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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED(dollars in thousands unless otherwise indicated)
Recoverability
and Impairment of Intangible Assets and Other Long-Lived Assets
Effective January 1, 2002, the Company
evaluates the possible impairment of its long-lived assets, including
intangible assets which are amortized pursuant to the provisions of SFAS 142,
under SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived
Assets” (“SFAS 144”). The Company
reviews the recoverability of its long-lived assets when events or changes in
circumstances occur that indicate that the carrying value of the asset may not
be recoverable. Evaluation of possible
impairment is based on the Company’s ability to recover the asset from the expected
future pretax cash flows (undiscounted and without interest charges) of the
related operations. If the expected
undiscounted pretax cash flows are less than the carrying amount of such asset,
an impairment loss is recognized for the difference between the estimated fair
value and carrying amount of the asset. The Company’s adoption of SFAS 144 did not result in any impairment loss
being recorded. Investments
The Company accounts for investments in equity
securities, which are included in “other assets” in conformity with SFAS No.
115, “Accounting for Certain Investments in Debt and Equity Securities”, which
requires the use of fair value accounting for trading or available-for-sale
securities. Both realized and
unrealized gains and losses for trading securities are recorded currently in earnings
as a component of non-operating expenses within “other income (expense), net”
in the consolidated statements of operations. Unrealized gains and losses for available-for-sale securities are
recorded as a component of accumulated other comprehensive income (loss) within
stoc kholders’ equity. Gains and losses
on securities sold are based on the average cost method.
Investments at December 31, 2003 and 2002
consisted of the following:
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2003 |
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2002 |
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Available-for-sale equity securities.................................................................. |
$26,195 |
$ 5,692 |
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Trading equity securities ................................................................................... |
19,168 |
14,808 |
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Other investments ............................................................................................... |
12,598 |
9,744 |
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Total............................................................................................................... |
$57,961 |
$30,244
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Investments in available-for-sale equity
securities consist primarily of equity securities in public corporations. Investments in trading equity securities
represent participant directed investments of deferred employee compensation
and related Company matching contributions held in a trust pursuant to the
Company’s supplemental deferred compensation plan (see Note 13). Other investments do not have readily
determinable fair values and consist primarily of investments in preferred and
common shares of privately held companies.
As of December 31, 2003 and 2002, the Company
had gross unrealized gains (losses) from available-for-sale equity securities
of $15.5 million and $(6.6) million, respectively. “Other income (expense), net” for the year ended December 31,
2001 included a gain of $6.3 million associated with the sale of certain
available-for-sale equity securities. For the years ended December 31, 2003, 2002 and 2001, gains (losses)
from trading equity securities totaled $1.9 million, $(1.0) million and $(0.1)
million, respectively, and are included in “other income (expense), net” within
the consolidated statements of operations. Financial
Instruments
The Company’s policy for managing exposure to
market risks may include the use of financial instruments, including
derivatives. The Company has
established a control environment that includes policies and procedures for
risk assessment and the approval, reporting and monitoring of derivative
financial instrument activities. These
policies prohibit holding or issuing derivative financial instruments for
trading purposes.
SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as
amended, requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in
the fair value of derivatives are recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and, if it is, the type of hedge transaction. Effective January 1, 2001, the Company
adopted SFAS 133, as amended. The
cumulative effect of the change in accounting for derivative financial
instruments upon adoption on January 1, 2001 of SFAS 133, as amended, reduced
comprehensive income by approximately $1 million. Fair Value
of Financial Instruments
The carrying amounts of cash and cash
equivalents, accounts receivable and accounts payable and accrued expenses
approximate fair value based on the short maturity of these instruments. At
December 31, 2003 and 2002, the fair value of the Company’s debt was estimated
at $1.2 billion and $899 million, respectively, using quoted market prices and
yields for the same or similar types of borrowings, taking into account the
underlying terms of the debt instruments. At December 31, 2003 and 2002, the estimated fair value exceeded the
carrying value of the debt by $86 million and $77 million, respectively.
The Company’s 1 ¾% contingent convertible
notes due 2021 have a contingent interest component that will require the
Company to pay contingent interest based on certain thresholds, as outlined
in the indenture governing such notes. The contingent
interest component, which is more fully described in Note 11, is considered to
be a derivative instrument subject to SFAS 133, as amended. As such, the derivative
was recorded at its fair value in the consolidated balance sheets and was
not material at both December 31, 2003 and 2002. Comprehensive
Income
Comprehensive income encompasses all changes in
stockholders’ equity (except those arising from transactions with stockholders)
and includes net income, net unrealized capital gains or losses on
available-for-sale securities and foreign currency translation adjustments. Segment Reporting
The Company currently
operates in one reportable business segment. Substantially all of the Company’s services are provided within the
United States, and substantially all of the Company’s assets are located within
the United States. No one customer
accounted for ten percent or more of net revenues in 2003, 2002, or 2001.
New Accounting Standards
In January 2003, the
FASB issued Interpretation No. 46, “Consolidation of Variable Interest
Entities”, as revised in December 2003 (“FIN 46”). FIN 46 requires a variable
interest entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity’s activities or
entitled to receive a majority of the entity’s residual returns or both.
Historically, entities generally were not consolidated unless the entity was
controlled through voting interests. FIN 46 also requires disclosures about
variable interest entities that a company is not required to consolidate but in
which it has a significant variable interest. The consolidation requirements of
FIN 46 will apply to variable interest entities as of March 31, 2004 for the
Company. Also, certain disclosure requirements apply to all financial
statements issued after December 31, 2003, regardless of when the variable
interest entity was established. The adoption of this standard is not expected
to have a material impact on the Company’s consolidated financial statements.
3.
BUSINESS ACQUISITIONS
Acquisition
of Unilab Corporation
On February 28, 2003, the Company completed the
acquisition of Unilab Corporation (“Unilab”), the leading commercial clinical
laboratory in California. In
connection with the acquisition, the Company paid $297 million in cash and
issued 7.1 million shares of Quest Diagnostics common stock to acquire all of
the outstanding capital stock of Unilab. In addition, the Company reserved approximately 0.3 million shares of
Quest Diagnostics common stock for outstanding stock options of Unilab which
were converted upon the completion of the acquisition into options to acquire
shares of Quest Diagnostics common stock (the “converted options”).
The aggregate purchase price of $698 million
included the cash portion of the purchase price of $297 million and transaction
costs of approximately $20 million, with the remaining portion of the purchase
price paid through the issuance of 7.1 million shares of Quest Diagnostics
common stock (valued at $372 million or $52.80 per share, based on the average
closing stock price of Quest Diagnostics common stock for the five trading days
ended March 4, 2003) and the issuance of approximately 0.3 million converted
options (valued at approximately $9 million, based on the Black Scholes
option-pricing model). Of the total
transaction costs incurred, approximately $8 million was paid during fiscal
2002.
In conjunction with the acquisition of Unilab,
the Company repaid $220 million of debt, representing substantially all of
Unilab’s then existing outstanding debt, and related accrued interest.
Of the $220 million, $124 million represents payments related to the Company’s
cash tender offer, which was completed on March 7, 2003, for all of the outstanding
$101 million principal amount and related accrued interest of Unilab’s
12 ¾% Senior Subordinated Notes due 2009
and $23 million of related tender premium and associated tender offer
costs.
The Company financed the cash portion of the
purchase price and related transaction costs, and the repayment of
substantially all of Unilab’s outstanding debt and related accrued interest,
with the proceeds from a new $450 million amortizing term loan due June 2007
(see Note 11) and cash on-hand.
As part of the Unilab acquisition, Quest
Diagnostics acquired all of Unilab’s operations, including its primary testing
facilities in Los Angeles, San Jose and Sacramento, California, and
approximately 365 patient service centers and 35 rapid response laboratories
and approximately 4,100 employees. The
Company expects to realize significant benefits from the acquisition of
Unilab. As the leading commercial
clinical laboratory in California, the acquisition of Unilab positions the
Company to capitalize on its leading position within the laboratory testing
industry, further enhancing its national network and access to its
comprehensive range of services. Customers and patients are expected to benefit from the acquisition by
having greater access to diagnostic testing services through the Company’s
expanded network of patient service centers. In addition, customers will be provided with state-of-the-art electronic
connectivity services, innovative technologies and an expanded esoteric testing
menu from the Company’s Nichols Institute based in San Juan Capistrano,
California.
In connection with the acquisition of Unilab, as
part of a settlement agreement with the United States Federal Trade Commission,
the Company entered into an agreement to sell to Laboratory Corporation of
America Holdings, Inc., (“LabCorp”), certain assets in northern California for
$4.5 million, including the assignment of agreements with four independent
physician associations (“IPA”) and leases for 46 patient service centers (five
of which also serve as rapid response laboratories) (the “Divestiture”). Approximately $27 million in annual net
revenues were generated by capitated fees under the IPA contracts and
associated fee-for-service testing for physicians whose patients use these
patient service centers, as well as from specimens received directly from the
IPA physicians. The Company completed
the transfer of assets and assignment of the IPA agreements to LabCorp and
recorded a $1.5 million gain in the third quarter of 2003 in connection with
the Divestiture, which is included in “other operating (income) expense, net”
within the consolidated statements of operations.
The acquisition of Unilab was accounted for under the
purchase method of accounting. As such,
the cost to acquire Unilab has been allocated to the assets and liabilities
acquired based on estimated fair values as of the closing date. The consolidated financial statements
include the results of operations of Unilab subsequent to the closing of the
acquisition.
The following table summarizes the Company’s purchase
price allocation related to the acquisition of Unilab based on the estimated
fair value of the assets acquired and liabilities assumed on the acquisition
date.
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Current assets.......................................................................................................... |
$ 193,798 |
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Property, plant and equipment.............................................................................. |
10,855 |
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Goodwill.................................................................................................................... |
735,853 |
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Other assets.............................................................................................................. |
47,777 |
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Total assets acquired.......................................................................................... |
988,283 |
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Current liabilities...................................................................................................... |
62,002 |
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Long-term liabilities................................................................................................. |
7,369 |
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Long-term debt......................................................................................................... |
221,291 |
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Total liabilities assumed...................................................................................... |
290,662 |
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Net assets acquired............................................................................................. |
$ 697,621 |
Based on management’s review of the net assets
acquired and consultations with third-party valuation specialists, no
intangible assets meeting the criteria under SFAS No. 141, “Business
Combinations”, were identified. Of the
$736 million allocated to goodwill, approximately $85 million is expected to be
deductible for tax purposes. Acquisition of American Medical Laboratories, Incorporated
On April 1, 2002, the
Company completed its acquisition of all of the outstanding voting stock of
American Medical Laboratories, Incorporated, (“AML”) and an affiliated company
of AML, LabPortal, Inc. (“LabPortal”), a provider of electronic connectivity
products, in an all-cash transaction with a combined value of approximately
$500 million, which included the assumption of approximately $160 million in
debt.
Through the acquisition of
AML, Quest Diagnostics acquired all of AML’s operations, including two
full-service laboratories, 51 patient service centers, and hospital sales,
service and logistics capabilities. The
all-cash purchase price of approximately $335 million and related transaction
costs, together with the repayment of approximately $150 million of principal
and related accrued interest, representing substantially all of AML’s debt, was
financed by Quest Diagnostics with cash on-hand, $300 million of borrowings
under its secured receivables credit facility and $175 million of borrowings
under its unsecured revolving credit facility. During 2002, Quest Diagnostics repaid all of the $475 million in
borrowings related to the acquisition of AML.
The acquisition of AML was
accounted for under the purchase method of accounting. As such, the cost to acquire AML has been
allocated to the assets and liabilities acquired based on estimated fair values
as of the closing date. The
consolidated financial statements include the results of operations of AML
subsequent to the closing of the acquisition.
The
following table summarizes the Company’s purchase price allocation related to
the acquisition of AML based on the estimated fair value of the assets acquired
and liabilities assumed on the acquisition date.
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Current assets......................................................................................................... |
$ 83,403 |
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Property, plant and equipment............................................................................. |
31,475 |
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Goodwill................................................................................................................... |
426,314 |
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Other assets............................................................................................................ |
8,211 |
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Total assets acquired......................................................................................... |
549,403 |
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Current portion of long-term debt....................................................................... |
11,834 |
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Other current liabilities.......................................................................................... |
51,403 |
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Long-term debt....................................................................................................... |
139,465 |
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Other liabilities........................................................................................................ |
4,925 |
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Total liabilities assumed.................................................................................... |
207,627 |
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Net assets acquired............................................................................................ |
$ 341,776 |
Based
on management’s review of the net assets acquired and consultations with
valuation specialists, no intangible assets meeting the criteria under SFAS No.
141, “Business Combinations”, were identified. Of the $426 million allocated to goodwill, approximately $17 million is
expected to be deductible for tax purposes.
Acquisition
of LabPortal
The
all-cash purchase price for LabPortal of approximately $4 million and related
transaction costs, together with the repayment of all of LabPortal’s
outstanding debt of approximately $7 million and related accrued interest, was
financed by Quest Diagnostics with cash on-hand. The acquisition of LabPortal was accounted for under the purchase
method of accounting. As such, the cost
to acquire LabPortal has been allocated to the assets and liabilities acquired
based on estimated fair values as of the closing date, including approximately
$8 million of goodwill. The
consolidated financial statements include the results of operations of LabPortal
subsequent to the closing of the acquisition.
Pro Forma Combined Financial Information
The
following unaudited pro forma combined financial information for the years
ended December 31, 2003 and 2002 assumes that the Unilab and AML acquisitions and
the Divestiture were completed on January 1, 2002. The unaudited pro forma
combined financial information for the year ended December 31, 2001 assumes
that the AML acquisition was completed on January 1, 2001 (in thousands, except
per share data):
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Net revenues............................................................................................... |
$ 4,803,875 |
$ 4,607,242 |
$ 3,925,418 |
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Net income................................................................................................... |
444,944 |
365,448 |
171,346 |
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Basic earnings per common
share: |
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Net income................................................................................................... |
$ 4.26 |
$ 3.53 |
$ 1.84 |
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Weighted average common shares outstanding—basic..................... |
104,552 |
103,522 |
93,053 |
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Diluted earnings per common
share: |
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Net income................................................................................................... |
$ 4.16 |
$ 3.42 |
$ 1.76 |
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Weighted
average common shares outstanding—diluted.................. |
107,079 |
106,926 |
97,610 |
The
pro forma combined financial information presented above reflects certain
reclassifications to the historical financial statements of Unilab and AML to
conform the acquired companies’ accounting policies and classification of
certain costs and expenses to that of Quest Diagnostics. These adjustments had no impact on pro forma
net income. Pro forma results for the
year ended December 31, 2003 exclude $14.5 million of direct transaction costs,
which were incurred and expensed by Unilab in conjunction with its acquisition
by Quest Diagnostics. Pro forma results for the year ended December 31, 2002
exclude $14.5 million and $6.3 million, respectively, of direct transaction
costs, which were incurred and expensed by AML and Unilab, respectively, in
conjunction with their acquisitions by Quest Diagnostics. 2001 Acquisitions During 2001, the Company acquired the assets of
Clinical Laboratories of Colorado, LLC and the assets of Las Marías Reference
Lab Corp. and Laboratorio Clínico Las Marías, Inc., a clinical laboratory based
in San Juan, Puerto Rico. During 2001, the Company also acquired the
outstanding voting shares that it did not already own of MedPlus, Inc., a
leading developer and integrator of clinical connectivity and data management
solutions for healthcare organizations and clinicians, and all of the voting
stock of Clinical Diagnostic Services, Inc. (“CDS”), which operated a
diagnostic testing laboratory and more than 50 patient service centers in New
York and New Jersey. Additionally,
during 2001, the Company acquired the minority ownership interest of a
consolidated joint venture from its joint venture partner. The combined purchase
price for these acquisitions was $155 million, which was paid primarily in
cash.
The Company accounted for the above acquisitions
under the purchase method of accounting. In connection with the above transactions, the Company recorded $153
million of goodwill during 2001, representing acquisition costs in excess of
the fair value of net assets acquired, and approximately $8 million associated
with non-compete agreements. The amounts paid under the non-compete agreements
are being amortized on the straight-line basis over their five-year terms. During 2002, the Company recorded
approximately $4 million of adjustments to finalize the purchase price
allocations associated with the businesses acquired in 2001, primarily related
to accruals for integration costs for actions impacting the employees and
operations of the acquired businesses, partially offset by adjustments to
finalize the deferred tax position of the acquired entities.
The historical financial statements
of Quest Diagnostics include the results of operations of each acquired company
subsequent to the closing of the respective acquisition. |
