10-Q 1 form10q_063002.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-22758 UNILAB CORPORATION (Exact name of Registrant as specified in its charter) Delaware 95-4415490 -------------------------------- --------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 18448 Oxnard Street, Tarzana, California 91356 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (818) 996-7300 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of August 12, 2002, 33,523,700 shares of Registrant's Common Stock, par value $.01 per share, were outstanding. Page 1 of 19 pages UNILAB CORPORATION Form 10-Q for the Quarterly Period Ended June 30, 2002 INDEX Page Part I - FINANCIAL INFORMATION: Item 1. Financial Statements (Unaudited) Balance Sheets - June 30, 2002 and December 31, 2001. 3 Statements of Operations - Three and six month periods ended June 30, 2002 and June 30, 2001. 4 Statements of Cash Flows - Six month periods ended June 30, 2002 and June 30, 2001. 5 Notes to Financial Statements. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures about Market Risks 17 Part II - OTHER INFORMATION: Item 1. Legal Proceedings 17 Item 2. Changes in Securities and Use of Proceeds 17 Item 3. Defaults Upon Senior Securities 17 Item 4. Submission of Matters to a Vote of Security Holders 17 Item 5. Other Information 17 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 19 UNILAB CORPORATION BALANCE SHEETS JUNE 30, 2002 AND DECEMBER 31, 2001 (amounts in thousands, except per share data) (Unaudited) June 30, December 31, 2002 2001 Assets -------------------------------------------------------------------------------- Current assets: Cash and cash equivalents $ 35,751 $ 24,200 Accounts receivable, net 66,101 62,702 Inventory of supplies 6,119 4,423 Deferred tax assets 20,583 17,702 Prepaid expenses and other current assets 2,009 2,888 -------------------------------------------------------------------------------- Total current assets 130,563 111,915 Property and equipment, net 12,423 13,465 Deferred tax assets 39,408 43,692 Goodwill, net 93,508 90,600 Other intangible assets, net 285 581 Other assets 5,842 6,275 -------------------------------------------------------------------------------- $ 282,029 $ 266,528 -------------------------------------------------------------------------------- Liabilities and Shareholders' Equity -------------------------------------------------------------------------------- Current liabilities: Current portion of long-term debt $ 7,758 $ 6,839 Accounts payable and accrued liabilities 21,524 22,111 Accrued payroll and benefits 12,216 12,865 -------------------------------------------------------------------------------- Total current liabilities 41,498 41,815 -------------------------------------------------------------------------------- Long-term debt, net of current portion 191,749 195,799 Other liabilities 5,353 5,374 Commitments and contingencies Shareholders' equity: Preferred stock, no par value; Authorized 15,000 shares; none issued -- -- Common stock, $.01 par value; Authorized 60,000 shares; Issued and Outstanding - 33,524 at June 30 and 33,435 at December 31 335 334 Additional paid-in capital 292,609 292,417 Accumulated deficit (249,515) (269,211) -------------------------------------------------------------------------------- Total shareholders' equity 43,429 23,540 -------------------------------------------------------------------------------- $ 282,029 $ 266,528 -------------------------------------------------------------------------------- The accompanying notes are an integral part of these financial statements.

UNILAB CORPORATION STATEMENTS OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (amounts in thousands) (Unaudited) Six months ended June 30, 2002 2001 -------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 19,696 $ 4,517 Adjustments to reconcile net income to net cash provided by operating activities: Amortization and depreciation 3,850 7,328 Provision for doubtful accounts 14,936 14,081 Stock-based compensation charges -- 1,505 Loss on early extinguishment of debt -- 582 Loss on disposals of property and equipment 120 -- Net changes in assets and liabilities affecting operations, net of acquisitions: Increase in Accounts receivable (18,335) (18,285) Increase in Inventory of supplies (1,696) (329) (Increase) decrease in Prepaid expenses and other current assets 879 (798) Decrease in Deferred tax assets 1,403 2,336 Decrease in Other assets 82 203 Increase (decrease) in Accounts payable and accrued liabilities (968) 4,956 Increase (decrease) in Accrued payroll and benefits (289) 1,543 Other 409 639 -------------------------------------------------------------------------------- Net cash provided by operating activities 20,087 18,278 -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments of third party debt (3,189) (52,550) Net proceeds from issuance of common stock -- 112,900 Proceeds from exercise of options 193 -- -------------------------------------------------------------------------------- Net cash provided (used) by financing activities (2,996) 60,350 -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (2,632) (4,762) Payments for acquisitions, net of cash acquired (2,908) (650) -------------------------------------------------------------------------------- Net cash used by investing activities (5,540) (5,412) -------------------------------------------------------------------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS 11,551 73,216 CASH AND CASH EQUIVALENTS - Beginning of Period 24,200 2,593 -------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS - End of Period $ 35,751 $ 75,809 -------------------------------------------------------------------------------- The accompanying notes are an integral part of these financial statements. UNILAB CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The accompanying unaudited financial statements have been prepared by Unilab Corporation ("Unilab" or the "Company") in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of the Company's management, all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation have been included. The interim financial information is not necessarily an indication of the results that may be expected for the entire year. On June 5, 2001, the initial public offering ("IPO") of the Company's common stock was declared effective by the SEC (See Note 4). The accompanying interim financial statements and related notes should be read in conjunction with the audited financial statements of the Company and related notes as contained in the Annual Report on Form 10-K for the year ended December 31, 2001, as filed with the SEC. 2. Acquisition of Unilab Corporation by Quest Diagnostics On April 2, 2002, the Company entered into a definitive agreement ("the Merger Agreement") with Quest Diagnostics ("Quest"), which provides that Quest will acquire all of the outstanding shares of the Company's common stock and assume the Company's existing debt of approximately $200 million. In exchange for the Company's shares, Company stockholders may elect to receive $26.50 in cash, 0.3256 shares of Quest common stock or a combination of cash and stock. The aggregate amount of cash available to the Company stockholders will be limited to 30% of the total consideration available for the Company shares. The Company has approximately 37.4 million shares of common stock outstanding on a fully diluted basis. If the Company stockholders elect to receive 30% of the consideration in cash and if all options are exercised, Quest would issue approximately 8.5 million shares and pay $297 million in cash to the stockholders of the Company. If Company stockholders elect to receive 100% of the consideration in Quest common stock and all of the Company's options were exercised, Quest would issue approximately 12.2 million common shares to the stockholders of the Company. The transaction, which has been approved by the Boards of Directors of both companies, is subject to the satisfaction of customary conditions, including the tender for a majority of the Company's common stock on a fully diluted basis, and regulatory review. During the second quarter of 2002, the Company and Quest received a request for additional information (commonly referred to as a "second request") from the Federal Trade Commission ("FTC") under the Hart-Scott-Rodino Antitrust Improvements Act (the "HSR Act") in connection with Quest's pending acquisition of the Company. Subject to completion of the HSR process and satisfaction of the other conditions to the cash election exchange offer and the agreement and plan of merger, the Company hopes to close the transaction in the third quarter of 2002. The Company and Quest are continuing their discussions with the FTC regarding the proposed transaction and the process is taking longer than anticipated. The Company continues to believe that the transaction is not anti-competitive. Concurrently with the execution of the Merger Agreement, Kelso Investment Associates VI, L.P. and KEP VI, LLC, stockholders collectively owning approximately 41% of the Company's current outstanding common stock, entered into a stockholders agreement (the "Stockholders Agreement") pursuant to which they have agreed to tender all of their respective shares of common stock of the Company in the exchange offer and, under certain circumstances, sell their shares of common stock of the Company to Quest if the Merger Agreement is terminated. The foregoing description is qualified in its entirety by reference to the full text of the exhibits to the Company's report on Form 8-K, filed on April 2, 2002. 3. Net Income Per Share Basic net income per common share has been computed by dividing the net income by the weighted average number of common shares outstanding for each period presented. Diluted net income per share includes the effect of additional common shares that would have been outstanding if potential dilutive common shares had been issued. For the three and six month periods ended June 30, 2001, the weighted average number of dilutive stock options were 1.6 million and 1.4 million respectively, which had no effect on the diluted earnings per share calculation for the three months ended June 30, 2001 and a $0.01 reduction in diluted net income per share for the six month period ended June 30, 2001. For the three and six month periods ended June 30, 2002, the weighted average number of dilutive stock options were 1.8 million and 1.7 million respectively, which reduced the diluted earnings per share calculation by $0.02 in diluted net income per share for the three months ended June 30, 2002 and a $0.03 reduction in diluted net income per share for the six month period ended June 30, 2002. 4. Initial Public Offering, Increase in Authorized Shares and Reverse Stock Split On June 6, 2001, the Company completed an IPO of common stock, $.01 par value. The shares of common stock sold in the IPO were registered under the Securities Act of 1933, as amended, on a Registration Statement Form S-1 (the "Registration Statement") (Reg. No. 333-60154) that was declared effective by the SEC on June 5, 2001. The offering commenced on June 6, 2001 where 6,700,000 shares of common stock registered under the Registration Statement were sold at a price of $16.00 per share. The Underwriters exercised an overallotment option for 1,005,000 shares on June 8, 2001. All 1,005,000 shares were sold at a price of $16.00 per share. The aggregate price of the offering amount registered, including the overallotment, was $123.3 million. In connection with the IPO, the Company incurred underwriting discounts and commissions and other related offering expenses in the amount of approximately $10.6 million. The Company received net proceeds from the IPO of approximately $112.7 million. The net proceeds were primarily used to repay debt and pay $2.5 million in consideration for the termination of annual fees for financial advisory services from Kelso & Company ("Kelso"), the Company's majority shareholder. The $2.5 million paid to Kelso was recorded as a non-recurring charge in the second quarter of 2001. On May 15, 2001, the Board of Directors and Stockholders approved: (1) the Company's filing of a Restated Certificate of Incorporation that was amended to increase the number of shares of capital stock which the Company is authorized to issue to 75 million shares consisting of (a) 60 million shares of common stock, par value $0.01 per share and (b) 15 million shares of preferred stock, no par value, and (2) a 1 for 0.986312 reverse stock split for the common stock. All common stock and per share data have been retroactively adjusted to reflect the 1 for 0.986312 reverse stock split. 5. Early Extinguishment of Debt With certain of the proceeds from the IPO, the Company repaid $15.0 million of the Term A and $34.2 million of the Term B bank loans and wrote-off $1.0 million in related deferred financing costs. The $1.0 million in deferred financing costs, net of $0.4 million in taxes, is shown as an extraordinary loss from the early extinguishment of debt of $0.6 million in the statement of operations for the three months ended June 30, 2001. 6. Commitments and Contingencies On November 4, 1999, a purported class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company and its board of directors by two of the Company's former stockholders, seeking compensatory damages, prejudgment interest, expenses on behalf of the class of shareholders and a preliminary injunction against the November 1999 recapitalization. The complaint alleges, among other things, that the proxy statement relating to the Company's recapitalization contained material misrepresentations and omissions in violation of the federal proxy rules and that approval of the terms of the recapitalization amounted to a breach of the fiduciary duties owed to the Company's stockholders by its directors. Plaintiffs and defendants negotiated a settlement in principle of the action, subject to completion of confirmatory discovery and definitive documentation relating to the settlement and court approval. However, on November 15, 2000, plaintiffs announced that they would not agree to consummate the settlement. On September 26, 2001, plaintiffs filed a second amended complaint against the Company and its former board of directors. The second amended complaint adds as a defendant BT Alex. Brown, the investment banker that delivered a fairness opinion in connection with the Company's recapitalization. The complaint asserts additional claims and allegations, including that the defendants brought the Company private in order to obtain large profits for themselves and others, to the detriment of the public shareholders prior to the recapitalization. The complaint also seeks exemplary damages. On April 16, 2002, the court granted defendants' motion to dismiss the second amended complaint, but granted plaintiffs leave to amend. On May 16, 2002, plaintiffs filed their third amended complaint; defendants have renewed their motion to dismiss. The Company believes the plaintiffs' claims are without merit, but because this matter is in the early stages of litigation it is not possible to predict the likelihood of a favorable or unfavorable outcome. In May of 1999, the Company learned of a federal investigation under the False Claims Act relating to its billing practices for certain test procedures including offering apolipoprotein in conjunction with coronary risk panel assessments. In cooperation with the government, the Company has completed the process of gathering and submitting documentation to the Department of Justice regarding the tests with respect to which they requested information. The Company 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 healthcare programs such as Medicare and Medicaid. 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. On May 31, 2001, the Department of Justice orally offered to settle the claims subject to the federal investigation for a payment by the Company of approximately $2.8 million. The Company cannot assure that this matter will be resolved pursuant to this offer. Although the Company disputes the claims that are the subject of the investigation and hopes to negotiate a settlement with the Department of Justice for less than the government's initial settlement offer, the Company has recorded a legal charge, included in legal and other non-recurring charges in the statement of operations for the year ended December 31, 2001 of $2.95 million, which reflects the verbal settlement offer plus certain legal expenses. The Company is a party to various legal proceedings arising in the ordinary course of the Company's 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 the Company's financial condition, liquidity or results of operations. 7. Goodwill and Other Intangible Assets In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets." In accordance with the guidelines of this accounting principle, goodwill and indefinite-lived intangible assets are no longer amortized but will be assessed for impairment on at least an annual basis. The Company adopted SFAS No. 142 on January 1, 2002 and ceased amortization of goodwill. During the second quarter ended June 30, 2002 the Company completed an impairment analysis of goodwill to assess the fair value of the Company and concluded that the fair value of the reporting unit exceeded the carrying amount of its net assets as of January 1, 2002. The following table provides the comparable effects of adoption of SFAS No. 142 for the three and six months ended June 30, 2002 and 2001:

The following table provides information relating to the Company's amortized and unamortized intangible assets as of June 30, 2002 and December 31, 2001(amounts in thousands):

The total intangible amortization expense for the six months ended June 30, 2002 and 2001 were $0.3 million and $4.1 million, respectively. The Company expects to record annual amortization expense of $0.6 million for the year ended December 31, 2002 and $0 for the years ended December 31, 2003-2006. The changes in the carrying value of goodwill for the six months ended June 30, 2002 are as follows (in thousands): Balance as of January 1, 2002 $ 90,600 Goodwill acquired during the year 2,908 ------------------- Balance as of June 30, 2002 $ 93,508 ------------------- 8. Supplemental Disclosure of Cash Flow Information (amounts in thousands) Six months ended June 30, 2002 2001 ----------- ----------- Cash paid during the period for: Interest, net $ 8,735 $ 16,903 Income taxes $ 12,736 $ 1,411 9. Recent Accounting Pronouncement In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and nullifies Emerging Issues Task Force Issue No. 94-3. The Company plans to adopt Statement No. 146 in January 2003. The provisions of SFAS No. 146 are effective for exit and disposal activities that are initiated after December 31, 2002. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Three and Six Month Periods Ended June 30, 2002 Compared with the Three and Six Month Periods Ended June 30, 2001 This discussion and analysis should be read in conjunction with our financial statements and related notes included elsewhere in this report. Unilab Merges with Quest Diagnostics Incorporated On April 2, 2002, we entered into a definitive Merger Agreement with Quest providing for the acquisition by Quest of all our outstanding capital stock. See Note 2 to the interim financial statements for a full discussion of this transaction. Critical Accounting Policies In our annual report of Form 10-K for the year ended December 31, 2001, we identified our most critical accounting policies upon which our financial status depends as those relating to revenue and accounts receivable, billing, goodwill and income taxes. We reviewed our policies and determined that those policies remain our most critical accounting policies for the three and six months ended June 30, 2002. We did not make any changes in those policies. Revenue Revenue increased to $109.2 million and $213.0 million for the three and six month periods ended June 30, 2002 from $98.9 million and $194.2 million for the comparable prior year periods, representing increases of $10.2 million or 10.4% and $18.8 million or 9.7%, respectively. Approximately $1.5 million and $2.9 million of the increases for the three and six month periods ended June 30, 2002 were attributable to revenue generated from acquisitions. Exclusive of the acquired businesses, revenue increased $8.7 million and $15.9 million for the respective periods, primarily the result of increases in reimbursement levels of $3.7 million and $8.2 million, respectively, and additional specimen volume generating $5.0 million and $7.7 million, respectively. We experienced 3.6% and 4.1% increases, exclusive of the acquired businesses, in the average reimbursement received for each specimen processed during the three and six month periods ended June 30, 2002 versus the comparable prior year periods. The increase in reimbursement levels is primarily due to increases in rates charged to managed care clients, the conversion of our Pap Smear testing to the Thin Prep technology and higher reimbursement from insurance carriers. Exclusive of the acquired businesses, we experienced 5.1% and 4.0% increases in the number of specimens processed in the core business during the three and six month periods ended June 30, 2002 versus the comparable prior year periods. The volume increase was the result of new physician accounts and additional volume from existing clients. Salaries, Wages and Benefits Salaries, wages and benefits increased to $30.6 million and $61.3 million for the three and six month periods ended June 30, 2002 from $28.5 million and $57.4 million for the comparable prior year periods. As a percentage of revenue, salaries, wages and benefits decreased to 28.0% and 28.8% for the three and six month periods ended June 30, 2002 from 28.8% and 29.6% for the comparable prior year periods. The percentage decreases resulted from the economies of scale associated with processing a significantly higher specimen volume (5.9% and 4.8% volume increases including the effect of acquisitions for the three and six month periods ended June 30, 2002) without the same corresponding increase in headcount. We continue to see some easing of wage pressures in the California market and reduced turnover in the traditionally higher turnover departments like specimen processing, couriers and billing personnel. Supplies Expense Supplies expense increased to $15.5 million and $30.4 million for the three and six month periods ended June 30, 2002 from $13.8 million and $27.5 million for the comparable prior year periods. As a percentage of revenue, supplies expense increased to 14.2% and 14.3% for the three and six month periods ended June 30, 2002 from 14.0% and 14.2% for the comparable prior year periods. The percentage increases were primarily attributable to the increased use of the Thin Prep Pap Smear technology, which is more costly. The percentage increases in supply cost were partially offset by vendor price reductions and efficiency improvements. Other Operating Expenses Other operating expenses increased to $23.9 million and $46.9 million for the three and six month periods ended June 30, 2002 from $21.9 million and $43.9 million for the comparable prior year periods. As a percentage of revenue, other operating expenses decreased to 21.9% and 22.0% for the three and six month periods ended June 30, 2002 from 22.1% and 22.6% for the comparable prior year periods. The percentage decreases were primarily attributable to the economies of scale and efficiencies gained from the operating leverage of the existing infrastructure. Selling, General and Administrative Expense Selling, general and administrative expenses increased to $13.8 million and $27.4 million for the three and six month periods ended June 30, 2002 from $12.6 million and $25.0 million for the comparable prior year periods. As a percentage of revenue, selling, general and administrative expenses decreased to 12.6% for the three month period ended June 30, 2002 and was consistent at 12.9% for the six month period ended June 30, 2002 from 12.7% and 12.9% for the comparable prior year periods. On a percentage basis, costs remain roughly the same as the prior periods. We continue to maintain the economies of scale and efficiencies gained from processing a higher specimen count without the same corresponding increase in expenses. Legal and Other Non-Recurring Charges In May of 1999, we learned of a federal investigation under the False Claims Act relating to our billing practices for certain test procedures including offering apolipoprotein in conjunction with coronary risk panel assessments. In cooperation with the government, we have completed the process of gathering and submitting documentation to the Department of Justice regarding the tests with respect to which they 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 healthcare programs such as Medicare and Medicaid. The resolution of such investigation could be material to our operating results for any particular period, depending upon the level of income for such period. On May 31, 2001, the Department of Justice orally offered to settle the claims subject to the federal investigation for a payment by us of approximately $2.8 million. We cannot assure that this matter will be resolved pursuant to this offer. Although we dispute the claims that are the subject of the investigation and hope to negotiate a settlement with the Department of Justice for less than the government's initial settlement offer, we recorded in the second quarter of 2001 a legal charge of $2.95 million, which reflects the verbal settlement offer plus certain legal expenses. In addition, we also recorded in the second quarter of 2001 a non-recurring charge for $2.5 million paid to Kelso, our majority shareholder, in consideration for the termination of annual fees for financial advisory services provided to us. This amount was paid out of the $112.7 million in net IPO proceeds (see Note 4 to the interim financial statements). Stock-Based Compensation Charges On June 29, 2001, we accelerated the vesting of Class A service options issued to consultants and recorded a non-cash compensation charge of $1.4 million and $1.5 million for the three and six month periods ended June 30, 2001. These amounts increased additional paid-in capital. We have recorded all remaining non-cash compensation expenses for Class A options held by consultants under their current agreements as of June 30, 2001. For the year ended December 31, 2001, we recorded $22.3 million in non-cash charges related to the first two tranches of certain employee related Class C performance-based stock options that met contingent vesting provisions in the fourth quarter of 2001. These amounts increased additional paid-in capital. In addition, expense for the one remaining tranche of 489,972 Class C performance options held by employees and for the 193,258 Class B options held by non-employee consultants may be recognized in the future if the contingent provisions are met (see the Annual Report on Form 10-K for the year ended December 31, 2001, as filed with the SEC). Any ultimate possible charge is difficult to determine since the expense is based on a future stock price. Amortization and Depreciation Amortization and depreciation expense decreased to $1.8 million and $3.9 million for the three and six month periods ended June 30, 2002 from $3.9 million and $7.3 million for the comparable prior year periods. The decrease is due to the adoption of Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets" during the first half of 2002, as we no longer record amortization expense for goodwill. EBITDA Earnings before interest, taxes, depreciation and amortization ("EBITDA") were $25.3 million and $47.0 million for the three and six month periods ended June 30, 2002, compared to $14.4 million and $32.4 million for the comparable prior year periods, representing a 76.1% and 45.0% increase, respectively over the comparable prior year periods. Adjusting EBITDA for legal and other non-recurring charges, stock-based compensation charges and extraordinary loss on extinguishment of debt, adjusted EBITDA for the three and six month periods ended June 30, 2002 would be $25.3 million and $47.0 million respectively, compared to $22.2 million and $40.3 million for the comparable prior year periods. EBITDA is presented because it is a widely accepted financial indicator of a company's ability to generate cash flow and to service or incur indebtedness. EBITDA should not be considered an alternative to net income as a measure of operating results or to cash flows from operations as a measure of liquidity or performance in accordance with accounting principles generally accepted in the United States of America. EBITDA as presented may not be comparable to similarly captioned measures used by other companies. Interest Expense Net interest expense decreased to $4.5 million and $9.1 million for the three and six month periods ended June 30, 2002 compared to $8.2 million and $17.3 million for the comparable prior year periods. The decreases were attributable to a combination of lower debt balances due to a significant paydown of debt from proceeds received from the IPO, regularly scheduled principal payments and lower interest rates. Tax Provision We maintained an effective tax rate of approximately 42% in the three and six months ended June 30, 2002 and 2001. Liquidity and Capital Resources Net cash provided by operating activities was $20.1 million for the six months ended June 30, 2002 and reflects an increase of $1.8 million over the six months ended June 30, 2001 when net cash provided by operating activities was $18.3 million. The increase in cash flow from operations primarily resulted from improved earnings before amortization and depreciation and an increase in cash collections on accounts receivable. Net cash used by financing activities was $3.0 million for the six months ended June 30, 2002, resulting from $3.2 million in scheduled principal repayments under debt and capital lease obligations offset by $0.2 million proceeds of exercised stock options. Net cash used by investing activities was $5.5 million for the six months ended June 30, 2002, resulting from $2.9 million paid for acquisitions and fixed asset additions of $2.6 million. We have $35.8 million of cash and cash equivalents at June 30, 2002. Management believes that the amount of cash and cash equivalents available at June 30, 2002, the cash flow expected from operations, and additional borrowing capabilities under the revolving credit facility of $25.0 million will be adequate for us to meet anticipated requirements for working capital, interest payments, capital expenditures and scheduled principal payments under debt and capital lease obligations for the foreseeable future. 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. Risk Factors The Private Securities Litigation Reform Act of 1995 (the "Litigation Reform Act") provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation, provided those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. We would like to take advantage of the "safe harbor" provisions of the Litigation Reform Act in connection with the forward-looking statements included in this document. The risks and other factors that could cause our actual financial results to differ materially from those projected, forecasted or estimated by us in forward-looking statements are detailed in our 2001 Annual Report on Form 10-K. Item 3. Quantitative and Qualitative Disclosures about Market Risks As of June 30, 2002, the Company had borrowings of $99.6 million under a $185.0 million credit facility. The credit facility consists of $160.0 million in term loans ($50.0 million Term A and $110.0 million Term B) and $25.0 million in revolving loans. Interest on amounts borrowed under the credit facility is subject to adjustment determined based on certain levels of financial performance. For LIBOR borrowings, the applicable margin added to LIBOR can range from 2.00% to 3.375% for Term A and revolving loans, and 3.50% to 3.875% for Term B loans. For every one-half percent rise in interest rates on the Company's variable note obligations held at June 30, 2002, interest expense would increase by $0.5 million annually. PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note 6 to the interim financial statements for information regarding the status of government investigations and private claims. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 2.1 Agreement and Plan of Merger, dated as of April 2, 2002, by and among Quest Diagnostics Incorporated, Quest Diagnostics Newco Incorporated and Unilab Corporation (incorporated by reference to Exhibit 2.1 to the Company's report on Form 8-K, filed on April 2, 2002). 99.1 Press Release, dated April 2, 2002 (incorporated by reference to Exhibit 99.1 to the Company's report on Form 8-K, filed on April 2, 2002). 99.2 Stockholders Agreement, dated as of April 2, 2002, by and among Quest Diagnostics Incorporated, Quest Diagnostics Newco Incorporated, Kelso Investment Associates VI, L.P. and KEP VI, LLC (incorporated by reference to Exhibit 99.2 to the Company's report on Form 8-K, filed on April 2, 2002). 99.3 Press Release, dated July 31, 2002 announcing second quarter earnings results. 99.4 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith (signed by Chief Executive Officer, Robert E. Whalen). 99.5 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith (signed by Chief Financial Officer, Brian D. Urban). (b) Reports on Form 8-K A current report, Form 8-K, dated April 2, 2002, was filed with the Securities and Exchange Commission, in connection with the Agreement and Plan of Merger, dated as of April 2, 2002, by and among Quest Diagnostics Incorporated, Quest Diagnostics Newco Incorporated and Unilab Corporation. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UNILAB CORPORATION By: /s/ Brian D. Urban ----------------------------------- Date: August 13, 2002 Brian D. Urban Executive Vice President, Chief Financial Officer and Treasurer

UNILAB CORP /DE/ 10-Q