prevailing
interpretations of the staff of the SEC do not permit us to effect the
exchange offer, or (2) if for any other reason the exchange offer registration
statement
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is not declared effective by May 1, 2000, or (3) the exchange offer is not
consummated by June 5, 2000, or (4) in certain circumstances, certain holders
of unregistered New Notes so request, or (4) in the case of any holder that
participates in the exchange offer, such holder does not receive New Notes on
the date of the exchange that may be sold without restriction under state and
federal securities laws, other than due solely to the status of such holder as
our affiliate within the meaning of the Securities Act, then in each case, we
will:
. promptly deliver to the holders and the trustee written notice thereof;
and
. at our sole expense, (1) as promptly as practicable, file a shelf
registration statement covering resales of the Notes, and (2) use its
best efforts to keep effective the shelf registration statement until
the earlier of two years after the issue date or such time as all of the
applicable Notes have been sold thereunder.
We will, in the event that a shelf registration statement is filed, (1)
provide to each holder of the Notes copies of the prospectus that is a part of
the shelf registration statement, (2) notify each such holder when the shelf
registration statement for the Notes has become effective and (3) take certain
other actions as are required to permit unrestricted resales of the Notes. A
holder of Notes that sells Notes pursuant to the shelf registration statement
will be (1) required to be named as a selling security holder in the related
prospectus and to deliver a prospectus to purchasers, (2) required to deliver
the prospectus to purchasers, (3) subject to certain of the civil liability
provisions under Securities Act in connection with such sales and (4) bound by
the provisions of the registration rights agreement that are applicable to such
a holder, including certain indemnification rights and obligations.
If we fail to meet the targets listed above, then liquidated damages shall
become payable in respect of the Old Notes as follows:
(1) if (A) neither the exchange offer registration statement nor the shelf
registration statement is filed with the SEC by January 7, 2000 or (B)
notwithstanding that we have consummated or will consummate an exchange
offer, we are required to file a shelf registration statement and such
shelf registration statement is not filed on or prior to the date
required by the registration rights agreement, then commencing on the
day after either such required filing date, we will required to pay
liquidated damages in an amount equal to $0.096 per week per $1,000
principal amount of the Old Notes for the first 90-day period following
the registration default so long as the registration default continues,
and for each subsequent 90-day period, this amount will increase by an
additional $0.096 per week; or
(2) if (A) neither the exchange offer registration statement nor a shelf
registration statement is declared effective by the SEC by May 1, 2000
or (B) notwithstanding that we have consummated or will consummate an
exchange offer, we are required to file a shelf registration statement
and such shelf registration statement is not declared effective by the
SEC on or prior to the 90th day following the date such shelf
registration statement was filed, then, commencing on the day after
either such required effective date, we will be required to pay
liquidated damages in an amount equal to $0.096 per week per $1,000
principal amount of the Old Notes for the first 90-day period following
the registration default so long as the registration default continues,
and for each subsequent 90-day period, this amount will increase by
$0.096 per week; or
(3) if (A) we have not exchanged New Notes for all Old Notes validly
tendered in accordance with the terms of the exchange offer by June 5,
2000 or (B) if applicable, the shelf registration statement has been
declared effective and such shelf registration statement ceases to be
effective at any time prior to the second anniversary of the issue date
of the Old Notes (other than after such time as all Notes have been
disposed of thereunder), then we will be required to pay liquidated
damages in an amount equal to $0.096 per week per $1,000 principal
amount of the Old Notes for the first 90-day period commencing on (x)
June 6, in the case of (A) above, or (y) the day such shelf
registration statement ceases to be effective, in the case of (B)
above, such liquidated damages rate increasing by an additional $0.096
per week for each subsequent 90-day period;
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provided, however, that the liquidated damages rate on the Old Notes may not
accrue under more than one of the foregoing clauses at any one time and at no
time shall the aggregate amount of liquidated damages accruing exceed $0.192
per week per $1,000 principal amount; provided, further, however, that:
. upon the filing of the exchange offer registration statement or a shelf
registration statement (in the case of clause (1) above);
. upon the effectiveness of the exchange offer registration statement or a
shelf registration statement (in the case of clause (2) above); or
. upon the exchange of New Notes for all Old Notes tendered (in the case
of clause (3) (A) above), or upon the effectiveness of the shelf
registration statement which had ceased to remain effective (in the case
of clause (3) (B) above)
liquidated damages on the Old Notes as a result of such clause (or the relevant
subclause thereof), as the case may be, shall cease to accrue.
Any amounts of liquidated damages due pursuant to clause (1), (2) or (3)
above will be payable in cash on the same original interest payment dates as
the Old Notes.
The summary in this prospectus of certain provisions of the registration
rights agreement does not purport to be complete and is subject to, and is
qualified in its entirety by reference to, all the provisions of the
registration rights agreement, which is filed as an exhibit to the registration
statement to which this prospectus forms a part.
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MATERIAL FEDERAL INCOME TAX CONSIDERATIONS
The following is a general discussion of certain United States federal income
tax consequences of the exchange of Old Notes for New Notes pursuant to the
exchange offer and the ownership and disposition of the New Notes. This summary
applies only to a beneficial owner of an Old Note who acquired such Old Note at
the initial offering for the original offering price thereof and who acquires a
New Note pursuant to the Exchange Offer. This discussion is based on provisions
of the Internal Revenue Code of 1986, as amended (the "Code"), Treasury
regulations promulgated thereunder, and administrative and judicial
interpretations thereof, all as in effect on the date hereof and all of which
are subject to change, possibly with retroactive effect. This discussion does
not address the tax consequences to subsequent purchasers of New Notes and is
limited to holders who will hold the New Notes as capital assets. Furthermore,
this discussion does not address all aspects of United States federal income
taxation that may be applicable to holders in light of their particular
circumstances, or to holders subject to special treatment under United States
federal income tax law (including, without limitation, certain financial
institutions, insurance companies, tax-exempt entities, dealers in securities,
persons who hold Old Notes or will hold New Notes as part of a straddle, hedge,
conversion transaction or other integrated investment or persons whose
functional currency is not the United States dollar).
Each holder should consult its tax advisor as to the particular tax
consequences to such holder of the exchange of Old Notes for New Notes pursuant
to the exchange offer and the ownership and disposition of the New Notes,
including the applicability of any federal, state, local or foreign tax laws,
any changes in applicable tax laws and any pending or proposed legislation or
regulations.
United States Taxation of United States Holders
As used herein, (A) the term "United States Holder" means a beneficial owner
of a Note that is, for United States federal income tax purposes, (1) a citizen
or resident of the United States, (2) a corporation or partnership created or
organized in or under the laws of the United States or of any political
subdivision thereof, (3) an estate the income of which is subject to United
States federal income taxation regardless of its source and (4) a trust (x) if
it validly elects to be treated as a United States person for United States
federal income tax purposes or (y) if a United States court is able to exercise
primary supervision over the administration of such trust and one or more
United States persons have the authority to control all substantial decisions
of such trust and (B) the term "Non-U.S. Holder" means a beneficial owner of an
Old Note or a New Note that is not a United States Holder.
Exchange Offer
The exchange of an Old Note for a New Note pursuant to the Exchange Offer
will not constitute a "significant modification" of the Old Note for United
States federal income tax purposes and, accordingly, the New Note received will
be treated as a continuation of the Old Note in the hands of such holder. As a
result, there will be no United States federal income tax consequences to a
United States Holder who exchanges an Old Note for a New Note pursuant to the
Exchange Offer and any such holder will have the same adjusted tax basis and
holding period in the New Note as it had in the Old Note immediately before the
exchange.
Payments of Interest
Stated interest payable on the New Notes generally will be included in the
gross income of a United States Holder as ordinary interest income at the time
accrued or received, in accordance with such United States Holder's method of
accounting for United States federal income tax purposes.
Original Issue Discount. For United States federal income tax purposes, the
New Notes will be issued with original issue discount ("OID") in an amount
equal to the difference between the stated redemption price at maturity of the
Notes and their issue price. United States Holders must include such OID in
gross income as ordinary interest income as it accrues under a method taking
into account an economic accrual of the discount. In general, a United States
Holder must include OID in income in advance of the receipt of the cash
representing that income regardless of the method of accounting generally used
by the United States Holder.
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The "issue price" of a New Note generally will be the initial offering price
of the Old Notes. The "stated redemption price at maturity" of a New Note
generally will be equal to the stated principal amount due at maturity of the
Old Notes.
United States Holders are required to include OID in income as it accrues in
accordance with a constant yield method based on semiannual compounding
(regardless of a holder's regular method of tax accounting). In general, the
amount of OID that is includable in income is determined by allocating to each
day in an accrual period the ratable portion of OID allocable to the accrual
period. The amount of OID that is allocable to an accrual period is generally
an amount equal to the product of the adjusted issue price of a Note at the
beginning of such accrual period (the issue price of the Notes determined as
described above, generally increased by all prior accruals of OID with respect
to the Notes) and the yield to maturity (the discount rate, which when applied
to all payments under the Notes results in a present value equal to the issue
price) less any qualified stated interest (interest that is unconditionally
payable in cash or property at least annually at a single fixed rate) allocable
to the accrual period.
Payments on Registration Default
Because the Old Notes provide for the payment of liquidated damages under
certain circumstances (see "Exchange Offer; Registration Rights"), the Old
Notes may be subject to Treasury regulations applicable to debt instruments
that provide for one or more contingent payments. We intend to take the
position that these regulations do not apply to the Old Notes because (i) the
payments of liquidated damages are not payments of interest with respect to the
Old Notes, but rather payments in the nature of liquidated damages or (ii) the
payment of liquidated damages is a "remote" or "incidental" contingency within
the meaning of such regulations. Accordingly, any such liquidated damages, if
made, should be taken into account by a United States Holder as ordinary income
at the time received or accrued in accordance with the United States Holder's
method of accounting. If the regulations were to apply to the liquidated
damages, if made, then such payments generally would be taxed as interest
income and the Old Notes would be treated as reissued at the time such
liquidated damages payments are made at the Notes then adjusted issue price
(i.e., generally, the stated principal amount of the Old Notes). In addition,
if, at the time of exchange offer, the possibility that we would be required to
make future liquidated damages payments were not a remote or incidental
contingency, a United States Holder could be required to accrue the projected
payments of liquidated damages into income on a constant yield basis, which
could result in a holder recognizing income prior to the receipt of the related
cash payment. Prospective investors should consult their tax advisors regarding
the United States federal income tax consequences of the receipt of liquidated
damages payments on the Old Notes.
Disposition of the New Notes
Upon the sale, exchange, retirement at maturity or other disposition of a New
Note (collectively, a "disposition"), a United States Holder generally will
recognize capital gain or loss equal to the difference between the amount
realized by such holder (except to the extent such amount is attributable to
accrued but unpaid interest and any unamortized OID, which will be treated as
ordinary interest income to the extent not previously included in income) and
such holder's adjusted tax basis in the New Note. A United States Holder's
adjusted tax basis in a New Note will be equal to the cost of the Note to the
holder increased by any OID included in income by the holder prior to the date
of the disposition of the New Note. Any capital gain or loss recognized by a
United States Holder upon a disposition of a New Note will be long-term capital
gain or loss if the holding period for the New Note exceeds one year at the
time of the disposition. Non-corporate taxpayers are generally subject to a
maximum regular federal income tax rate of 20% on net long-term capital gains.
The deductibility of capital losses is subject to certain limitations.
United States Taxation of Non-U.S. Holders
Payments of Interest
Subject to the discussion below under "Backup Withholding and Information
Reporting", in general, payments of interest (including any accruals of OID)
received by a Non-U.S. Holder will not be subject to
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United States federal withholding tax, provided that (1)(a) the Non-U.S. Holder
does not actually or constructively own 10% or more of the total combined
voting power of all our classes of stock entitled to vote, (b) the Non-U.S.
Holder is not a controlled foreign corporation that is related to us actually
or constructively through stock ownership, and (c) the beneficial owner of the
New Note, under penalties of perjury, either directly or through a financial
institution which holds the Note on behalf of the Non-U.S. Holder and holds
customers' securities in the ordinary course of its trade or business, provides
us or our agent with the beneficial owner's name and address and certifies,
under penalties of perjury, that it is not a United States Holder, (2) the
interest received on the Note is effectively connected with the conduct by the
Non-U.S. Holder of a trade or business within the United States and the Non-
U.S. Holder complies with certain reporting requirements; or (3) the Non-U.S.
Holder is entitled to the benefits of an income tax treaty under which the
interest is exempt from United States withholding tax and the Non-U.S. Holder
complies with certain reporting requirements. Payments of interest not exempt
from United States federal withholding tax as described above will be subject
to such withholding tax at the rate of 30% (subject to reduction under an
applicable income tax treaty). Payments of interest on a Note to a Non-U.S.
Holder generally will not be subject to United States federal income tax unless
such income is effectively connected with the conduct by such Non-U.S. Holder
of a trade or business in the United States.
Disposition of the New Notes
Subject to the discussion below under "Backup Withholding and Information
Reporting", a Non-U.S. Holder generally will not be subject to United States
federal income tax (and generally no tax will be withheld) with respect to
gains realized on the disposition of a New Note, unless (1) the gain is
effectively connected with a United States trade or business conducted by the
Non-U.S. Holder or (2) the Non-U.S. Holder is an individual who is present in
the United States for 183 or more days during the taxable year of the
disposition and certain other requirements are satisfied. In addition, an
exchange of an Old Note for a New Note pursuant to the exchange offer described
in "Exchange Offer; Registration Rights" will not constitute a taxable exchange
of the Old Note for Non-U.S. Holders. See "United States Taxation of United
States Holders--Exchange Offer."
Effectively Connected Income
If interest and other payments received by a Non-U.S. Holder with respect to
the Notes (including proceeds from the disposition of the New Notes) are
effectively connected with the conduct by the Non-U.S. Holder of a trade or
business within the United States (or the Non-U.S. Holder is otherwise subject
to United States federal income taxation on a net basis with respect to such
holder's ownership of the Notes), such Non-U.S. Holder will generally be
subject to the rules described above under "United States Taxation of United
States Holders" (subject to any modification provided under an applicable
income tax treaty). Such Non-U.S. Holder may also be subject to the "branch
profits tax" if such holder is a corporation.
Backup Withholding and Information Reporting
Certain non-corporate United States Holders may be subject to backup
withholding at a rate of 31% on payments of principal, premium and interest on,
and the proceeds of the disposition of, the New Notes. In general, backup
withholding will be imposed only if the United States Holder (1) fails to
furnish its taxpayer identification number ("TIN"), which, for an individual,
would be his or her Social Security number, (2) furnishes an incorrect TIN, (3)
is notified by the IRS that it has failed to report payments of interest or
dividends or (4) under certain circumstances, fails to certify, under penalty
of perjury, that it has furnished a correct TIN and has been notified by the
IRS that it is subject to backup withholding tax for failure to report interest
or dividend payments. In addition, such payments of principal and interest to
United States Holders will generally be subject to information reporting.
United States Holders should consult their tax advisors regarding their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption, if applicable.
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Backup withholding generally will not apply to payments made to a Non-U.S.
Holder of a New Note who provides the certification described under "United
States Taxation of Non-U.S. Holders--Payments of Interest" (and the payor does
not have actual knowledge that a certificate is false) or otherwise establishes
an exemption from backup withholding. Payments by a United States office of a
broker of the proceeds of a disposition of the New Notes generally will be
subject to backup withholding at a rate of 31% unless the Non-U.S. Holder
certifies it is a Non-U.S. Holder under penalties of perjury or otherwise
establishes an exemption. In addition, if a foreign office of a foreign
custodian, foreign nominee or other foreign agent of such beneficial owner, or
if a foreign office of a foreign "broker" (as defined in applicable Treasury
regulations) pays the proceeds of the sale of a New Note to the seller thereof,
backup withholding and information reporting will not apply provided that such
nominee, custodian, agent or broker is not a "United States related person" (a
person which derives more than 50% of its gross income for certain periods from
the conduct of a trade or business in the United States or is a controlled
foreign corporation). The payment by a foreign office of a broker that is a
United States person or a United States related person of the proceeds of the
sale of New Notes will not be subject to backup withholding, but will be
subject to information reporting unless the broker has documentary evidence in
its records that the beneficial owner is not a United States person for
purposes of such backup withholding and information reporting requirements and
certain conditions are met, or the beneficial owner otherwise establishes an
exemption.
The amount of any backup withholding imposed on a payment to a holder of a
New Note will be allowed as a credit against such holder's United States
federal income tax liability and may entitle such holder to a refund, provided
that the required information is furnished to the IRS.
Recently Issued Treasury Regulations
Recently finalized treasury regulations govern information reporting and the
certification procedures regarding withholding and backup withholding on
certain amounts paid to Non-U.S. Holders after December 31, 2000. The new
Treasury regulations generally would not alter the treatment of Non-U.S.
Holders described above. The new Treasury regulations would alter the
procedures for claiming the benefits of an income tax treaty and may change the
certification procedures relating to the receipt by intermediaries of payments
on behalf of a beneficial owner of a Note. Prospective investors should consult
their tax advisors concerning the effect, if any, of such new Treasury
regulations on an investment in the New Notes.
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PLAN OF DISTRIBUTION
Each broker-dealer that receives New Notes for its own account pursuant to
the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. This prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with resales of New Notes received in exchange for Old Notes where
such Old Notes were acquired as a result of market-making activities or other
trading activities. For a period of 180 days after the Expiration Date, we will
make this prospectus, as amended or supplemented, available to any broker-
dealer for use in connection with any such resale. In addition, until March 18,
2000--90 days from the date of this prospectus--all dealers effecting
transactions in the New Notes may be required to deliver a prospectus.
We will not receive any proceeds from any sale of New Notes by broker-
dealers. New Notes received by broker-dealers for their own account pursuant to
the Exchange Offer may be sold from time to time in one or more transactions
(1) in the over-the-counter market, (2) in negotiated transactions, (3) through
the writing of options on the New Notes or (4) a combination of such methods of
resale, (a) at market prices prevailing at the time of resale, (b) at prices
related to such prevailing market prices or (c) negotiated prices. Any such
resale may be made directly to purchasers or to or through brokers or dealers
who may receive compensation in the form of commissions or concessions from any
such broker-dealer or the purchasers of any such New Notes. Any broker-dealer
that resells New Notes that were received by it for its own account pursuant to
the Exchange Offer, and any broker or dealer that participates in a
distribution of such New Notes, may be deemed to be an "underwriter" within the
meaning of the Securities Act. Any profit on any such resale of New Notes and
any commission or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that, by acknowledging that it will deliver and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of 180 days after the Expiration Date, we will promptly send
additional copies of this prospectus and any amendment or supplement to this
prospectus to any broker-dealer that requests such documents in the Letter of
Transmittal. We have agreed to pay all expenses incident to the Exchange Offer,
including the expenses of one counsel for the holders of the Notes, other than
commissions or concessions of any brokers or dealers. We also will indemnify
the holders of the Notes, including any broker-dealers, against certain
liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
The validity of the New Notes offered by this prospectus will be passed upon
for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York.
INDEPENDENT AUDITORS
The financial statements of Unilab Corporation for the years ended December
31, 1996, 1997 and 1998 included or incorporated by reference in this
prospectus and elsewhere in this registration statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
reports.
The consolidated financial statements of Meris for the years ended December
31, 1996 and 1997 included in this prospectus have been audited by Odenberg,
Ullakko, Muranishi & Co., independent auditors, as stated in their report which
is included herein, and are so included in reliance upon the report of such
firm given upon their authority as experts in accounting and auditing.
The consolidated financial statements of Physicians Clinical Laboratory, Inc.
for the year ended February 28, 1999 included in this prospectus have been
audited by Odenberg, Ullakko, Muranishi & Co., independent auditors, as stated
in their report which is included herein, and are so included in reliance upon
the report of such firm given upon their authority as experts in accounting and
auditing.
119
<PAGE>
The consolidated financial statements of Physicians Clinical Laboratory, Inc.
for the five months ended February 28, 1998 and the seven months ended
September 30, 1997 included in this prospectus have been audited by Grant
Thornton LLP, independent auditors, as stated in their report which is included
herein, and are so included in reliance upon the report of such firm given upon
their authority as experts in accounting and auditing.
The consolidated financial statements of Physicians Clinical Laboratory, Inc.
for the year ended February 28, 1997 appearing in this Prospectus and
Registration Statement and included in Unilab Corporation's Current Report on
Form 8-K/A dated November 10, 1999, have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon (which contains an
explanatory paragraph describing conditions that raise substantial doubt about
the Company's ability to continue as a going concern) included and incorporated
herein by reference. Such consolidated financial statements are included and
incorporated herein by reference in reliance upon such report given on the
authority of such firm as experts in accounting and auditing.
WHERE TO FIND MORE INFORMATION
We are subject to the information requirements of the Exchange Act. In
accordance with the Exchange Act, we file reports, proxy statements and other
information with the SEC. Such reports, proxy statements and other information
filed by us with the SEC can be inspected and copied at the public reference
facilities maintained by the SEC at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549 or at its regional offices located at 500
West Madison Street, Suite 1400, Chicago, Illinois 60661, and 7 World Trade
Center, Suite 1300, New York, New York 10048. Copies of such material can be
obtained from the Public References Section of the SEC at 450 Fifth Street,
N.W., Washington, D.C. 20549 at prescribed rates. The SEC maintains an Internet
"website" that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the SEC at
http://www.sec.gov.
The following documents previously filed by us (File No. 0-22758) with the
SEC are incorporated in this prospectus by reference:
(1) Annual Report on Form 10-K/A for the year ended December 31, 1998;
(2) Proxy Statement, dated April 15, 1998, which was mailed to our
stockholders in connection with the Annual Meeting of Stockholders
held on May 19, 1998;
(3) Quarterly Report on Form 10-Q/A for the quarter ended March 31, 1999;
(4)Current Report on Form 8-K dated April 6, 1999;
(5)Current Report on Form 8-K dated May 11, 1999;
(6)Current Report on Form 8-K dated May 17, 1999;
(7)Current Report on Form 8-K dated May 27, 1999;
(8)Current Report on Form 8-K/A dated July 23, 1999;
(9)Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1999;
(10)Current Report on Form 8-K, dated August 13, 1999;
(11)Current Report on Form 8-K/A, dated October 25, 1999;
(12)Current Report on Form 8-K/A, dated October 26, 1999;
(13)Current Report on Form 8-K/A, dated November 10, 1999;
(14)Current Report on Form 8-K, dated November 30, 1999; and
(15)Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this prospectus to the extent that a statement contained
herein, or in any other subsequently filed document that also is or is deemed
to be incorporated by reference herein, modifies or supersedes such statement.
Any such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute part of this prospectus.
120
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Page
Unilab Financial Statements:
Balance Sheets as of December 31, 1998 and September 30, 1999
(unaudited)............................................................. F-2
Statements of Operations for the three and nine month periods ended
September 30, 1998 and 1999 (unaudited)................................. F-3
Statements of Cash Flows for the nine months ended September 30, 1998 and
1999 (unaudited)........................................................ F-4
Notes to Financial Statements (unaudited)................................ F-5
Report of Independent Public Accountants................................. F-10
Statements of Operations for the years ended December 31, 1996, 1997 and
1998.................................................................... F-11
Balance Sheets as of December 31, 1997 and 1998.......................... F-12
Statements of Shareholders' Equity (Deficit) for the years ended December
31, 1996, 1997 and 1998................................................. F-13
Statements of Cash Flows for the years ended December 31, 1996, 1997 and
1998.................................................................... F-14
Notes to Financial Statements............................................ F-15
Report of Independent Public Accountants on Schedules.................... F-31
Schedule II--Valuation and Qualifying Accounts........................... F-32
</TABLE>
<TABLE>
<S> <C>
Meris Financial Statements:
Report of Independent Accountants......................................... F-33
Consolidated Balance Sheets as of September 30, 1998 (unaudited) and
December 31, 1996 and 1997............................................... F-34
Consolidated Statements of Operations for the nine months ended September
30, 1998 (unaudited) and the years ended December 31, 1996 and 1997...... F-35
Consolidated Statements of Shareholders' Deficit for the nine months ended
September 30, 1998 (unaudited) and the years ended December 31, 1996 and
1997..................................................................... F-36
Consolidated Statements of Cash Flows for the nine months ended September
30, 1998 (unaudited) and the years ended December 31, 1996 and 1997...... F-37
Notes to Consolidated Financial Statements................................ F-39
</TABLE>
<TABLE>
<S> <C>
Physicians Clinical Laboratory, Inc. (which operated under the name Bio-
Cypher Laboratories) Financial Statements:
Report of Independent Auditors............................................ F-49
Consolidated Balance Sheets as of February 28, 1998 and 1999.............. F-52
Consolidated Statements of Operations for the year ended February 28,
1997, the seven months ended September 30, 1997, the five months ended
February 28, 1998 and the year ended February 28, 1999................... F-53
Consolidated Statements of Stockholders' Deficit for the year ended
February 28, 1997, the seven months ended September 30, 1997, the five
months ended February 28, 1998 and the year ended February 28, 1999...... F-54
Consolidated Statements of Cash Flows for the year ended February 28,
1997, the seven months ended September 30, 1997, the five months ended
February 28, 1998 and the year ended February 28, 1999................... F-55
Notes to Consolidated Financial Statements................................ F-56
</TABLE>
F-1
<PAGE>
UNILAB CORPORATION
BALANCE SHEETS
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(amounts in thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................... $ 25,753 $ 20,137
Restricted cash................................... 5,497 --
Accounts receivable, net.......................... 55,830 41,326
Inventory of supplies............................. 3,970 3,055
Prepaid expenses and other current assets......... 2,346 1,045
-------- --------
Total current assets............................ 93,396 65,563
Property and equipment, net....................... 13,009 11,277
Deferred tax asset................................ 16,558 --
Goodwill, net..................................... 83,347 56,949
Other intangible assets, net...................... 1,922 2,370
Other assets...................................... 5,168 6,301
-------- --------
$213,400 $142,460
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of long-term debt................. $ 1,763 $ 1,206
Accounts payable and accrued liabilities.......... 23,236 14,533
Accrued payroll and benefits...................... 10,336 6,892
-------- --------
Total current liabilities....................... 35,335 22,631
-------- --------
Long-term debt, net of current portion............ 160,778 137,170
Other liabilities................................. 5,251 4,026
Commitments and contingencies
Shareholders' equity (deficit):
Convertible preferred stock, $.01 par value
Issued and outstanding--364 at September 30 and
December 31.................................... 4 4
Common stock, $.01 par value
Issued and outstanding--42,016 at September 30
and 40,708 at December 31...................... 420 407
Additional paid-in capital........................ 231,973 228,395
Accumulated deficit............................... (220,361) (250,173)
-------- --------
Total shareholders' equity (deficit)............ 12,036 (21,367)
-------- --------
$213,400 $142,460
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-2
<PAGE>
UNILAB CORPORATION
STATEMENTS OF OPERATIONS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
(amounts in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended September Nine Months Ended
30, September 30,
---------------- ------------------
<S> <C> <C> <C> <C>
1999 1998 1999 1998
------- ------- -------- --------
Revenue................................. $76,210 $53,160 $213,496 $162,046
------- ------- -------- --------
Direct laboratory and field expenses:
Salaries, wages and benefits.......... 22,940 16,255 63,226 49,645
Supplies.............................. 11,307 7,480 30,653 22,585
Other operating expenses.............. 18,855 13,075 53,254 39,404
------- ------- -------- --------
53,102 36,810 147,133 111,634
Legal charge............................ -- -- 600 --
Amortization and depreciation........... 3,062 1,848 7,189 5,774
Selling, general and administrative
expenses............................... 10,120 8,132 29,323 24,990
------- ------- -------- --------
Total operating expenses............ 66,284 46,790 184,245 142,398
------- ------- -------- --------
Operating income........................ 9,926 6,370 29,251 19,648
Third party interest, net............... (3,978) (3,308) (11,244) (10,068)
------- ------- -------- --------
Income before income taxes.............. 5,948 3,062 18,007 9,580
Tax benefit............................. 11,904 -- 11,904 --
------- ------- -------- --------
Net income.............................. $17,852 $ 3,062 $ 29,911 $ 9,580
------- ------- -------- --------
Preferred stock dividends............... $ 33 $ 33 $ 99 $ 99
Net income available to common
shareholders........................... $17,819 $ 3,029 $ 29,812 $ 9,481
Earnings per share:
Basic................................... $ 0.42 $ 0.07 $ 0.72 $ 0.22
Diluted................................. $ 0.36 $ 0.07 $ 0.63 $ 0.22
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-3
<PAGE>
UNILAB CORPORATION
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine months
ended
September 30,
----------------
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................. $29,911 $ 9,580
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation............................ 7,189 5,774
Provision for doubtful accounts.......................... 15,376 11,697
Deferred tax benefit..................................... (11,904) --
Net changes in assets and liabilities affecting operations,
net of acquisitions:
Increase in accounts receivable.......................... (21,189) (15,508)
(Increase) decrease in inventory of supplies............. (378) 35
Increase in prepaid expenses and other current assets.... (1,301) (286)
(Increase) decrease in other assets...................... 697 (147)
Increase (decrease) in accounts payable and accrued
liabilities............................................. 4,683 (820)
Increase in accrued payroll and benefits................. 2,118 1,946
Other.................................................... 99 319
------- -------
Net cash provided by operating activities................ 25,301 12,590
------- -------
Cash flows from financing activities:
Payments of third party debt............................... (835) (1,303)
Proceeds from exercise of stock options.................... 253 15
Other...................................................... (99) (99)
------- -------
Net cash used by financing activities.................... (681) (1,387)
------- -------
Cash flows from investing activities:
Capital expenditures....................................... (4,903) (2,335)
Payments for acquisitions, net of cash acquired............ (8,604) (619)
------- -------
Net cash used by investing activities.................... (13,507) (2,954)
------- -------
Net increase in cash, cash equivalents and restricted cash... 11,113 8,249
Cash, cash equivalents and restricted cash--Beginning of
Period...................................................... 20,137 11,652
------- -------
Cash, cash equivalents and restricted cash--End of Period.... $31,250 $19,901
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Management Opinion
In the opinion of management, the accompanying unaudited interim financial
statements reflect all adjustments which are necessary to present fairly the
financial position, results of operations and cash flows for the interim
periods reported. All such adjustments made were of a normal recurring nature.
The accompanying interim financial statements and related notes should be
read in conjunction with the financial statements of Unilab Corporation
("Unilab" or the "Company") and related notes as contained in the Annual Report
on Forms 10-K and 10K/A for the year ended December 31, 1998.
2. Net Income Per Share
Basic earnings per common share has been computed by dividing the net income
less preferred dividends by the weighted average number of common shares
outstanding for each period presented. The weighted average number of common
shares used in the calculation of basic earnings per share was 42.0 million and
40.7 million for the three months ended September 30, 1999 and 1998,
respectively and 41.4 million and 40.7 million for the nine months ended
September 30, 1999 and 1998, respectively.
Diluted earnings per share includes the effect of additional common shares
that would have been outstanding if dilutive potential common shares had been
issued plus a reduction of interest expense assuming conversion of the
convertible debt. For the three and nine month periods ended September 30,
1998, the weighted average number of dilutive stock options were 1.3 million
and 1.5 million respectively, which would have had no effect on the basic
earnings per share calculation. For the three and nine month periods ended
September 30, 1999, the weighted average number of dilutive stock options were
2.7 million and 2.3 million, respectively, and both periods include the
incremental shares from the assumed conversion of the $14.0 million
subordinated convertible note of 4.7 million, which reduced the earnings per
share calculation by $0.06 and $0.09, respectively.
Without the benefit from the reduction in the valuation allowance previously
recorded against the Company's deferred tax assets as discussed in Note 4,
basic and diluted earnings per share would have been $0.14 and $0.13 per share,
respectively, for the three month period ended September 30, 1999 and $0.43 and
$0.39 per share, respectively, for the nine month period ended September 30,
1999.
3. Acquisitions
On September 16, 1998, the Company and Meris Laboratories, Inc. ("Meris")
signed an asset purchase agreement whereby Unilab acquired substantially all of
the assets of Meris. The agreement was approved on October 28, 1998 by the
United States Bankruptcy Court in Los Angeles, California and Unilab took
possession of the acquired net assets on November 5, 1998. The purchase price
consisted of the issuance of a $14.0 million convertible subordinated note,
$2.5 million in cash payable in seventy-two equal monthly installments and the
assumption of net assets of $3.5 million, consisting primarily of accounts
receivable. The acquisition was accounted for under the purchase method of
accounting and the statements of operations include the results of Meris since
November 5, 1998.
F-5
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Unaudited)
The purchase price was allocated to the net assets acquired based on their
fair value at the date of acquisition, as follows:
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Accounts receivable....................................... $ 3,251
Inventory of supplies..................................... 138
Property and equipment.................................... 175
Goodwill.................................................. 14,889
Other intangible assets-non-compete agreements............ 235
Other assets.............................................. 46
-------
Assets acquired........................................... 18,734
=======
Issuance of convertible subordinated notes................ 14,000
Accrued employee benefits................................. 306
Assumed accounts payable.................................. 2,520
Liabilities associated with integration period............ 1,400
Acquisition fees, primarily legal costs................... 508
-------
Liabilities assumed or incurred........................... $18,734
=======
</TABLE>
As noted in the table above and in connection with the integration of the
acquired Meris operations with those of Unilab, the Company recorded
liabilities of $1.4 million, primarily related to severance (for the reduction
in headcount of approximately 230 employees) and other employee related
liabilities. At September 30, 1999, all significant liabilities have been paid
in connection with the integration.
On April 5, 1999, the Company and Physicians Clinical Laboratory, Inc. (doing
business as Bio-Cypher Laboratories) ("BCL") signed an asset purchase agreement
whereby Unilab acquired substantially all of the assets of BCL. The acquisition
was completed on May 10, 1999. The purchase price consisted of a $25.0 million
subordinated promissory note, the issuance of 1.0 million shares of Unilab
common stock and approximately $8.6 million of cash. In addition, Unilab
acquired $9.6 million of tangible assets, the majority of which are trade
accounts receivable, and assumed liabilities of approximately $4.3 million. The
acquisition was accounted for under the purchase method of accounting and the
statements of operations include the results of BCL since May 10, 1999.
F-6
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Unaudited)
The purchase price was allocated to the assets acquired based on their fair
value at the date of acquisition as follows:
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Accounts receivable........................................ $ 8,691
Inventory of supplies...................................... 537
Property and equipment..................................... 358
Goodwill................................................... 33,839
-------
Assets acquired.......................................... 43,425
=======
Issuance of note........................................... 25,000
Accrued payroll and benefits............................... 1,987
Assumed accounts payable................................... 2,275
Liabilities associated with integration period............. 1,957
Acquisition fees, primarily legal costs.................... 350
Cash payment............................................... 8,606
Common stock issued........................................ 3,250
-------
Purchase Price/Liabilities assumed or incurred........... $43,425
=======
</TABLE>
As noted in the table above and in connection with the integration of the
acquired BCL operations with those of Unilab, the Company recorded liabilities
of $2.0 million, primarily related to severance (for the reduction in headcount
of over 500 employees), relocation and moving expenses and other employee
related liabilities. At September 30, 1999, approximately $1.2 million of
liabilities, expected to be paid primarily in the next six months were
outstanding.
Based upon the final review and valuation of certain assets acquired in the
Meris and BCL acquisitions, the Company has changed its estimate of goodwill
amortization arising from these acquisitions to a 10-year period effective July
1, 1999. The effect of the change was to increase amortization expense by $0.6
million and decrease net income by $0.6 million or $0.01 per diluted common
share for the three month period ended September 30, 1999 and $0.02 per diluted
common share for the nine month period ended September 30, 1999.
4. Income Taxes
The Company did not recognize an income tax provision for the three and nine
month periods ended September 30, 1999 and 1998. During these periods the
Company reduced the valuation allowance against its deferred tax assets, which
offset any potential income tax provision.
The Company establishes a valuation allowance in accordance with the
provisions of Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes". The Company continually reviews the adequacy of the
valuation allowance and recognizes the benefits from its deferred tax assets
only when an analysis of both positive and negative factors indicate that it is
more likely than not that the benefits will be realized. The Company has
approximately $29.6 million of deferred tax assets at September 30, 1999. Based
on the Company's improved operating performance in 1998 and 1999, having fully
integrated the Meris acquisition and being substantially complete with the BCL
integration, the Company believes it will have sufficient future taxable income
to reduce its valuation allowance by approximately $16.6 million at
September 30, 1999. The Company's estimate of future taxable income considers
the completion of the merger agreement, and the Company's more highly leveraged
position, as discussed in Note 7.
F-7
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Approximately $4.7 million of the tax asset recorded at September 30, 1999
reduced the amount of goodwill from certain acquisitions and the remaining
amount of the benefit was recognized as an income tax benefit in the statements
of operations for the three and nine month periods ended September 30, 1999. If
the Company does not further reduce its valuation allowance in the future, the
Company expects to have an effective tax rate of approximately 42% on a going
forward basis.
5. Legal Matters
The Company is currently in settlement negotiations with a group of insurance
companies regarding claims by the insurance companies that the Company over-
billed them in the early to mid-1990s in connection with several chemistry
profile tests that were previously the subject of a settlement agreement with
the government. While no formal settlement agreement with the insurance
companies has been executed, the Company believes that it is likely that it
will do so for a settlement amount of approximately $600,000, and such amount
has been reflected as a charge in the statement of operations for the second
quarter of 1999.
In May of 1999, Unilab learned of a new federal investigation under the False
Claims Act relating to Unilab's billing practices for the following four test
procedures: (1) apolipoprotein in conjunction with coronary risk panel
assignments; (2) microscopic evaluation in conjunction with urinalysis; (3)
performance of T7 index in conjunction with T3 and T4 tests; and (4)
fragmenting billing of unlisted panel codes. Unilab is in the process of
gathering and voluntarily submitting documentation regarding these tests to the
Department of Justice. The Company accrues for potential liabilities in matters
such as this as they become known and can be reasonably estimated. In the
Company's opinion, this investigation is not reasonably likely to have a
material adverse effect on the Company's results of operations or financial
position. However, no assurance can be given as to the ultimate outcome with
respect to such investigation. The resolution of such investigation could be
material to the Company's operating results for any particular period,
depending upon the level of income for such period.
6. Supplemental Disclosure of Cash Flow Information
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------
1999 1998
----------- -----------
(amounts in thousands)
<S> <C> <C>
Cash paid during the period for:
Interest, net.................................... $ 6,954 $ 6,821
Income taxes..................................... 421 2
In connection with business acquisitions, liabilities were assumed as
follows:
<CAPTION>
Nine months ended
September 30,
-----------------------
1999 1998
----------- -----------
(amounts in thousands)
<S> <C> <C>
Fair value of asset acquired..................... $ 43,425 --
Cash paid........................................ 8,606 --
Value of common stock issued..................... 3,250 --
----------- ----------
Liabilities assumed.............................. $ 31,569 --
=========== ==========
</TABLE>
F-8
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Unaudited)
7. Pending Transaction
On May 25, 1999, the Company signed a definitive agreement to merge with UC
Acquisition Sub, Inc., a corporation formed by Kelso & Company ("Kelso"). Kelso
is a private investment firm based in New York. The transaction is valued at
approximately $437 million, including indebtedness of approximately $145
million which will be refinanced. Unilab will continue to operate as an
independent company under its current name.
Pursuant to a merger agreement, all but approximately 1.8 million shares of
common stock of the Company (approximately 7% of the Company's post-merger
shares outstanding) will be converted into the right to receive $5.85 per
common share in cash, with the Company's current stockholders retaining those
1.8 million shares. Unilab currently has 42.0 million shares of common stock
outstanding, excluding outstanding options and convertible securities.
Following the merger, Kelso and its affiliates are expected to own
approximately 93% of the Company's outstanding shares. Kelso and its affiliates
will invest approximately $139 million of equity in the transaction. The
transaction is structured to be accounted for as a recapitalization for
accounting purposes.
As part of the Company's refinancing of its existing indebtedness and
obtaining additional financing to pay the merger consideration, the Company
sold $155 million of 10-year notes (the "Senior Notes") in a private placement
in the Rule 144A market. Interest on the Senior Notes is 12.75% and the Company
is not required to make any mandatory redemption or sinking fund payment with
respect to the Senior Notes prior to maturity. The Senior Notes were issued at
a discounted rate of 97.268% per note. The aggregate discount on the Senior
Notes approximated $4.2 million and will be charged to operations as additional
interest expense over the life of the Senior Notes using the interest method
starting at the completion of the merger agreement. In order to complete the
Senior Notes offering, the Company was required to place in escrow $5.6
million, which represents interest expense on the Senior Notes from September
28, 1999 through January 20, 2000 (the mandatory redemption date of the Senior
Notes if the merger agreement is not finalized by January 20, 2000), offset by
the expected interest income earned on the escrow deposit. In addition, the
Company was required to place in escrow a breakage premium of 1% of the net
proceeds from the Senior Notes offering in the event the merger agreement is
not finalized. Net interest of approximately $103,000 was earned on the Senior
Notes from September 28 through September 30 and the remaining escrow balance
of approximately $5.5 million has been shown as restricted cash on the
Company's balance sheet at September 30, 1999.
The Company mailed a Proxy Statement to shareholders on October 26, 1999
asking shareholders to approve the merger agreement at a special meeting of
shareholders scheduled for November 23, 1999. The merger is subject to approval
by the Company's shareholders and other customary conditions.
F-9
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Unilab Corporation
We have audited the accompanying balance sheets of Unilab Corporation (a
Delaware corporation) as of December 31, 1998 and 1997, and the related
statements of operations, shareholders' equity (deficit) and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Unilab Corporation as of
December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
Arthur Andersen llp
Los Angeles, California
February 12, 1999
F-10
<PAGE>
UNILAB CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the years ended December 31,
-------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
(amounts in thousands, except per share data)
<S> <C> <C> <C>
Revenue.................... $ 217,370 $ 214,001 $ 205,217
--------------- --------------- ---------------
Direct Laboratory and Field
Expenses:
Salaries, wages and
benefits................ 67,742 69,094 70,869
Supplies................. 30,671 29,858 28,631
Other operating
expenses................ 53,594 56,990 54,672
--------------- --------------- ---------------
152,007 155,942 154,172
Legal and acquisition
related charges........... -- -- 4,940
Restructuring charges...... -- -- 65,655
Amortization and
depreciation.............. 7,592 8,885 11,491
Selling, general and
administrative expenses... 33,530 34,570 41,801
--------------- --------------- ---------------
Total Operating
Expenses.............. 193,129 199,397 278,059
--------------- --------------- ---------------
Operating Income (Loss).... 24,241 14,604 (72,842)
Other Income (Expenses):
Third party interest,
net..................... (13,538) (14,068) (13,401)
Related party interest,
net..................... -- -- 1,279
Loss on sale of
promissory note......... -- -- (4,529)
--------------- --------------- ---------------
Total Other Income
(Expenses)............ (13,538) (14,068) (16,651)
--------------- --------------- ---------------
Income (Loss) Before Income
Taxes and Extraordinary
Item...................... 10,703 536 (89,493)
Tax Provision.............. -- -- --
--------------- --------------- ---------------
Income (Loss) Before
Extraordinary Item........ 10,703 536 (89,493)
Extraordinary Item--loss on
early extinguishment of
debt...................... -- -- 3,451
--------------- --------------- ---------------
Net Income (Loss).......... $ 10,703 $ 536 $ (92,944)
--------------- --------------- ---------------
Preferred Stock Dividends.. 131 138 144
Net Income (Loss) Available
to Common Shareholders.... $ 10,572 $ 398 $ (93,088)
=============== =============== ===============
Basic Earnings Per Share:
Income (Loss) Before
Extraordinary Item........ $ 0.26 $ 0.01 $ (2.43)
Extraordinary Item......... -- -- (0.10)
Net Income (Loss).......... $ 0.26 $ 0.01 $ (2.53)
=============== =============== ===============
Diluted Earnings Per Share:
Income (Loss) Before
Extraordinary Item........ $ 0.25 $ 0.01 $ (2.43)
Extraordinary Item......... -- -- (0.10)
Net Income (Loss).......... $ 0.25 $ 0.01 $ (2.53)
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-11
<PAGE>
UNILAB CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------
1998 1997
Assets --------- --------
(amounts in
thousands, except
per share data)
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................ $ 20,137 $ 11,652
Accounts receivable, net of allowance for doubtful
accounts
of $10,813 and $9,819 in 1998 and 1997, respectively.... 41,326 36,583
Inventory of supplies.................................... 3,055 2,811
Prepaid expenses and other current assets................ 1,045 1,295
--------- --------
Total Current Assets................................... 65,563 52,341
--------- --------
Property and Equipment, net.............................. 11,277 13,160
Goodwill, net of accumulated amortization of $7,754
and $6,368 in 1998 and 1997, respectively............... 56,949 43,699
Other Intangible Assets, net............................. 2,370 2,731
Other Assets............................................. 6,301 6,769
--------- --------
$ 142,460 $118,700
========= ========
Liabilities and Shareholders' Equity
Current Liabilities:
Current portion of long-term debt........................ $ 1,206 $ 1,811
Accounts payable and accrued liabilities................. 14,533 15,678
Accrued payroll and benefits............................. 6,892 6,302
--------- --------
Total Current Liabilities.............................. 22,631 23,791
--------- --------
Long-Term Debt, net of current portion................... 137,170 124,285
Other Liabilities........................................ 4,026 2,907
Commitments and Contingencies
Shareholders' Equity (Deficit):
Convertible preferred stock, $.01 par value; Authorized--
20,000 shares;
Issued and Outstanding--364 at December 31, 1998 and
1997
Liquidation preference--$2,093.......................... 4 4
Common stock, $.01 par value; Voting--Authorized--100,000
shares;
Issued and Outstanding--40,708 and 40,578 at December
31, 1998 and 1997, respectively......................... 407 406
Additional paid-in capital............................... 228,395 228,052
Accumulated deficit...................................... (250,173) (260,745)
--------- --------
Total Shareholders' Equity (Deficit)................... (21,367) (32,283)
--------- --------
$ 142,460 $118,700
========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-12
<PAGE>
UNILAB CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Voting Non-Voting Convertible Total
Common Stock Common Stock Preferred Stock Additional Shareholders'
-------------- -------------- ------------------ Paid-In Accumulated Equity
Shares Amount Shares Amount Shares Amount Capital Deficit (Deficit)
------ ------ ------ ------ ------- ------- ---------- ----------- -------------
(amounts in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31,
1995................... 35,052 $351 1,050 $ 10 400 $ 4 $224,020 $(168,055) $ 56,330
Issuance of shares in
connection with a prior
acquisition............ 413 4 -- -- -- -- 996 -- 1,000
Restricted shares issued
to employees........... 100 1 -- -- -- -- 350 -- 351
Issuance of shares for
Company's 401(k) plan
matching
contributions.......... 434 4 -- -- -- -- 544 -- 548
Issuance of shares to
certain executives in
lieu of monthly cash
compensation........... 164 2 -- -- -- -- 108 -- 110
Issuance of shares to a
consultant for services
rendered............... 50 1 -- -- -- -- 43 -- 44
Issuance of shares to
certain Board Directors
for services rendered.. 22 -- -- -- -- -- 17 -- 17
Conversion of non-voting
common stock to voting
common stock........... 1,050 10 (1,050) (10) -- -- -- -- --
Issuance of preferred
stock dividend--$0.36
per share.............. -- -- -- -- -- -- -- (144) (144)
Net loss................ -- -- -- -- -- -- -- (92,944) (92,944)
------ ---- ------ ---- ------- ------- -------- ---------- --------
Balances, December 31,
1996................... 37,285 $373 -- $-- 400 $ 4 $226,078 $ (261,143) $(34,688)
Restricted shares issued
to employees........... 15 -- -- -- -- -- 237 -- 237
Restricted shares
forfeited by
employees.............. (20) -- -- -- -- -- (45) -- (45)
Issuance of shares for
Company's 401(k) plan
matching
contributions.......... 29 -- -- -- -- -- 49 -- 49
Issuance of shares to
certain Board Directors
for services rendered.. 84 1 -- -- -- -- 63 -- 64
Conversion of preferred
stock to common stock.. 36 -- -- -- (36) -- -- -- --
Issuance of shares at
$0.625 upon exercise of
stock options.......... 75 1 -- -- -- -- 46 -- 47
Issuance of shares to
the Company's former
CEO in connection with
CEO's resignation...... 500 5 -- -- -- -- 214 -- 219
Shares sold to the
Company's former CEO
pursuant to transition
agreements in
connection with CEO's
resignation............ 533 5 -- -- -- -- 295 -- 300
Shares sold to Company's
current CEO pursuant to
an employment
agreement.............. 1,143 12 -- -- -- -- 488 -- 500
Issuance of shares to
Company's current CEO
as bonus pursuant to an
employment agreement... 229 2 -- -- -- -- 98 -- 100
Shares sold to a Board
Director pursuant to
the 1997 Directors'
Stock Purchase Plan.... 500 5 -- -- -- -- 276 -- 281
Issuance of shares to
employees as special
year-end bonus......... 169 2 -- -- -- -- 253 -- 255
Issuance of preferred
stock dividend--$0.36
per share.............. -- -- -- -- -- -- -- (138) (138)
Net income.............. -- -- -- -- -- -- -- 536 536
------ ---- ------ ---- ------- ------- -------- ---------- --------
Balances, December 31,
1997................... 40,578 $406 -- $-- 364 $ 4 $228,052 $ (260,745) $(32,283)
Issuance of shares to
certain Board Directors
for services rendered.. 72 1 -- -- -- -- 159 -- 160
Issuance of shares at
$0.63--$2.19 upon
exercise of options.... 19 -- -- -- -- -- 15 -- 15
Issuance of shares for
Company's 401(k) plan
matching
contributions.......... 14 -- -- -- -- -- 25 -- 25
Restricted shares issued
to employees........... 17 -- -- -- -- -- 132 -- 132
Issuance of shares to
part-time employees as
special bonus.......... 8 -- -- -- -- -- 12 -- 12
Issuance of preferred
stock dividend--$0.36
per share.............. -- -- -- -- -- -- -- (131) (131)
Net income.............. -- -- -- -- -- -- -- 10,703 10,703
------ ---- ------ ---- ------- ------- -------- ---------- --------
Balances, December 31,
1998................... 40,708 $407 -- $-- 364 $ 4 $228,395 $ (250,173) $(21,367)
------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-13
<PAGE>
UNILAB CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the years ended
December 31,
-----------------------------
1998 1997 1996
-------- -------- ---------
(in thousands)
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net income (loss).............................. $ 10,703 $ 536 $ (92,944)
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating
activities:
Amortization and depreciation................ 7,592 8,885 11,491
Provision for doubtful accounts.............. 15,662 15,663 14,180
Loss on sale of promissory note.............. -- -- 4,529
Write-off of goodwill and customer lists..... -- -- 61,645
Extraordinary item--loss on early
extinguishment of debt...................... -- -- 3,451
Net changes in assets and liabilities affecting
operations, net of acquisitions:
Increase in Accounts receivable.............. (17,154) (14,967) (11,125)
Increase in Inventory of supplies............ (106) (207) (243)
Decrease in Prepaid expenses and other
current assets.............................. 250 407 117
(Increase) decrease in Other assets.......... (112) (1,107) 229
Increase (decrease) in Accounts payable and
accrued liabilities......................... (4,047) (7,221) 1,112
Increase in Accrued payroll and benefits..... 800 816 1,504
Other........................................ 408 910 926
-------- -------- ---------
Net cash provided (used) by operating
activities.................................... 13,996 3,715 (5,128)
-------- -------- ---------
Cash Flows From Financing Activities:
Borrowings under third party debt.............. -- -- 123,490
Payments of third party debt................... (1,720) (1,776) (104,772)
Financing costs under the Senior Notes and
Receivables Financing......................... -- -- (4,932)
Proceeds from the sale of stock................ -- 581 --
Proceeds from exercise of options.............. 15 47 --
Other.......................................... (131) (236) --
-------- -------- ---------
Net cash provided (used) by financing
activities.................................... (1,836) (1,384) 13,786
-------- -------- ---------
Cash Flows From Investing Activities:
Capital expenditures........................... (3,005) (1,935) (3,948)
Payments for acquisitions, net of cash
acquired...................................... (670) (1,824) (2,700)
Net cash proceeds from sale of equity
investment and promissory note................ -- -- 11,000
-------- -------- ---------
Net cash provided (used) by investing
activities.................................... (3,675) (3,759) 4,352
-------- -------- ---------
Net Increase (Decrease) in Cash and Cash
Equivalents................................... 8,485 (1,428) 13,010
Cash and Cash Equivalents--Beginning of Year... 11,652 13,080 70
-------- -------- ---------
Cash and Cash Equivalents--End of Year......... $ 20,137 $ 11,652 $ 13,080
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-14
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Description of the Company and Significant Accounting Policies
a. Description of the Company
Unilab Corporation ("Unilab" or the "Company") provides clinical laboratory
testing services to physicians, managed-care organizations, hospitals and other
health care providers primarily in the State of California.
b. Inventory of Supplies
Inventories, which consist principally of purchased clinical laboratory
supplies, are valued at the lower of cost (first-in, first-out) or market.
c. Revenue Recognition
Revenue is recognized at the time the service is provided. The Company's
revenue is based on amounts billed or billable for services rendered, net of
contractual adjustments and other arrangements made with third-party payors to
provide services at less than established billing rates.
In addition, certain laboratory services are provided pursuant to managed
care contracts which provide for the payment of capitated fees (a fixed monthly
fee per individual enrolled with a managed care plan for some or all laboratory
tests performed during the month) rather than individual fees for tests
actually performed. Revenue under capitated arrangements is recognized monthly
when billed or when due under the terms of the related contracts.
d. Use of Estimates
The preparation of the financial statements requires management to make
estimates and assumptions that effect 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 revenue and expenses
during the reporting period. Actual results could differ from these estimates.
The most significant estimates with regards to these financial statements
relate to accounts receivable and insurance reserves.
The Company's net accounts receivable balance is determined after deductions
for contractual adjustments, which are estimated based on established billing
rates made with third party payors, and an allowance for doubtful accounts,
which primarily is based on the aging of the accounts and historical collection
experience. In addition, the Company accrues for both asserted and unasserted
claims arising from workers' compensation (1994 and 1995 only) and automobile
liability losses (1994 through 1997 only). The estimate of the liability for
unasserted claims arising from unreported incidents is based on an analysis of
historical claims experience.
e. Fair Value of Financial Instruments and Concentration of Credit Risk
The carrying amount reported in the balance sheets for cash, accounts
receivable, accounts payable and accrued liabilities approximates fair value
because of the immediate or short-term maturity of these financial instruments.
The fair value of the Company's $120.0 million of senior notes approximates
$125.4 million based on quotes from brokers. The Company believes that its non-
bank indebtedness approximates fair value based on current yields for debt
instruments of similar quality and terms.
Concentration of credit risk with respect to accounts receivable are limited
due to the diversity of the Company's client base. However, the Company
provides services to certain patients covered by various third-party payors,
including the Federal and California Medicare/Medicaid programs. Revenue, net
of contractual allowances, from direct billings under Federal and California
Medicare/Medicaid programs during each of the years ended December 31, 1998,
1997 and 1996 approximated 25-30% of revenue.
F-15
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
f. Property and Equipment
Property and equipment are stated at cost and depreciated using the straight-
line method over the estimated useful lives of the related assets. Buildings
are depreciated over 28 years, laboratory and computer equipment are generally
depreciated over 7 and 3 years, respectively, and furniture and fixtures are
depreciated over 5 years. Leasehold improvements are amortized using the
straight-line method over the remaining term of the related lease. Major
repairs which extend the life or add value to equipment are capitalized and
depreciated over their remaining useful life.
g. Goodwill
Goodwill represents the excess of cost over the fair value of net tangible
and identifiable intangible assets acquired and is amortized using the
straight-line method. Goodwill is amortized over 40 years for acquisitions
completed prior to January 1, 1995 and over 20 years for acquisitions after
that date. The Company continually evaluates whether events and circumstances
have occurred that indicate the remaining estimated useful life of goodwill
might warrant revision or that the remaining balance of goodwill and other
long-lived assets may not be recoverable. When factors indicate that goodwill
and other long-lived assets should be evaluated for possible impairment, the
Company uses an estimate of undiscounted future net cash flows over the
remaining life of goodwill to determine if impairment has incurred. Assets are
grouped at the lowest level for which there are identifiable cash flows that
are largely independent from other asset groups. The Company uses discounted
future expected net cash flows to determine the amount of impairment loss.
h. Other Intangible Assets
Customer lists and covenants not to compete are recorded at cost and are
amortized utilizing the straight-line method over the estimated lives of the
assets, generally 10 years for customer lists and 3-5 years for covenants not
to compete. The cost of other intangible assets is evaluated periodically and
adjusted, if necessary, if later events and circumstances indicate that a
permanent decline in value below the current unamortized historical cost has
occurred.
i. Income Taxes
The Company recognizes deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the basis for
financial reporting purposes and the basis for tax purposes, in accordance with
Statement of Financial Accounting Standards No. 109 ("FAS 109"), "Accounting
for Income Taxes".
j. Earnings Per Common Share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("FAS 128"), "Earnings Per Share",
which requires the disclosure of a basic and diluted earnings per share. The
implementation of FAS 128 had no impact on the calculation of earnings per
share previously reported for the year ended December 31, 1996.
Basic earnings per common share has been computed by dividing the net income
(loss) less preferred dividends by the weighted average number of common shares
outstanding for each period presented. The weighted average number of common
shares used in the calculation of basic earnings per share was 40.7 million,
39.9 million and 36.8 million for the years ended December 31, 1998, 1997, and
1996, respectively.
Diluted earnings per share includes the effect of additional common shares
that would have been outstanding if dilutive potential common shares had been
issued plus a reduction of interest expense assuming conversion of the
convertible debt. No dilutive securities existed in 1996. In 1997, the weighted
average number of dilutive stock options were 0.6 million, which had no effect
on the basic earnings per share calculation. In 1998, the weighted average
number of dilutive stock options were 1.4 million and the incremental shares
from the assumed conversion of the $14.0 million subordinated convertible note
were
F-16
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
0.7 million, which reduced the earnings per share calculation by $0.01. The
assumed conversion of the convertible preferred stock is excluded from the
calculation since its effect would be immaterial.
Options to purchase 2.1 and 2.9 million shares of common stock at prices
ranging from $2.63 to $6.88 and $1.19 to $6.88 were outstanding at December 31,
1998 and 1997, respectively, but were not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price for the year of the Company's common shares.
k. Cash and Cash Equivalents
For the purpose of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three months
or less to be cash equivalents.
2. Property and Equipment, Net and Other Intangible Assets
Property and equipment, net consists of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------- -------
(in thousands)
<S> <C> <C>
Buildings................................................... $ 3,166 $ 3,166
Leasehold improvements...................................... 5,564 5,236
Laboratory and other equipment.............................. 30,053 29,700
Furniture and fixtures...................................... 3,459 3,391
------- -------
42,242 41,493
Less accumulated depreciation and amortization.............. 30,965 28,333
------- -------
$11,277 $13,160
======= =======
</TABLE>
Depreciation expense was approximately $5.0 million in 1998, $6.0 million in
1997 and $5.0 million in 1996.
Other intangible assets consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------
1998 1997
------ ------
(in
thousands)
<S> <C> <C>
Customer lists................................................ $7,675 $7,675
Covenants not to compete...................................... 235 300
------ ------
7,910 7,975
Less accumulated amortization................................. 5,540 5,244
------ ------
$2,370 $2,731
====== ======
</TABLE>
Amortization expense for goodwill, other intangible assets and certain other
deferred costs was approximately $2.6 million in 1998, $2.9 million in 1997 and
$6.5 million in 1996.
3. Acquisitions
On September 16, 1998, the Company and Meris Laboratories, Inc. ("Meris")
signed an asset purchase agreement whereby Unilab acquired substantially all of
the assets of Meris. The agreement was approved on October 28, 1998 by the
United States Bankruptcy Court in Los Angeles, California and Unilab took
possession of the acquired net assets on November 5, 1998. The purchase price
consisted of the issuance of a
F-17
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
$14.0 million convertible subordinated note, $2.5 million in cash payable in
seventy-two equal monthly installments and the assumption of net assets of $3.5
million, consisting primarily of accounts receivable. The acquisition was
accounted for under the purchase method of accounting and the statements of
operations include the results of Meris since November 5, 1998.
The purchase price was allocated to the net assets acquired based on their
fair value at the date of acquisition, as follows:
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Accounts receivable........................................ $ 3,251
Inventory of supplies...................................... 138
Property and equipment..................................... 175
Goodwill................................................... 14,889
Other intangible assets-non-compete agreements............. 235
Other assets............................................... 46
-------
Assets Acquired........................................... 18,734
=======
Issuance of convertible subordinated notes................. 14,000
Accrued employee benefits.................................. 306
Assumed accounts payable................................... 2,520
Liabilities associated with integration period............. 1,400
Acquisition fees, primarily legal costs.................... 508
-------
Liabilities assumed or incurred........................... $18,734
=======
</TABLE>
As noted in the table above and in connection with the integration of the
acquired Meris operations with those of Unilab, the Company recorded
liabilities of $1.4 million, primarily related to severance (for the reduction
in headcount of approximately 230 employees) and other employee related
liabilities. At December 31, 1998, approximately $1.3 million of liabilities,
expected to be paid in the first six months of 1999, were outstanding.
The following unaudited pro forma results of operations for the years ended
December 31, 1998 and 1997 (in thousands except per share data) have been
prepared as if the acquisition of Meris occurred on January 1, 1997:
<TABLE>
<CAPTION>
Years Ended
December 31,
-----------------
1998 1997
-------- --------
(Unaudited)
<S> <C> <C>
Revenue................................................... $239,649 $243,904
Net Income................................................ 16,371 5,859
Net income available to common shareholders............... 16,263 5,721
Earnings per share:
Basic................................................... 0.40 0.14
Diluted................................................. 0.37 0.14
</TABLE>
The historical financial results of Unilab for 1998 and 1997 have been
adjusted primarily for the historical results of Meris, an increase in interest
expense due to the additional debt incurred to purchase Meris, an increase in
amortization of goodwill and cost savings from the integration of the Meris
operations into Unilab.
The unaudited pro forma information presented above does not purport to be
indicative of the results that actually would have been obtained if the
combined operations had been conducted during the periods presented or of
future operations of the combined operations.
F-18
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
4. Restructuring Charges
During the fourth quarter of 1996, the Company recorded charges of $65.7
million, consisting of the write-off of goodwill and customer lists of $61.7
million, and a reserve for managerial restructuring expenses, consisting
primarily of severance related expenses, of $4.0 million. The write-off of
goodwill and customer lists principally related to two of the Company's
laboratory operations, which had seen decreasing operating results and cash
flows throughout 1996.
The $4.0 million managerial restructuring expenses related primarily to a
reduction in headcount of approximately 25 employees, including the resignation
of the Company's then Chairman, President and Chief Executive Officer in
January 1997. Most affected employees were terminated in late December through
mid January. At December 31, 1998, approximately $0.5 million of liabilities
were outstanding and such amount is expected to be paid in 1999.
5. Legal and Acquisition Related Charges
During the third quarter of 1996, the Company recorded charges of $4.9
million, primarily related to settlements reached with the United States
("U.S.") Government, and certain other entities in connection with the
Company's sales, marketing and billing practices. The Company agreed to pay the
U.S. Government approximately $4.0 million to conclude an investigation of
certain of Unilab's billings to Medicare and certain other governmental
entities for hematology indices being billed in conjunction with complete blood
counts. The Company has remaining payments to the U.S. Government of $500,000
due March 1, 1999 and approximately $324,000 due on September 1, 1999. All
deferred payments to the U.S. Government bear interest at approximately 5.2
percent. In addition, Unilab paid the California MediCal program approximately
$160,000 in October 1996 to settle all their claims concerning the same issue.
6. Income Taxes
For the years ended December 31, 1998, 1997 and 1996, income (loss) before
income taxes consisted of domestic earnings (losses) and no provision for
Federal or State income taxes was recorded.
A reconciliation between the actual income tax expense and income taxes
computed by applying the statutory Federal income tax rate to earnings before
income taxes is as follows:
<TABLE>
<CAPTION>
Years Ended December
31,
------------------------
1998 1997 1996
------- ----- --------
(in thousands)
<S> <C> <C> <C>
Computed income taxes at U.S. statutory rate...... $ 3,746 $ 188 $(31,601)
Amortization and write-off of goodwill and
intangible assets disallowed for income tax
purposes......................................... 420 420 1,140
Capital and operating losses with no tax benefit.. -- -- 30,461
Change in valuation allowance..................... (4,166) -- --
Other............................................. -- (608) --
------- ----- --------
$ -- $ -- $ --
======= ===== ========
</TABLE>
F-19
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
Temporary differences and carryforwards, excluding the capital loss
carryforward discussed below, which give rise to deferred tax assets are as
follows:
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
(in thousands)
<S> <C> <C>
Bad debt reserve......................................... $ 2,972 $ 2,563
Intangible assets........................................ 9,807 11,752
Property and equipment................................... 383 383
Accrued liabilities...................................... 1,408 2,254
Net operating loss carryforwards......................... 21,166 21,761
-------- --------
35,736 38,713
Valuation allowance...................................... (35,736) (38,713)
-------- --------
$ -- $ --
======== ========
</TABLE>
The realization of the deferred tax assets at December 31, 1998 is dependent
upon the Company having future taxable income. A valuation allowance has been
provided against the entire deferred tax asset balance at December 31, 1998 and
1997. Approximately $4.0 million of benefit, if any, to be recorded from the
recognition of the deferred tax assets would reduce the amount of goodwill
recorded from certain acquisitions.
In addition, the Company has a capital loss of approximately $36.5 million
from the sale of an equity investment in 1995. The capital loss can only be
utilized by the Company to the extent it offsets capital gains generated. A
valuation allowance has also been entirely provided against the available
capital loss at December 31, 1998 and 1997.
The Company has net operating loss and capital loss carryforwards for tax
purposes in the U.S. which are available to offset future taxable income
through 2012 and 2000, respectively. At December 31, 1998, available net
operating loss and capital loss carryforwards for U.S. tax purposes were
approximately $62.0 million and $36.5 million, respectively. Net operating loss
carryforwards for California state tax purposes were approximately $31.0
million.
7. Loss on Sale of Promissory Note
In November 1996, the Company sold a 100% participation interest in its
rights under a $15.0 million promissory note (which the Company received upon
the sale of an equity investment in 1995) to a third party for $11.0 million.
The Company recorded a $4.5 million loss upon the sale, which reflected the
$4.0 million loss in principal plus the write-off of accrued and unpaid
interest from July 1, 1996 through the sale date of $0.5 million.
F-20
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
8. Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1997
-------- --------
(in thousands)
<S> <C> <C>
Senior Notes, interest at 11.0 percent payable semi-
annually................................................ $119,344 $119,253
Convertible subordinated note, interest at 7.5 percent
payable semi-annually................................... 14,000 --
Obligation under capital lease collateralized by land and
building with interest due through 2004................. 2,867 3,054
Obligations under capital leases collateralized by
equipment with interest due through 2000................ 2,165 3,789
-------- --------
138,376 126,096
Less -- current portion.................................. 1,206 1,811
-------- --------
$137,170 $124,285
======== ========
</TABLE>
In March 1996, the Company completed an offering of $120.0 million of senior
notes (the "Senior Notes"). The proceeds from the Senior Notes offering were
used to retire outstanding borrowings under the Company's then existing bank
term loan and revolving line of credit facility in the principal amount of
$102.1 million, plus accrued interest. Interest on the Senior Notes is 11% and
is payable on April 1st and October 1st of each year. The Senior Notes are due
April 2006 and the Company is not required to make any mandatory redemption or
sinking fund payment with respect to the Senior Notes prior to maturity.
In connection with the Senior Notes offering and the accounts receivable
financing discussed below, the Company incurred approximately $5.0 million of
financing costs. The debt financing costs are deferred and amortized, using the
interest method, over the term of the related debt. Upon completion of the
Senior Notes offering, the Company wrote off $3.5 million of deferred financing
costs related to the Company's previous credit facility in the first quarter of
1996. The $3.5 million charge has been shown as an extraordinary loss from the
early extinguishment of debt in the statement of operations.
The Senior Notes were issued at a discount of 99.242% per note. The aggregate
discount on the Senior Notes approximated $0.9 million and is charged to
operations as additional interest expense over the life of the Senior Notes
using the interest method. At December 31, 1998, the unamortized discount
approximated $0.7 million.
The Senior Notes are not redeemable prior to April 1, 2001, after which the
Senior Notes will be redeemable at any time at the option of the Company, in
whole or in part, at various redemption prices as set forth in the indenture
covering such Senior Notes (the "Indenture"), plus accrued and unpaid interest,
if any, to the date of redemption. In addition, at any time prior to April 1,
1999, the Company may redeem up to $42.0 million in aggregate principal amount
of the Senior Notes with the net proceeds of one or more public offerings of
common stock of the Company, at a redemption price of 110% of the principal
amount thereof, plus accrued and unpaid interest, if any, to the redemption
date.
In the event of a change in control, as defined in the Indenture, holders of
the Senior Notes will have the right to require the Company to purchase their
Notes, in whole or in part, at a price equal to 101% of the aggregate principal
amount thereof, plus accrued and unpaid interest, if any, to the date of
purchase.
F-21
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
The Notes are general unsecured obligations of the Company and rank pari
passu in right of payment with all unsubordinated indebtedness of the Company.
In addition, the Indenture limits the ability of the Company to incur
additional indebtedness, under certain circumstances.
In connection with the acquisition of Meris (see Note 3), the Company issued
a $14.0 million convertible subordinated note, bearing interest at the rate of
7.5%, payable in cash or in kind, at the Company's option (other than the
interest payment due in November 2006, which will be payable in cash). Interest
is payable on May 5 and November 5 of each year. The note is subordinated to
the Senior Notes and is due in November 2006.
The note is convertible into the Company's common stock at a conversion price
of $3.00 per share; however, the holder of such note cannot exercise its
conversion right unless the Company's average stock price during the thirty day
trading period preceding an offer to convert is equal to or greater than $3.60
a share (the "Offer Date"). The holder of the note can convert up to one-half
of the note during the first four years; any outstanding balance after November
2002 may be converted by the holder through the maturity date. The Company, at
its option, can force conversion of the note, in whole or in part, at any Offer
Date.
In addition, at the Company's option, the note may be redeemed, in whole or
in part, at any Offer Date; provided that the holder of such note may exercise
its conversion right to the extent noted in the preceding paragraph rather than
being redeemed. The redemption price would equal the face value of the note
being redeemed times a premium percentage (the average stock price during the
specified period divided by $3.00). If the note has not been converted or
redeemed prior to maturity, the remaining note balance will be paid in cash at
the then outstanding principal amount of the note. In the event of a change in
control, as defined in the note, the outstanding principal amount of the note
shall be automatically converted into shares of the Company's common stock.
In July 1996, the Company entered into an agreement with a financial
institution whereby it can sell accounts receivable up to a maximum of $20.0
million. As collections reduce accounts receivables which have been sold, the
Company may sell new receivables to bring the amount sold up to a maximum of
$20.0 million.
As of December 31, 1998, the Company had not sold any accounts receivable
under this agreement. Sales of receivables, if any, under the facility are
subject to a liquidity and debt service coverage ratio. The Company was in
compliance with such covenants in 1998. The termination date for the agreement
is July 1999. If the facility terminates prior to July 1999 for any reason, the
Company is obligated to pay a $200,000 early termination fee. A commitment fee
of 1/2 percent is required on the unused portion of the available facility. The
Company retains collection and administrative responsibilities on the
receivables sold as agent for the purchaser. In addition, accounts receivable
sold, if any, will be reflected as a reduction of accounts receivable in the
balance sheet. The full amount of the allowance for doubtful accounts will be
retained because the Company will retain substantially the same risk of credit
loss as if the receivables had not been sold.
At December 31, 1998, future scheduled principle payments of long-term debt
are as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
<S> <C>
1999................................ $ 1,206
2000................................ 1,557
2001................................ 442
2002................................ 562
2003................................ 706
Thereafter.......................... 133,903
--------
$138,376
========
</TABLE>
F-22
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
9. Capital Shares, Stock Options and Warrants
a. Convertible Preferred Stock
As of December 31, 1998, the Company has authorized 20,000,000 shares of
preferred stock at $.01 par value. The Board of Directors of the Company will
determine, among other things, the number of shares, voting rights, dividend
rates, liquidation preferences, and redemption and conversion privileges of
each series of such preferred stock. As of December 31, 1998, 18,600,000 shares
for which no series has been designated were authorized and unissued.
The Company has 364,000 shares of convertible preferred stock outstanding at
December 31, 1998. Holders of the convertible preferred stock are entitled to
receive, when and as declared by the Board of Directors of the Company,
cumulative dividends at an annual rate of $0.36 per share, payable semiannually
on June 30 and December 30 in each year. The convertible preferred stock is
convertible on a share for share basis into shares of the Company's common
stock, at the holder's option, at any time from and after November 10, 1996.
36,000 shares of preferred shares were converted into common stock during 1997.
In addition, the convertible preferred stock has a liquidation preference of
$5.75 per share and the Company has the right at its sole option to redeem the
shares any time after November 10, 1998, in whole or in part, at a redemption
price of $5.75 per share plus an amount equal to all declared and unpaid
dividends thereon to the redemption date.
b. Non-Voting Common Stock
At the Company's May 1996 annual meeting of stockholders, an amendment to the
Company's Certificate of Incorporation was approved and adopted by stockholders
permitting the holder of all the 1,050,000 outstanding shares of the Company's
non-voting common stock to convert such shares into regular voting common
stock. In July 1996, all of the outstanding shares of non-voting stock were
converted into shares of the Company's voting common stock on a share for share
basis.
c. Restricted Stock
The Company granted 17,000 restricted shares, 15,000 restricted shares and
99,500 restricted shares of common stock to certain employees at no cost in
1998, 1997 and 1996, respectively. The outstanding restricted shares vest
ratably each year on their anniversary date and become fully vested after a
period of two to five years. The cost of the restricted shares based on the
shares fair market value at the award dates, is charged to shareholders' equity
and subsequently amortized against earnings over the vesting period. At
December 31, 1998, 260,834 restricted shares were outstanding and approximately
$132,000, $192,000 and $351,000 was amortized to expense in 1998, 1997 and
1996, respectively.
d. Stock Options
Employee Stock Option Plan
In 1996, the Company's shareholders approved the adoption of the Unilab
Corporation Stock Option and Performance Incentive Plan (the "1996 Option
Plan") which effectively replaced and superseded both the Stock Option Program
for Key Executives (the "Key Executive Plan") and a stock option plan for the
benefit of a broad base of Company employees (the "1995 Option Plan"). The 1995
Option Plan was amended to discontinue grants under that plan. The 1996 Option
Plan provides one comprehensive plan for all employees and all future grants to
employees will be made under the 1996 Option Plan.
Under the terms of the 1996 Option Plan, incentive stock options, non-
statutory stock options, reload options or rights, stock appreciation rights,
restricted or unrestricted shares of Unilab stock, performance shares or units
and tax offset payments can be granted to any of the Company's employees, with
limited exceptions, and options for a maximum of 4,000,000 shares of the
Company's common stock may be granted. No employee may receive annual awards of
or relating to more than 250,000 shares of Unilab common stock.
F-23
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
The 1996 Option Plan is administered by a committee of the Board of Directors
(the "Administrator"). The number of options or awards granted, exercise price,
vesting and term will be determined by the Administrator. At December 31, 1998,
and 1997, 3,016,999 and 2,202,334 options, respectively, were outstanding under
the aggregate of the 1996 Option Plan, the 1995 Option Plan and the Key
Executive Plan.
Stock Program for Directors
In April 1997, the Company reserved 1,500,000 shares under a plan whereby
members of the Company's Board of Directors may purchase common shares at the
then current market price of the shares (the "1997 Directors Stock Purchase
Plan"). 500,000 shares were purchased in 1997 and 1,000,000 shares remain
outstanding under the 1997 Directors Stock Purchase Plan at December 31, 1998.
In 1996, the Company's shareholders approved the adoption of the Unilab
Corporation Non-Employee Directors Stock Plan (the "1996 Directors Plan"),
which effectively replaced the Stock Option Program for Directors (the "1995
Directors Plan").
Under the terms of the 1996 Directors Plan, each outside director will
receive an annual option grant of 10,000 shares and an additional annual option
grant of 10,000 shares will be awarded to each outside director who serves as
the chairman of a committee or committees of the Board of Directors. 50 percent
of options granted under the 1996 Directors Plans are exercisable immediately
and 50 percent are exercisable in one year.
At December 31, 1998 and 1997, 255,000 and 200,000 options, respectively,
were outstanding under the aggregate of the 1996 and 1995 Directors Plans.
Other
Prior to the adoption of the 1996 Option Plan and the 1996 Directors Plan,
the Company's Board of Directors also authorized the grant of nonqualified
stock options to individuals.
Information regarding the Company's stock option plans and nonqualified stock
options as of December 31, 1996, 1997 and 1998, and changes during the years
ending on those dates is summarized as follows:
<TABLE>
<CAPTION>
Weighted-
Average Exercise
Shares Price
--------- --------
<S> <C> <C>
December 31, 1995........................................ 3,478,500 $5.40
Granted................................................ 681,500 2.11
Exercised.............................................. -- --
Forfeited.............................................. (280,500) 5.56
--------- -----
December 31, 1996........................................ 3,879,500 $4.73
Granted................................................ 1,751,000 0.62
Exercised.............................................. (75,000) 0.63
Forfeited.............................................. (999,166) 4.76
--------- -----
December 31, 1997........................................ 4,556,334 $3.21
Granted................................................ 949,500 2.00
Exercised.............................................. (19,500) 0.79
Forfeited.............................................. (170,835) 4.05
--------- -----
December 31, 1998........................................ 5,315,499 $2.94
--------- -----
</TABLE>
In addition, 105,000 options were repriced from a weighted average price of
$5.16 to $2.19 during 1996. The options outstanding at December 31, 1998 expire
in various years through the year 2008. Options exercisable at December 31,
1998, 1997 and 1996 were 3,804,997, 2,940,907 and 3,049,255, respectively.
F-24
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
The weighted average fair value of options granted during 1998, 1997 and 1996
were $1.55, $0.55 and $1.90, respectively. The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions used for grants in 1998, 1997
and 1996, respectively: risk-free interest rates of 5.8 percent, 6.9 percent
and 6.1 percent; expected lives of 9.08 years, 9.09 years, 8.49 years; expected
volatility of 64.2 percent, 91.7 percent and 95.6 percent and no dividends
would be issued during the option terms.
Information about stock options outstanding at December 31, 1998, is
summarized as follows:
<TABLE>
<CAPTION>
Options Outstanding
-------------------
Weighted-
Average Weighted
Number Remaining Average
Range of Outstanding Contracted Exercise
Exercise Prices at 12/31/98 Life Price
--------------- ----------- ---------- --------
<S> <C> <C> <C>
$0.438 to $2.0 2,124,250 7.8 years $0.90
$2.063 to $4.0 1,117,333 8.1 years $2.16
$4.125 to $6.875 2,073,916 5.2 years $5.46
---------
5,315,499 6.9 years $2.94
=========
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding
-------------------
Weighted-
Number Average
Range of Exercisable Exercise
Exercise Prices at 12/31/98 Price
--------------- ----------- ---------
<S> <C> <C>
$0.438 to $2.0 1,277,415 $0.84
$2.063 to $4.0 468,666 $2.26
$4.125 to $6.875 2,058,916 $5.47
---------
3,804,997 $3.52
=========
</TABLE>
The Company accounts for its stock option plans under Accounting Principle
Board Opinion No. 25, "Accounting for Stock Issued to Employees," under which
no compensation cost has been recognized. Had compensation cost for the
Company's stock option plans been determined consistent with Statement of
Financial Accounting Standards No. 123 ("FAS 123"), "Accounting for Stock-Based
Compensation", the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
Years Ended December
31,
------------------------
1998 1997 1996
------- ------ --------
(in thousands)
<S> <C> <C> <C>
Net income (loss)
As Reported..................................... $10,703 $ 536 $(92,944)
Pro Forma....................................... $ 9,423 $ (508) $(94,391)
Net income (loss) per diluted share
As Reported..................................... $ 0.25 $ 0.01 $ (2.53)
Pro Forma....................................... $ 0.22 $(0.01) $ (2.57)
</TABLE>
Because the FAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting compensation cost may not be
representative of that to be expected in future years.
F-25
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
e. Stockholder Protection Rights Plan
In February 1994, the Company adopted a stockholder Protection Rights Plan,
which was amended and restated in February 1996 ("Rights Plan"). Pursuant to
the Rights Plan, a dividend of one Right for each outstanding share of the
Company's common stock was issued to shareholders of record on March 15, 1994.
Under certain conditions, each Right may be exercised to purchase one one-
hundredth of a share of Series A Junior Participating Preferred Stock at a
price of $22.50 for each share of common stock held. The Rights are exercisable
until 10 days after a person or group acquires 15% or more of the Company's
common stock or announces a tender or exchange offer, the consummation of which
would result in ownership by such person or group of 15% or more of the
Company's common stock. If thereafter, a person or group acquires 15% or more
of Unilab's outstanding Common Stock, each Right will entitle its holder (other
than such person or members of such group) to purchase, at the Right's then-
current purchase price, in lieu of one one-hundredth of a share of Preferred
Stock, a number of shares of Unilab's Common Stock having a market value of
twice the Right's purchase price. In addition, should Unilab be acquired in a
merger or other business combination, 50% or more of its assets or earning
power is sold or transferred, or a reclassification or recapitalization of the
Company occurs that has the effect of increasing by more than 1% the
proportionate ownership of Unilab's stock by the acquiring person, then, each
Right will entitle its holder to purchase, at the Right's then-current purchase
price, a number of the acquiring company's shares of common stock having a
market value at that time of twice the Right's purchase price.
The Rights may be redeemed prior to becoming exercisable by the Company,
subject to approval of the Board of Directors, for one cent per Right in
accordance with the provisions of the Rights Plan. The Rights expire on March
15, 2004. The Company has reserved 1,000,000 shares of Series A Junior
Participating Preferred Stock for issuance upon exercise of the Rights.
10. Related Party Transactions
The Company sold 533,333 shares, valued at $0.3 million at the time of
issuance, to its former CEO pursuant to transition agreements between the
former CEO and the Company in connection with the CEO's resignation in January
1997. The Company extended a $0.5 million loan to its current CEO for the
purchase of 1.1 million shares of the Company's common stock in January 1997.
The CEO repaid $250,000 of the loan during 1997 and the remaining $250,000 is
due in January 2002. The loan bears interest at 6% and is payable quarterly. In
addition, in 1997, the Company sold 500,000 shares, valued at approximately
$0.3 million at the time of issuance, to a director of the Company pursuant to
the 1997 Directors Stock Purchase Plan. Each of these transactions were
consummated at the then prevailing market price of the Company's common stock.
The Company guaranteed a loan of $0.4 million at December 31, 1998 made by a
bank to an executive of the Company. The loan was used to purchase a residence
and such residence serves as collateral for the Company's guarantee.
11. Commitments and Contingencies
Property and equipment leased under capital leases is as follows:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------- -------
(in thousands)
<S> <C> <C>
Building.................................................... $ 3,100 $ 3,100
Laboratory and other equipment.............................. 5,638 7,283
Less--Accumulated amortization.............................. 4,934 5,158
Net leased property under capital leases.................... $ 3,804 $ 5,225
</TABLE>
F-26
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
As of December 31, 1998, future minimum rental payments required under
capital and operating leases that have initial or remaining noncancelable terms
in excess of one year are approximately as follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
------- ---------
(in thousands)
<S> <C> <C>
1999....................................................... $1,854 $ 9,696
2000....................................................... 2,039 5,720
2001....................................................... 782 4,163
2002....................................................... 822 2,616
2003....................................................... 863 2,067
Thereafter................................................. 594 1,772
------ -------
Total minimum lease payments............................... $6,954 $26,034
-------
Less: Amount representing interest......................... 1,922
------
Present value of net minimum lease payments................ $5,032
======
</TABLE>
Rental expense for operating leases was approximately $10.8 million, $10.2
million and $9.6 million in 1998, 1997 and 1996, respectively.
The Company has employment agreements with its principal officers and certain
other key employees. Such agreements expire at various dates through November
10, 1999 and automatically renew for successive one or two year periods,
depending on the employee, until one of the parties gives notice of termination
in accordance with the agreement. The agreements also provide for annual
bonuses for certain officers and key employees, dependent upon the achievement
of certain performance objectives. In addition, the agreements for certain
employees provide for annual deferred compensation equal to 8% of the
employees' cash compensation (inclusive of bonuses) for the year. The aggregate
commitment under these agreements, excluding bonuses and any deferred
compensation related thereto, is approximately $2.2 million. The Company may
terminate the employment agreements without cause on specified advance notice
by providing severance pay equal to one to two times, depending on the
employee, the current base salary plus certain other benefits.
In addition, the employment agreements grant these employees the right to
receive two times their annual salary and bonus, plus continuation of certain
benefits and acceleration of certain stock options, if there is a change in
control of the Company (as defined) and a termination of such employees or
certain other events within two years thereafter. The maximum contingent
liability upon a change in control, excluding any bonus, deferred compensation,
continuation of benefits or acceleration of stock options, is approximately
$3.5 million.
The Company is party to certain legal proceedings considered incidental to
its business. Although the ultimate disposition of these legal proceedings is
not determinable, management does not believe that the ultimate outcome of such
legal proceedings will have a material adverse effect upon the financial
condition, liquidity or results of operations of the Company.
12. Benefit Plans
The Company provides a savings plan under Section 401(k) of the Internal
Revenue Code covering most employees. The expense related to Company
contributions to the plan totaled approximately $0.3 million, $0.1 million and
$0.5 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Effective January 1, 1995, the Company contributions, which were
previously made in cash, were made in shares of Unilab common stock. From
September 1, 1996 to September 30, 1997, the Company discontinued its matching
contributions. Effective October 1, 1997, the Company partially re-instated its
matching contributions. Such contributions were made in shares of Unilab common
stock. Effective January 1, 1998, the Company made Company contributions in
cash, which were used to purchase Company common stock by the plan's trustee.
F-27
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
Effective January 1, 1995, the Company adopted the Unilab Corporation
Executive Retirement Plan (the "SERP"), an unfunded defined contribution plan,
for the benefit of designated key employees. The benefit earned each year is
issued into participants' account through memorandum shares, which represent
rights to receive stock of the Company at a future date. The SERP limits the
aggregate number of shares issued annually to 200,000 shares and the memorandum
shares granted each year vest ratably over a three-year period. As of December
31, 1998, 457,195 memorandum shares were outstanding, of which 308,415 were
vested at December 31, 1998. The benefit formula to determine amounts earned by
participants is primarily based on the employee's final five-year average
compensation and years of service. Compensation expense is recorded each year
for the amount of shares that vest and changes in the price of the Company's
common stock. Pension (income) expense for the SERP was approximately $407,000,
$271,000 and ($153,000) in 1998, 1997 and 1996, respectively. At December 31,
1998, the accumulated obligation recognized as a liability in the balance sheet
was approximately $732,000. The weighted average discount rate and rate of
increase in future compensation levels used in determining the present value of
benefit obligations were 6.0% and 3.8% in 1998, 6.6% and 3.8% in 1997 and 6.1%
and 3.8% in 1996.
13. Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Cash paid during the year for:
Interest...................................... $ 13,419 $ 14,063 $ 12,139
Income taxes.................................. 2 1 9
Supplemental Disclosure of Noncash Investing and
Financing Activities:
Restricted shares of common stock issued to
employees.................................... 32 16 107
Shares issued for Company's 401(k) plan
matching contributions....................... 25 49 548
Shares issued to certain Board Directors and a
consultant for services rendered............. 160 64 61
Payment of purchase price for a prior
acquisition in common shares................. -- -- 1,000
In connection with business acquisitions,
liabilities were assumed as follows:
Fair value of assets acquired................. $ 18,734 $ -- $ --
Liabilities assumed........................... $ 18,734 $ -- $ --
</TABLE>
During 1997, the Company issued 500,000 shares, valued at $0.2 million at the
time of issuance, to the Company's former CEO in connection with the CEO's
resignation. In 1997, the Company also issued 228,571 shares, valued at $0.1
million at the time of issuance, to the Company's current CEO as a bonus
pursuant to an employment agreement. In addition, the Company issued in 1997
approximately 169,000 shares, valued at $0.3 million at the time of issuance,
to all full-time employees as a special year-end bonus. In the fourth quarter
of 1996, the Company wrote off $61.7 million of goodwill and customer lists.
F-28
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
14. Quarterly Financial Data (unaudited)
Summarized unaudited quarterly financial data for 1998 and 1997 (in
thousands, except per share data) is as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998
--------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue................................... $54,530 $54,356 $53,160 $55,324
Direct laboratory and field expenses:
Salaries, wages and benefits............ 16,823 16,567 16,255 18,097
Supplies................................ 7,613 7,492 7,480 8,086
Other operating expenses................ 13,129 13,200 13,075 14,190
Total................................. 37,565 37,259 36,810 40,373
Amortization and depreciation............. 1,985 1,941 1,848 1,818
Selling, general and administrative
expenses................................. 8,534 8,324 8,132 8,540
Operating income.......................... 6,446 6,832 6,370 4,593
Net income................................ 3,072 3,446 3,062 1,123
Net income available to common
shareholders............................. 3,039 3,413 3,029 1,091
Per common share data-diluted:
Net income.............................. $ 0.07 $ 0.08 $ 0.07 $ 0.03
Price Range:
High.................................... 3.00 3.125 2.625 2.375
Low..................................... 1.688 2.375 1.75 1.625
<CAPTION>
Year Ended December 31, 1997
--------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue................................... $53,033 $54,027 $54,238 $52,703
Direct laboratory and field expenses:
Salaries, wages and benefits............ 17,820 17,352 17,174 16,748
Supplies................................ 7,551 7,616 7,488 7,203
Other operating expenses................ 13,982 14,593 14,649 13,766
Total................................. 39,353 39,561 39,311 37,717
Amortization and depreciation............. 2,153 2,312 2,210 2,210
Selling, general and administrative
expenses................................. 9,155 8,539 8,491 8,385
Operating income.......................... 2,372 3,615 4,226 4,391
Net income (loss)......................... (1,135) 54 691 926
Net income (loss) available to common
shareholders............................. (1,171) 18 655 896
Per common share data-diluted:
Net income (loss)....................... $ (0.03) $ 0.00 $ 0.02 $ 0.02
Price Range:
High.................................... 0.875 1.125 1.813 2.125
Low..................................... 0.438 0.563 1.125 1.50
</TABLE>
F-29
<PAGE>
UNILAB CORPORATION
NOTES TO FINANCIAL STATEMENTS
Fourth Quarter--1998
Effective November 5, 1998, the Company acquired substantially all of the
assets of Meris. During the integration period between November 5, 1998 and
late December 1998, the Company estimates that the Meris operations had a
negative $1.2 million impact on operating profit for the quarter.
Fourth Quarter 1998 and 1997
Testing volume generally tends to be lower during the holiday seasons. As a
result, because a substantial portion of the Company's expenses are relatively
fixed over the short term, the Company's operating income as a percentage of
revenue tends to decrease during the fourth quarter, mainly due to the
Christmas and Thanksgiving holidays.
F-30
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES
To Unilab Corporation
We have audited in accordance with generally accepted auditing standards, the
balance sheets as of December 31, 1998 and 1997, and the related statements of
operations, shareholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1998 included in Unilab Corporation's
annual report to shareholders incorporated by reference in this Form 10-K, and
have issued our report thereon dated February 12, 1999. Our audits were made
for the purpose of forming an opinion on the basic financial statements taken
as a whole. The schedule listed in Item 14a(2) for the years ended December 31,
1998, 1997 and 1996 is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen llp
Los Angeles, California
February 12, 1999
F-31
<PAGE>
Schedule II
UNILAB CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)
<TABLE>
<CAPTION>
Balance Charged
at to Costs Balance
Beginning and End of
of Period Expenses Deductions Period
--------- -------- ---------- --------
<S> <C> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1996;
Allowance for doubtful accounts........ $ 8,454 $ 14,180 $ (13,296) $ 9,338
FOR THE YEAR ENDED DECEMBER 31, 1997;
Allowance for doubtful accounts........ $ 9,338 $ 15,663 $ (15,182) $ 9,819
FOR THE YEAR ENDED DECEMBER 31, 1998;
Allowance for doubtful accounts........ $ 9,819 $ 15,662 $ (14,668) $ 10,813
</TABLE>
F-32
<PAGE>
To the Board of Directors
and Shareholders of
Meris Laboratories, Inc.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, shareholders' deficit and cash flows
present fairly, in all material respects, the financial position of Meris
Laboratories, Inc. (Debtor-in-possession) and its subsidiary, Meris, Inc. at
December 31, 1997 and 1996, and the results of its operations and its cash
flows for the years then ended, in conformity with generally accepted
accounting principles. These consolidated financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards 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.
As discussed in Notes 1, 2, 10 and 11 to the consolidated financial
statements, on November 18, 1997, the Company filed a voluntary petition for
relief under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court. On November 5, 1998, the Company sold substantially
all of its assets and ceased operations. A loss of $1.9 million has been
provided in the consolidated financial statements for the year ended December
31, 1997 to write-down such assets to their net realizable value. The Company
intends to file a plan of reorganization under which it will liquidate and
distribute the net proceeds of the sale and any remaining assets to its
creditors, subject only to the satisfaction of certain administrative and other
priority liabilities. The consolidated financial statements do not reflect any
adjustments that may be required for the disposition of the remaining assets at
amounts different from those reflected in the financial statements or amounts
which creditors may be required to accept in settlement of obligations due them
by the Company. The Company and its directors and former officers are
defendants in several lawsuits. Plaintiffs in the lawsuits and their legal
counsel have filed bankruptcy claims in excess of $23 million. At December 31,
1997, the Company has accrued $515,000 in costs associated with such lawsuits.
The ultimate resolution of the lawsuits cannot be determined at the present
time; accordingly, the consolidated financial statements do not include any
adjustments, beyond the accrual noted above, that might result from the outcome
of these uncertainties.
Odenberg, Ullakko, Muranishi & Co.
San Francisco, California
November 12, 1998
F-33
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
December 31
September 30, ------------------
1998 1997 1996
------------- -------- --------
(Unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................. $ 273 $ 601 $ 552
Restricted cash............................ 2,036 1,979 1,964
Assets held for sale....................... 16,928 16,928 --
Accounts receivable, net of allowance for
doubtful accounts of $2,122, $5,971 and
$4,346.................................... 134 914 4,687
Supplies inventory......................... -- 66 511
Prepaid expenses and other current assets.. 926 1,397 1,018
-------- -------- --------
Total current assets................... 20,297 21,885 8,732
Property and equipment, net.................. -- -- 1,559
Intangibles, net............................. -- -- 15,343
Other assets, net............................ -- -- 699
-------- -------- --------
$ 20,297 $ 21,885 $ 26,333
======== ======== ========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Liabilities not subject to compromise:
Secured borrowings and accrued interest
after filing for bankruptcy............. $ 7,155 $ 601 $ --
Note payable to former executive......... 1,656 1,599 1,585
Accrued litigation charges............... 319 515 1,776
Accounts payable and accrued expenses.... 1,407 805 --
Liabilities subject to compromise:
Secured borrowings and accrued interest
before filing for bankruptcy............ 32,274 32,274 13,167
Accrued Medicare settlement.............. 3,350 3,350 4,250
Accounts payable......................... 4,142 4,142 2,783
Accrued expenses......................... 5,513 5,513 6,019
Convertible subordinated debt............ 11,000 11,000 10,918
-------- -------- --------
Total current liabilities.............. 66,816 59,799 40,498
-------- -------- --------
Commitments and contingencies (Notes 5, 6 and
10)......................................... -- -- --
Shareholders' deficit:
Preferred stock, no par value: 2,000,000
shares authorized; none issued and
outstanding............................... -- -- --
Common stock, no par value: 20,000,000
shares authorized; 8,043,859 shares issued
and outstanding........................... 37,171 37,171 37,171
Additional paid-in capital................. 826 826 826
Accumulated deficit........................ (84,516) (75,911) (52,162)
-------- -------- --------
(46,519) (37,914) (14,165)
-------- -------- --------
$ 20,297 $ 21,885 $ 26,333
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-34
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine months
ended Years ended December 31
September 30, ------------------------
1998 1997 1996
------------- ----------- -----------
(Unaudited)
<S> <C> <C> <C>
Net revenues.......................... $19,727 $ 29,903 $ 34,106
------- ----------- -----------
Costs of services:
Salaries, wages and benefits........ 6,763 12,507 12,227
Supplies............................ 3,267 4,946 5,144
Other cost of services.............. 6,341 7,208 7,197
------- ----------- -----------
16,371 24,661 24,568
Selling, general and administrative
expenses............................. 8,351 15,785 12,019
Depreciation and amortization......... -- 2,240 3,302
Provision for doubtful accounts....... 2,266 1,577 5,798
Litigation and investigation charges.. 990 1,241 4,072
Write-down of intangible assets....... -- 1,720 7,552
Write-off of fixed assets............. -- 1,982 --
------- ----------- -----------
Operating loss........................ (8,251) (19,303) (23,205)
Interest expense...................... (354) (4,538) (2,786)
Interest and other income, net........ -- 92 159
------- ----------- -----------
Net loss.............................. $(8,605) $ (23,749) $ (25,832)
======= =========== ===========
Net loss per share.................... $ (1.07) $ (2.95) $ (3.23)
======= =========== ===========
Weighted average shares outstanding... 8,044 8,044 8,006
======= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-35
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
(In thousands, except per share data)
<TABLE>
<CAPTION>
Common Stock Additional
-------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------- ---------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995... 7,982 37,136 826 (26,330) 11,632
Issuance of common stock for
option exercises and employee
stock purchase plan........... 62 35 -- -- 35
Net loss....................... -- -- -- (25,832) (25,832)
----- ------- ---- -------- --------
Balance at December 31, 1996... 8,044 37,171 826 (52,162) (14,165)
Net loss....................... -- -- -- (23,749) (23,749)
----- ------- ---- -------- --------
Balance at December 31, 1997... 8,044 37,171 826 (75,911) (37,914)
Net loss (unaudited)........... -- -- -- (8,605) (8,605)
----- ------- ---- -------- --------
Balance at September 30, 1998
(unaudited)................... 8,044 $37,171 $826 $(84,516) $(46,519)
===== ======= ==== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-36
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine months
ended Years ended December 31,
September 30, --------------------------
1998 1997 1996
------------- ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Operations:
Net loss........................... $(8,605) $ (23,749) $ (25,832)
Items not requiring the current use
of cash:
Depreciation and amortization.... -- 2,240 3,302
Amortization of debt discount and
issue costs..................... -- 446 531
Provision for doubtful accounts.. -- -- --
Provision for litigation and
investigation charges........... -- -- 3,282
Write-down of intangible assets.. -- 1,720 7,552
Write-down of property and
equipment....................... -- 1,982 --
Gain on sale of property and
equipment....................... -- (13) (71)
Compensation expense related to
loan forgiveness, charge for
unrealizable note receivable,
and discounted stock options.... -- -- --
Changes in items affecting
operations:
Restricted cash................ (57) (14) (380)
Accounts receivable............ 780 521 6,584
Income tax refund receivable... -- -- 384
Supplies inventory............. 66 (28) 238
Prepaid expenses and other
current assets................ 471 (404) (447)
Other assets................... -- 175 (97)
Accounts payable............... -- 1,359 963
Accrued expenses............... 870 384 (159)
Accrued litigation and
investigation charges......... (196) (2,161) (779)
------- ------------ ------------
Cash provided by (used in)
operating activities.......... (6,671) (17,542) (4,929)
Investments:
Cash expenditures for customer
lists and other assets related to
acquisitions...................... -- -- (920)
Proceeds from notes receivable..... -- 160 104
Purchase of property and
equipment......................... (21) (1,999) (334)
Proceeds from sale of property and
equipment......................... -- 13 99
------- ------------ ------------
Cash used for investing
activities...................... (21) (1,826) (1,051)
------- ------------ ------------
Financing:
Issuance of common stock, net...... -- -- 35
Proceeds from bank borrowings...... 6,554 19,707 5,510
Payments on bank borrowings........ -- -- --
Principal payments on capital
leases............................ (190) (290) (503)
Reduction in distribution payable
to related parties................ -- -- --
------- ------------ ------------
Cash provided by financing
activities...................... 6,364 19,417 5,042
------- ------------ ------------
Increase (decrease) in cash and cash
equivalents......................... (328) 49 (938)
Cash and cash equivalents at
beginning of period................. 601 552 1,490
------- ------------ ------------
Cash and cash equivalents at end of
period.............................. $ 273 $ 601 $ 552
======= ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-37
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Years
ended
Nine months December
ended 31,
September 30, ---------
1998 1997 1996
------------- ---- ----
(Unaudited)
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Interest paid--capital leases........................ $ 12 $ 28 $ 35
==== ==== ====
Interest paid--borrowing............................. $-- $-- $451
==== ==== ====
Income taxes paid.................................... $-- $-- $--
==== ==== ====
Supplemental disclosure of non-cash investing and
financing activities:
Capital lease obligations incurred for acquisition of
property and equipment.............................. $-- $219 $247
==== ==== ====
Reduction in consulting agreements related to
acquisition......................................... $-- $-- $--
==== ==== ====
Accrued transaction costs related to acquisitions.... $-- $-- $--
==== ==== ====
</TABLE>
See accompanying notes to consolidated financial statements.
F-38
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--Organization:
Meris Laboratories, Inc. (the "Company") was incorporated in California on
November 14, 1990 to effect the reorganization of Meris Laboratories, Ltd. Bay
Area, a California limited partnership (the "Partnership"). This reorganization
of entities under common control has been accounted for on the historical cost
basis. The consolidated financial statements of the Company and its subsidiary,
Meris, Inc., include the financial position, results of operations and cash
flows for the Company. The Company provides complete out-patient laboratory
services and operates in only one industry segment within the State of
California.
Petition for relief under Chapter 11
On November 18, 1997 the Company ("Debtor") filed a voluntary petition for
relief under Chapter 11 of Title 11 of the United States Code in the United
States Bankruptcy Court for the Central District of California. Under Chapter
11, certain claims against the Debtor in existence prior to the filing of the
petition for relief under the federal bankruptcy laws are stayed while the
Debtor continues business operations as Debtor-in-possession. Such claims are
reflected in the December 31, 1997 and September 30, 1998 balance sheets as
"liabilities subject to compromise."
On September 16, 1998 the Company signed a definitive agreement with Unilab
Corporation ("Unilab") whereby the Company would sell substantially all of its
assets to Unilab. The agreement was approved on October 28, 1998 by the United
States Bankruptcy Court in Los Angeles, California (see Note 11). The Company
consummated the sale on November 5, 1998 and ceased operations. A loss of
$1,982,000 has been provided in the consolidated financial statements for the
year ended December 31, 1997, to write-down such assets to their net realizable
values. The Company plans to file a plan of reorganization under which it will
distribute all of the net proceeds of the sale and any remaining assets to its
creditors, subject only to the satisfaction of certain administrative and other
priority liabilities.
NOTE 2--Summary of significant accounting policies:
Principles of consolidation
The consolidated financial statements include the accounts of the Company and
Meris, Inc. All significant intercompany accounts and transactions have been
eliminated.
Basis of presentation
The consolidated financial statements have been prepared on a going concern
basis except that, for the period from November 18, 1997 to December 31, 1997,
interest totaling approximately $800,000 has not been accrued on indebtedness
outstanding as of November 18, 1997, the date on which the Company filed a
voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. As
discussed in the second and third paragraphs of Note 1, the Company has sold
substantially all of its assets and ceased operations, and intends to file a
plan of reorganization under which it will liquidate and distribute the net
proceeds of the sale and any remaining assets. The consolidated financial
statements do not reflect any adjustments that may be required for the
disposition of the remaining assets in amounts different from those reflected
in the consolidated financial statements or in amounts which creditors may be
required to accept in settlement of obligations due them by the Company.
Use of estimates
The preparation of financial statements requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
F-39
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue recognition
Revenues are recognized upon performance of laboratory services. Revenues are
based on amounts billed or billable for services rendered, net of price
adjustments made with third-party payors by contract or otherwise. Certain
laboratory services are provided pursuant to managed care contracts which
provide for the payment of capitated fees rather than individual fees for tests
actually performed. The Company periodically evaluates such contracts to
ascertain their overall profitability. Such evaluations include both expected
capitated fees and identifiable referral revenues. Contract losses, if any, are
recognized as soon as they are identified. No such accruals were provided at
December 31, 1997 and 1996.
Laboratory services billed to Medicare comprised approximately 22.5% and
22.9% of net revenues for the years ended December 31, 1997 and 1996,
respectively, and approximately 29.3% and 20.8% of outstanding net accounts
receivable at December 31, 1997 and 1996, respectively.
Expense recognition
All costs are expensed as incurred.
Financial instruments
Financial instruments which subject the Company to concentration of credit
risk consist primarily of accounts receivable. The primary payors are
individual patients, government agencies, insurance companies and, to a lesser
extent, physician clients. The Company provides an allowance for doubtful
accounts based on historical experience and current factors. The carrying value
of all other financial instruments is not presently determinable, since they
may be subject to compromise upon liquidation of the company.
Cash equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
F-40
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentration of credit risk
The Company places its cash and temporary cash investments with high credit
quality institutions. At December 31, 1997 and throughout the year, such
investments were in excess of FDIC insurance limits.
Restricted cash
The Company purchased a certificate of deposit in the amount of $1,585,000
representing the full amount to satisfy the Company's obligations owing to a
former executive pursuant to and in connection with a promissory note dated
October 28, 1992. The Company is holding the balance in a separate account
pending the outcome of the litigation. The interest on the certificate of
deposit is also being held in a restricted account.
The Company deposited $379,000 to perfect its appeal in a legal action, in
which the courts awarded judgments totaling $253,000 against the Company and in
favor of the former employee.
Supplies inventory
Supplies inventory is stated at the lower of cost, determined on a first-in,
first-out basis, or market.
Assets held for sale
On October 28, 1998, the Company sold substantially all of its assets,
including accounts receivable, property and equipment, and intangible assets
(see Note 1). As a result, the Company has reported such assets at their net
realizable values under the caption, "Assets held for sale" at December 31,
1997 and September 30, 1998. The loss on the sale of such assets has been
reflected in the results of operations for the year ended December 31, 1997.
A summary of assets held for sale is as follows:
<TABLE>
<CAPTION>
December 31,
1997
--------------
(in thousands)
<S> <C>
Accounts receivable, net...................................... $ 3,252
Supplies inventory............................................ 473
Prepaid expenses and other current assets..................... 25
Property and equipment, net:
Laboratory equipment........................................ 689
Furniture, fixtures and equipment........................... 12
Vehicles.................................................... 219
Leasehold improvements...................................... 1,883
Intangibles, net:
Covenant not-to-compete..................................... 283
Customer lists.............................................. 11,612
Goodwill.................................................... 462
-------
18,910
Less -- valuation reserve..................................... (1,982)
-------
Net realizable value of assets held for sale.................. $16,928
=======
</TABLE>
Property and equipment
Property and equipment is recorded at cost. Property and equipment, other
than leasehold improvements, is depreciated using the straight-line method over
the estimated useful lives of the assets, generally three to five
F-41
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
years. Amortization of leasehold improvements is computed using the straight-
line method over the shorter of the remaining lease term or the estimated
useful lives of the improvements. The costs of assets sold or retired and the
related accumulated depreciation and amortization are eliminated from the
accounts and a gain or loss is included in operations.
Intangible assets
Intangible assets are stated at cost and include acquisition-related assets
such as customer lists, covenants not-to-compete and goodwill. Amortization of
acquisition-related assets is computed using the straight-line method over the
estimated useful lives of the assets. Customer lists are amortized over ten to
sixteen years. Goodwill is amortized over twenty years.
Impairment of goodwill and intangible assets is measured on the basis of
anticipated undiscounted cash flows for each asset. Based upon the Company's
analysis, an impairment loss of $1,720,000 and $7,552,000 was charged to
operations for the years ended December 31, 1997 and 1996, respectively.
Debt issuance costs
Debt issuance costs are amortized using the interest method over the
estimated term of the related debt.
Income taxes
A deferred income tax liability or asset, net of valuation allowance, is
established for the expected future consequences resulting from the differences
between the financial reporting and income tax basis of assets and liabilities
and from net operating loss and tax credit carryforwards. Deferred income tax
expense or benefit represents the net change during the year in the deferred
income tax liability or asset.
Loss per share
In 1997, the Company adopted Statement of Financial Accounting Standard No.
128, "Earnings Per Share." This standard requires that both basic earnings or
loss per share and diluted earnings or loss per share be presented. All
effective prior period per share amounts have been restated, following the new
standard requirements. Diluted loss per share excludes the effect of
convertible debt, stock options, and warrants (See Notes 4 and 9), because
their effect would have been antidilutive.
F-42
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--Balance sheet detail:
<TABLE>
<CAPTION>
December 31,
1996
--------------
(in thousands)
<S> <C>
Property and equipment consisted of:
Laboratory and computer equipment............................ $ 9,798
Furniture, fixtures and office equipment..................... 2,154
Vehicles..................................................... 1,249
Leasehold improvements....................................... 907
-------
14,108
Less--accumulated depreciation and amortization................ (12,549)
-------
$ 1,559
=======
Amount relating to capitalized leases, which are included in
property and equipment above.................................. $ 982
Less--accumulated amortization................................. (778)
-------
$ 204
=======
Intangibles consisted of:
Customer lists............................................... $ 1,720
Covenants not-to-compete..................................... 21,997
Goodwill..................................................... 1,485
Consulting agreements........................................ 50
-------
25,252
Less--accumulated amortization................................. (9,909)
-------
$15,343
=======
Other assets consisted of:
Note receivable.............................................. $ 182
Deferred debt issuance costs, net............................ 363
Other........................................................ 154
-------
$ 699
=======
</TABLE>
NOTE 4--Unsecured senior subordinated debt:
On November 14 and December 5, 1994, the Company completed a private
placement consisting of the sale of $11,000,000 of unsecured convertible senior
subordinated debentures (the "Debentures"). The Debentures carry a 10% interest
rate and require interest to be paid monthly. In addition, the Debentures
mature three years from the date of issue and are convertible sixty days from
the date of issuance, at the option of the holders, into 3,055,555 shares of
the Company's common stock at a conversion price based on certain antidilution
provisions of the Debenture agreement. The Board of Directors has resolved to
reserve an aggregate of 3,055,555 shares of the Company's common stock for
issuance upon conversion of the Debentures, provided that the number of shares
reserved for issuance may be subject to change in the event of any further
adjustment in the conversion price of the Debentures.
The Company defaulted on the November 14, 1997 principal payoff of $11
million and is still in default. The Company has not paid interest relating to
the subordinated debt of approximately $1,705,000 and $735,000 at December 31,
1997 and 1996, respectively. The unpaid interest is reflected on the balance
sheets as accrued expenses under "liabilities subject to compromise."
F-43
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Through December 31, 1997, the Company incurred $1,021,000 related to the
issuance and registration of the Debentures which is being amortized over the
three-year term of the Debentures. At December 31, 1997, debt issue cost was
fully amortized.
NOTE 5--Secured borrowings:
On September 20, 1996 a bank with whom the Company had a line of credit
agreement sold its rights and claims under the agreement to an unrelated party,
who in turn assigned all such rights to an affiliate of the unrelated party
("Lender").
On November 18, 1996, the Company entered into an agreement with the Lender
(the "Second Amended Agreement") which provided, among other things, that the
Company would repay the Lender $12,770,874, on demand, at an interest rate of
15% per annum. Interest is capitalized and added to the outstanding principal
evidenced by issuance of Payment-In-Kind ("PIK") notes, payable on demand of
the Lender. The Company granted a security interest in substantially all of the
assets of the Company. The proceeds from the loan were used to repay the
outstanding balance under the bank line of credit in the amount of $8,202,461
and certain other obligations, including a facility fee to the Lender in the
amount of $1,242,332. The remaining proceeds were used for working capital
purposes. The Second Amended Agreement calls for an anniversary fee equal to 2%
of the average balance of the loans outstanding during the first year, a fee
equal to 3% of the average balance of the loans outstanding during the second
year, and a fee equal to 4% of the average balance of the loans outstanding
during the third year. In conjunction with the Second Amended Agreement, the
Company issued to the Lender a warrant to purchase an aggregate of 800,000
shares of common stock of the Company at $0.01 per share. The warrant was
exercisable immediately and expires on November 18, 2006.
The Second Amended Agreement allowed the Company to borrow, at the Lender's
sole discretion, and not more frequently than once every 28 days, additional
borrowings of not less than $250,000 per borrowing. The Lender extended twenty
one additional demand notes ("Interim Funding Agreements") to the Company
during the period February 3, 1997 through November 12, 1997, totaling
$13,750,000, with interest accrued thereon at an interest rate of 24.9% per
annum.
On November 18, 1997, the Company filed a voluntary petition for relief under
Chapter 11 of Title 11 of the United States Bankruptcy Code. The Company owed
the Lender pre-petition obligations in the aggregate amount of $32,273,665,
consisting of $31,891,132 of principal and interest (including capitalized
interest) related to the Second Amended Agreement, and $382,534 for
unreimbursed costs, expenses, fees and other charges the Company owed to the
Lender pursuant to the Second Amended Agreement dated November 18, 1996 and the
twenty one Interim Funding Agreements.
On November 18, 1997, the Company and the Lender signed a Loan and Security
Agreement ("DIP Loan Agreement") whereby the Lender provided the Company with a
$5,000,000 credit facility to provide operating capital while the Company
continued as Debtor-in-possession. The DIP Loan Agreement allowed the Company
to borrow minimum increments of $250,000, not more frequently than once every
14 days, at an interest rate of 12% per annum. The DIP Loan Agreement required
a nonrefundable commitment fee of $100,000, payable from the proceeds of the
loans, and expired June 3, 1998, which was subsequently extended until December
31, 1998 (see Note 11).
As the debt owed to the Lender by the Company is impaired (undersecured)
under the plan of liquidation (see Note 11), the debt is reflected on the
balance sheets at December 31, 1997 and September 30, 1998 as "liabilities
subject to compromise."
F-44
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--Lease commitments:
The Company leases various laboratories, Patient Service Centers and office
facilities under non-cancelable operating lease agreements which expire at
various times through the year 2002. The leases generally require the Company
to pay property taxes, maintenance expense and certain insurance. Certain of
the lease agreements require escalation of the minimum rental based upon
factors defined in the leases. Total rent expense under operating leases
amounted to approximately $3,090,000, $2,655,000 and $2,686,000 in 1997, 1996
and 1995, respectively.
Minimum future lease payments under non-cancelable operating leases subject
to compromise are as follows:
<TABLE>
<CAPTION>
Fiscal year
-----------
<S> <C>
1998.......................................................... $ 699,600
1999.......................................................... 699,600
2000.......................................................... 699,600
2001.......................................................... 699,600
2002.......................................................... 233,200
----------
$3,031,600
==========
</TABLE>
NOTE 7--Transactions with related parties:
One member of the Board of Directors of the Company received approximately
$86,000 and $154,000 for consulting and legal services rendered to the Company
during 1997 and 1996, respectively.
NOTE 8--Income taxes:
The provision for income taxes is as follows:
<TABLE>
<CAPTION>
Years ended
December 31,
-------------
1997 1996
------ ------
<S> <C> <C>
Current tax expense............................................ $ -- $ --
Deferred tax expense........................................... -- --
------ ------
Total........................................................ $ -- $ --
====== ======
</TABLE>
The net deferred income tax asset comprises:
<TABLE>
<CAPTION>
December 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
Net operating loss carryforwards......................... $ 20,141 $ 13,026
Alternative minimum tax credit carryforwards............. 122 122
Temporarily nondeductible reserves and allowances........ 1,293 1,963
Bad debt reserves........................................ 4,412 3,443
Loss on sale of assets................................... 813 --
Depreciation and amortization............................ 2,234 2,355
-------- --------
29,015 20,909
Valuation allowance...................................... (29,015) (20,909)
-------- --------
$ -- $ --
======== ========
</TABLE>
F-45
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Changes in the valuation allowance for the years ended December 31, 1997 and
1996 are due to uncertainty regarding the ultimate realization of the gross
deferred tax assets based on the Company's recent operating results.
Differences between the Company's benefit for income taxes and that computed by
applying the federal statutory rate applied to the Company's loss before income
taxes are as follows:
<TABLE>
<CAPTION>
December 31,
--------------
1997 1996
------ ------
<S> <C> <C>
Federal statutory rate....................................... (35.0)% (35.0)%
State income taxes, net of federal tax benefit............... (6.5)% (6.5)%
Deferred tax assets not recognized........................... 41.5% 41.5%
------ ------
0.0% 0.0%
====== ======
</TABLE>
At December 31, 1997 and 1996, the Company had federal and state net
operating loss carryforwards of approximately $82 million and $54 million,
respectively. The federal and state net operating losses will begin to expire
in the years ending December 31, 2003 and 1999, respectively.
NOTE 9--Employee benefit plans:
1991 Employee Stock Purchase Plan:
In May 1991, the Company adopted the 1991 Employee Stock Purchase Plan (the
"Purchase Plan") under which 225,000 shares of common stock have been reserved
for issuance. The Purchase Plan provides for sequential offering periods,
generally of six months. At the end of each offering period, shares may be
purchased by participants at 85% of the market value at the beginning or end of
the offering period. Shares are to be purchased from payroll deductions which
are limited to 10% of base compensation. A total of 49,841 shares of common
stock were issued under the Purchase Plan during the year ended December 31,
1996 and no shares of common stock were issued in 1997.
Amended and restated 1991 Stock Option Plan:
In February 1991, the Company adopted the 1991 Stock Option Plan (the "Option
Plan"), which was amended and restated. The Option Plan, which expires in
February 2001, provides for incentive as well as nonstatutory stock options to
be granted to employees and consultants of the Company. The Board of Directors
may terminate the Option Plan at any time at its discretion.
A Committee of the Board determines the terms of options granted under the
Option Plan. Options granted generally vest over four years and will be
adjusted for certain changes in capitalization of the Company. In addition, the
outstanding options issued under the Option Plan will terminate within a period
set by the Board after termination of employment.
The Option Plan also provides for automatic grants of non-qualified stock
options to directors who are not employees of the Company (the "Outside
Directors"). Under these provisions, as amended by the Board in November 1992,
each Outside Director on August 20, 1991 received an option to purchase 10,000
shares of common stock. Additionally, each Outside Director on November 23,
1992 (other than Outside Directors receiving options on August 20, 1991)
received on such date an option to purchase 10,000 shares of common stock, and
each new Outside Director receives an option to purchase 10,000 share upon his
or her election or appointment to the Board. In addition, beginning with the
fifth annual meeting of shareholders following the initial 10,000 share option
grant, each Outside Director will receive an option to purchase 2,500 shares on
the
F-46
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
date of each annual meeting at which he or she is elected the Board. All
options granted to Outside Directors will have an exercise price equal to 100%
of the fair market value at the date of grant and will vest ratably over four
years commencing on the first anniversary of the date of grant.
Options under the Option Plan are generally granted at prices ranging from
85% to 110% of the fair market value of the stock at the date of grant. Except
as discussed below, no options have been granted at exercise prices less than
100% of such fair market value at the date of grant. In December 1991, an
Executive was granted, in connection with his employment with the Company, an
option to purchase 150,000 shares of common stock at an exercise price of
$8.00 per share. The last reported sale price of the Company's common stock on
such date was $14.00 per share. In October 1993, the Executive irrevocably
terminated the option to the extent of 100,000 unvested shares. Accordingly,
the Company ceased recognizing compensation associated with this option
effective September 30, 1993. There is no commitment to grant the Executive
any additional options. The Company recorded $122,000 of compensation expense
during the year ended December 31, 1993 related to this stock option grant.
The Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25") for its stock
option plan. Accordingly, no compensation cost has been recognized for the
plan for the years ended December 31, 1997, 1996, and 1995. Certain
information related to the Company's stock option plan was not available for
the years ended December 31, 1997 and 1996. Consequently, the effect of the
Company's adoption of Financial Accounting Standards Board Statement No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), was not
calculated. However, the increase in net loss would not be material to the
financial statements.
A summary of the status of the Company's stock option plan as of December
31, 1997 and 1996 and changes during the years then ended is presented below:
<TABLE>
<CAPTION>
1997 1996
--------------------- ----------------------
Range of Range of
Number of Exercise Number of Exercise
Shares Prices Shares Prices
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Outstanding at beginning of
year........................ 2,092,089 $.73-$4.38 1,450,579 $ .73-$4.38
Granted...................... 1,211,709 $1.00-$1.50
Exercised.................... (12,150)
Canceled or expired.......... (389,176) -- (558,049) --
--------- ---------
Outstanding at end of year... 1,702,913 $.73-$4.38 2,092,089 $ .73-$4.38
========= ========== ========= ===========
</TABLE>
Employee savings and retirement plan
In January 1992, the Company adopted the 401(k) Retirement Plan of Meris
Laboratories, Inc. (the "Plan"), a savings and investment plan, as allowed
under Section 401(k) of the Internal Revenue Code (the "Code"). Under the
terms of the Plan, eligible participants may contribute up to 15% of their
eligible earnings to the Plan, not to exceed the amount allowed under the
Code. Under the Plan Agreement, the Company may make contributions at the
discretion of the Board of Directors. As of December 31, 1997, no
contributions have been made to the Plan by the Company.
F-47
<PAGE>
MERIS LABORATORIES, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 10--Contingencies:
The Company and its directors and former officers are defendants in several
lawsuits. Plaintiffs in the lawsuits and their legal counsel have filed
bankruptcy claims in excess of $23 million. At December 31, 1997, the Company
has accrued $515,000 in costs associated with such lawsuits. The ultimate
resolution of the lawsuits cannot be determined at the present time;
accordingly, the consolidated financial statements do not include any
adjustments, beyond the accrual noted above, that might result from the outcome
of the lawsuits.
In February 1997, the Company entered into a settlement agreement with the
U.S. Department of Justice and Department of Health and Human Services related
to certain Medicare and other billing practices. Under the terms of the
settlement, the Company agreed to pay $4.25 million in monthly installments of
$100,000. This obligation is reflected in the consolidated balance sheet as
accrued Medicare settlement, under liabilities subject to compromise. The
Company has made no payments since it filed for bankruptcy.
NOTE 11--Subsequent events:
Amendment to DIP Loan Agreement
On November 23, 1998, the Company and the Lender amended the terms of the DIP
Loan Agreement to extend the terms of the agreement from June 3, 1998 to
December 31, 1998 and to increase the amount of funds available to the Company
from $5 million to $9.5 million.
Plan of liquidation
On September 16, 1998, the Company signed a definitive agreement with Unilab
whereby Unilab would acquire substantially all of the assets of the Company.
The purchase price of $16,928,000 consisted of the following: an eight-year
convertible subordinated note in the amount of $14 million, bearing interest at
a rate of 7.5% per annum, with a $3.00 per share conversion price plus
$2,520,000 in cash payable in seventy-two equal monthly installments; and the
assumption of certain liabilities totaling approximately $408,000. The
agreement was approved on October 28, 1998 by the U.S. Bankruptcy Court in Los
Angeles, California, and Unilab took possession of the acquired assets on
November 5, 1998.
The Company intends to file a plan of liquidation under which it will
distribute all of the net proceeds of the sale to its creditors, subject to the
satisfaction of certain administrative and other priority liabilities.
F-48
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Physicians Clinical Laboratory,
Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of
Physicians Clinical Laboratory, Inc. and its subsidiary at February 28, 1999,
and the results of their operations and their cash flows for the fiscal year
then ended, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards 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 audit provides a reasonable basis for the
opinion expressed above. The consolidated financial statements of Physicians
Clinical Laboratory, Inc. and its subsidiary for the five month period ended
February 28, 1998, the seven month period ended September 30, 1997, and the
fiscal year ended February 28, 1997 were audited by other auditors whose
reports dated August 31, 1998 and May 9, 1997 on those statements included an
explanatory paragraph expressing substantial doubt about the Company's ability
to continue as a going concern.
As discussed in Note 17, the Company consummated on May 9, 1999 the sale of
its business and substantially all of its assets and ceased operations. The
Company used part of the net sales proceeds to repay its line of credit, and
plans to liquidate and distribute the remaining sales proceeds to its Senior
Secured Note holder. The consolidated financial statements do not reflect any
adjustments that may be required for the disposition of the remaining assets at
amounts different from those reflected in the financial statements or amounts
which creditors may be required to accept in settlement of obligations due them
by the Company. As discussed in Note 14, the Company is a defendant in several
lawsuits. At February 28, 1999, the Company has not recorded a liability for
amounts which may be payable as a result of such lawsuits. The ultimate
resolution of the lawsuits cannot be determined at the present time;
accordingly, the consolidated financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
Odenberg, Ullakko, Muranishi & Co.
San Francisco, California
July 16, 1999
F-49
<PAGE>
REPORT OF INDEPENDENT CERTIFICATE PUBLIC ACCOUNTANTS
To the Stockholders
Physicians Clinical Laboratory, Inc.
We have audited the accompanying consolidated balance sheet of Physicians
Clinical Laboratory, Inc.(a Delaware corporation) and subsidiaries as of
February 28,1 998, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the five month period ended
February 28, 1998 and the seven month period ended September 30, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Physicians
Clinical Laboratory, Inc. and subsidiaries as of February 28, 1998 and the
consolidated results of their operations and their cash flows for the five
month period ended February 28, 1998 and the seven month period ended September
30, 1997 in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that Physicians Clinical Laboratory, Inc. will continue as a going concern. As
more fully described in Notes 1 and 3 to the consolidated financial statements,
the Company has suffered recurring losses from operations and is in default of
loan covenants, which raises substantial doubt about its ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 3. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
On April 5, 1999, as discussed in note 17 to the consolidated financial
statements, the Company entered into an agreement to sell the business and
substantially all assets.
As more fully described in Notes 1 and 2 to the consolidated financial
statements, effective October 3, 1997, the Company emerged from bankruptcy. In
accordance with an American Institute of Certified Public Accountants'
Statement of Position, the Company has adopted "fresh start" reporting whereby
its assets, liabilities and new capital structure have been adjusted to reflect
estimated fair values as of September 30, 1997. As a result, the consolidated
financial statements for periods subsequent to September 30, 1997 reflect this
basis of reporting and are not comparable to the Company's pre-reorganization
consolidated financial statements.
Grant Thornton LLP
Sacramento, California
August 31, 1998, except for
Notes 3 and 5 as to which the
date is October 29, 1998 and
except for Note 17 as to which
the date is April 5, 1999
F-50
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Stockholders of Physicians Clinical Laboratory, Inc.:
We have audited the accompanying consolidated statements of operations,
stockholders' deficit and cash flows of Physicians Clinical Laboratory, Inc.
for the year ended February 28, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards 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. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
Physicians Clinical Laboratory, Inc. for the year ended February 28, 1997, in
conformity with generally accepted accounting principles.
The financial statements referred to above have been prepared assuming that the
Company will continue as a going concern. As more fully described in the
accompanying financial statements and notes, the Company has incurred recurring
operating losses. In addition, the Company has not complied with certain
covenants of loan agreements with financial institutions. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments to reflect the
possible future effects that may result from the outcome of this uncertainty.
Ernst & Young LLP
Sacramento, California
May 9, 1997
F-51
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
February 28,
--------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 420,718 $ 190,013
Current assets held for sale..................... 12,390,000 --
Trade accounts receivable, net of allowance for
doubtful accounts of $2,245,986, including
$476,642 from related parties................... -- 10,931,708
Supplies inventory............................... -- 1,180,920
Prepaid costs and other assets................... 524,540 394,474
------------ ------------
Total current assets........................... 13,335,258 12,697,115
Equipment and leasehold improvements, less
accumulated depreciation and amortization of
$594,972.......................................... -- 2,531,448
Assets held for sale............................... 21,657,940 --
Reorganization value in excess of amounts allocable
to identifiable assets, less accumulated
amortization of $1,571,000........................ -- 24,012,605
Other long-term assets............................. 444,231 424,131
------------ ------------
$ 35,437,429 $ 39,665,299
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current installments of long-term debt........... $ 56,697,329 $ 48,360,853
Line of credit................................... 4,658,014 4,517,766
Accounts payable................................. 7,589,316 5,117,344
Accrued payroll and vacation..................... 1,982,977 2,216,057
Accrued interest................................. 3,619,627 2,730,411
Other accrued expenses........................... 2,672,686 3,293,075
------------ ------------
Total current liabilities...................... 77,219,949 66,235,506
Long-term debt, less current installments.......... 9,210,040 2,346,173
------------ ------------
Total liabilities.............................. 86,429,989 68,581,679
------------ ------------
Commitments and contingencies (Notes 11, 12, and
14)............................................... -- --
Stockholders' deficit:
Preferred stock, par value $0.01 per share--20
million shares authorized; none issued or
outstanding..................................... -- --
Common stock, par value $0.01 per share--50
million shares authorized; 2.5 million shares
issued and outstanding.......................... 25,000 25,000
Additional paid-in capital....................... 22,775,000 22,775,000
Accumulated deficit.............................. (73,792,560) (51,716,380)
------------ ------------
Total stockholders' deficit.................... (50,992,560) (28,916,380)
------------ ------------
$ 35,437,429 $ 39,665,299
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-52
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Reorganized Company Predecessor Company
-------------------------- ---------------------------
Fiscal year Five months Seven months Fiscal year
ended ended ended ended
February 28, February 28, September February 28,
1999 1998 30, 1997 1997
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net revenue:
Net revenue from third parties..................................... $ 53,404,926 $ 25,432,951 $ 39,466,458 $ 60,422,858
Net revenue from related parties................................... 2,166,905 740,462 856,377 2,407,989
------------ ------------ ------------ -------------
Total net revenue................................................ 55,571,831 26,173,413 40,322,835 62,830,847
Direct laboratory costs.............................................. 24,096,059 9,839,627 15,775,669 23,117,090
------------ ------------ ------------ -------------
Gross profit..................................................... 31,475,772 16,333,786 24,547,166 39,713,757
Laboratory support costs............................................. 18,553,460 7,328,075 11,233,414 20,013,962
------------ ------------ ------------ -------------
Laboratory profit................................................ 12,922,312 9,005,711 13,313,752 19,699,795
Selling, general and administrative.................................. 15,785,249 7,093,342 10,652,308 24,880,448
Provision for doubtful accounts...................................... 4,223,393 2,245,986 2,908,004 8,843,252
Reorganization charges............................................... -- 503,470 1,982,032 1,558,820
Depreciation and amortization........................................ 3,668,861 2,170,769 2,910,593 9,698,163
Write-down of intangibles and equipment and leasehold improvements... 1,330,673 45,327,000 -- 59,371,934
------------ ------------ ------------ -------------
Operating loss................................................... (12,085,864) (48,334,856) (5,139,185) (84,652,822)
Interest expense..................................................... (9,878,333) (3,568,405) (10,491,718) (15,838,895)
Interest income...................................................... 31,466 1,634 8 21,855
Nonoperating income (expense), net................................... 144,551 185,247 (2,294,285) (1,708,848)
------------ ------------ ------------ -------------
Loss before income taxes and extraordinary items................. (21,788,180) (51,716,380) (17,925,180) (102,178,710)
Provision for state income taxes..................................... 288,000 -- -- --
------------ ------------ ------------ -------------
Loss before extraordinary items.................................. (22,076,180) (51,716,380) (17,925,180) (102,178,710)
Fresh start adjustment............................................... -- -- 60,053,472 --
Gain on extinguishment of debt, net of taxes
of $0............................................................... -- -- 121,128,723 3,500,000
------------ ------------ ------------ -------------
Net (loss) income................................................ $(22,076,180) $(51,716,380) $163,257,015 $ (98,678,710)
============ ============ ============ =============
Loss per common share basic and diluted.............................. $ (8.83) $ (20.69) * *
============ ============
Weighted average common shares outstanding........................... 2,500,000 2,500,000 * *
============ ============
</TABLE>
- --------
* Loss per share amount as it relates to the predecessor company is not
meaningful due to the reorganization.
See accompanying notes to consolidated financial statements.
F-53
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Common Stock Additional
------------------- Paid-in Accumulated Stockholders'
Shares Amount Capital Deficit Deficit
---------- ------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at February 29,
1996................... 6,033,087 $60,331 $15,536,906 $(80,209,821) $(64,612,584)
Net loss............... -- -- -- (98,678,710) (98,678,710)
Proceeds from exercise
of capital
stock options......... 38,332 383 33,896 -- 34,279
---------- ------- ----------- ------------ ------------
Balance at February 28,
1997................... 6,071,419 60,714 15,570,802 (178,888,531) (163,257,015)
Net income--Predecessor
Company............... -- -- -- 163,257,015 163,257,015
Issuance of stock for
debt.................. 2,500,000 25,000 22,775,000 -- 22,800,000
Retired under plan of
reorganization........ (6,071,419) (60,714) 60,714 -- --
Fresh start
adjustments........... -- -- (15,631,516) 15,631,516 --
---------- ------- ----------- ------------ ------------
Balance at September 30,
1997................... 2,500,000 25,000 22,775,000 -- 22,800,000
Net loss--Reorganized
Company............... -- -- -- (51,716,380) (51,716,380)
---------- ------- ----------- ------------ ------------
Balance at February 28,
1998................... 2,500,000 25,000 22,775,000 (51,716,380) (28,916,380)
Net loss............... -- -- -- (22,076,180) (22,076,180)
---------- ------- ----------- ------------ ------------
Balance at February 28,
1999................... 2,500,000 $25,000 $22,775,000 $(73,792,560) $(50,992,560)
========== ======= =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-54
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Reorganized Company Predecessor Company
-------------------------- --------------------------
Fiscal year Five months Seven months Fiscal year
ended ended ended ended
February 28, February 28, September February 28,
1999 1998 30, 1997 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Operations:
Net (loss) income................................................... $(22,076,180) $(51,716,380) $163,257,015 $(98,678,710)
Items not requiring current use of cash:
Fresh start adjustments............................................ -- -- (60,087,877) --
Gain on debt extinguishment........................................ -- -- (121,128,723) --
Write-down of equipment and leasehold improvements................. 1,330,673 -- -- --
Medicare/MediCal settlement in debt................................ -- -- 2,100,000 --
Interest payments made in kind..................................... 6,798,000 -- -- --
Depreciation, amortization and write down of intangible and other
assets............................................................ 3,668,861 47,497,769 2,910,593 69,070,097
Provision for doubtful accounts.................................... 2,151,034 2,245,986 2,908,004 8,843,252
Amortization of debt discount...................................... 1,427,000 588,000 -- --
Net changes in operating assets and liabilities.................... 1,032,249 (1,879,888) 7,511,988 19,626,940
------------ ------------ ------------ ------------
Cash used in operating activities................................. (5,668,363) (3,264,513) (2,529,000) (1,138,421)
------------ ------------ ------------ ------------
Investments:
Increase in intangible assets in connection with acquisitions....... -- -- -- (1,632,968)
Net acquisitions and disposals of equipment and leasehold
improvements....................................................... (569,237) (79,189) (194,655) 366,613
------------ ------------ ------------ ------------
Cash used in investing activities................................. (569,237) (79,189) (194,655) (1,266,355)
------------ ------------ ------------ ------------
Financing:
Borrowings of debt.................................................. 7,000,000 4,517,766 4,556,818 5,443,182
Payments of debt.................................................... (531,695) (3,082,155) (235,575) 536,016
Gain on extinguishment of debt...................................... -- -- -- (3,500,000)
Proceeds from issuance of common stock.............................. -- -- -- 34,279
------------ ------------ ------------ ------------
Cash provided by financing activities............................. 6,468,305 1,435,611 4,321,243 2,513,477
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents................. 230,705 (1,908,091) 1,597,588 108,701
Cash and cash equivalents, beginning of period....................... 190,013 2,098,104 500,516 391,815
------------ ------------ ------------ ------------
Cash and cash equivalents, end of period............................. $ 420,718 $ 190,013 $ 2,098,104 $ 500,516
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-55
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--REORGANIZATION:
Physicians Clinical Laboratory, Inc. and subsidiary ("PCL" or the "Company")
provides clinical laboratory services in the State of California. The Company
is a "hybrid" among clinical laboratory companies in that it serves both as a
traditional reference laboratory for office based physician-clients and as an
independent clinical laboratory for regional acute care hospitals. PCL
operates within the health care industry which is undergoing significant
changes such as managed care (including capitated payment arrangements),
proposed federal and state health care reform measures, third party payor
reimbursement decreases (including Medicare, MediCal and private insurance),
industry consolidation and increasing regulation of laboratory operations.
On November 8, 1996, the Company and all of its then subsidiaries filed a
petition for relief under Chapter 11 of the Federal Bankruptcy Laws in the
United States Bankruptcy Court. The Bankruptcy court confirmed the Company's
Second amended Plan of Reorganization (Plan) on April 18, 1997 and the Company
emerged from bankruptcy on October 3, 1997, the effective date of the Plan.
During the period from November 8, 1996 through October 3, 1997, the Company
operated as debtor-in-possession. The plan reflects the results of
negotiations among the parties-in-interest and Nu-Tech Bio-Med, Inc. ("Nu-
Tech"), which resulted inNu-Tech's investment of $14.8 million into the
Company in return for the majority of new common stock.
The Company received approval from the Bankruptcy Court to pay or otherwise
honor certain of its prepetition obligations, including employee wages. Credit
arrangements entered into subsequent to theChapter 11 filings are described
below:
Under the plan, holders of claims and interests were settled as follows:
. Nu-Tech received 890,000 shares (35.6%) of the reorganized Company's
common stock in exchange for its holdings of senior secured debts.
. Nu-Tech received 425,000 shares (17%) of the reorganized Company's common
stock as a result of the purchase of Medical Science Institute (MSI) by
the Company from Nu-Tech (see Note 16).
. Senior Lenders received $55 million in new senior secured promissory
notes and 952,500 shares (38.1%) of the reorganized Company's common
stock.
. The holders of the Company's Subordinated Debentures received 232,500
shares (9.3%) of the reorganized Company's common stock.
. The Company's general unsecured creditors received a pro rata share of
$2.45 million in cash, plus a $400,000 non-interest bearing note due
October, 1998.
. Priority tax claims received deferred cash payments payable in quarterly
installments over 6 years plus interest.
. The Debtor-in-Possession financing facility was forgiven in full.
. The Company's existing stockholders received warrants to purchase up to
5% of the shares of the reorganized Company's common stock at a price of
$13.30 per share.
. All previously outstanding stock options and warrants were cancelled.
In accordance with the Plan, effective October 3, 1997, all previous wholly-
owned subsidiaries were merged into the Company and the Certificate of
Incorporation of the Company was amended whereby the authorized number of
shares of common stock was changed to 50,000,000 shares with a par value of
$.01 per share. Each original outstanding share of common stock of the Company
was cancelled.
F-56
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Upon consummation of the Plan, the Company recognized an extraordinary gain
on debt discharge of approximately $121 million, which represented forgiveness
of debt, reduced by the estimated fair value of common stock and new debt
issued under the Plan. There was no tax expense recorded on the gain due to the
net operating loss carryforwards available at September 30, 1997. The Company's
new senior debt was stated at the present value of amounts to be paid,
determined at estimated current interest rates on October 3, 1997. This
adjustment to present value resulted in an aggregate carrying amount for the
senior debt which is less than the aggregate principal amount thereof, and will
result in the amortization of the difference into interest expense over the
term of the debt.
NOTE 2--FRESH START REPORTING:
The Company has accounted for the reorganization using the principles of
fresh start accounting, as required by Statement of Position 90-7 ("SOP 90-7"),
"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,
issued by the American Institute of Certified Public Accountants. Fresh start
accounting is required because pre-reorganization stockholders received less
than 50% of the new common stock and the reorganization value of the assets of
the reorganized Company is less that the total of all post-petition liabilities
and allowed claims.
Under the principles of fresh start accounting, the Company's total assets
were recorded at their assumed reorganization value, with the reorganization
value allocated to identifiable assets on the basis of their estimated fair
value. Accordingly, the Company's property and equipment and other assets were
reduced by approximately $10.8 million. In addition, the Company's accumulated
deficit of approximately $76 million was eliminated. The excess of the
reorganization value over the value of identifiable assets is reported as
"reorganization value in excess of amounts allocable to identifiable assets".
The total reorganization value was determined in consideration of several
factors. The methodology employed involved estimation of the Company's
enterprise value (the market value of stockholders' equity and the Company's
debt), taking into account the new investment by Nu-Tech and market rates for
similar debt instruments. This resulted in an estimated reorganization value of
approximately $87 million, of which the reorganization value in excess of
amounts allocable to identifiable assets was approximately $71 million. The
excess reorganization value will be amortized over 15 years.
For accounting purpose, the effects of the Plan and fresh start accounting
have been recorded as of September 30, 1997. Accordingly, all financial
statements for any period prior to September 30, 1997 are referred to as
"Predecessor Company" as they reflect the periods prior to the implementation
of fresh start accounting and are not comparable to the financial statements
for periods after the implementation of fresh start accounting.
F-57
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The effect of the Plan and the implementation of fresh start accounting on
the Company's consolidated balance sheet as of September 30, 1997 was as
follows:
<TABLE>
<CAPTION>
Pre-Fresh
Start Balance Reorganized
Sheet Confirmation Fresh-Start Balance Sheet
September 30, of Plan Debt Fair Value September 30,
1997 Discharge(a) Adjustments(b) 1997
------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash.................. $ 575,692 $ 1,556,817 $ (34,405) $ 2,098,104
Accounts receivable,
net.................. 13,220,958 -- (4,267,201) 8,953,757
Inventory and other
assets............... 2,483,683 -- (448,264) 2,035,419
------------- ------------- ----------- -----------
Total current
assets............. 16,280,333 1,556,817 (4,749,870) 13,087,280
Equipment and
improvements, net.... 8,879,962 -- (5,827,934) 3,052,028
Reorganization value.. -- -- 70,910,605 70,910,605
Other assets.......... 687,139 -- (279,329) 407,810
------------- ------------- ----------- -----------
$ 25,847,434 $ 1,556,817 $60,053,472 $87,457,723
============= ============= =========== ===========
Liabilities and
stockholders' equity
(deficit)
Current liabilities:
Current portion of
debt................. $ 1,255,132 $ -- $ -- $ 1,255,132
Accounts payable and
accruals............. 11,056,542 -- -- 11,056,542
Note payable to
creditors............ -- 2,850,000 -- 2,850,000
Debtor-in-possession
borrowings........... 8,243,182 (8,243,182) -- --
Note payable to
related party........ 5,000,000 (5,000,000) -- --
------------- ------------- ----------- -----------
Total current
liabilities........ 25,554,856 (10,393,182) -- 15,161,674
Long-term debt........ 2,240,377 47,255,672 -- 49,496,049
Liabilities subject to
compromise........... 179,234,396 (179,234,396) -- --
------------- ------------- ----------- -----------
Total liabilities... 207,029,629 (142,371,906) -- 64,657,723
Stockholders' equity
(deficit)............ (181,182,195) 143,928,723 60,053,472 22,800,000
------------- ------------- ----------- -----------
$ 25,847,434 $ 1,556,817 $60,053,472 $87,457,723
============= ============= =========== ===========
</TABLE>
- --------
(a) To record the settlement of liabilities, the issuance of new debt and the
issuance of new stock pursuant to the Plan.
(b) To record the adjustments to state assets and liabilities at their
estimated fair value, including the establishment of reorganization value
in excess of amounts allocable to identifiable assets.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of presentation
The consolidated financial statements as of and for the five months ended
February 28, 1998 are presented for the Company after the consummation for the
Plan. As discussed above, these statements were prepared under the principles
of fresh start accounting and are not comparable to the statements of prior
periods.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. In May 1999, the Company sold its
business operations and substantially all of it assets (see Note 17). The
Company used part of the net sales proceeds to repay its line of credit, and
plans to liquidate and distribute the remaining sales proceeds to its Senior
Secured Note holder.
F-58
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Consolidation
The accompanying consolidated financial statements include the accounts of
Physicians Clinical Laboratory, Inc. and its subsidiary (Physicians Clinical
Laboratory, Inc. and its subsidiary are collectively referred to hereinafter as
the "Company"). All significant intercompany accounts and transactions have
been eliminated in consolidation.
Cash equivalents
Cash and cash equivalent include cash in bank and on hand and liquid
investments with original maturities of three months or less. Included in cash
is restricted cash of $70,018 at February 28, 1999 under the line of credit
(see Note 6).
Concentration of credit risk
The Company places its cash and temporary cash investments with high credit
quality institutions. At February 28, 1999, and throughout the year, such
investments were in excess of FDIC insurance limits.
Supplies inventory
Supplies inventory is stated at cost, which approximates market value, on a
first-in, first-out (FIFO) basis. Supplies inventory consists primarily of
clinical laboratory supplies.
Equipment and leasehold improvements
As a result of the adoption of fresh start accounting, equipment and
leasehold improvements were adjusted to their estimated fair value as of
September 30, 1997 and historical accumulated depreciation and amortization was
eliminated. All equipment and leasehold improvements purchased after the
reorganization are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, except for leasehold improvements which are being
amortized over the life of the lease. When assets are retired or otherwise
disposed of, the cost and related accumulated depreciation or amortization are
removed from the accounts and any resulting gain or loss is recognized in
operations for the period. The cost of maintenance and repairs is charged to
income as incurred, significant renewals and betterments are capitalized. The
estimated useful lives of equipment and leasehold improvements are as follows:
<TABLE>
<CAPTION>
Estimated
Useful
Lives
----------
<S> <C>
Leasehold improvements................. 5-12 years
Laboratory equipment................... 5-20 years
Computer equipment..................... 5-12 years
Furniture and fixtures................. 5-12 years
Automobiles............................ 1-5 years
</TABLE>
Excess reorganization value
Excess reorganization value is being amortized on a straight line basis over
15 years. Amortization expense was approximately $2,382,000 for the twelve
months ended February 28, 1999 and $1,571,000 for the five months ended
February 28, 1998.
F-59
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of assets held for sale at February 28, 1999 is as follows:
<TABLE>
<S> <C>
Trade accounts receivable, net of allowance for doubtful accounts
of $4,397,020.................................................... $ 9,148,414
Supplies inventory................................................ 1,469,253
Prepaid expenses and other current assets......................... 225,000
Equipment, net of accumulated depreciation and amortization of
$1,458,739:
Equipment....................................................... 875,912
Furniture and fixtures.......................................... 106,780
Vehicles........................................................ 65,585
Capital leases.................................................. 79,522
Reorganization value in excess of amounts allocable to
identifiable assets, less amortization of $3,950,362............. 21,633,243
Other long-term assets............................................ 444,231
-----------
34,047,940
Less current portion.............................................. 12,390,000
-----------
Assets held for sale.............................................. $21,657,940
===========
</TABLE>
Debt issuance cost
Costs incurred in connection with the issuance of the convertible
subordinated debentures, notes payable to banks and lines of credit are
deferred and amortized over the life of the related debt using an effective
interest rate method. In fiscal 1996, the debt issuance costs related to the
bank debt and the Convertible Subordinated Debentures was expensed due to
defaults with covenants in the lending agreement and the Indenture.
Earnings (loss) per share
Basic and diluted loss per common share is based upon the weighted average
number of common shares outstanding during the period. Diluted loss per common
share excludes the options and warrants to purchase common stock, since their
effect would be antidilutive.
Amounts for the predecessor company are not presented as the data is not
meaningful due to the Company's reorganization.
Reorganization charges
Reorganization charges consist primarily of professional fees incurred as
part of the Chapter 11 bankruptcy.
Direct laboratory and laboratory support costs
Direct laboratory costs consist of labor costs, supplies expense, reference
and pathology fees, utilities and other expenses. Included in reference and
pathology fees are charges from related parties of approximately $180,000,
$200,000, and $326,920 for fiscal 1999, 1998, and 1997, respectively.
Laboratory support costs consist of patient service center costs, courier
costs, laboratory administration expenses, customer service costs, materials
management costs and management service charges from related parties.
Management service charges from related parties were approximately $190,000,
$200,000 and $405,419 for fiscal 1999, 1998, and 1997, respectively.
F-60
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Repairs and maintenance expense
Repairs and maintenance expense were $473,530, $605,965 and $908,795 in
fiscal 1999, 1998, and 1997, respectively.
Stock based compensation
In 1997, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation". In accordance with the provisions of the pronouncement, the
Company elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock option plans. There is no compensation
expense recognized for qualified stock options with an exercise price equal to
the fair value of the shares at the date of grant. For certain non-qualified
stock options granted to employees, the Company recognizes as compensation
expense the excess of the market value of the common stock issuable upon
exercise of such options over the aggregate price of such options.
Income taxes
The liability method is used to account for income taxes. Deferred tax assets
and liabilities are determined based on differences between financial reporting
and income tax bases of assets, liabilities and net operating loss
carryforwards. Deferred tax assets are reduced by a valuation allowance to
reflect the uncertainty associated with their ultimate realization.
Accounts receivable and revenue recognition
Revenues are recognized when services are performed. The Company's revenue is
based on amounts billed or billable for services rendered, net of contractual
adjustments and other arrangements made with third-party payors to provide
services at less than established rates. Revenues under capitated agreements
are recognized monthly as earned. Expenses are accrued on a monthly basis as
services are provided.
As a result of the adoption of fresh start accounting, trade accounts
receivable were adjusted to their estimated fair value as of September 30, 1997
and the allowance for doubtful accounts was eliminated at that date.
Due to the significant changes occurring in the health care industry related
to managed care, billing system/process challenges and accounts receivable
collection problems, it is reasonably possible that the Company's estimate of
the net realizable value of accounts receivable will change in the near term.
No estimate can be made of a range of amounts of loss that are reasonably
possible.
Services under government programs represent approximately 34%, 30% and 33%
of net revenue for fiscal 1999, 1998, and 1997, respectively. The Company's
primary concentration of credit risk is accounts receivable, which consist of
amounts owed by various governmental agencies, insurance companies and private
patients. Significant concentrations of gross accounts receivable at February
28, 1999 and 1998 reside in receivables from governmental agencies of 62% and
55%, respectively.
Fair values of financial instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate the
value.
The carrying amounts reported in the balance sheet for cash, accounts
receivable, accounts payable and accrued liabilities approximate fair value
because of the immediate or short-term maturities of these financial
instruments. As of February 28, 1999, the Company's carrying value of debt
approximates fair value based on similar debt instruments available.
F-61
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally accepted
accounting principles 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 revenue and expenses during the reporting period.
Actual results could differ from those estimates.
NOTE 4--EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Equipment and leasehold improvements at February 28, 1998 consist of the
following:
<TABLE>
<S> <C>
Equipment..................................................... $1,845,219
Automobile.................................................... 9,813
Furniture and fixtures........................................ 304,238
Leasehold improvements........................................ 967,150
----------
3,126,420
Less--accumulated depreciation and amortization............... 594,972
----------
$2,531,448
==========
</TABLE>
Depreciation expense relating to equipment, and leasehold improvements
charged to operations was $1,301,010, $3,510,363, and $4,967,068 for fiscal
1999, 1998 and 1997, respectively. The Company wrote off all leasehold
improvements at February 28, 1999, because the related leases were terminated
in early fiscal 2000.
NOTE 5--LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
February 28,
-----------------------
1999 1998
----------- -----------
<S> <C> <C>
Senior Secured Notes due in 2004, with a face amount
of $55,000,000, net of unamortized discount of
$5,984,000 at February 28, 1999 and $7,411,200 at
February 28, 1998, plus capitalized interest of
$6,798,000 and $0 at February 28, 1999 and 1998,
respectively, currently in default................... $55,813,800 $47,588,000
Notes payable to the Senior Secured Note holder, due
and payable in June 2001............................. 7,000,000 --
Note payable to the United States government, bearing
interest monthly at the 30-day Treasury Bill rate
(5.6% at February 28, 1999 and 1998), principal due
in monthly installments of $25,000 through July 2003
(see Note 14)........................................ 1,375,000 1,650,000
Note payable to the Internal Revenue Service, bearing
interest at 9%, principal and interest due in monthly
installments of $5,301 through May 2002.............. 174,577 237,915
Note payable to the Employment Development Department
bearing interest at 10%, principal and interest due
in monthly installments of $616 through November 1,
2002................................................. 26,288 37,386
Notes payable to Ford Credit Corp., bearing interest
at 10.95%, principal and interest due monthly,
through December 2003................................ 590,148 --
Note payable to the Internal Revenue Service, bearing
interest at 8%, principal and interest due in
quarterly installments of $18,418 through December
2003................................................. 250,077 255,672
Capital lease obligations (see Note 8)................ 677,479 938,053
----------- -----------
65,907,369 50,707,026
Less--current installments............................ 56,697,329 48,360,853
----------- -----------
$ 9,210,040 $ 2,346,173
=========== ===========
</TABLE>
F-62
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As provided by the Plan of Reorganization, the Company issued $55 million in
Senior Secured Notes, due in September 2004, to a group of senior lenders who
are also significant stockholders. The Notes have been recorded at their
present value of $47 million, based upon an estimated discount rate of 15%. The
difference between the present value and the aggregate principal amount will be
amortized into interest expense over the term of the debt. For the first two
years after issuance, the Notes bear interest at the rate of either 10% in cash
or 12% in kind (increase to principal), at the option of the Company. The
Company may not elect interest payments in kind once a cash interest payment
has been made. After two years, the Notes will bear interest at the rate of 11%
in cash, which rate will be increased by 1% per annum through maturity.
Interest is payable semi-annually. Interest on overdue payments will be at 1%
over the then applicable interest rate.
The Notes may be redeemed at the Company's option upon certain notice. The
Company is obligated to offer to repurchase the Notes upon the occurrence of a
change of control, upon certain defined asset sales, or upon consummation of an
underwritten public offering of its capital stock. All redemptions are at 100%
of principal plus accrued interest, except upon a change of control at 101% of
principal accrued interest. Under a registration rights agreement, at any time
after December 31, 1998, the holders of a majority of then outstanding Notes
have one right to request the Company to effect the registration of these Notes
under the Securities Act, subject to certain exceptions.
The Notes are collateralized by a first priority security interest in all
assets of the Company, including capital stock of its subsidiary, under a
Security Agreement and Pledge Agreement. Under an intercreditor and
subordination agreement, the security interests in the Company's receivables
are subordinated to Daiwa Healthco-2 LLC (see Note 6).
Each of the agreements contains certain financial covenants and restrictions.
The Company was in violation of certain covenants in fiscal 1999 and does not
expect to be in compliance subsequent to fiscal year end, which constitutes an
event of default. The lender has the right to accelerate payment of the debt,
and accordingly, the debt has been classified as current portion of long-term
debt.
In fiscal 1997, in connection with a credit facility entered into by the
Predecessor Company, the Company recognized an extraordinary gain of $3.5
million when one of its largest stockholders repaid a portion of the Company's
debt which was in default and guaranteed by a stockholder.
In fiscal 1999, a significant stockholder, who is also a significant holder
of Senior Secured Notes, loaned the Company $7 million for working capital. The
loan bears interest at 15% per annum, payable semi-annually, and matures in
June 2001. The Company has the option to pay interest in cash or by addition to
principal. The loan is senior to the $55 million in Senior Secured Notes and is
subordinated to the Daiwa credit facility. In connection with and as additional
consideration for the loan, Nu-Tech sold a portion of its shares to the lender
and amended the Stockholders' Agreement (see Note 13). In connection with the
loan, the Stockholders' Agreement was amended to modify certain corporate
governance rights previously granted to Nu-Tech.
Maturities of long-term debt, excluding capital lease obligations, in each of
the next five fiscal years are as follows:
<TABLE>
<S> <C>
2000.......................................................... $56,448,785
2001.......................................................... 651,344
2002.......................................................... 7,568,424
2003.......................................................... 386,337
2004.......................................................... 175,000
Thereafter.................................................... --
-----------
$65,229,890
===========
</TABLE>
F-63
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--LINE OF CREDIT:
At February 28, 1999, the Company had a $10 million line of credit, under
which it could borrow up to 85% of eligible accounts receivable, subject to
certain adjustments. Interest is payable monthly at the LIBOR Rate plus 3%,
which interest rate will increase by 2% after an event of default. The
effective interest rate was 9.95% on February 28, 1999. The Agreement also
provides for a monthly non-utilization fee equal to 1/2% on the unused maximum
available and upon early termination, a fee of $200,000. The loan is
collateralized by a first priority lien on all healthcare receivables and
certain bank accounts. The line of credit agreement contained financial and
other covenants, and the Company was not in compliance with certain covenants.
In May 1999, the Company repaid the borrowings under the line of credit (see
Note 17).
NOTE 7--INCOME TAXES:
The expense for income taxes consists of the following:
<TABLE>
<CAPTION>
Reorganized Company Predecessor Company
------------------------- --------------------------
Fiscal year Five months Seven months Fiscal year
ended ended ended ended
February 28, February 28, September 30, February 28,
1999 1998 1997 1997
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Current:
Federal.................. $ -- $-- $-- $--
State.................... 288,000 -- -- --
-------- --- --- ---
288,000 -- -- --
Deferred................... -- -- -- --
-------- --- --- ---
$288,000 $-- $-- $--
======== === === ===
</TABLE>
The effective tax rate and statutory federal income tax rates are reconciled
as follows:
<TABLE>
<CAPTION>
Reorganized Company Predecessor Company
------------------------- --------------------------
Fiscal year Five months Seven months Fiscal year
ended ended ended ended
February 28, February 28, September 30, February 28,
1999 1998 1997 1997
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Federal statutory income
tax rate................ (34.0)% (34.0)% 34.0 % (34.0)%
State franchise taxes,
net of federal income
tax benefit............. (4.8)% (6.1)% 6.1 % (6.1)%
Change in a valuation
allowance............... 40.1 % 9.9 % (27.6)% 40.1 %
Reorganization value..... -- 29.3 % (12.5)% --
Other.................... -- 0.9 % -- --
----- ----- ----- -----
1.3 % 0.0 % 0.0 % 0.0 %
===== ===== ===== =====
</TABLE>
At February 28, 1999, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $30 million. The loss
carryforwards expire between fiscal 1998 and 2013 for federal income tax
purposes. As a result of emerging from bankruptcy and the change in ownership,
approximately $5.3 million of the net operating loss carryforwards will be
subject to an annual limitation regarding their utilization against taxable
income in future periods. Under fresh start accounting, realization of these
pre-effective date net operating loss carryforwards, if any, will be recorded
first as a reduction to excess reorganization value, then to additional paid in
capital.
F-64
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes are as follows:
<TABLE>
<CAPTION>
February 28,
-----------------
1999 1998
---- ------------
<S> <C> <C>
Current:
Accrued expenses.................................... $ (382,489)
Bad debt............................................ (3,371,865)
Prepaid expenses.................................... (158,673)
Other............................................... $-- 455,544
--- ------------
Total current deferred (assets) liabilities....... -- (3,457,483)
Valuation allowance................................... -- 3,457,483
--- ------------
Net current deferred (assets) liabilities......... -- --
--- ------------
Non-current:
Amortization........................................ (25,290,782)
Depreciation........................................ (1,068,831)
Net operating loss.................................. -- (4,448,792)
--- ------------
Total non-current deferred (assets) liabilities... -- (30,808,405)
Valuation allowance................................... -- 30,808,405
--- ------------
Net non-current deferred (assets) liabilities..... -- --
--- ------------
Total net deferred (assets) liabilities............... $-- $ --
=== ============
</TABLE>
The Company has not filed its federal and state income tax returns for fiscal
1997 and subsequent years. The Company's deferred tax assets and liabilities as
of February 28, 1999 are not determinable. However, they would be fully offset
by a valuation allowance.
NOTE 8--LEASES:
The Company is obligated under capital leases for certain computer and
laboratory equipment that expire at various dates during the next five years.
Equipment under capital leases was $482,073, and related accumulated
amortization was $402,551 and $128,612 as of February 28, 1999 and 1998,
respectively.
The Company also leases its laboratories and patient service centers under
operating leases expiring over various terms. Many of the monthly lease
payments are subject to increases based on the Consumer Price Index from the
base year.
The Company also leases remote draw station space, several automobiles and
other equipment, which have been classified as operating leases and which
expire over the next 5 years. Many of the draw station leases have renewal
options and monthly lease payments subject to annual increases.
F-65
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum lease payments under noncancelable operating leases and the
present value of future minimum capital lease payments as of February 28, 1999
are:
<TABLE>
<CAPTION>
Capital Operating
Fiscal years ended February 28, leases leases
------------------------------- -------- ----------
<S> <C> <C>
2000................................................ $318,020 $2,043,534
2001................................................ 259,939 1,048,527
2002................................................ 216,616 626,918
2003................................................ -- 486,540
2004................................................ -- 380,815
Thereafter.......................................... -- 18,836
-------- ----------
Total minimum lease payments........................ 794,575 $4,605,170
==========
Less--amounts representing interest................. 116,829
--------
Present value of net minimum capital lease
payments........................................... $677,746
========
</TABLE>
Rental expense under operating leases was $4,398,950, $4,480,602, and
$6,113,445 for fiscal 1999, 1998, and 1997, respectively.
NOTE 9--RELATED PARTY TRANSACTIONS:
The Company provides laboratory and computer services to certain of its
stockholders (and their affiliated entities). Laboratory and computer service
charges are billed to and paid by the stockholders at negotiated rates. Under
the Plan of Reorganization in fiscal 1998 (see Note 1), these former
stockholders no longer own stock and hold only warrants.
<TABLE>
<CAPTION>
Fiscal years ended February 28,
--------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Laboratory and computer service
revenue from stockholders (warrant
holders)............................ $2,166,905 $1,596,839 $2,407,989
========== ========== ==========
</TABLE>
Amounts due from stockholders (warrant holders) and included in accounts
receivable were as follows:
<TABLE>
<CAPTION>
February 28,
-----------------
1999 1998
-------- --------
<S> <C> <C>
Amounts due from stockholders (warrant holders)........ $337,368 $476,642
======== ========
</TABLE>
The Company received management services from Diagnostic Pathology Medical
Group, Inc. ("DPMG"), a former stockholder (warrant holder) of the Company. The
services of certain management personnel were provided to the Company for
management fees at a cost of $0, $0 and $104,010 in fiscal 1999, 1998, and
1997, respectively.
The Company occasionally uses the specialized laboratory services of one of
its owners and several of its owners' stockholders. These owners only hold
warrants in 1998 and 1999. Most of these services are billed to the Company at
negotiated discounts from the billing entities' customary charges. Amounts
billed to the Company were as follows:
<TABLE>
<CAPTION>
Fiscal years ended
February 28,
--------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Billings from stockholders (warrant
holders)................................... $190,000 $200,000 $326,920
======== ======== ========
</TABLE>
F-66
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company also leases draw station space and purchases other services and
various supplies from several of its prior stockholders (warrant holders). The
total amount paid by the Company for these items was $0, $0, and $26,691 for
fiscal 1999, 1998, and 1997 respectively.
At various times the Company has loaned its former President and CEO funds
totaling approximately $350,000. During the fiscal year ended February 28,
1998, the Company released the former President from all payment obligations
under the loans.
NOTE 10--EMPLOYEE BENEFIT PLAN:
As of January 1, 1989, the Company adopted a 401(k) profit sharing plan under
which employees may contribute between 1% and 20% of their annual compensation
to the Plan. A minimum of 90 days of service is required prior to participation
in the Plan by an employee. On April 30, 1990, the plan was amended to provide
that the Company would contribute 50% of employee contributions up to 6% of
their annual gross compensation for those employees who have at least one full
year of service. The Company contribution to the 401(k) plan was discontinued
effective December 31, 1995.
NOTE 11--STOCK OPTION PLANS AND WARRANTS:
Stock option plans
All options outstanding at the petition date and the related plans have been
cancelled under the Plan of Reorganization (see Note 1).
Effective with the Company's reorganization, a new stock option plan was put
into place. Under an employment agreement effective September 30, 1997, the
Company granted the president a 10 year option to purchase 200,000 shares of
common stock at an exercise price of $.25, which option is fully vested and
exercisable immediately. The option provides for payment of the option price in
cash or pursuant to a cashless exercise, and is subject to the same anti-
dilution provisions under the new warrants discussed below. The option is not
transferable except in limited circumstances and will terminate one year after
termination of the optionee's employment, except where such shares have not
been registered. The Company is obligated to register the shares upon any
appropriate filing and the expiration date will extend to the date of such
registration. Management estimated the market value of the stock to be less
than the exercise price and, accordingly, no compensation cost has been
recognized.
Had compensation cost for the plan been determined based on the fair value of
the option at the grant date consistent with the method of Statement of
Financial Accounting Standards 123, Accounting for Stock-Based Compensation,
the Company's net loss and loss per share would not have been changed
materially for the five month period ended February 28, 1998 and the fiscal
year ended February 28, 1999.
The fair value of the option grant is estimated on the date of grant using
the Black-Scholes options--pricing model with the following assumptions used:
expected volatility 80%, risk-free interest rate 6%, no dividend yield and
expected life of 5 years.
Stock options outstanding at February 28, 1999 and 1998 was 200,000.
F-67
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Additional information regarding stock options:
<TABLE>
<CAPTION>
February 28
---------------
1999 1998
------- -------
<S> <C> <C>
Authorized shares......................................... 200,000 200,000
Shares available for granting............................. 200,000 200,000
Exercisable shares........................................ 200,000 200,000
</TABLE>
Warrants
All warrants outstanding at the bankruptcy's effective date have been
canceled under the Plan of Reorganization (see Note 1).
Pursuant to the Plan of Reorganization and a Warrant Agreement, the Company
issued warrants to prior stockholders for the purchase of an aggregate of
131,579 shares of common stock. The exercise price under the warrants is $13.30
per share and the warrants expire October 3, 2002. The agreement includes anti-
dilution provisions for the adjustment of number of shares and exercise price
upon the occurrence of certain events.
NOTE 12--EMPLOYMENT AGREEMENTS:
Reorganized company
Effective September 30, 1997, the Company entered into an employment
agreement with its new president and CEO with a term of three years at a base
salary of $104,000 annually through October 31, 1997 and $208,000 annually
thereafter through September 30, 2000. Other benefits typical of such
agreements are also provided. The Company may terminate the agreement before
the end of its term for cause. The Company may also terminate the agreement
without any cause by providing severance pay equal to the base salary for the
unexpired portion of the agreement plus one year. The Company is obligated to
pay the base salary for the unexpired portion of the agreement upon the death,
disability or reduction in title or duties of the executive. In early fiscal
2000, the Company terminated the CEO and recorded severance payments under the
employment agreement totaling approximately $300,000.
NOTE 13--STOCKHOLDERS' EQUITY (DEFICIT):
Stock registration rights
Effective with the Plan of Reorganization, the Company entered into a Common
Stock Registration Rights Agreement with the stockholders who received Senior
Secured Notes. The agreement provides these holders with the right for one
demand upon the Company, after the earlier of 30 months from the date of the
agreement or six months after a registration statement for an underwritten
public offering becomes effective, for the filing of a stock registration
statement with respect to their shares. The Company is liable for liquidated
damages in the event of a default.
Stockholders agreement
Effective with the Plan of Reorganization, Nu-Tech entered into a
Stockholders Agreement with certain of the stockholders who received Senior
Secured Notes. The agreement provides for restrictions on transfers of stock
and rights to acquire additional shares pro rata to their holdings if
additional shares are issued or transferred by the Company. The agreement also
provides rights to Nu-Tech to designate 3 members of the 5 member board of
directors and the other stockholders to designate 2 members, as long as certain
ownership percentage is maintained. Corporate governance provisions include
limitations on certain issuance of securities, merger or sale, capital
expenditures, issuance of debt, or modifications to the certificate of
incorporation,
F-68
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
bylaws or the president's employment agreement without at least one vote of a
director designated by the stockholder group.
The agreement was amended in fiscal 1999 in conjunction with a working
capital loan to the Company (see Note 5). The agreement as amended provides the
lender stockholder with the right to elect the majority of the board and
provides Nu-Tech the rights under the corporate governance provisions above. In
addition, Nu-Tech has granted to the lender stockholder an exclusive option to
purchase Nu-Tech's shares of the Company for a price of $10 million. The option
is exercisable upon certain actions of the board, subject to Nu-Tech
stockholder approval. The amended agreement also has a buy-sell provision at
defined prices.
Certificate of Incorporation
The Certificate of Incorporation provides the same purchase rights as under
the original Stockholders Agreement to all stockholders who received Senior
Secured Notes. The Company shall reserve shares of common stock for issuance
under the rights. The purchase rights terminate upon an initial public
offering.
NOTE 14--LEGAL PROCEEDINGS:
On or about January 22, 1997, Taylor R. McKeeman, the Company's former Vice
President for Laboratory Operations, filed a Request for Payment of
Administrative Expense with respect to a prepetition Separation Agreement
between the Company and Mr. McKeeman. Under the Separation Agreement, Mr.
McKeeman is entitled to receive a severance payment in the event he is
terminated after a "Change in Control" occurs, as such term is defined in the
Separation Agreement. This request was denied by order of the Bankruptcy Court,
entered on March 19, 1997, because (i) no Change in Control occurred prior to
the termination of Mr. McKeeman's employment and (ii) any claim of Mr. McKeeman
against the Company's bankruptcy estate arising out of the Separation Agreement
constitutes a prepetition claim. Mr. McKeeman filed a notice of appeal on or
about March 5, 1997. On February 2, 1998, the Bankruptcy Court dismissed Mr.
McKeeman's appeal.
On June 9, 1998, Richard M. Brooks, the Company's former Senior Vice-
President and Chief Financial Officer, filed an Amended Proof of Administrative
Claim and Request for Payment Based Upon Post-Petition Torts seeking in excess
of $3,000,000 in damages for (a) the allegedly tortuous termination of Brook's
employment with the Company and (b) allegedly defamatory statements made by the
Company's chief executive officer about Brooks. The Company filed its Debtors'
Objection to and Motion for Summary Judgment of Mr. Brooks' Amended Proof of
Claim. On August 12, 1998, the Court denied the motion. The matter is currently
in discovery stages. The Company believes the claim has no merit and intends to
defend vigorously against the matter; however, the outcome cannot be predicted.
If Mr. Brooks were to prevail on either part of this Claim, the Company would
incur an administrative expense claim against its Chapter 11 estate in an
amount which would be fixed by the Bankruptcy Court. It is reasonably possible
the outcome could have a material financial impact on the Company.
On December 11, 1998, Arnold N. Oldre, M.D., Inc. filed a lawsuit asserting a
breach of contract and seeking approximately $200,000 in damages. The Company
is currently responding to a document production request. However, the Company
recently informed the plaintiff that the Company does not intend to contest the
action. The Company has not recorded a liability for any amounts that may be
paid in connection with resolving this lawsuit.
In the ordinary course of business, two related complaints have been filed
against the Company with the Department of Fair Employment and Housing (DFEH)
and the Equal Employment Opportunity Commission by former employees alleging
wrongful termination and discrimination. The Company has denied all
allegations.
F-69
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
One complaint has been closed by the DFEH for lack of probable cause. It is not
possible to estimate the outcome of these complaints.
In the ordinary course of business, several lawsuits have been filed against
employees of the Company, and the Company has filed suit against former
employees of the Company which resulted in countersuits against the Company,
relating to alleged violations of employee agreements not to compete. In the
opinion of management, based upon advice of counsel, the ultimate outcome of
these lawsuits will not have a material impact on the Company.
Regulatory investigation
In April of 1997, the Company received a subpoena to furnish certain
documents to the United States Department of Defense ("DOD") with respect to
the Company's Civilian Health and Medical Program of Uniformed Services
("CHAMPUS") billing practices. In late May 1997, the Company was notified that
its Medicare and MediCal billing practices also were undergoing review by the
United States Department of Health and Human Services ("HHS"), and in early
June of 1997, the Company received a subpoena to furnish certain documents to
HHS in connection with such review. The Company cooperated with DOD and HHS in
such investigations and in August 1997 entered into a settlement agreement,
which was approved by the Bankruptcy Court in September 1997. Under the
settlement, the Company agreed to pay $2 million to the United States, $200,000
immediately and the balance over six years (see Note 5). The Company also
entered into a 5 year corporate integrity agreement with HHS to provide for an
internal corporate compliance plan. The settlement releases the Company and its
president from civil and criminal liability. Should the Company default on any
provisions under the agreement, the government may offset any remaining unpaid
balance against monies due the Company under any government program and may
exclude the Company from participation in the Medicare and State health care
programs.
Subsequent to reaching agreement with the United States, the Company proposed
and reached a settlement with the State of California with respect to billing
practices under the MediCal program. The terms of the agreement are similar to
the agreement with the United States except the Company paid $100,000 in cash
to the state.
NOTE 15--ACQUISITIONS:
In February 1997, the Company purchased 100% of the common stock of MSI from
Nu-Tech for $7,643,183. The Company accounted for the transaction using the
purchase method of accounting and included MSI in the accompanying financial
statements at February 28, 1997. There is no operating activity of MSI included
in the statement of operations of the Company for the year ended February 28,
1997. Under the Plan of Reorganization, MSI was legally merged into the Company
effective October 3, 1997.
Pro forma results of operations are as follows for the fiscal year ended
February 28, 1997 (unaudited):
<TABLE>
<S> <C>
Net revenue................................................. $ 75,125,077
Net loss.................................................... (102,004,130)
Net loss per common share................................... *
</TABLE>
- --------
* Loss per share amount relates to the predecessor company and is not
meaningful due to the reorganization (see Note 1).
F-70
<PAGE>
PHYSICIANS CLINICAL LABORATORY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Concluded)
NOTE 16--STATEMENT OF CASH FLOWS:
Statement of cash flows
Net changes in operating assets and liabilities consist of the following:
<TABLE>
<CAPTION>
Reorganized Company Predecessor Company
-------------------------- --------------------------
Fiscal year Five months Seven months Fiscal year
ended ended ended ended
February 28, February 28, September 30, February 28,
1999 1998 1997 1997
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Increase in accounts
receivable............. $ (367,740) $(4,223,937) $(6,176,108) $(4,640,852)
Net decrease (increase)
in supplies inventory,
prepaid costs, deposits
and other assets....... (1,107,730) 443,704 551,923 (1,257,077)
Increase in accounts
payable and accrued
expenses............... 3,307,719 1,900,345 13,136,173 25,524,869
----------- ----------- ----------- -----------
Net change in operating
assets and
liabilities............ $ 1,832,249 $(1,879,888) $ 7,511,988 $19,626,940
=========== =========== =========== ===========
Cash paid for interest.. $ 764,117 $ 249,994 $ -- $ 26,277
=========== =========== =========== ===========
</TABLE>
Supplemental disclosure of cash flow information is as follows:
Non-cash transactions consist of the following:
Year ended February 28, 1997:
Gain on extinguishment of debt paid by a related party of $3.5
million.
Note payable to related party resulting from MSI acquisition of $5
million.
Year ended February 28, 1998:
Issuance of stock for debt under the Plan of Reorganization (see
Note 1).
NOTE 17--SUBSEQUENT EVENT SALE OF BUSINESS:
On April 5, 1999, the Company entered into an Asset Purchase Agreement for
the sale of its business and substantially all assets to Unilab Corp. for a
total purchase price of approximately $40 million. The purchase price includes
approximately $9 million cash, one million shares of the common stock of
Unilab, assumption of approximately $3 million in liabilities, and a note for
$25 million. The note has a 7.5% interest rate, with $10 million annual
principal payments, which may be paid in cash or in shares of Unilab common
stock, at Unilab's option, at a $3.00 per share conversion price for 75% of the
note, with the balance converting at then-current market price. The stock is
subject to a registration rights agreement. The agreement also provides for the
repayment of outstanding borrowings under the Company's line of credit (see
Note 6) prior to closing.
As a result of the agreement, the Company reevaluated the recoverability of
the excess reorganization value based upon an estimated loss on the sale,
including costs of disposal. The Company recorded an additional write-down of
$10.6 million, resulting in a total write-down of excess reorganization value
of approximately $45.3 million.
The sale of the Company's business and assets was consummated on May 9, 1999.
The Company has used part of the net sales proceeds to repay its line of
credit, and plans to liquidate and distribute the remaining sales proceeds to
its Senior Secured Note holder.
F-71
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$155,000,000
[LOGO OF UNILAB]
12 3/4% Senior Subordinated
Notes due 2009
----------------
PROSPECTUS
----------------
January 18, 2000
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
