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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[Quest Diagnostics Logo]
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2002
Commission File Number 1-12215
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Quest Diagnostics Incorporated
One Malcolm Avenue, Teterboro, NJ 07608
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock
with attached Preferred Share Purchase Right New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No ___
As of June 28, 2002, the aggregate market value of the approximately 74.6
million shares of voting and non-voting common equity held by non-affiliates of
the registrant was approximately $6.4 billion, based on the closing price on
such date of the Company's Common Stock on the New York Stock Exchange.
As of February 28, 2003, there were outstanding 105,181,208 shares of Common
Stock, $.01 par value.
Documents Incorporated by Reference
Part of Form 10-K into
Document which incorporated
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Portions of the registrant's Proxy Statement
to be filed by April 30, 2003 ................ Part III
Such Proxy Statement, except for portions thereof, which have been specifically
incorporated by reference, shall not be deemed "filed" as part of this report on
Form 10-K.
PART I
Item 1. Business
Overview
We are the nation's leading provider of diagnostic testing, information and
services, providing insights that enable physicians, hospitals, managed care
organizations and other healthcare professionals to make decisions to improve
health. We offer patients and physicians the broadest access to diagnostics
laboratory services through our national network of laboratories and patient
service centers. We provide interpretive consultation through the largest
medical and scientific staff in the industry, with over 300 physicians and
Ph.D.'s around the country. We are the leading provider of esoteric testing,
including gene-based testing, and testing for drugs of abuse. We are also a
leading provider of anatomic pathology services and testing for clinical trials.
We empower healthcare organizations and clinicians with state-of-the-art
connectivity solutions that improve patient care.
During 2002, we generated net revenues of $4.1 billion and processed over
115 million requisitions for testing. After giving effect to our recent
acquisition of Unilab Corporation, we process over 130 million requisitions on
an annual basis. Each requisition form accompanies a patient specimen,
indicating the tests to be performed and the party to be billed for the tests.
Our customers include physicians, hospitals, managed care organizations,
employers, governmental institutions and other independent clinical
laboratories.
We currently operate a nationwide network of approximately 1,700 patient
service centers, principal laboratories located in more than 30 major
metropolitan areas throughout the United States, and approximately 140 smaller
"rapid response" laboratories (including, in each case, facilities operated at
our joint ventures and facilities operated by Unilab Corporation which we
acquired in February 2003). We are the only company in our industry to provide
full esoteric testing services, including gene-based testing, on both coasts
through our Quest Diagnostics Nichols Institute facilities, located in San Juan
Capistrano, California and Chantilly, Virginia. We also have laboratory
facilities in Mexico City, Mexico and San Juan, Puerto Rico and near London,
England.
We are a Delaware corporation. We sometimes refer to ourselves and our
subsidiaries as the "Company". We are the successor to MetPath Inc., a New York
corporation that was organized in 1967. From 1982 to 1996, we were a subsidiary
of Corning Incorporated ("Corning"). On December 31, 1996, Corning distributed
all of the outstanding shares of our common stock to the stockholders of
Corning. In August 1999, we completed the acquisition of SmithKline Beecham
Clinical Laboratories, Inc. ("SBCL"), which operated the clinical laboratory
business of SmithKline Beecham plc ("SmithKline Beecham").
Our principal executive offices are located at One Malcolm Avenue,
Teterboro, New Jersey 07608, telephone number: (201) 393-5000. Our filings with
the Securities and Exchange Commission (the "SEC"), including our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports, are available free of charge on our website as soon
as reasonably practicable after they are filed with, or furnished to, the SEC.
Our Internet website is located at http://www.questdiagnostics.com.
The United States Clinical Laboratory Testing Market
Clinical laboratory testing is an essential element in the delivery of
healthcare services. Physicians use laboratory tests to assist in the detection,
diagnosis, evaluation, monitoring and treatment of diseases and other medical
conditions. Clinical laboratory testing is generally categorized as clinical
testing and anatomic pathology testing. Clinical testing is performed on body
fluids, such as blood and urine. Anatomic pathology testing is performed on
tissues and other samples, such as human cells. Most clinical laboratory tests
are considered routine and can be performed by most independent clinical
laboratories. Tests that are not routine and that require more sophisticated
equipment and highly skilled personnel are considered esoteric tests. Esoteric
tests, including gene-based tests, are generally referred to laboratories that
specialize in performing those tests.
We believe that the United States diagnostics testing industry had over $36
billion in annual revenues in 2002. Most laboratory tests are performed by one
of three types of laboratories: independent clinical laboratories;
hospital-affiliated laboratories; and physician-office laboratories. In 2002, we
believe that hospital-affiliated laboratories performed over one half of the
clinical laboratory tests in the United States, independent clinical
laboratories performed approximately one-third of those tests, and
physician-office laboratories performed the balance.
After years of declining reimbursement and reduced test utilization during
the early to mid-1990s, the underlying fundamentals of the diagnostics testing
industry have improved during the last several years. During the early 1990s,
the industry was negatively impacted by significant government regulation and
investigations into various billing practices. In addition, the rapid growth of
managed care, as a result of the need to reduce overall healthcare costs, and
excess laboratory testing capacity, led to revenue and profit declines across
the diagnostics testing industry, which in turn led to industry consolidation,
particularly among commercial laboratories. As a result of these dynamics, fewer
but larger commercial laboratories have emerged, which have greater economies of
scale, rigorous programs designed to assure compliance with government billing
regulations and other laws, and a more disciplined approach to pricing services.
These changes have resulted in improved profitability and a reduced risk of
non-compliance with complex government regulations. At the same time, a slowdown
in the growth of managed care and decreasing influence by managed care
organizations on the ordering of clinical laboratory testing by physicians has
contributed to renewed growth in testing volumes and further improvements in
profitability since 1999.
We believe that during the next several years, the industry will continue
to experience revenue growth of approximately 5% per year and, in the longer
term, we expect industry revenue growth to increase as much as 7% per year due
to the following factors:
o general expansion and aging of the United States population;
o increasing focus on early detection and prevention as a means to
reduce the overall cost of healthcare and development of more
sophisticated and specialized tests for early detection of disease and
disease management;
o continuing research and development in the area of genomics and
proteomics, which is expected to yield new genetic tests and
techniques;
o increasing volume of tests for diagnosis and monitoring of infectious
diseases such as AIDS and hepatitis C;
o increasing affordability of tests due to advances in technology and
cost efficiencies; and
o increasing awareness by consumers of the value of clinical laboratory
testing and increasing willingness of consumers to pay for tests that
may not be covered by third party payers.
Business Strategy
Our mission is to be recognized by our customers and employees as the best
provider of comprehensive and innovative diagnostic testing, information and
related services. The principal components of this strategy are to:
o Capitalize on Our Leading Position Within the Laboratory Testing
Market: We are the leader in our core clinical laboratory testing
business offering the broadest national access to clinical laboratory
testing services, with facilities in substantially all of the major
metropolitan areas in the United States. We currently operate a
nationwide network of approximately 1,700 patient service centers,
principal laboratories located in more than 30 major metropolitan
areas throughout the United States and about 140 smaller "rapid
response" laboratories that enable us to serve physicians, managed
care organizations, hospitals, employers and other healthcare
providers and their patients throughout the United States. We believe
that customers will increasingly seek to utilize laboratory testing
companies that have a nationwide presence and offer a comprehensive
range of services and that, as a result, we will be able to profitably
enhance our market position.
o Compete Through Providing the Highest Quality Services: We intend to
become recognized as the quality leader in the healthcare services
industry. We are implementing a Six Sigma initiative throughout our
organization. Six Sigma is a management approach that requires a
thorough understanding of customer needs and requirements, process
discipline, rigorous tracking and measuring of services, and training
of employees in methodologies so that they can be held accountable for
improving results. During the second half of 2001, we began to
integrate our Six Sigma initiative with our initiative to standardize
operations and processes across all of Quest Diagnostics by adopting
identified company best practices. We plan to continue these
initiatives during the next several years and expect that successful
implementation of these initiatives will result in measurable
improvements in customer satisfaction as well as significant economic
benefits. The Quest Diagnostics Nichols Institute was the first
clinical laboratory in North America to achieve ISO-9001
certification. Two of our clinical trials laboratories and our
diagnostic kits facility have also achieved ISO-9001 certification. In
addition, five of our laboratories, including a forensic toxicology
laboratory, have achieved ISO-9002 certification. These certifications
are international standards for quality management systems.
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o Continue to Lead Innovation: We intend to build upon our reputation as
a leading innovator in the clinical laboratory industry by continuing
to introduce new tests, technology and services. As the industry
leader with the largest and broadest network and the leading provider
of esoteric testing, including gene-based testing, we believe that we
are the best channel for developers of new technology and tests to
introduce their products to the marketplace. Through our relationship
with members of the academic community and pharmaceutical and
biotechnology firms, as well as our collaboration with emerging
medical technology companies that develop and commercialize novel
diagnostics, pharmaceutical and device technologies, we believe that
we are one of the leaders in transferring technical innovation to the
market.
During 2002, through our research and development, marketing and
commercial alliance with Roche Diagnostics, we were the first
laboratory to offer several new tests of Roche, including its Elecsys
NT-proBNP test (which aids in the diagnostics of congestive heart
failure). We entered into a relationship with Celera Diagnostics that
gives us access to potentially significant markers for the risk of
cardiovascular disease, the leading cause of death in the United
States, and diabetes. We also established a relationship with
Correlogic Systems and gained access to its new ovarian cancer blood
test, which we expect will be available to the marketplace later in
2003.
In addition, we continue to introduce new tests that we develop at
Nichols Institute, one of the leading esoteric testing laboratories in
the world and the largest provider of molecular diagnostics testing in
the United States. During 2002, we developed and introduced a new test
called CF Complete'TM' for the diagnosis of cystic fibrosis in high
risk patients. The CF Complete'TM' test is the only test that
sequences the entire CF gene and its 1,000 mutations. We are expanding
DNA based testing in the clinical laboratory to provide enhanced
sensitivity, accuracy and reliability of this next generation
technology.
We believe that, with the unveiling of the human genome, new genes and
the linkages of genes with disease will continue to be discovered at
an accelerating pace, leading to research that will result in ever
more complex and thorough predictive, diagnostic and therapeutic
testing. We believe that we are well positioned to capture much of
this growth.
We continue to invest in the development and improvement of our
connectivity products for customers and providers by developing
differentiated products that will provide friendlier, easier access to
ordering and resulting of laboratory tests and patient-centric
information. In February 2003, we launched our eMaxx'TM' Internet
portal to physicians nationwide, which enables doctors to order
diagnostic tests and review laboratory results online, as well as
check patients' insurance eligibility in real time and view clinical
information from many sources.
o Pursue Strategic Growth Opportunities: We intend to continue to
leverage our network in order to capitalize on targeted strategic
growth opportunities both inside and outside our core clinical
laboratory testing business. These opportunities are more fully
described under "Strategic Growth Opportunities" and include expanding
our gene-based and specialty testing capabilities, expanding our
geographic presence across the United States, and continuing to make
selective acquisitions and developing connectivity products for
customers and providers.
o Leverage Our Satisfaction Model: Our approach to conducting business
states that satisfied employees lead to satisfied customers, which in
turn benefits our stockholders. We regularly survey our employees and
customers and follow up on their concerns. We emphasize skills
training for all employees and leadership training for our supervisory
employees, which also includes Six Sigma training to manage
high-impact quality improvement projects throughout our organization,
and annual compliance training. We are committed to engaging each
employee with dignity and respect and trust them to treat our
customers the same way. We believe that our treatment and training of
employees, together with our competitive pay and benefits, helps
increase employee satisfaction and performance, thereby enabling us to
provide better services to our customers.
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Recent Acquisitions
On February 26, 2003, we accepted for payment more than 99% of the
outstanding capital stock of Unilab Corporation, or Unilab, the leading
independent clinical laboratory in California. On February 28, 2003, we acquired
the remaining shares of Unilab through a merger. In connection with the
acquisition, we issued approximately 7.4 million shares of Quest Diagnostics
common stock (including 0.3 million shares of Quest Diagnostics common stock
reserved 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), paid $297 million in cash and we plan to repay
substantially all of Unilab's outstanding indebtedness. Unilab, which generated
net revenues of approximately $425 million in 2002, has three regional
laboratories, approximately 365 patient service centers and 35 rapid response
laboratories and approximately 4,100 employees. We expect to incur up to $20
million of costs during 2003 and 2004 to integrate Unilab and our existing
California operations. Upon completion of the Unilab integration, we expect to
realize approximately $25 million to $30 million of annual synergies. We expect
to achieve this annual rate of synergies by the end of 2005.
In connection with the acquisition of Unilab, as part of a settlement
agreement with the United States Federal Trade Commission, we entered into an
agreement to sell to Laboratory Corporation of America Holdings, Inc., or
LabCorp, certain assets in northern California, 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) for $4.5 million. Approximately $27 million in annual net revenues
are 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.
On April 1, 2002, we acquired American Medical Laboratories, Incorporated,
or AML, and an affiliated company of AML, LabPortal, Inc., a provider of
electronic connectivity products, in an all-cash transaction valued at
approximately $500 million, which included the assumption of approximately $160
million in debt. AML is a national provider of esoteric testing to hospitals and
specialty physicians and is a leading provider of diagnostics testing services
in the Nevada and metropolitan Washington, D.C. markets. The Company's
Chantilly, Virginia laboratory, acquired as part of the AML acquisition, has
become the primary esoteric testing laboratory and hospital service center for
the eastern United States and will complement our Nichols Institute esoteric
testing facility in San Juan Capistrano, California. Esoteric testing volumes
will be redirected within our national network to provide customers with
improved turnaround time and customer service. Certain routine clinical
laboratory testing currently performed in the Chantilly, Virginia laboratory
will transition over time to other testing facilities within our regional
laboratory network. During 2002, we repaid all of the $475 million in
indebtedness we incurred in connection with the acquisition.
Following an acquisition, the integration process requires the dedication
of significant management resources, which could result in a loss of momentum in
the activities of our business and may cause an interruption of, or
deterioration in, our services. Since most of our clinical laboratory testing is
performed under arrangements that are terminable at will or on short notice, any
interruption of, or deterioration in, our services may also result in a
customer's decision to stop using us for clinical laboratory testing. These
events could have a material adverse impact on our business. However, management
believes that the successful implementation of our integration plans and our
value proposition based on expanded patient access, our broad testing
capabilities and most importantly, the quality of the services we provide, will
mitigate customer attrition.
Our Services
Our laboratory testing business consists of routine testing, esoteric
testing, and clinical trials testing. Routine testing generates approximately
83% of our net revenues, esoteric and gene-based testing generates approximately
13% of our net revenues, and clinical trials testing generates less than 3% of
our net revenues. We derive less than 2% of our net revenues from foreign
operations.
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Routine Testing
Routine tests measure various important bodily health parameters such as
the functions of the kidney, heart, liver, thyroid and other organs. Commonly
ordered tests include:
o blood cholesterol level tests;
o complete blood cell counts;
o pap smears;
o HIV-related tests;
o urinalyses;
o pregnancy and other prenatal tests; and
o alcohol and other substance-abuse tests.
We perform routine testing through our network of major laboratories, rapid
response laboratories, or "stat" labs, and patient service centers. We also
perform routine testing at the hospital laboratories we manage. Major
laboratories offer a full line of routine clinical tests. Rapid response
laboratories are local facilities where we can quickly perform an abbreviated
line of routine tests for customers that require rapid turnaround. Patient
service centers are facilities where specimens are collected. These centers are
typically located in or near a building used by medical professionals.
We operate 24 hours a day, 365 days a year. We perform and report most
routine procedures within 24 hours. Most test results are delivered
electronically.
Esoteric Testing
Esoteric tests are those tests that are performed less frequently than
routine tests and require more sophisticated technology, equipment and
materials, professional "hands-on" attention and more highly skilled
professional and technical personnel. Because it is not cost-effective for most
clinical laboratories to perform the low volume of esoteric tests in-house, they
generally refer many esoteric tests to an esoteric clinical testing laboratory.
Due to their complexity, esoteric tests are generally reimbursed at higher
levels than routine tests.
Our Quest Diagnostics Nichols Institute is one of the leading esoteric
clinical testing laboratories in the world. In 1998, Nichols Institute, located
in San Juan Capistrano, California, became the first clinical laboratory in
North America to achieve ISO-9001 certification. Our esoteric testing laboratory
in Chantilly, Virginia, acquired as part of the AML acquisition, now enables us
to provide full esoteric testing services, including gene-based testing, on the
east coast. Our two esoteric testing laboratories, which conduct business as
Quest Diagnostics Nichols Institute, perform hundreds of esoteric tests that are
not routinely performed by our regional laboratories. These esoteric tests are
generally in the following fields:
o endocrinology (the study of glands, their hormone secretions and their
effects on body growth and metabolism);
o genetics (the study of chromosomes, genes, and their protein products
and effects);
o immunology (the study of the immune system including antibodies,
immune system cells and their effects);
o microbiology (the study of microscopic forms of life including
bacteria, viruses, fungi and other infectious agents);
o oncology (the study of abnormal cell growth including benign tumors
and cancer);
o serology (a science dealing with the body fluids and their analysis,
including antibodies, proteins and other characteristics);
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o special chemistry (more sophisticated testing requiring special
expertise and technology); and
o toxicology (the study of chemicals and drugs and their effects on the
body's metabolism).
Through our relationship with members of the academic community and
pharmaceutical and biotechnology firms, as well as our collaboration with
emerging medical technology companies that develop and commercialize novel
diagnostics, pharmaceutical and device technologies, we believe that we are one
of the leaders in transferring technical innovation to the market. For example,
through our relationships with Roche Diagnostics, Celera Diagnostics and
Correlogic Systems, we have either introduced or gained access to new innovative
tests that help provide insights to detect, treat and monitor various diseases
and disorders. In addition, Nichols Institute continues to introduce new tests,
such as the CF Complete'TM' test, the most comprehensive genetic test available
to sequence cystic fibrosis gene mutations (see "Business Strategy - Continue to
Lead Innovation").
Through our Academic Associates program, leading academics and
biotechnology firms work directly with our staff scientists to monitor and
consult on existing test procedures and develop new esoteric test methods. In
addition, we have entered into licensing arrangements and co-development
agreements with biotechnology companies and academic medical centers (see
"Business Strategy-Continue to Lead Innovation").
Clinical Trials Testing
We believe that we are the second largest provider of clinical laboratory
testing performed in connection with clinical research trials on new drugs in
the world. Clinical research trials are required by the Food and Drug
Administration, or FDA, to assess the safety and efficacy of new drugs. We have
clinical trials testing centers in the United States and in England. We also
provide clinical trials testing in Australia, Singapore, and South Africa
through arrangements with third parties. Clinical trials involving new drugs are
increasingly being performed both inside and outside the United States.
Approximately 40% of our net revenues from clinical trials testing in 2002
represented testing for GlaxoSmithKline plc ("GSK"). We currently have a
long-term contractual relationship with GSK, under which we are the primary
provider of testing to support GSK's clinical trials testing requirements
worldwide.
Other Services and Products
We manufacture and market diagnostic test kits and systems primarily for
esoteric testing under the Nichols Institute Diagnostics brand name. These are
sold principally to hospitals and clinical laboratories, both domestically and
internationally. Our MedPlus subsidiary is a developer and integrator for
clinical connectivity and data management solutions for healthcare organizations
and clinicians primarily through its ChartMaxx'TM' electronic medical record
system, and provides workflow and content management solutions to customers in a
variety of industries. Recently, Quest Diagnostics has begun deploying
eMaxx'TM', a new state-of-the-art physician's Internet portal across the United
States. The Internet portal was developed in conjunction with MedPlus and will
give physicians greater access to laboratory testing and other clinical
information on-line.
Payers and Customers
We provide testing services to a broad range of healthcare providers. We
consider a "payer" as the party that pays for the test. Depending on the billing
arrangement and applicable law, the payer may be (1) the physician or other
party (such as another laboratory or an employer) who referred the testing to
us, (2) the patient, or (3) a third party who pays the bill for the patient,
such as an insurance company, Medicare or Medicaid. Some states, including New
York, New Jersey and Rhode Island, prohibit us from billing physician clients.
We generally consider a "customer" to be the party who refers tests to us. We
also consider a managed care organization as both our customer and a payer, when
it contracts with us on an exclusive or semi-exclusive basis on behalf of its
patients.
During 2002, only two customers accounted for more than 5% of our net
revenues, and no single customer accounted for more than 7% of our net revenues.
We believe that the loss of any one of our customers would not have a material
adverse effect on our financial condition, results of operations, or cash flow.
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Payers
The following table shows current estimates of the breakdown of the
percentage of our total volume of requisitions and total clinical laboratory
revenues during 2002 applicable to each payer group:
Revenue
as % of
Requisition Volume Total
as % of Clinical Laboratory
Total Volume Revenues
------------------ -------------------
Patient............................. 2% -- 5% 5% -- 10%
Medicare and Medicaid............... 15% -- 20% 15% -- 20%
Physicians, Hospitals, Employers
and Other Monthly-Billed Payers..... 30% -- 35% 25% -- 30%
Third Party Fee-for-Service......... 30% -- 35% 40% -- 45%
Managed Care-Capitated.............. 15% -- 20% 5% -- 10%
Customers
Physicians
Physicians requiring testing for patients are the primary source of our
clinical laboratory testing volume. We typically bill physician accounts on a
fee-for-service basis. Fees billed to physicians are based on the laboratory's
client fee schedule and are typically negotiated. Fees billed to patients and
insurance companies are based on the laboratory's patient fee schedule, subject
to any limitations on fees negotiated with the insurance companies or with
physicians on behalf of their patients. Medicare and Medicaid reimbursements are
based on fee schedules set by governmental authorities.
Managed Care Organizations and Other Insurance Providers
Managed care organizations and other insurance providers, which typically
contract with a limited number of clinical laboratories for their members,
represent approximately one half of our total testing volumes and one half of
our net revenues. Larger managed care organizations and other insurance
providers typically prefer to use large independent clinical laboratories
because they can provide services on a national or regional basis and can manage
networks of local or regional laboratories. In addition, larger laboratories are
better able to achieve the low-cost structures necessary to profitably service
large managed care organizations and can provide test utilization data across
their various plans. In certain markets, such as California, managed care
organizations may delegate their covered members to independent physician
associations, which in turn contract with laboratories for clinical laboratory
services.
While the growth in the number of patients participating in managed care
plans has slowed in recent years, over the last decade, the managed care
industry has been consolidating, resulting in fewer but larger managed care
organizations with significant bargaining power in negotiating fee arrangements
with healthcare providers, including clinical laboratories. Managed care
organizations demand that clinical laboratory service providers accept
discounted fee structures or assume all or a portion of the financial risk
associated with providing testing services to their members through capitated
payment contracts. Under capitated payment contracts, clinical laboratories
receive a fixed monthly fee per individual enrolled with the managed care
organization for all laboratory tests performed during the month regardless of
the number or cost of the tests actually performed. Some services, such as
various esoteric tests, new technologies and anatomic pathology services, may be
carved out from a capitated rate and, if carved out, are charged on a
fee-for-service basis.
In the last several years, there has been a shift in the way major managed
care organizations contract with clinical laboratories. Managed care
organizations have begun to offer more freedom of choice to their affiliated
physicians, including greater freedom to determine which laboratory to use and
which tests to order. Accordingly, most of our agreements with major managed
care organizations are non-exclusive contracts. As a result, under these
non-exclusive arrangements, physicians have more freedom of choice in selecting
laboratories, and laboratories are likely to compete more on the basis of
service and quality rather than price alone. Also, managed care organizations
have been giving patients greater freedom of choice and patients have
increasingly been selecting plans (such as preferred provider organizations)
that offer a greater choice of providers. Pricing for these preferred provider
organizations is typically negotiated on a fee-for-service basis, which
generally results in higher revenue per requisition than under a capitated fee
arrangement. Despite these trends, managed care organizations continue to
aggressively seek cost reductions in order to
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keep their premiums to their customers competitive. If we are unable to agree on
pricing with a managed care organization, we would become a "non-participating"
provider and could then only bill the ordering physician or the patient rather
than the managed care organization. This "non-participating" status could lead
to loss of business since the physician is likely to refer testing to a
participating provider whose testing is covered by the patient's managed care
benefit plan. We cannot assure investors that we will continue to be successful
in negotiating contracts with major managed care organizations. Loss of multiple
major managed care agreements could have a material adverse effect on our
financial condition, results of operations and cash flow.
Quest Diagnostics offers QuestNet'TM', an innovative product to develop and
manage a customized network of clinical laboratory providers for managed care
organizations. Through QuestNet'TM', physicians and members are provided
multiple choices for clinical laboratory testing while managed care
organizations realize cost reductions under a single capitated arrangement.
Hospitals
We provide services to hospitals throughout the United States that vary
from esoteric testing to helping manage their laboratories. We believe that we
are the industry's market leader in servicing hospitals. Testing for hospitals
accounts for approximately 12% of our net revenues. Hospitals generally maintain
an on-site laboratory to perform testing on patients and refer less frequently
needed and highly specialized procedures to outside laboratories, which
typically charge the hospitals on a negotiated fee-for-service basis. We believe
that most hospital laboratories perform approximately 90% to 95% of their
patients' clinical laboratory tests. In addition, many hospitals compete with
independent clinical laboratories for outreach (non-hospital patients) testing.
Most physicians have admitting privileges or other relationships with hospitals
as part of their medical practice. Many hospitals leverage their relationships
with community physicians and encourage the physicians to send their outreach
testing to the hospital's laboratory. In addition, hospitals that own physician
practices generally require the physicians to refer tests to the hospital's
affiliated laboratory. As a result, hospital-affiliated laboratories can be both
customers and competitors for independent clinical laboratories.
During 2002, in conjunction with the acquisition of AML, we launched
dedicated sales and service teams focused on serving the unique needs of
hospital customers. We believe that the combination of full-service, bi-coastal
esoteric testing capabilities, medical and scientific professionals for
consultation, innovative connectivity products, focus on Six Sigma quality and
dedicated sales and service professionals positions us to be the partner of
choice for hospital customers.
We have joint venture arrangements with leading integrated health delivery
networks in several metropolitan areas. These joint venture arrangements, which
provide testing for affiliated hospitals as well as for unaffiliated physicians
and other healthcare providers in their geographic areas, serve as our principal
laboratory facilities in their service areas. Typically, we have either a
majority ownership interest in, or day-to-day management responsibilities for,
our hospital joint venture relationships. We also manage the laboratories at a
number of other hospitals.
Employers, Governmental Institutions and Other Clinical Laboratories
We provide testing services to governmental agencies, including the
Department of Defense and state and federal prison systems, and to large
employers. We believe that we are the leading provider of clinical laboratory
testing to employers for substance abuse, occupational exposures, and
comprehensive wellness programs. Wellness programs enable employers to take an
active role in lowering their overall healthcare costs. Testing services for
employers account for approximately 4% of our net revenues. The volume of
testing services for employers, which generally have relatively low profit
margins, declined significantly during 2001 and 2002, driven by a general
slowing of the economy and a corresponding slowdown in hiring. We also perform
esoteric testing services for other independent clinical laboratories that do
not have the full range of our testing capabilities. All of these customers are
charged on a fee-for-service basis.
Consumers
Consumers are becoming increasingly interested in managing their own health
and health records. Currently, almost all the testing we perform is ordered
directly by a physician, who then receives the test results. However, over time,
we believe that consumers will increasingly want to order clinical laboratory
tests themselves.
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Sales and Marketing
We market to and service our customers through our direct sales force sales
representatives, customer service and patient service representatives and
couriers.
We focus our sales efforts on pursuing and keeping profitable accounts that
generate an acceptable return. We have an active account management process to
evaluate the profitability of all of our accounts. Where appropriate, we change
the service levels, terminate accounts that are not profitable, or adjust
pricing.
Most sales representatives market routine laboratory services primarily to
physicians. Some sales representatives focus on particular market segments or on
testing niches. For example, some representatives concentrate on market segments
such as managed care organizations and others concentrate on testing niches such
as substance-abuse testing. During 2001, we created a team of sales
representatives who concentrate on gene-based and other esoteric testing. During
2002, following our acquisition of AML, we created a team of sales
representatives who are dedicated to sales to hospital clients and we increased
the number of sales representatives who concentrate on gene-based testing.
Customer service representatives perform a number of services for patients
and customers. They monitor services, answer questions and help resolve
problems. Our couriers pick up specimens from most clients daily.
Strategic Growth Opportunities
In addition to expanding our core clinical laboratory business through
internal growth and pursuing our strategy to become a leading provider of
medical information, we intend to continue to leverage our network in order to
capitalize on targeted growth opportunities both inside and outside our core
laboratory testing business.
o Gene-Based and Other Esoteric Tests: We intend to remain a leading
innovator in the clinical laboratory industry by continuing to
introduce new tests, technology and services. We estimate that the
current United States market in esoteric testing, including gene-based
testing, is $3 billion to $4 billion per year. We believe that we have
the largest gene-based testing business in the United States, with
approximately $400 million in annual net revenues, and that this
business is growing by more than 20% per year. We believe that the
unveiling of the human genome, the discovery of new genes and the
linkages of these genes with disease will result in more complex and
thorough predictive, diagnostic and therapeutic testing. We believe
that we are well positioned to realize this growth. We intend to focus
on commercializing diagnostic applications of discoveries in the areas
of functional genomics (the analysis of genes and their functions),
and proteomics (the discovery of new proteins made possible by the
human genome project).
o Anatomic Pathology: While we are one of the leading providers of
anatomic pathology services in the United States, we have
traditionally been strongest in cytology, and specifically in the
analysis of pap smears to detect cervical cancer. During the last
several years, we have led the industry in converting approximately
80% of our pap smear business to the use of monolayer technology for
cervical cancer screening, a higher quality, and more profitable
product offering. We intend to continue to expand our anatomic
pathology business into higher growth segments, including histology
(tissue pathology). We estimate that the current United States market
for anatomic pathology services is approximately $6 billion per year.
We estimate that cytology represents about $1 billion per year of this
market, and that tissue pathology represents about $5 billion per year
of this market. We generate approximately $400 million in net revenues
from such services each year.
o Selective Regional Acquisitions: The clinical laboratory industry
remains highly fragmented. We expect to continue to acquire other
regional clinical laboratories that can be integrated with our
existing laboratories, thereby enabling us to reduce costs and improve
efficiencies through the elimination of redundant facilities and
equipment, and reductions in personnel. (See "Recent Acquisitions" for
a discussion of our recent acquisitions). We may also consider
acquisitions of ancillary businesses as part of our overall growth
strategy, such as our November 2001 acquisition of MedPlus Inc., which
develops clinical connectivity products designed to enhance patient
care (see "Connectivity Solutions").
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o Connectivity Solutions: We continue to invest in the development and
improvement of connectivity products for customers and providers by
developing differentiated products that will provide friendlier,
easier access to ordering and resulting of laboratory tests and
patient-centric information. In February 2003, we launched our
eMaxx'TM' Internet portal to physicians nationwide. The eMaxx'TM'
Internet portal helps doctors order diagnostic tests and review
laboratory results online, as well as check patients' insurance
eligibility in real time and view clinical information from many
sources. The eMaxx'TM' Internet portal is the gateway that physicians
can now use to access our Internet-based Test Orders and Results
On-Line service, which is experiencing acceptance in the marketplace
today. This service will allow us to replace older technology desktop
products that we currently provide to many physicians and thereby
streamline our support structure. Demand has been growing for our
electronic connectivity solutions as physician offices have expanded
their usage of the Internet. By the end of 2002, we were receiving
approximately 10% of all test orders and delivering about 15% of all
test results via our secure on-line service.
The eMaxx'TM' Internet portal was developed in conjunction with
MedPlus, which we acquired in November 2001. MedPlus' ChartMaxx'TM'
and E. Maxx'TM' patient record systems are designed to support the
creation and management of electronic patient records, by bringing
together in one patient-centric view information from various sources,
including the physician's records and laboratory and hospital data. We
intend to expand the services offered through our portal over time as
other strategic arrangements are realized, which will enhance our
ability to introduce a broad range of electronic services to
healthcare providers.
Information Systems
Information systems are used extensively in virtually all aspects of our
business, including laboratory testing, billing, customer service, logistics,
and management of medical data. Our success depends, in part, on the continued
and uninterrupted performance of our information technology (IT) systems.
Computer systems are vulnerable to damage from a variety of sources, including
telecommunications or network failures, malicious human acts and natural
disasters. Moreover, despite network security measures, some of our servers are
potentially vulnerable to physical or electronic break-ins, computer viruses and
similar disruptive problems. We have taken precautionary measures to prevent
unanticipated problems that could affect our systems. Sustained or repeated
system failures that interrupt our ability to process test orders, deliver test
results or perform tests in a timely manner could adversely affect our
reputation and result in a loss of customers and net revenues.
During the 1980s and early 1990s when we acquired many of our laboratory
facilities, our regional laboratories were operated as local, decentralized
units, and we did not standardize their billing, laboratory, and some of their
other information systems. As a result, by the end of 1995 we had many different
information systems for billing, test results reporting, and other transactions.
Over time, the growth in the size and network of our customers and the
increasing complexity of billing demonstrated a greater need for standardized
systems.
During 2002, we began implementation of a standard laboratory information
system and a standard billing system. We expect that deployment of the
standardized systems will take several years to complete and will result in
significantly more centralized systems than we have today. We expect the
integration of these systems will improve operating efficiency and provide
management with more timely and comprehensive information with which to make
management decisions. However, failure to properly implement this
standardization process could materially adversely impact us. During system
conversions of this type, workflow may be re-engineered to take advantage of
enhanced system capabilities, which may cause temporary disruptions in service.
In addition, the implementation process, including the transfer of databases and
master files to new data centers, presents significant conversion risks which
need to be managed carefully.
Billing
Billing for laboratory services is complicated. Laboratories must bill
various payers, such as patients, insurance companies, Medicare, Medicaid,
doctors and employer groups, all of which have different requirements.
Additionally, auditing for compliance with applicable laws and regulations as
well as internal compliance policies and procedures add further complexity to
the billing process. Among many other factors complicating billing are:
o pricing differences between our fee schedules and the reimbursement
rates of the payers;
o disputes with payers as to which party is responsible for payment; and
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o disparity in coverage and information requirements among various
payers.
We incur significant additional costs as a result of our participation in
Medicare and Medicaid programs, as billing and reimbursement for clinical
laboratory testing is subject to considerable and complex federal and state
regulations. These additional costs include those related to: (1) complexity
added to our billing processes; (2) training and education of our employees and
customers; (3) compliance and legal costs; and (4) costs related to, among other
factors, medical necessity denials and advanced beneficiary notices. Compliance
with applicable laws and regulations, as well as internal compliance policies
and procedures, adds further complexity and costs to the billing process.
Changes in laws and regulations could negatively impact our ability to bill our
clients. The Center for Medicare and Medicaid Services, or CMS (formerly the
Health Care Financing Administration), establishes procedures and continuously
evaluates and implements changes in the reimbursement process.
We believe that most of our bad debt expense, which was 5.3% of our net
revenues in 2002, is primarily the result of missing or incorrect billing
information on requisitions received from healthcare providers rather than
credit related issues. In general, we perform the requested tests and report
test results regardless of whether the billing information is incorrect or
missing. We subsequently attempt to contact the provider to obtain any missing
information and rectify incorrect billing information. Missing or incorrect
information on requisitions adds complexity to and slows the billing process,
creates backlogs of unbilled requisitions, and generally increases the aging of
accounts receivable. When all issues relating to the missing or incorrect
information are not resolved in a timely manner, the related receivables are
written-off to the allowance for doubtful accounts.
We have implemented "best practices" for billing that have significantly
reduced the percentage of requisitions with missing billing information from
approximately 16% at the beginning of 1996 to approximately 5% in 2002. These
initiatives, together with our Six Sigma and Standardization initiatives and
progress in dealing with Medicare medical necessity documentation requirements,
have significantly reduced bad debt expense as a percentage of net revenues from
about 7% during 1996 to 5.3% during 2002. We believe that in the longer term,
with a continuing focus on process discipline, bad debt as a percentage of net
revenues can be reduced to 4% or less (see "Regulation of Reimbursement for
Clinical Laboratory Services").
Competition
The clinical laboratory testing business remains fragmented and highly
competitive. We compete with three types of providers: hospital-affiliated
laboratories, other independent clinical laboratories, and physician-office
laboratories. We are the leading clinical laboratory provider in the United
States, with net revenues of $4.1 billion during 2002, and facilities in
substantially all of the country's major metropolitan areas. Our largest
competitor is LabCorp. In addition, we compete with, and service, many smaller
regional and local independent clinical laboratories, as well as laboratories
owned by physicians and hospitals (see "Payers and Customers - Customers").
We believe that healthcare providers consider a number of factors when
selecting a laboratory, including:
o service capability and quality;
o accuracy, timeliness and consistency in reporting test results;
o number and type of tests performed by the laboratory;
o number, convenience and geographic coverage of patient service
centers;
o reputation in the medical community; and
o pricing.
We believe that we compete favorably in each of these areas.
We believe that large independent clinical laboratories may be able to
increase their share of the overall clinical laboratory testing market due to
their large service networks and lower cost structures. These advantages should
enable larger clinical laboratories to more effectively serve large customers,
including managed care organizations. In addition, we believe that consolidation
in the clinical laboratory testing business will continue. However, a majority
of the clinical laboratory testing is likely to continue to be performed by
hospitals, which generally have affiliations with community
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physicians that refer testing to us (see "Payers and Customers - Customers -
Hospitals"). As a result of these affiliations, we compete against
hospital-affiliated laboratories primarily on the basis of service capability
and quality as well as other non-pricing factors. Our failure to provide service
superior to hospital-affiliated laboratories and other laboratories could
negatively impact our net revenues.
Advances in technology may lead to the development of more cost-effective
tests that can be performed outside of an independent clinical laboratory such
as (1) point-of-care tests that can be performed by physicians in their offices
and (2) home testing that can be performed by patients or by physicians in their
offices. Development of such technology and its use by our customers would
reduce the demand for our laboratory testing services and negatively impact our
revenues (see "Regulation of Clinical Laboratory Operations").
Quality Assurance
Our goal is to continually improve the processes for collection, storage
and transportation of patient specimens, as well as the precision and accuracy
of analysis and result reporting. Our quality assurance efforts focus on
proficiency testing, process audits, statistical process control and personnel
training for all of our laboratories and patient service centers. We are
implementing the Six Sigma approach to help achieve our goal of becoming
recognized as the undisputed quality leader in the healthcare services industry.
Internal Proficiency Testing, Quality Control and Audits. Quality control
samples are processed in parallel with the analysis of patient specimens. The
results of tests on quality control samples are then monitored to identify
trends, biases or imprecision in the analytical processes. In addition, we
administer an internal proficiency testing program, where proficiency testing
samples are processed through our systems the same way as are routine patient
specimens. We also perform internal process audits as part of our comprehensive
Quality Assurance program.
External Proficiency Testing and Accreditation. All our laboratories
participate in various quality surveillance programs conducted externally. They
include proficiency testing programs administered by the College of American
Pathologists, or CAP, as well as some state agencies.
CAP is an independent, non-governmental organization of board certified
pathologists. CAP is approved by the CMS to inspect clinical laboratories to
determine compliance with the standards required by the Clinical Laboratory
Improvement Amendments of 1988, or CLIA. CAP offers an accreditation program
to which laboratories may voluntarily subscribe. All of our major regional
laboratories are accredited by the CAP. Accreditation includes on-site
inspections and participation in the CAP (or equivalent) proficiency testing
program.
Regulation of Clinical Laboratory Operations
The clinical laboratory industry is subject to significant federal and
state regulation, including inspections and audits by governmental agencies.
Governmental authorities may impose fines or criminal penalties or take other
enforcement actions to enforce laws and regulations, including revoking a
clinical laboratory's right to conduct business. Changes in regulation may
increase the costs of performing clinical laboratory tests or increase the
administrative requirements of claims.
CLIA and State Regulation. All of our laboratories and patient service
centers are licensed and accredited by applicable federal and state agencies.
CLIA regulates virtually all clinical laboratories by requiring they be
certified by the federal government to ensure that all clinical laboratory
testing services are uniformly accurate, reliable and timely. CLIA permits
states to adopt regulations that are more stringent than federal law. For
example, state laws may require additional personnel qualifications, quality
control, record maintenance and proficiency testing. Currently, most of our
clinical laboratory testing is categorized as "high" or "moderate" complexity,
and therefore subject to extensive and costly regulation under CLIA. The cost
of compliance with CLIA makes it cost prohibitive for many physicians to
operate clinical laboratories in their offices. However, manufacturers of
laboratory equipment and test kits could seek to increase their sales by
marketing point-of-care laboratory equipment to physicians and by selling
test kits approved for home use to both physicians and patients. Diagnostic
tests approved or cleared by the FDA for home use are automatically deemed to
be "waived" tests under CLIA and may be performed in physician office
laboratories with minimal regulatory oversight as well as by patients in
their homes.
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Drug Testing. The Substance Abuse and Mental Health Services
Administration, or SAMHSA, regulates drug testing for public sector employees
and employees of certain federally regulated businesses. SAMHSA has established
detailed performance and quality standards that laboratories must meet to
perform drug testing on federal employees and contractors and other regulated
entities. All laboratories that perform such testing must be certified as
meeting SAMHSA standards.
Controlled Substances. The federal Drug Enforcement Administration, or DEA,
regulates access to controlled substances used to perform drugs of abuse
testing. Laboratories that use controlled substances are licensed by the DEA.
Medical Waste, Hazardous Waste and Radioactive Materials. Clinical
laboratories are also subject to federal, state and local regulations relating
to the handling and disposal of regulated medical waste, hazardous waste and
radioactive materials. We generally use outside vendors to dispose of specimens.
FDA. The FDA has regulatory responsibility over instruments, test kits,
reagents and other devices used by clinical laboratories and has taken
responsibility from the Centers for Disease Control and Prevention, or CDC, for
test classification. In the past, the FDA has claimed regulatory authority over
laboratory-developed tests, but has exercised enforcement discretion in not
regulating tests performed by CLIA-certified laboratories. In December 2000, the
Department of Health and Human Services, or HHS, Secretary's Advisory Committee
on Genetic Testing recommended that the FDA regulate laboratory developed
genetic testing. In late 2002, a new HHS Secretary's Advisory Committee on
Genetics, Health and Society was appointed to replace the prior Advisory
Committee, but it has not yet met or made any recommendations. In the meantime,
the FDA continues to consider whether to regulate laboratory developed genetic
testing. Representatives of clinical laboratories (including Quest Diagnostics)
and the American Clinical Laboratory Association (the industry's trade
association) have met with two branches of the FDA to address their respective
issues pertaining to regulation of genetic testing in general and issues with
regard to premarket approval of the analyte specific reagents used in
laboratory-developed HIV Genotype tests in particular. We expect those
discussions to continue. FDA regulation of laboratory-developed genetic testing
could lead to increased costs and delay in introducing new genetic tests.
Occupational Safety. The federal Occupational Safety and Health
Administration, or OSHA, has established extensive requirements relating
specifically to workplace safety for healthcare employers. This includes
protecting workers from exposure to blood-borne pathogens, such as HIV and
hepatitis B and C, and requiring employers to develop a program to reduce or
eliminate needle stick injuries such as through the use of safety needles.
Specimen Transportation. Transportation of infectious substances such as
clinical laboratory specimens is subject to regulation by the Department of
Transportation, the Public Health Service, the United States Postal Service
and the International Civil Aviation Organization.
Corporate Practice of Medicine. Many states, including several in which our
principal laboratories are located, prohibit corporations from engaging in the
practice of medicine. The corporate practice of medicine doctrine has been
interpreted to prohibit corporations from employing licensed healthcare
professionals to provide services on the corporation's behalf. These
restrictions may affect our ability to provide services directly to consumers.
Privacy and Security of Health Information; Standard Transactions
Pursuant to the Health Insurance Portability and Accountability Act of
1996, or HIPAA, on December 28, 2000, the Secretary of HHS issued final
regulations that would establish comprehensive federal privacy standards with
respect to the uses and disclosures of protected health information by health
plans, healthcare providers or healthcare data clearinghouses. The regulations
establish a complex regulatory framework on a variety of subjects, including:
o the circumstances under which uses and disclosures of protected health
information are permitted or required without a specific authorization
by the patient;
o a patient's rights to access, amend and receive an accounting of the
disclosures and uses of protected health information;
o the content of notices of privacy practices for protected health
information; and
o administrative, technical and physical safeguards required of entities
that use or receive protected health information.
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The federal healthcare privacy regulations establish a "floor" and do not
supersede state laws that are more stringent. Therefore, we are required to
comply with both federal privacy standards and varying state privacy laws. In
addition, for healthcare data transfers relating to citizens of other countries,
we will need to comply with the laws of other countries. The federal privacy
regulations became effective in April 2001 for healthcare providers, who have
until April 2003 to comply. In March 2002, HHS issued a notice of proposed
rulemaking to modify the final privacy standards and a final rule modifying the
privacy standards was published on August 14, 2002. In addition, final standards
for electronic transactions were issued in August 2000 and became effective in
October 2002, although covered entities were eligible to obtain a one year
extension if approved through an application to the Secretary of HHS, that
includes a plan for achieving compliance by October 16, 2003. We received from
HHS a one-year extension through October 16, 2003. The regulation on electronic
transactions provide uniform standards for code sets (billing codes representing
medical procedures, such as laboratory tests, and diagnosis codes, which are
used, among others, in connection with the identification and billing of medical
procedures and laboratory tests), electronic claims, remittance advice,
enrollment, eligibility and other electronic transactions. Finally, the security
and electronic signature regulations were published on February 20, 2003 and
will become effective on April 21, 2003, although healthcare providers have
until April 21, 2005 to comply. HIPAA provides for significant fines and other
penalties for wrongful disclosure of protected health information. We have
completed our analyses and are engaged in finalizing our standard operating
procedures and policies for implementation in 2003. Compliance with the HIPAA
requirements, when finalized, will require significant capital and personnel
resources from all healthcare organizations, including Quest Diagnostics. These
regulations, when effective, will likely restrict our ability to use our
laboratory database to provide medical information for purposes other than
payment, treatment or healthcare operations (as defined by HIPAA), except for
disclosures for various public policy purposes outlined in the final privacy
standards and information that does not specifically identify a patient.
Regulation of Reimbursement for Clinical Laboratory Services
Overview. The healthcare industry has experienced significant changes in
reimbursement practices during the past several years. Governmental payers, such
as Medicare (which principally serves patients 65 years and older) and Medicaid
(which principally serves indigent patients), as well as private insurers and
large employers, have taken steps to control the cost, utilization and delivery
of healthcare services. Principally as a result of reimbursement reductions and
measures adopted by CMS to reduce utilization described below, the percentage of
our aggregate net revenues derived from Medicare and Medicaid programs declined
from approximately 20% in 1995 to approximately 15% in 2002. While the total
cost to comply with Medicare administrative requirements is disproportionate to
our cost to bill other payers, average Medicare reimbursement rates approximate
the Company's overall average reimbursement rate from all payers, making this
business generally less profitable. However, we believe that our other business
may significantly depend on continued participation in the Medicare and Medicaid
programs, because many customers may want a single laboratory to perform all of
their clinical laboratory testing services, regardless of whether reimbursements
are ultimately made by themselves, Medicare, Medicaid or other payers.
Billing and reimbursement for clinical laboratory testing is subject to
significant and complex federal and state regulation. Penalties for violations
of laws relating to billing federal healthcare programs and for violations of
federal fraud and abuse laws include: (1) exclusion from participation in
Medicare/Medicaid programs; (2) asset forfeitures; (3) civil and criminal
penalties and fines; and (4) the loss of various licenses, certificates and
authorizations necessary to operate some or all of a clinical laboratory's
business. Civil monetary penalties for a wide range of violations are not more
than $10,000 per violation plus three times the amount claimed and, in the case
of kickback violations, not more than $50,000 per violation plus up to three
times the amount of remuneration involved. A parallel civil remedy under the
federal False Claims Act provides for damages not more than $11,000 per
violation plus up to three times the amount claimed.
Reduced Reimbursements. In 1984, Congress established a Medicare fee
schedule payment methodology for clinical laboratory services performed for
patients covered under Part B of the Medicare program. Congress then imposed a
national ceiling on the amount that carriers could pay under their local
Medicare fee schedules. Since then, Congress has periodically reduced the
national ceilings. The Medicare national fee schedule limitations were reduced
in 1996 to 76% of the 1984 national median of the local fee schedules and in
1998 to 74% of the 1984 national median. The Balanced Budget Act of 1997
eliminated the provision for annual fee schedule increases based on the consumer
price index from 1998 through 2002. However, a 1.1% increase based on the
consumer price index became effective on January 1, 2003. The limitation amount
for new clinical laboratory tests as determined by the Secretary of HHS, for
which no limitation amount has previously been established, is 100% of the
median of all the fee schedules established for that test.
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Pathology services are reimbursed by Medicare based on a resource-based
relative value scale ("RBRVS") that is periodically updated by CMS. Less than 1%
of our aggregate net revenues are derived from pathology services reimbursed by
Medicare based on RBRVS.
Laboratories must bill the Medicare program directly and must accept the
carrier's fee schedule amount as payment in full for most tests performed on
behalf of Medicare beneficiaries. In addition, state Medicaid programs are
prohibited from paying more (and in most instances, pay significantly less) than
Medicare. Major clinical laboratories, including Quest Diagnostics, typically
use two fee schedules:
o "Client" fees charged to physicians, hospitals, and institutions to
which a laboratory supplies services on a wholesale basis and which
are billed on a monthly basis. These fees are generally subject to
negotiation or discount.
o "Patient" fees charged to individual patients and third-party payers,
like Medicare and Medicaid. These generally require separate bills for
each requisition.
The fee schedule amounts established by Medicare are typically
substantially lower than patient fees otherwise charged by us, but are sometimes
higher than our fees actually charged to certain other clients. During 1992, the
Office of the Inspector General, or OIG, of the HHS issued final regulations
that prohibited charging Medicare fees substantially in excess of a provider's
usual charges. The OIG, however, declined to provide any guidance concerning
interpretation of these rules, including whether or not discounts to
non-governmental clients and payers or the dual-fee structure might be
inconsistent with these rules.
A proposed rule released in September 1997 would have authorized the OIG to
exclude providers from participation in the Medicare program, including clinical
laboratories, that charge Medicare and other programs fees that are
"substantially in excess of . . . usual charges . . . to any of [their]
customers, clients or patients." This proposal was withdrawn by the OIG in 1998.
In November 1999, the OIG issued an advisory opinion which indicated that a
clinical laboratory offering discounts on client bills may violate the "usual
charges" regulation if the "charge to Medicare substantially exceeds the amount
the laboratory most frequently charges or has contractually agreed to accept
from non-Federal payers." The OIG subsequently issued a letter clarifying that
the usual charges regulation is not a blanket prohibition on discounts to
private pay customers.
The 1997 Balanced Budget Act permits CMS to adjust statutorily prescribed
fees for some medical services, including clinical laboratory services, if the
fees are "grossly excessive." In December 2002, CMS issued an interim final rule
setting forth a process and factors for establishing a "realistic and equitable"
payment amount for all Medicare Part B services (except physician services and
services paid under a prospective payment system) when the existing payment
amounts are determined to be inherently unreasonable. Payment amounts may be
considered unreasonable because they are either grossly excessive or deficient.
We cannot provide any assurances to investors that fees payable by Medicare
could not be reduced as a result of the application of this rule or that the
government might not assert claims for reimbursement by purporting to
retroactively apply this rule or the OIG interpretation concerning "usual
charges."
Currently, there are no Medicare co-insurance or co-payments required for
clinical laboratory testing. When co-insurance was last in effect in 1984,
clinical laboratories received from Medicare carriers only 80% of the Medicare
allowed amount and were required to bill Medicare beneficiaries for the unpaid
balance of the Medicare allowed amount. If enacted, a co-insurance proposal
could adversely affect the revenues of the clinical laboratory industry,
including us, by exposing the testing laboratory to the credit of individuals
and by increasing the number of bills. In addition, a laboratory could be
subject to potential fraud and abuse violations if adequate procedures to bill
and collect the co-insurance payments are not established and followed.
Reduced Utilization of Clinical Laboratory Testing. In recent years, CMS
has taken several steps to reduce utilization of clinical laboratory testing.
Since 1995, Medicare carriers have adopted policies under which they do not pay
for many commonly ordered clinical tests unless the ordering physician has
provided an appropriate diagnostic code supporting the medical necessity of the
test. Physicians are required by law to provide diagnostic information when they
order clinical tests for Medicare and Medicaid patients. However, CMS has not
prescribed any penalty for physicians who fail to provide diagnostic information
to laboratories.
We are generally permitted to bill patients directly for some statutorily
excluded clinical laboratory services. We are also generally permitted to bill
patients for clinical laboratory tests that Medicare does not pay for due to
"medical necessity" limitations (these tests include limited coverage tests for
which a carrier-approved diagnosis code is not
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provided by the ordering physician and certain tests ordered at a frequency
greater than covered by Medicare) if the patient signs an advance beneficiary
notice ("ABN") under which the patient makes an informed decision as to whether
to personally assume financial liability for laboratory tests which are likely
to be not covered by Medicare because they are deemed to be not medically
necessary. We do not have any direct contact with most of these patients and, in
such cases, cannot control the proper use of the ABN by the physician or the
physician's office staff. If the ABN is not timely completed or is not completed
properly, we end up performing tests that we cannot subsequently bill to the
patient if they are not reimbursable by Medicare. In 2002, CMS adopted a
standard, CMS-approved ABN form. Because the new form is longer and more complex
than the format previously used by most laboratories, adoption of the new ABN
form could result in even fewer valid ABNs and consequently prevent us from
billing additional beneficiaries for services denied by Medicare for lack of
medical necessity.
Inconsistent Practices. Currently, many different local carriers administer
Medicare. They have inconsistent policies on matters such as: (1) test coverage;
(2) automated chemistry panels; (3) diagnosis coding; (4) claims documentation;
and (5) fee schedules (subject to the national limitations). Inconsistent
regulation has increased the complexity of the billing process for clinical
laboratories. As part of the 1997 Balanced Budget Act, HHS was required to adopt
uniform policies on the above matters by January 1, 1999, and replace the
current local carriers with no more than five regional carriers. Although HHS
has finalized a number of uniform policies, it has not taken any final action to
replace the local carriers with five regional carriers. However, in November
2000, CMS published a solicitation in the Commerce Business Daily seeking two
contractors to process Part B clinical laboratory claims. In the solicitation,
CMS stated that the Secretary has decided to limit the number of carriers
processing clinical diagnostic laboratory test claims to two contractors. The
solicitation indicated that the Request for Proposal would be released on
or before December 31, 2000 but as of February 2003, it had not been issued; the
solicitation did not indicate the effective date for a final transition to the
regional carrier model. We are not aware of any plans by CMS to transition to
fewer regional carriers for laboratory services despite the legislative mandate
of the 1997 Balanced Budget Act.
CMS plans to achieve standardization in part through implementing a single
claims processing system for all carriers. This initiative, however, was
suspended due to CMS's Year 2000 compliance priorities.
Competitive Bidding. The 1997 Balanced Budget Act requires CMS to conduct
five Medicare bidding demonstrations involving various types of medical services
and complete them by 2002. CMS is expected to include a clinical laboratory
demonstration project in a metropolitan statistical area as part of the
legislative mandate. Florida has issued a proposal for competitive bidding for
its Medicaid program. If competitive bidding were implemented on a regional or
national basis for clinical laboratory testing, it could materially adversely
affect the clinical laboratory industry and us.
Future Legislation. Future changes in federal, state and local regulations
(or in the interpretation of current regulations) affecting governmental
reimbursement for clinical laboratory testing could adversely affect us. We
cannot predict, however, whether and what type of legislative proposals will be
enacted into law or what regulations will be adopted by regulatory authorities.
Fraud and Abuse Regulations. Medicare and Medicaid anti-kickback laws
prohibit clinical laboratories from making payments or furnishing other benefits
to influence the referral of tests billed to Medicare, Medicaid or other federal
programs. As noted above, the penalties for violation of these laws may include
criminal and civil fines and penalties and/or suspension or exclusion from
participation in federal programs. Many of the anti-fraud statutes and
regulations, including those relating to joint ventures and alliances, are vague
or indefinite and have not been interpreted by the courts. We cannot predict if
some of the fraud and abuse rules will be interpreted contrary to our practices.
In November 1999, the OIG issued an advisory opinion concluding that the
industry practice of discounting client bills may constitute a kickback if the
discounted price is below a laboratory's overall cost (including overhead) and
below the amounts reimbursed by Medicare. Advisory opinions are not binding but
may be indicative of the position that prosecutors may take in enforcement
actions. The OIG's opinion, if enforced, could result in fines and possible
exclusion and could require us to eliminate offering discounts to clients below
the rates reimbursed by Medicare. The OIG subsequently issued a letter
clarifying that it did not intend to imply that discounts are a per se violation
of the federal anti-kickback statute, but may merit further investigation
depending on the facts and circumstances presented.
In addition, since 1992, a federal anti-"self-referral" law, commonly known
as the "Stark" law, prohibits, with certain exceptions, Medicare payments for
laboratory tests referred by physicians who have, personally or through a family
member, an investment interest in, or a compensation arrangement with, the
testing laboratory. Since January 1995, these restrictions have also applied to
Medicaid-covered services. Many states have similar anti-"self-referral" and
16
other laws that also affect investment and compensation arrangements with
physicians who refer other than government-reimbursed laboratory testing to us.
We cannot predict if some of the state laws will be interpreted contrary to our
practices.
Government Investigations and Related Claims
We are subject to extensive and frequently changing federal, state and
local laws and regulations. We believe that, based on our experience with
government settlements and public announcements by various government officials,
the federal government continues to strengthen its position on healthcare fraud.
In addition, legislative provisions relating to healthcare fraud and abuse give
federal enforcement personnel substantially increased funding, powers and
remedies to pursue suspected fraud and abuse. While we believe that we are in
material compliance with all applicable laws, many of the regulations applicable
to us, including those relating to billing and reimbursement of tests and those
relating to relationships with physicians and hospitals, are vague or indefinite
and have not been interpreted by the courts. They may be interpreted or applied
by a prosecutorial, regulatory or judicial authority in a manner that could
require us to make changes in our operations, including our billing practices.
If we fail to comply with applicable laws and regulations, we could suffer civil
and criminal penalties, including the loss of licenses or our ability to
participate in Medicare, Medicaid and other federal and state healthcare
programs.
During the mid-1990s, Quest Diagnostics and SBCL settled government claims
that primarily involved industry-wide billing and marketing practices that both
companies believed to be lawful. The aggregate amount of the settlements for
these claims exceeded $500 million. The federal or state governments may bring
additional claims based on new theories as to our practices that we believe to
be in compliance with law. The federal government has substantial leverage in
negotiating settlements since the amount of potential fines far exceeds the
rates at which we are reimbursed, and the government has the remedy of excluding
a non-compliant provider from participation in the Medicare and Medicaid
programs, which represented approximately 15% of our net revenues during 2002.
Although management believes that established reserves for claims are
sufficient, it is possible that additional information may become available that
may cause the final resolution of these matters to exceed established reserves
by an amount which could be material to our results of operations and cash flows
in the period in which such claims are settled. We do not believe that these
issues will have a material adverse effect on our overall financial condition.
However, we understand that there may be pending qui tam claims brought by
former employees or other "whistle blowers" as to which we have not been
provided with a copy of the complaint and accordingly cannot determine the
extent of any potential liability.
As an integral part of our compliance program discussed below, we
investigate all reported or suspected failures to comply with federal healthcare
reimbursement requirements. Any non-compliance that results in Medicare or
Medicaid overpayments is reported to the government and reimbursed by us. As a
result of these efforts, we have periodically identified and reported
overpayments. While we have reimbursed these overpayments and have taken
corrective action where appropriate, we cannot assure investors that in each
instance the government will necessarily accept these actions as sufficient.
Compliance Program
Compliance with all government rules and regulations has become a
significant concern throughout the clinical laboratory industry because of
evolving interpretations of regulations and the national debate over healthcare.
We began a compliance program early in 1993.
We emphasize the development of training programs intended to ensure the
strict implementation and observance of all applicable laws, regulations and
company policies. Further, we conduct in-depth reviews of procedures, personnel
and facilities to assure regulatory compliance throughout our operations. The
Quality, Safety and Compliance Committee of the Board of Directors requires
periodic reporting of compliance operations from management. In October 1996, we
signed a five-year corporate integrity agreement with the OIG that expired in
October 2001.
We believe we comply in all material respects with all applicable statutes
and regulations. However, we cannot assure you that no statutes or regulations
will be interpreted or applied by a prosecutorial, regulatory or judicial
authority in a manner that would adversely affect us. Potential sanctions for
violation of these statutes include significant damages, penalties, and fines,
exclusion from participation in governmental healthcare programs and the loss of
various licenses, certificates and authorization necessary to operate some or
all of our business.
17
Insurance
As a general matter, providers of clinical laboratory testing services may
be subject to lawsuits alleging negligence or other similar legal claims. These
suits could involve claims for substantial damages. Any professional liability
litigation could also have an adverse impact on our client base and reputation.
We maintain various liability insurance programs for claims that could result
from providing or failing to provide clinical laboratory testing services,
including inaccurate testing results and other exposures. Our insurance coverage
limits our maximum exposure on individual claims; however, we are essentially
self-insured for a significant portion of these claims. The basis for claims
reserves incorporates actuarially determined losses based upon our historical
and projected loss experience. Management believes that present insurance
coverage and reserves are sufficient to cover currently estimated exposures, but
we cannot assure you that we will not incur liabilities in excess of recorded
reserves. Similarly, although we believe that we will be able to obtain adequate
insurance coverage in the future at acceptable costs, we cannot assure you that
we will be able to do so.
Employees
At December 31, 2002 and 2001, we employed approximately 33,400 and 29,000
people, respectively. These totals exclude employees of the joint ventures where
we do not have a majority interest. Unilab, which we acquired in February 2003,
had approximately 4,100 employees at December 31, 2002. We have no collective
bargaining agreements with any unions, and we believe that our overall relations
with our employees are good.
18
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Some statements and disclosures in this document are forward-looking
statements. Forward-looking statements include all statements that do not relate
solely to historical or current facts and can be identified by the use of words
such as "may", "believe", "will", "expect", "project", "estimate", "anticipate",
"plan" or "continue". These forward-looking statements are based on our current
plans and expectations and are subject to a number of risks and uncertainties
that could significantly cause our plans and expectations, including actual
results, to differ materially from the forward-looking statements. The Private
Securities Litigation Reform Act of 1995 ("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.
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. Investors are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
document. The following important factors could cause our actual financial
results to differ materially from those projected, forecasted or estimated by us
in forward-looking statements:
(a) Heightened competition, including increased pricing pressure,
competition from hospitals for testing for non-patients and
competition from physicians. See "Business - Competition."
(b) Impact of changes in payer mix, including any shift from traditional,
fee-for-service medicine to capitated managed-cost healthcare. See
"Business - Payers and Customers - Customers - Managed Care
Organizations and Other Insurance Providers."
(c) Adverse actions by government or other third-party payers, including
unilateral reduction of fee schedules payable to us and an increase in
the practice of negotiating for exclusive contracts that involve
aggressively priced capitated payments by managed care organizations.
See "Business - Regulation of Reimbursement for Clinical Laboratory
Services" and "Business - Payers and Customers - Customers - Managed
Care Organizations and Other Insurance Providers."
(d) The impact upon our volume and collected revenue or general or
administrative expenses resulting from our compliance with Medicare
and Medicaid administrative policies and requirements of third-party
payers. These include:
(1) the requirements of Medicare carriers to provide diagnosis codes
for many commonly ordered tests and the likelihood that
third-party payers will increasingly adopt similar requirements;
(2) the policy of CMS to limit Medicare reimbursement for tests
contained in automated chemistry panels to the amount that would
have been paid if only the covered tests, determined on the basis
of demonstrable "medical necessity", had been ordered;
(3) continued inconsistent practices among the different local
carriers administering Medicare; and
(4) recent changes by CMS to the advanced beneficiary notice form.
See "Business - Regulation of Reimbursement for Clinical Laboratory
Services" and "Business - Billing."
(e) Adverse results from pending or future government investigations or
private actions. These include, in particular significant monetary
damages and/or exclusion from the Medicare and Medicaid programs
and/or other significant litigation matters. See "Business -
Government Investigations and Related Claims."
(f) Failure to obtain new customers at profitable pricing or failure to
retain existing customers, and reduction in tests ordered or specimens
submitted by existing customers.
(g) Failure to efficiently integrate acquired clinical laboratory
businesses, including Unilab and AML, or to efficiently integrate
clinical laboratory businesses from joint ventures and alliances with
hospitals, and the costs related to any such integration, or to retain
key technical and management personnel. See "Business - Recent
Acquisitions."
19
(h) Inability to obtain professional liability or other insurance coverage
or a material increase in premiums for such coverage. See "Business -
Insurance."
(i) Denial of CLIA certification or other license for any of Quest
Diagnostics' clinical laboratories under the CLIA standards, by CMS
for Medicare and Medicaid programs or other federal, state and local
agencies. See "Business - Regulation of Clinical Laboratory
Operations."
(j) Increased federal or state regulation of independent clinical
laboratories, including regulation by the FDA.
(k) Inability to achieve expected synergies from the acquisition of Unilab
and AML. See "Business - Recent Acquisitions."
(l) Inability to achieve additional benefits from our Six Sigma and
Standardization initiatives.
(m) Adverse publicity and news coverage about us or the clinical
laboratory industry.
(n) Computer or other system failures that affect our ability to perform
tests, report test results or properly bill customers, including
potential failures resulting from systems conversions, including from
the integration of the systems of Quest Diagnostics, SBCL, AML and
Unilab, telecommunications failures, malicious human acts (such as
electronic break-ins or computer viruses) or natural disasters. See
"Business - Information Systems" and "Business - Billing."
(o) Development of technologies that substantially alter the practice of
laboratory medicine, including technology changes that lead to the
development of more cost-effective tests such as (1) point-of-care
tests that can be performed by physicians in their offices and (2)
home testing that can be carried out without requiring the services of
clinical laboratories. See "Business - Competition" and "Business -
Regulation of Clinical Laboratory Operations."
(p) Issuance of patents or other property rights to our competitors or
others that could prevent, limit or interfere with our ability to
develop, perform or sell our tests or operate our business.
(q) Development of tests by our competitors or others which we may not be
able to license, or usage of our technology or similar technologies or
our trade secrets by competitors, any of which could negatively affect
our competitive position.
(r) Development of an Internet-based electronic commerce business model
that does not require an extensive logistics and laboratory network.
(s) The impact of the privacy and security regulations issued under HIPAA
on our operations (including its medical information services) as well
as the cost to comply with the regulations. See "Business - Privacy
and Security of Health Information; Standard Transactions."
(t) Changes in interest rates and changes in our credit ratings from
Standard & Poor's and Moody's Investor Services causing an unfavorable
impact on our cost of and access to capital.
(u) An ability to hire and retain qualified personnel or the loss of the
services of one or more of our key senior management personnel.
(v) Terrorist and other criminal activities, which could affect our
customers, transportation or power systems, or our facilities, and for
which insurance may not adequately reimburse us for.
20
Item 2. Properties
Our principal laboratories (listed alphabetically by state) are located in
or near the following metropolitan areas. In certain areas (indicated by the
number (2)), we have two principal laboratories as a result of recent
acquisitions.
Location Leased or Owned
- -------- ---------------
Phoenix, Arizona Leased by Joint Venture
Los Angeles, California (2) One owned, one leased
Sacramento, California Leased
San Diego, California Leased
San Francisco, California (2) One owned, one leased
San Juan Capistrano, California Owned
Denver, Colorado Leased
New Haven, Connecticut Owned
Washington, D.C. (Chantilly, Virginia) Leased
Miami, Florida (2) One owned, one leased
Tampa, Florida Owned
Atlanta, Georgia Owned
Chicago, Illinois (2) One owned, one leased
Indianapolis, Indiana Leased by Joint Venture
Lexington, Kentucky Owned
New Orleans, Louisiana Owned
Baltimore, Maryland Owned
Boston, Massachusetts Leased
Detroit, Michigan Leased
St. Louis, Missouri Owned
Las Vegas, Nevada Owned
New York, New York (Teterboro, New Jersey) Owned
Long Island, New York Leased
Dayton, Ohio Leased by Joint Venture
Oklahoma City, Oklahoma Leased by Joint Venture
Portland, Oregon Leased
Erie, Pennsylvania Leased by Joint Venture
Philadelphia, Pennsylvania Leased
Pittsburgh, Pennsylvania Leased
Nashville, Tennessee Leased
Dallas, Texas Leased
Houston, Texas Leased
Seattle, Washington Leased
Our executive offices are located at an owned facility in Teterboro, New
Jersey and at a leased facility in Lyndhurst, New Jersey. We also lease a site
in Norristown, Pennsylvania, that serves as a billing center; a site in West
Norriton, Pennsylvania that serves as our national data center; a site in San
Clemente, California that serves as the main facility for Nichols Institute
Diagnostics; and a site in Cincinnati that serves as the main office of MedPlus.
We also lease under a capital lease an administrative office in Collegeville,
Pennsylvania. We own our laboratory facility in Mexico City and lease laboratory
facilities in San Juan, Puerto Rico and near London, England. We believe that,
in general, our laboratory facilities are suitable and adequate for our current
and anticipated future levels of operation. We believe that if we were unable to
renew a lease on any of our testing facilities, we could find alternative space
at competitive market rates and relocate our operations to such new location.
21
Item 3. Legal Proceedings
In addition to the investigations described in "Business-Government
Investigations and Related Claims," we are involved in various legal proceedings
arising in the ordinary course of business. Some of the proceedings against us
involve claims that are substantial in amount. Although we cannot predict the
outcome of such proceedings or any claims made against us, we do not anticipate
that the ultimate outcome of the various proceedings or claims will have a
material adverse effect on our financial position.
Item 4. Submission of Matters to a Vote of Security Holders
None.
22
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
Our common stock is listed and traded on the New York Stock Exchange under
the symbol "DGX." The following table sets forth, for the periods indicated, the
high and low sales price per share as reported on the New York Stock Exchange
Consolidated Tape (all prices have been restated to reflect the two-for-one
stock split effected on May 31, 2001 - See Note 2 to the Consolidated Financial
Statements):
High Low
---- ---
2001
First Quarter 70.47 36.60
Second Quarter 75.75 42.15
Third Quarter 75.50 48.10
Fourth Quarter 72.27 55.02
2002
First Quarter 84.10 66.00
Second Quarter 96.14 79.25
Third Quarter 85.31 51.29
Fourth Quarter 66.99 49.09
As of February 28, 2003, we had approximately 6,200 record holders of our
common stock.
We have never declared or paid cash dividends on our common stock and do
not anticipate paying any dividends on our common stock in the foreseeable
future.
Item 6. Selected Financial Data
See page 33.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
See page 35.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Item 8. Financial Statements and Supplementary Data
See Item 15 (a) 1 and 2.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
23
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning the directors of the Company is incorporated by
reference to the information in the Company's Proxy Statement to be filed on or
before April 30, 2003 (the "Proxy Statement") appearing under the caption
"Election of Directors."
Executive Officers of the Registrant
Officers of the Company are elected annually by the Board of Directors and
hold office at the discretion of the Board of Directors. The following persons
serve as executive officers of the Company:
Kenneth W. Freeman (52) is Chairman of the Board and Chief Executive
Officer of the Company. Mr. Freeman joined the Company in May 1995 as President
and Chief Executive Officer, was elected a Director in July 1995 and was elected
Chairman of the Board in December 1996. Prior to 1995, he served in a variety of
financial and managerial positions at Corning, which he joined in 1972. He was
elected Controller and a Vice President of Corning in 1985, Senior Vice
President in 1987, General Manager of the Science Products Division in 1989 and
Executive Vice President in 1993. He was appointed President and Chief Executive
Officer of Corning Asahi Video Products Company in 1990.
Surya N. Mohapatra, Ph.D. (53) is President and Chief Operating Officer and
a Director of the Company. Prior to joining the Company in February 1999 as
Senior Vice President and Chief Operating Officer, he was Senior Vice President
of Picker International, a worldwide leader in advanced medical imaging
technologies, where he served in various executive positions during his 18-year
tenure. Dr. Mohapatra was appointed President and Chief Operating Officer in
June 1999.
Robert A. Hagemann (46) is Vice President and Chief Financial Officer. He
joined Corning Life Sciences, Inc., in 1992, where he held a variety of senior
financial positions before being named Vice President and Corporate Controller
of the Company in 1996. Prior to joining the Company, Mr. Hagemann was employed
by Prime Hospitality, Inc. and Crompton & Knowles, Inc. in senior financial
positions. He was also previously associated with Ernst & Young. Mr. Hagemann
assumed his present responsibilities in August 1998.
Gerald C. Marrone (60) is Senior Vice President, Administration. Mr.
Marrone joined the Company in November 1997 as Chief Information Officer, after
12 years with Citibank, N.A. While at Citibank, he was most recently Vice
President, Division Executive for Citibank's Global Production Support Division,
and was also the Chief Information Officer of Citibank's Global Cash Management
business. Prior to joining Citibank, he was the Chief Information Officer for
Memorial Sloan-Kettering Cancer Center in New York for five years.
Michael E. Prevoznik (41) is Vice President for Legal and Compliance and
General Counsel. Prior to joining SBCL in 1994 as its Chief Legal Compliance
Officer, Mr. Prevoznik was with Dechert Price & Rhodes. In 1996, he became Vice
President and Chief Legal Compliance Officer for SmithKline Beecham Healthcare
Services. In 1998, he was appointed Vice President, Compliance for SmithKline
Beecham, assuming additional responsibilities for coordinating all compliance
activities within SmithKline Beecham worldwide. Mr. Prevoznik assumed his
current responsibilities with the Company in August 1999.
David M. Zewe (51) is Senior Vice President, Diagnostics Testing Services.
He leads the newly-formed Hospital Business Team and oversees diagnostic testing
operations company-wide, including physician, hospital, international and drugs
of abuse testing. Mr. Zewe joined the Company in 1994 as General Manager of the
Philadelphia regional laboratory, became Regional Vice President Sales and
Marketing for the mid-Atlantic region in August 1996, became Vice President,
Revenue Services in August 1999 leading the billing function company-wide and
became Senior Vice President, U.S. Operations in January 2001, responsible for
all core business operations and revenue services. Mr. Zewe assumed his current
position in May 2002. Prior to joining the Company, Mr. Zewe was with the Squibb
Diagnostics Division of Bristol Myers Squibb, most recently serving as Vice
President of Sales.
24
Item 11. Executive Compensation
The information called for by this Item is incorporated by reference to the
information under the caption "Executive Compensation" appearing in the Proxy
Statement. The information contained in the Proxy Statement under the captions
"Compensation Committee Report on Executive Compensation" and "Performance
Graph" is not incorporated herein by reference.
Reflecting its commitment to sound business planning and the establishment
of best practices, the Board of Directors has established a formalized
succession planning process for the position of Chairman and Chief Executive
Officer. The recently renewed employment agreement with Mr. Freeman outlines the
process and appears as Exhibit 10.34 to this report.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Except for the Equity Compensation Plan information set forth below, the
information called for by this Item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" appearing in the Proxy Statement.
Equity Compensation Plan Information
The following table provides information as of December 31, 2002 about our
common stock that may be issued upon the exercise of options, warrants and
rights under our existing equity compensation plans:
- -------------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan category (a) (b) (c)
- -------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by
security holders 8,921,609 $ 38.83 7,220,964
- -------------------------------------------------------------------------------------------------------------------
Equity compensation plans not approved
by security holders -- not applicable 1,680,316
- -------------------------------------------------------------------------------------------------------------------
Total 8,921,609 $ 38.83 8,901,280
- -------------------------------------------------------------------------------------------------------------------
The only equity compensation plan that has not been approved by the
Company's stockholders is the Company's Employee Stock Purchase Plan ("ESPP").
The ESPP permits employees to purchase the Company's common stock each calendar
quarter through payroll deductions. The purchase price is 85% of the closing
market price on the last business day of the calendar quarter (or, if lower, the
closing market price on the first business day of the calendar quarter). The
ESPP, which was adopted prior to the spinoff of the Company in 1996, authorizes
the issuance of 4 million shares of the Company's common stock. The number of
securities reflected in the table above for the ESPP includes the share
allocation for the fourth quarter of 2002, which were purchased in January 2003.
Item 13. Certain Relationships and Related Transactions
The information called for by this Item is incorporated by reference to the
information under the caption "Certain Relationships and Related Transactions"
appearing in the Proxy Statement.
25
Item 14. Controls and Procedures
(a) Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined under Rules 13a-14 and 15d-14 of the Securities
Exchange Act of 1934, as amended) as of a date within ninety days of the
filing date of this report. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures are adequate and effective.
(b) There were no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to
the date of such evaluation.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents filed as part of this report:
1. Index to financial statements and supplementary data filed as part of
this report:
Item Page
---- ----
Report of Independent Accountants............................. F-1
Consolidated Balance Sheets................................... F-2
Consolidated Statements of Operations......................... F-3
Consolidated Statements of Cash Flows......................... F-4
Consolidated Statements of Stockholders' Equity............... F-5
Notes to Consolidated Financial Statements.................... F-6
Supplementary Data: Quarterly Operating Results (unaudited)... F-34
2. Financial Statement Schedule:
Item Page
Schedule II - Valuation Accounts and Reserves................. F-35
3. Exhibits filed as part of this report:
See (c) below.
(b) Report on Form 8-K filed during the last quarter of 2002:
On October 31, 2002, the Company filed a current report on Form 8-K
reporting under Item 9 sworn statements of its Chief Executive Officer
and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(c) Exhibits filed as part of this report:
Exhibit
Number Description
- ------- -----------
3.1 Restated Certificate of Incorporation (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report: May 31, 2001)
and incorporated herein by reference)
3.2 Amended and Restated By-Laws of the Registrant (filed as an Exhibit to
the Company's 2000 annual report on Form 10-K and incorporated herein
by reference)
4.1 Form of Rights Agreement dated December 31, 1996 (the "Rights
Agreement") between Corning Clinical Laboratories Inc. and Harris
Trust and Savings Bank as Rights Agent (filed as an Exhibit to the
Company's Registration Statement on Form 10 (File No. 1-12215) and
incorporated herein by reference)
26
4.2 Form of Amendment No. 1 effective as of July 1, 1999 to the Rights
Agreement (filed as an Exhibit to the Company's current report on Form
8-K (Date of Report: August 16, 1999) and incorporated herein by
reference)
4.3 Form of Amendment No. 2 to the Rights Agreement (filed as an Exhibit
to the Company's 1999 annual report on Form 10-K and incorporated
herein by reference)
4.4 Form of Amendment No. 3 to the Rights Agreement (filed as an Exhibit
to the Company's 2000 annual report on Form 10-K and incorporated
herein by reference)
10.1 Form of 6 3/4% Senior Notes due 2006, including the form of guarantee
endorsed thereon (filed as an Exhibit to the Company's current report
on Form 8-K (Date of Report: June 27, 2001) and incorporated herein by
reference)
10.2 Form of 7 1/2% Senior Notes due 2011, including the form of guarantee
endorsed thereon (filed as an Exhibit to the Company's current report
on Form 8-K (Date of Report: June 27, 2001) and incorporated herein by
reference)
10.3 Form of 1.75% Contingent Convertible Debentures due 2021, including
the form of guarantee endorsed thereon (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report: November 26,
2001) and incorporated herein by reference)
10.4 Indenture dated as of June 27, 2001, among the Company, the Subsidiary
Guarantors, and the Trustee (filed as an Exhibit to the Company's
current report on Form 8-K (Date of Report: June 27, 2001) and
incorporated herein by reference)
10.5 First Supplemental Indenture, dated as of June 27, 2001, among the
Company, the Subsidiary Guarantors, and the Trustee to the Indenture
referred to in Exhibit 10.4 (filed as an Exhibit to the Company's
current report on Form 8-K (Date of Report: June 27, 2001) and
incorporated herein by reference)
10.6 Second Supplemental Indenture, dated as of November 26, 2001, among
the Company, the Subsidiary Guarantors, and the Trustee to the
Indenture referred to in Exhibit 10.4 (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report: November 26,
2001) and incorporated herein by reference)
10.7 Third Supplemental Indenture, dated as of April 4, 2002, among Quest
Diagnostics, the Additional Subsidiary Guarantors, and the Trustee to
the Indenture referred to in Exhibit 10.4 (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report: April 1, 2002)
and incorporated herein by reference)
10.8 Credit Agreement, dated as of June 27, 2001, among the Company, the
Subsidiary Guarantors and the Banks (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report: June 27, 2001)
and incorporated herein by reference)
10.9 Amended an