Liquidity and Capital Resources

Cash and Cash Equivalents

Cash and cash equivalents at December 31, 2003 totaled $155 million, compared to $97 million at December 31, 2002. Cash flows from operating activities in 2003 provided cash of $663 million, which together with cash on-hand were used to fund investing and financing activities, which required cash of $417 million and $188 million, respectively. Cash and cash equivalents at December 31, 2002 totaled $97 million, a decrease of $26 million from December 31, 2001. Cash flows from operating activities in 2002 provided cash of $596 million, which together with cash on-hand were used to fund investing and financing activities, which required cash of $477 million and $145 million, respectively.

Cash Flows from Operating Activities

Net cash provided by operating activities for 2003 was $663 million compared to $596 million in the prior year period. This increase was primarily due to improved operating performance, partially offset by an increase in accounts receivable associated with growth in net revenues. Days sales outstanding, a measure of billing and collection efficiency, improved to 48 days at December 31, 2003 from 49 days at December 31, 2002. Net cash provided by operating activities for 2002 benefited from our ability to accelerate the tax deduction for certain operating expenses resulting from Internal Revenue Service rule changes.

Net cash from operating activities for 2002 was $131 million higher than the 2001 level. This increase was primarily due to improved operating performance, our ability to accelerate the tax deductions resulting from Internal Revenue Service rule changes, efficiencies in our billing and collection processes and a reduction in SBCL integration costs paid. The increase was partially offset by settlement payments, primarily related to contractual disputes previously reserved for, and a decrease in the tax benefits realized associated with the exercise of employee stock options. The year-over-year comparisons were also impacted by the payment of indemnifiable tax matters to GlaxoSmithKline in 2002 and cash received from Corning Incorporated in 2001 related to an indemnified billing-related claim. Days sales outstanding decreased to 49 days at December 31, 2002 from 54 days at December 31, 2001.

Cash Flows from Investing Activities

Net cash used in investing activities in 2003 was $417 million, consisting primarily of acquisition and related transaction costs of $238 million to acquire the outstanding capital stock of Unilab and capital expenditures of $175 million. The acquisition and related transaction costs included the cash portion of the Unilab purchase price of $297 million and approximately $12 million of transaction costs paid in 2003, partially offset by $72 million of cash acquired from Unilab.

Net cash used in investing activities in 2002 was $477 million, consisting primarily of acquisition and related costs of $334 million, primarily to acquire the outstanding voting stock of AML, and capital expenditures of $155 million.

Cash Flows from Financing Activities

Net cash used in financing activities in 2003 was $188 million, consisting primarily of debt repayments totaling $392 million and purchases of treasury stock totaling $258 million, partially offset by $450 million of borrowings under our term loan due June 2007. Borrowings under our term loan due June 2007 were used to finance the cash portion of the purchase price and related transaction costs associated with the acquisition of Unilab, and to repay $220 million of debt, representing substantially all of Unilab’s then existing outstanding debt, and related accrued interest. Of the $220 million, $124 million represented payments related to our cash tender offer, which was completed on March 7, 2003, for all of the outstanding $101 million principal amount of Unilab’s 12¾% Senior Subordinated Notes due 2009 and $23 million of related tender premium and associated tender offer costs. The remaining debt repayments in 2003 consisted primarily of $145 million of repayments under our term loan due June 2007 and $24 million of capital lease repayments. The $258 million in treasury stock purchases represents 4.0 million shares of our common stock repurchased at an average price of $64.54 per share.

Net cash used in financing activities in 2002 was $145 million, consisting primarily of the net cash activity associated with the financing of the AML acquisition. We financed AML’s all-cash purchase price of approximately $335 million and related transaction costs, together with the repayment of approximately $150 million of acquired AML debt and accrued interest with cash on-hand, $300 million of borrowings under our secured receivables credit facility and $175 million of borrowings under our unsecured revolving credit facility. During the last three quarters of 2002, we repaid all of the $475 million in borrowings related to the acquisition of AML.

Dividend Policy

Through October 20, 2003, we had never declared or paid cash dividends on our common stock. On October 21, 2003, our Board of Directors declared the payment of a quarterly cash dividend of $0.15 per common share. The initial quarterly dividend was paid on January 23, 2004 to shareholders of record on January 8, 2004 and totaled $15.4 million. We expect to fund future dividend payments with cash flows from operations, and do not expect the dividend to have a material impact on our ability to finance future growth.

                Share Repurchase Plan

In May 2003, our Board of Directors authorized a share repurchase program, which permits us to purchase up to $300 million of our common stock. In October 2003, our Board of Directors increased our share repurchase authorization by an additional $300 million. Through December 31, 2003, we have repurchased 4.0 million shares of our common stock at an average price of $64.54 per share for a total of $258 million under the program. We expect to fund the share repurchase program with cash flows from operations and do not expect the share repurchase program to have a material impact on our ability to finance future growth.

Contingent Convertible Debentures

On November 30, 2004, 2005, 2008, 2012 and 2016 each holder of the Debentures may require us to repurchase the holder’s Debentures for the principal amount of the Debentures plus any accrued and unpaid interest. We may repurchase the $250 million Debentures for cash, common stock, or a combination of both. We expect to settle any repurchases from any put on the Debentures with a cash payment, funding such payment with a combination of cash on-hand and borrowings under our credit facilities.

Contractual Obligations and Commitments

The following table summarizes certain of our contractual obligations as of December 31, 2003. See Notes 11 and 15 to the Consolidated Financial Statements for further details.

See Note 11 to the Consolidated Financial Statements for a full description of the terms of our indebtedness and related debt service requirements. A full discussion and analysis regarding our minimum rental commitments under noncancelable operating leases, noncancelable commitments to purchase products or services, and reserves with respect to insurance and billing-related claims is contained in Note 15 to the Consolidated Financial Statements.

In December 2003, we entered into two lines of credit with two financial institutions totaling $68 million for the issuance of letters of credit, which mature in December 2004. Standby letters of credit are obtained, principally in support of our risk management program, to ensure our performance or payment to third parties and amounted to $57 million at December 31, 2003, of which $44 million was issued against the $68 million letter of credit lines with the remaining $13 million issued against our $325 million unsecured revolving credit facility. The letters of credit, which are renewed annually, primarily represent collateral for automobile liability and workers’ compensation loss payments.

Our credit agreements relating to our unsecured revolving credit facility and our term loan facilities contain various covenants and conditions, including the maintenance of certain financial ratios, that could impact our ability to, among other things, incur additional indebtedness, repurchase shares of our outstanding common stock, make additional investments and consummate acquisitions. We do not expect these covenants to adversely impact our ability to execute our growth strategy or conduct normal business operations.

Unconsolidated Joint Ventures

We have investments in unconsolidated joint ventures in Phoenix, Arizona; Indianapolis, Indiana; and Dayton, Ohio, which are accounted for under the equity method of accounting. We believe that our transactions with our joint ventures are conducted at arm’s length, reflecting current market conditions and pricing. Total net revenues of our unconsolidated joint ventures, on a combined basis, are less than 6% of our consolidated net revenues. Total assets associated with our unconsolidated joint ventures are less than 3% of our consolidated total assets. We have no material unconditional obligations or guarantees to, or in support of, our unconsolidated joint ventures and their operations.

Requirements and Capital Resources

We estimate that we will invest approximately $180 million to $190 million during 2004 for capital expenditures to support and expand our existing operations, principally related to investments in information technology, equipment, and facility upgrades. During January 2004, $13 million in letters of credit issued against our $325 million unsecured revolving credit facility were cancelled and $17 million of letters of credit were issued under the letter of credit lines. As of February 26, 2004, all of the $325 million unsecured revolving credit facility and all of the $250 million secured receivables credit facility remained available to us for future borrowing. Our secured receivables credit facility is set to expire on April 21, 2004. We are currently in discussions with our lenders regarding a replacement for the facility and expect to have a replacement in place during the second quarter of 2004. If in the unexpected instance the facility is not renewed, we expect that other sources of liquidity could be readily obtained.

We believe that cash from operations and our borrowing capacity under our credit facilities and any replacement facilities will provide sufficient financial flexibility to meet seasonal working capital requirements and to fund capital expenditures, debt service requirements, cash dividends on common shares, share repurchases and additional growth opportunities for the foreseeable future, exclusive of any potential temporary impact of the Health Insurance Portability and Accountability Act of 1996, as discussed below. Our investment grade credit ratings have had a favorable impact on our cost of and access to capital, and we believe that our improved financial performance should provide us with access to additional financing, if necessary, to fund growth opportunities that cannot be funded from existing sources.

Health Insurance Portability and Accountability Act of 1996

The Secretary of the Department of Human Health and Services, or HHS, has issued final regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, designed to improve the efficiency and effectiveness of the healthcare system by facilitating the electronic exchange of information in certain financial and administrative transactions while protecting the privacy and security of the information exchanged. Three principal regulations have been issued: privacy regulations, security regulations, and standards for electronic transactions.

We implemented the HIPAA privacy regulations by April 2003, as required, and are conducting an analysis to determine the proper security measures to reasonably and appropriately comply with the standards and implementation specifications by the compliance deadline of April 20, 2005.

The HIPAA regulations on electronic transactions, which we refer to as the transaction standards, establish uniform standards for electronic transactions and code sets, including the electronic transactions and code sets used for claims, remittance advices, enrollment and eligibility.

On September 23, 2003, CMS announced that it would implement a contingency plan for the Medicare program to accept electronic transactions that are not fully compliant with the transaction standards after the October 16, 2003 compliance deadline. The CMS contingency plan, as announced, allows Medicare carriers to continue to accept and process Medicare claims in the pre-October 16 electronic formats to give healthcare providers additional time to complete the testing process, provided that they continue to make a good faith effort to comply with the new standards. Almost all other payers have followed the lead of CMS, accepting legacy formats until both parties to the transactions are ready to implement the new electronic transaction standards.

As part of its plan, CMS is expected to regularly reassess the readiness of its healthcare providers to determine how long the contingency plan will remain in effect. Many of our payers were not ready to implement the transaction standards by the October 2003 compliance deadline or were not ready to test or trouble-shoot claims submissions. We are working in good faith with payers that have not converted to the new standards to reach agreement on each payer’s data requirements and to test claims submissions.

The HIPAA transaction standards are complex, and subject to differences in interpretation by payers. For instance, some payers may interpret the standards to require us to provide certain types of information, including demographic information not usually provided to us by physicians. As a result of inconsistent interpretation of transaction standards by payers or our inability to obtain certain billing information not usually provided to us by physicians, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and net revenues. We are working closely with our payers to establish acceptable protocols for claims submissions and with our trade association and an industry coalition to present issues and problems as they arise to the appropriate regulators and standards setting organizations. Compliance with the HIPAA requirements requires significant capital and personnel resources from all healthcare organizations. While we believe that our total costs to comply with HIPAA will not be material to our results of operations or cash flows, additional customer contact to obtain data for billing as a result of different interpretations of the current regulations could impose significant additional costs on us.