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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, 2004
Commission File Number 001-12215
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Quest Diagnostics Incorporated
1290 Wall Street West, Lyndhurst, NJ 07071
(201) 393-5000
Delaware
(State of Incorporation)
16-1387862
(I.R.S. Employer Identification Number)
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
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 30, 2004, the aggregate market value of the approximately 80 million
shares of voting and non-voting common equity held by non-affiliates of the
registrant was approximately $6.8 billion, based on the closing price on such
date of the registrant's Common Stock on the New York Stock Exchange.
As of February 28, 2005, there were outstanding 101,422,952 shares of Common
Stock, $.01 par value.
Documents Incorporated by Reference
Part of Form 10-K into
Document which incorporated
- -------- ------------------
Portions of the registrant's Proxy Statement to be filed by April 29, 2005 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.
TABLE OF CONTENTS
Item Page
---- ----
Item 1. Business.................................................................... 1
Overview.................................................................... 1
The United States Clinical Laboratory Testing Market........................ 1
Corporate Strategy and Growth Opportunities................................. 2
Our Services................................................................ 4
Routine Testing........................................................ 4
Esoteric Testing....................................................... 5
New Test Introductions................................................. 5
Clinical Trials Testing................................................ 6
Other Services and Products............................................ 6
Payers and Customers........................................................ 7
Sales and Marketing......................................................... 9
Information Systems......................................................... 9
Billing..................................................................... 10
Competition................................................................. 11
Quality Assurance........................................................... 11
Regulation of Clinical Laboratory Operations................................ 12
Healthcare Information Technology........................................... 13
Privacy and Security of Health Information; Standard Transactions........... 13
Regulation of Reimbursement for Clinical Laboratory Services................ 14
Government Investigations and Related Claims................................ 18
Compliance Program.......................................................... 19
Intellectual Property Rights................................................ 19
Insurance................................................................... 19
Employees................................................................... 20
Cautionary Statement For Purposes Of The "Safe Harbor" Provisions Of The
Private Securities Litigation Reform Act Of 1995....................... 21
Item 2. Properties................................................................. 24
Item 3. Legal Proceedings.......................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders........................ 24
Item 5. Market for Registrant's Common Stock, Related Stockholder Matters and
Issuer Purchases of Equity Securities....................................... 25
Item 6. Selected Financial Data.................................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................. 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................... 26
Item 8. Financial Statements and Supplementary Data................................ 26
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................. 26
Item 9A. Controls and Procedures..................................................... 26
Item 9B. Other Information........................................................... 26
Item 10. Directors and Executive Officers of the Registrant......................... 27
Item 11. Executive Compensation..................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management............. 28
Item 13. Certain Relationships and Related Transactions............................. 28
Item 14. Principal Accounting Fees and Services..................................... 28
Item 15. Exhibits, Financial Statement Schedules.................................... 28
Selected Historical Financial Data of Our Company.................................... 33
Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................. 35
Report of Management on Internal Control Over Financial Reporting.................... 48
Report of Independent Registered Public Accounting Firm.............................. F-1
Consolidated Financial Statements and Related Notes.................................. F-3
Supplementary Data: Quarterly Operating Results (unaudited).......................... F-36
Schedule II - Valuation Accounts and Reserves........................................ F-37
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PART I
Item 1. Business
Overview
We are the nation's leading provider of diagnostic testing,
information and services, providing insights that enable physicians and other
healthcare professionals to make decisions to improve health. We offer patients
and physicians the broadest access to diagnostic laboratory services through our
nation-wide network of laboratories and patient service centers. We provide
interpretive consultation through the largest medical and scientific staff in
the industry, with approximately 400 M.D.'s 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 information technology solutions that can
improve patient care and medical practice.
During 2004, we generated net revenues of $5.1 billion and processed
over 137 million requisitions for testing. 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 patients, physicians, hospitals,
healthcare insurers, employers, governmental institutions and other commercial
clinical laboratories.
We operate a nationwide network of greater than 1,900 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). We 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, San Juan, Puerto Rico
and Heston, England.
We are a Delaware corporation. We sometimes refer to our subsidiaries
and ourselves 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, or 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., or SBCL, which operated the clinical laboratory
business of SmithKline Beecham plc, or SmithKline Beecham.
Our principal executive offices are located at 1290 Wall Street West,
Lyndhurst, New Jersey 07071, telephone number: (201) 393-5000. Our filings with
the Securities and Exchange Commission, or 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 website is 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 commercial 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 clinical laboratory testing market
approximated $40 billion in annual revenues in 2004. Most laboratory tests are
performed by one of three types of laboratories: commercial clinical
laboratories; hospital-affiliated laboratories; and physician-office
laboratories. In 2004, we believe that hospital-affiliated laboratories
accounted for approximately 60% of the market, commercial clinical laboratories
approximately one-third, and physician-office laboratories the balance.
The underlying fundamentals of the diagnostic testing industry have
improved since the early to mid-1990s. Since that time there has been
significant industry consolidation, particularly among commercial laboratories,
resulting in fewer but larger commercial laboratories with greater economies of
scale, better equipped to service the members of large healthcare plans, and
more disciplined in their approach to operating their business. Orders for
laboratory testing are generated from physician offices, hospitals, and
employers. As such, factors including changes in the United States economy which
can affect
the number of unemployed and uninsured, and design changes in healthcare plans,
which impact the number of physician office and hospital visits, can impact the
utilization of laboratory testing.
While the diagnostic testing industry may be impacted by a number of
factors, we believe it will continue to grow over the long term as a result of
the following:
o the growing and aging population of the United States;
o continuing research and development in the area of genomics (the
study of DNA, genes and chromosomes) and proteomics (the analysis
of individual proteins and collections of proteins), which is
expected to yield new, more sophisticated and specialized
diagnostics tests;
o increasing recognition by consumers and payers of the value of
laboratory testing as a means to improve health and reduce the
overall cost of healthcare through early detection and
prevention; and
o increasing affordability of, and access to, tests due to advances
in technology and cost efficiencies.
Corporate Strategy and Growth Opportunities
Our mission is to be the undisputed world leader in diagnostic
testing, information and services. We focus on Patients, Growth and People to
help achieve our goals.
Patients are at the center of everything we do. Increasingly, patients
and their doctors have a choice when it comes to selecting a healthcare
provider, and we strive to give them new and compelling reasons to put their
trust in us. We differentiate our Company to patients and doctors by:
o Providing the Highest Quality Services: We continue to implement
Six Sigma initiatives throughout all aspects of our organization
and we are utilizing Lean Six Sigma principles to further
increase the efficiency of our operations. Six Sigma is a
management approach that enhances quality and requires a thorough
understanding of customer needs and requirements, root cause
analysis, process improvements and rigorous tracking and
measuring. Lean Six Sigma streamlines processes and eliminates
waste. We have integrated our Six Sigma initiative with our
initiative to standardize operations and processes across the
Company by adopting identified Company best practices.
Additionally, we are focusing our Six Sigma resources on
improving all aspects of our interactions with patients and
customers. This goes beyond ordering tests and getting results -
it also covers our couriers picking up samples; phlebotomists
drawing blood; medical staff performing the tests and providing
consultations; and interactions during the billing cycle.
o Offering Unparalleled Access and Distribution: We are the leader
in the clinical laboratory testing business offering the broadest
test menu and national access to testing services, with
facilities in substantially all of the major metropolitan areas
in the United States. We operate a nationwide network of greater
than 1,900 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 patients, physicians, hospitals,
employers and other healthcare providers throughout the United
States. We believe that customers will increasingly seek to
utilize laboratory-testing providers that offer a comprehensive
range of tests and services and the most convenient access to
those services.
Growth will be driven organically and through acquisition. We expect
to grow organically at or above the industry growth rate by gaining more
customers and selling more to existing customers. Historically, our industry has
focused primarily on service levels and aggressive pricing to drive organic
growth. We believe that the differentiation we are creating through our focus on
Six Sigma quality, unparalleled access and distribution, the most comprehensive
test menu, and innovative test and information technology offerings will provide
us with opportunities to effectively compete beyond pricing, as we drive organic
growth. Additionally, we are expanding our sales force, providing them better
tools and training, and adding innovative, new products to sell. We are
specifically focused on driving organic growth in higher-growth areas and by
being a leading innovator. Our principal areas of focus include:
o Physician Sub Specialists: With the aging of the population, the
incidence of cancer and other disease states are increasing,
driving higher-growth in several physician sub specialties,
including urology, gastoenterology, dermatology and oncology.
Historically, we have had a smaller market share in these sub
specialties. While we
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provide a strong value proposition in the routine clinical
testing category, we have not been the provider of choice for
their more complex testing needs. We are enhancing our test menu
and service capabilities to more effectively compete in these
markets. We have added innovative tests, such as CellSearch'TM'
for women with metastatic breast cancer (see "Our Services - New
Test Introductions"), introduced new specialized medical reports,
customized specimen collection kits and added specially trained
sales representatives.
o Anatomic Pathology: We estimate that the current United States
market for anatomic pathology services is approximately $7
billion per year. We estimate that cytology represents
approximately $1.3 billion per year of this market, and that
tissue pathology represents approximately $5.7 billion per year
of this market. With the aging of the population and the
increased incidence of cancer, we believe that the tissue
pathology business is growing more rapidly than the cytology
business. 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 tests to detect cervical cancer. During the last several
years, we have led the industry in converting over 85% of our Pap
testing business to the use of liquid-based technology, a more
effective means of screening for cervical cancer. We have also
enhanced patient service by adding significant choices to our
test menu, including SurePath'TM' liquid-based Pap tests and
human papilloma virus (HPV) molecular testing as part of a
primary screening tool. We intend to continue to expand our
anatomic pathology business, particularly in tissue pathology,
the higher growth and more profitable segment. In conjunction
with our physician sub-specialty focus, we have been enhancing
our anatomic pathology capabilities and service offerings and are
adding specially trained sales representatives. We generated
approximately $500 million in net revenues from anatomic
pathology services during 2004.
o Innovation Leadership: 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, we believe that we are the
best partner for developers of new technologies and tests to
introduce their products to the marketplace. Through our
relationships with members of the academic community,
pharmaceutical and biotechnology firms, and 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. Our innovation activities are focused
on:
- Gene-Based and Other Esoteric Testing Capabilities: We
intend to remain a leading innovator in the diagnostic
testing industry by continuing to introduce new tests,
technology and services. We believe that gene-based and
other esoteric tests are the fastest growing segments of
the diagnostic testing industry. We believe that we have
the largest gene-based testing business in the United
States, with approximately $600 million in net revenues
during 2004, and that this business is growing by over 10%
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 and diagnostic testing. We believe that we are
well positioned to benefit from this growth. We intend to
focus on commercializing diagnostic applications of
discoveries in the areas of functional genomics and
proteomics.
- Information Technology: We continue to invest in the
development and improvement of information technology
products for customers and healthcare providers. We plan to
develop differentiated products that will provide more
convenient ordering and resulting of laboratory tests and
patient-centric information. We believe that these products
will enhance the value we provide to our customers and
result in increased customer loyalty. Our Care360'r'
Physician Portal'TM', or Care360, enables doctors to order
diagnostic tests and review laboratory results online,
electronically prescribe and order medication at the point
of care, view clinical and administrative information from
many sources, file documents received electronically or in
hard copy into a health record, and share confidential
information with medical colleagues in a manner consistent
with the Health Insurance Portability and Accountability Act
of 1996, or HIPAA. Further, Care360 is designed to receive,
store and view clinical information from many sources,
including other healthcare providers. Care360 allows 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
information technology solutions as physicians have expanded
their usage of the Internet. By the end of 2004, we were
receiving approximately 40% of all test orders and
delivering about 60% of all test results via the Internet.
Care360 was developed by MedPlus Inc., or MedPlus, our wholly
owned subsidiary. MedPlus' ChartMaxx'r' and Care360 patient
record systems are designed to support the creation and
management of electronic patient
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records, by bringing together, in one patient-centric view,
information from various sources, including physician's records
and laboratory and hospital data. We intend to expand the
services offered through our portal over time through internal
development and forming strategic relationships.
We expect to continue pursuing growth through acquisitions.
Historically, as the clinical laboratory industry consolidated, acquisitions
contributed a significant portion of our growth. We believe that organic growth
will become more significant, while acquisitions will continue to be an
important contributor to growth.
The clinical laboratory industry remains highly fragmented. We expect
to continue to selectively evaluate potential acquisitions of regional clinical
laboratories that can be integrated into our existing laboratories, thereby
increasing access for patients and enabling us to reduce costs and improve
efficiencies. We will also selectively assess potential acquisition
opportunities that will increase clinical capabilities or geographic presence,
both domestically and internationally.
Technology is making possible the convergence of various healthcare
disciplines. Information technology will eventually enable doctors to diagnose
and treat disease by aggregating a patient's genetic predisposition, diagnostic
test results and diagnostic images into a single patient-centric electronic
medical record. Having such clinical data in one easily accessed place will
drive better decision-making and improved outcomes for patients. Accordingly,
potential acquisitions in adjacent industries such as healthcare information
technology and diagnostic imaging will also be considered. Our acquisition of
MedPlus in 2001 was our first acquisition of a healthcare information technology
company.
Acquisitions and their integration into our operations could
potentially create issues, which could cause an interruption of, or
deterioration in, our services provided to customers. 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 our rigorous integration planning and
execution, and our value proposition based on expanded patient access, broad
testing capabilities, and most importantly, the quality of the services we
provide, will mitigate customer attrition.
People are the key to us being able to realize our mission. In this
regard, an important challenge is to prepare the workforce for the future. Our
people strategy is built on concepts of stringent employee selection, effective
engagement, and ongoing development which results in a staff of highly qualified
and motivated employees who are committed to our goals. Quest Diagnostics is
recognized as a "best place to work" in numerous locales as a consequence of our
workplace initiatives that reflect our belief that people are our most important
asset. We take diversity seriously, believing that every person who joins our
organization should be comfortable in the workplace and that we should
reasonably reflect the communities that we serve. We strive to make all of our
employees effective ambassadors of our Company.
Our Services
Our laboratory testing business accounts for approximately 96% of our
net revenues, with the balance derived from clinical trials testing and other
services and products. Laboratory testing includes routine testing and esoteric
testing, which generate approximately 82% and 14%, respectively, of our net
revenues. Clinical trials testing generates less than 3% of our net revenues. We
derive approximately 2% of our net revenues from foreign operations.
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 tests;
o HIV-related tests;
o urinalyses;
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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 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 smaller
facilities where we can quickly perform an abbreviated group of routine tests
for customers that require rapid turnaround times. Patient service centers are
facilities where specimens are collected, and 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. The majority of test results are delivered
electronically.
Esoteric Testing
Esoteric tests are those tests that require more sophisticated
technology, equipment and materials, professional "hands-on" attention and more
highly skilled professional and technical personnel, and may be performed less
frequently than routine tests. Because it is not cost-effective for most
hospital and clinical laboratories to perform low-volume esoteric tests
in-house, they generally refer many of these tests to an esoteric clinical
testing laboratory that specializes in performing these more complex tests. Due
to their complexity, esoteric tests are generally reimbursed at higher levels
than routine tests.
Our two esoteric testing laboratories, which conduct business as Quest
Diagnostics Nichols Institute, are among the leading esoteric clinical testing
laboratories in the world. In 1998, our esoteric testing laboratory 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 enables us to provide full esoteric testing services on the east coast.
Our two esoteric testing laboratories 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 and metabolism (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 hematology (the study of blood and bone marrow cells) and
coagulation (the process of blood clotting);
o immunology (the study of the immune system including antibodies,
immune system cells and their effects);
o microbiology and infectious diseases (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 body fluids and their analysis,
including antibodies, proteins and other characteristics); and
o toxicology (the study of chemicals and drugs and their effects on
the body's metabolism).
New Test Introductions
We intend to build upon our reputation as a leading innovator in the
clinical laboratory industry by continuing to introduce new diagnostic tests. As
the industry leader with the largest and broadest network and the leading
provider of esoteric testing, we believe that we are the best partner for
developers of new technology and tests to introduce their products to the
marketplace.
We continued to be a leading innovator in the industry in 2004, through
tests that we developed at Quest Diagnostics Nichols Institute, the largest
provider of molecular diagnostic testing in the United States, as well as
through relationships with technology developers. We believe that we are one of
the leaders in transferring technical innovations to the market, through our
relationships with members of the academic community and pharmaceutical and
biotechnology firms, as well as
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collaborations with emerging medical technology companies that develop and
commercialize novel diagnostics, pharmaceutical and device technologies.
During 2004, we introduced:
o The new CellSearch'TM' circulating tumor cell assay, licensed
from the Veridex division of Johnson & Johnson. This assay
identifies and counts circulating tumor cells in blood samples
from patients being treated for metastatic breast cancer. Results
of a prospective, multi-center study published August 19, 2004,
in the New England Journal of Medicine demonstrated that the number
of circulating tumor cells is predictive of progression free
survival and overall survival in metastatic breast cancer
patients. We are the only national commercial reference
laboratory to offer this test. Veridex received clearance from
the U.S. Food and Drug Administration in January, 2004, for the
CellSearch'TM' Epithelial Cell Kit to be used for the enumeration
of circulating tumor cells of epithelial origin in whole blood.
o Gene-based tests to detect hereditary nonpolyposis colon cancer
(HNPCC). To complement mutation analysis we developed novel
deletion assays to identify the at least 10% of HNPCC
patients with gene deletions.
o Next generation testing technology for measurement of steroid
hormones and other small molecules in blood and body fluids.
Tandem mass spectrometry (MS/MS) is a technology that offers
greater sensitivity and specificity with shorter testing time.
In the short-term, it has potential application in tests for
ovarian and testicular hormones, adrenal steroids, vitamin D,
and catecholamine metabolites.
o The TA 90 serum assay for malignant melanoma, licensed from the
John Wayne Cancer Institute in Los Angeles, California, one of
the foremost melanoma treatment centers in the world. This
assay is both sensitive and specific for melanoma and measures
circulating immune complexes to detect recurrence of disease
following curative surgery.
o New test panels to identify patients with immune-mediated gluten
sensitivity, known as celiac disease. In addition, we began to
perform HVALA typing for celiac disease risk assessment in our
Nichols Institute esoteric testing laboratory in Chantilly,
Virginia. Celiac disease is associated with specific HVALA types.
o New tests in hematopathology to help doctors diagnose, predict
response to therapy, and monitor patients with chronic
lymphocytic leukemia, the most common leukemia in the Western
world. Additionally, several assays were introduced in 2004 to
monitor the effectiveness of targeted therapy in patients with
chronic myeloid leukemia.
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, and will result in ever more complex and thorough predictive
and diagnostic testing. We believe that we are well positioned to benefit from
these advances.
Clinical Trials Testing
We believe that we are the world's second largest provider of clinical
laboratory testing performed in connection with clinical research trials on new
drugs. Clinical research trials are required by the Food and Drug
Administration, or FDA, and other international regulatory authorities to assess
the safety and efficacy of new drugs. We have clinical trials testing centers in
the United States and in the United Kingdom. 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 55% of our
net revenues from clinical trials testing in 2004 represented testing for
GlaxoSmithKline plc, or 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 through our Nichols Institute Diagnostics subsidiary. These
are sold principally to hospitals, clinical laboratories and dialysis centers,
both domestically and internationally. Our MedPlus subsidiary is a developer and
integrator of clinical connectivity and data management solutions for healthcare
organizations, physicians and clinicians primarily through its ChartMaxx'r'
electronic medical record system for hospitals and Care360. Care360 was
developed by MedPlus and enables physicians to order
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diagnostic tests and review laboratory results online; electronically prescribe
and order medication at the point of care; view clinical and administrative
information from multiple sources; file documents received electronically or in
hard copy into a health record; and share confidential patient information with
medical colleagues in a manner that is consistent with HIPAA privacy and
security requirements.
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 and a "customer" as
the party who refers the test to us. Depending on the billing arrangement and
applicable law, the payer may be (1) the physician or other party (such as a
hospital, 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. During
2004, only two customers accounted for more than 5% of our net revenues, and no
single customer accounted for more than 6% 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 flows.
The following table shows current estimates of the breakdown of the
percentage of our total volume of requisitions and total clinical laboratory net
revenues during 2004 applicable to each payer group:
Net Revenues
as % of
Requisition Volume Total
as % of Clinical Laboratory
Total Volume Net Revenues
------------ ------------
Patient................................. 2% - 5% 5% - 10%
Medicare and Medicaid................... 15% - 20% 15% - 20%
Physicians, Hospitals, Employers and
Other Monthly-Billed Clients......... 30% - 35% 20% - 25%
Healthcare Insurers-Fee-for-Service..... 30% - 35% 40% - 45%
Healthcare Insurers-Capitated........... 15% - 20% 5% - 10%
Physicians
Physicians requiring testing for patients are the primary referral
source of our clinical laboratory testing volume. Testing referred by physicians
is typically billed to healthcare insurers, government programs such as Medicare
and Medicaid, patients and physicians. 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.
Healthcare Insurers
Healthcare insurers, including managed care organizations and other
healthcare insurance providers, which typically directly or indirectly contract
with a number of clinical laboratories on behalf of their members, represent
approximately one-half of our total testing volumes and one-half of our net
revenues. Larger healthcare insurers typically prefer to use large commercial
clinical laboratories because they can provide services to their members on a
national or regional basis. In addition, larger laboratories are better able to
achieve the low-cost structures necessary to profitably service the members of
large healthcare plans, and can provide test utilization data across various
products in a consistent format. Healthcare insurers frequently require test
utilization data in order to meet the reporting requirements of the National
Committee for Quality Assurance, or NCQA, to implement disease management
programs and for other health plan operation purposes. In certain markets, such
as California, healthcare insurers delegate their covered members to independent
physician associations, or IPAs, which in turn contract with laboratories for
clinical laboratory services on behalf of their members.
In recent years, there has been a shift in the way major healthcare
insurers reimburse clinical laboratories. Healthcare insurers have begun to
offer more freedom of choice to their members, including greater freedom to
determine which laboratory to use and which tests to order. Accordingly, most of
our agreements with major healthcare insurers are non-exclusive arrangements. As
a result, under these non-exclusive arrangements, physicians and patients have
more freedom of
7
choice in selecting laboratories, and laboratories are likely to compete more on
the basis of service and quality rather than price alone. Also, healthcare
insurers are increasingly offering programs such as preferred provider
organizations, or PPOs, and consumer driven plans that offer a greater choice of
healthcare providers. Pricing for these programs is typically negotiated on a
fee-for-service basis, which generally results in higher revenue per requisition
than under capitation arrangements. If consumer driven plans and PPO plans
increase in popularity, it will be increasingly important for healthcare
providers to differentiate themselves based on quality, service and convenience
to avoid competing on price alone. Under a capitation arrangement, the Company
and healthcare insurers agree to a predetermined monthly reimbursement rate for
each member of the healthcare insurer's plan, regardless of the number or cost
of services provided by the Company. Despite these trends, healthcare insurers
continue to aggressively seek cost reductions in order to keep premiums to their
customers competitive. If the Company is unable to agree on pricing with a
healthcare insurer, we could become a "non-participating" provider which may
require us to bill the patient, or in certain cases the physician, rather than
the healthcare insurer. This "non-participating" status could lead to loss of
business since typically in these instances patients have a higher co-insurance
responsibility and physicians may not refer testing to a non-participating
provider in order to avoid the additional expense for the patient.
The trend of consolidation among healthcare insurers has continued,
resulting in fewer but larger insurers with significant bargaining power in
negotiating fee arrangements with healthcare providers, including clinical
laboratories. These healthcare insurers, as well as IPAs, 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 arrangements. 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. We work closely with healthcare insurers as they evaluate
new tests; however, as innovation in the testing area increases, there is no
guarantee that healthcare insurers will agree to offer the technology as a
covered service, carve out these services or reimburse them at rates that
reflect the true cost or value associated with such services.
Historically most Medicare beneficiaries were covered under the
traditional Medicare program, but the federal government has over the last
several years affected various proposals in an effort to increase enrollment of
Medicare beneficiaries in the private managed care system. With the enactment of
The Medicare Prescription Drug, Improvement and Modernization Act of 2003, or
MMA, which renamed the private Medicare program "Medicare Advantage" and created
an additional product that allows for regional Preferred Provider Organization,
it is possible that the Company may begin to experience a shift of traditional
Medicare beneficiaries to private Medicare Advantage programs.
A significant portion of the laboratory costs incurred by healthcare
insurers is for payments made to non-contracted providers (primarily hospitals)
at rates exceeding those of contracted providers. We offer QuestNet'TM', a
service whereby we develop and administer customized networks of clinical
laboratory providers for healthcare insurers. Through QuestNet'TM', physicians
and members are provided multiple choices for clinical laboratory testing while
healthcare insurers realize cost reductions from reducing testing performed by
non-contracted providers.
Hospitals
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. Fee schedules for hospital reference testing are
typically negotiated on behalf of the hospitals by group purchasing
organizations. We believe that most hospital laboratories perform approximately
90% to 95% of their patients' clinical laboratory tests. 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. Our hospital customers account for approximately
13% of our net revenues, the majority of which represents services billed to the
hospitals for certain testing that the hospitals do not perform internally.
Hospitals continue to look for ways to fully utilize their existing laboratory
capacity through test internalization as well as competing with commercial
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.
We have 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 has positioned us to be a partner
of choice for hospital customers.
8
We have joint venture arrangements with leading integrated healthcare
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 federal, state and local governmental
agencies and to large employers. We believe that we are the leading provider of
clinical laboratory testing to employers for drugs of abuse. We also provide
wellness testing to employers to enable employees to take an active role in
improving their health. Testing services for employers account for approximately
3% of our net revenues. The volume of testing services for employers, which
generally have relatively low profit margins, has increased moderately in 2004,
driven by an increase in hiring. We also perform esoteric testing services for
other commercial clinical laboratories that do not have a full range of 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 physicians who then receive the test results. Certain states
limit the ability of consumers to order tests themselves or to obtain test
results directly. However, over time, we believe that consumers will
increasingly want to order clinical laboratory tests themselves. We offer a
focused menu of clinical laboratory testing directly to consumers in certain
states that permit us to do so. Consumers pay for and receive the test results
directly. In each case, a physician reviews the order and result. We believe
this market will continue to grow over time.
Sales and Marketing
We market to and service our customers through our direct sales force,
healthcare insurers sales force, customer service representatives and couriers.
We focus our sales efforts on obtaining and retaining profitable
accounts. We have an active customer management process to evaluate the growth
potential and profitability of all accounts. Where appropriate, we manage
service levels, to ensure our growth and profitability goals are achieved.
Our sales force is organized by customer type with the majority of
representatives focused on marketing laboratory services to physicians,
including specialty physicians such as oncologists, urologists and
gastroenterologists. Additionally, we have a healthcare insurer sales
organization that focuses on regional and national insurance and healthcare
organizations. We also have a hospital sales organization that focuses on
meeting the unique needs of hospitals and leverages the specialized capabilities
of our Nichols Institute esoteric testing laboratories. Supporting our hospital
and physician sales teams are genomics and esoteric testing specialists, who are
specially trained and focused on educating our clients on new and more complex
tests. A smaller portion of our sales force focuses on selling
substance-of-abuse testing to employers.
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.
Our corporate marketing function is organized by customer type and is
responsible for developing and executing marketing strategies, new product
launches, and promotional and advertising support. The marketing function is
also responsible for customer satisfaction surveys, market research, tradeshow
administration, database marketing tools, and market analysis.
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, or 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. Despite the precautionary measures that
we have taken to prevent unanticipated problems that could affect our IT
systems, sustained or repeated system failures that interrupt our ability to
process test orders, deliver test
9
results or perform tests in a timely manner could adversely affect our
reputation and result in a loss of customers and net revenues.
Historically, 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. This resulted in many different information systems for billing, test
results reporting, and other transactions.
During 2002, we began implementation of a standard laboratory
information system and a standard billing system. We expect the deployment of
the standardized systems will take several more years to complete and will
result in fewer 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 and 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 that need to be managed carefully.
Billing
Billing for laboratory services is complicated. Depending on the
billing arrangement and applicable law, we must bill various payers, such as
patients, insurance companies, Medicare, Medicaid, doctors and employer groups,
all of which have different requirements. Additionally, other factors that
complicate billing include:
o differences between our fee schedules and the reimbursement rates
of the payers;
o disparity in coverage and information requirements among various
payers;
o incomplete or inaccurate billing information provided by ordering
physicians;
o auditing for compliance with applicable laws and regulations as
well as internal compliance policies and procedures; and
o disputes with payers as to which party is responsible for
payment.
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 advance 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 Centers for Medicare & 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 4.4% of our net
revenues in 2004, 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 healthcare 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 significantly reduced bad debt expense as a percentage of net
revenues from about 7% during 1996 to 4.4% during 2004 by using Six Sigma and
implementing our standardization initiatives and billing "best practices". We
believe that in the longer term, with a continuing focus on process discipline
and the increased use of electronic ordering by our customers, bad debt as a
percentage of net revenues can be reduced to 4% or less (see "Regulation of
Reimbursement for Clinical Laboratory Services").
10
Competition
While there has been significant consolidation in the clinical
laboratory testing business in recent years, our industry remains fragmented and
highly competitive. We compete with three types of laboratory providers:
hospital-affiliated laboratories, other commercial clinical laboratories and
physician-office laboratories. We are the leading clinical laboratory provider
in the United States, with net revenues of $5.1 billion during 2004, and
facilities in substantially all of the country's major metropolitan areas. Our
largest competitor is Laboratory Corporation of America Holdings, Inc. In
addition, we compete with many smaller regional and local commercial clinical
laboratories, as well as laboratories owned by physicians and hospitals (see
"Payers and 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 commercial 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
and members of large healthcare plans. 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
physicians that refer testing to us (see "Payers and 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.
The diagnostic testing industry is faced with changing technology and
new product introductions. Advances in technology may lead to the development of
more cost-effective tests that can be performed outside of a commercial clinical
laboratory such as (1) point-of-care tests that can be performed by physicians
in their offices; (2) esoteric tests that can be performed by hospitals in their
own laboratories; and (3) testing that can be performed by patients in their
homes. Development of such technology and its use by our customers and patients
would reduce the demand for our laboratory testing services and negatively
impact our net 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
continue to implement our Six Sigma and standardization initiatives to help
achieve our goal of becoming recognized as the undisputed quality leader in the
healthcare services industry. Our Nichols Institute facility in San Juan
Capistrano was the first clinical laboratory in North America to achieve
ISO-9001 certification. Two of our clinical trials laboratories, our diagnostic
kits facility and one of our routine laboratories have also achieved ISO-9001
certification. These certifications are international standards for quality
management systems.
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 monitored to
identify trends, biases or imprecision in the analytical processes. We also
perform internal process audits as part of our comprehensive Quality Assurance
program.
11
External Proficiency Testing and Accreditation. All of our laboratories
participate in various external quality surveillance programs. 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 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 CAP. Accreditation includes on-site inspections
and participation in the CAP (or equivalent) proficiency testing program.
Recently the CAP has required all CAP accredited laboratories to post "whistle
blower" hotline posters to escalate quality and laboratory safety issues to CAP
that have not been resolved through other internal reporting.
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
actions to enforce laws and regulations, including revoking a clinical
laboratory's federal certification to operate a clinical laboratory operation.
Changes in regulation may increase the costs of performing clinical laboratory
tests, increase the administrative requirements of claims or decrease the amount
of reimbursement.
CLIA and State Regulation. All of our laboratories and (where
applicable) patient service centers are licensed and accredited by the
appropriate federal and state agencies. CLIA regulates virtually all clinical
laboratories by requiring they be certified by the federal government and comply
with various operational, personnel and quality requirements intended to ensure
that their clinical laboratory testing services are accurate, reliable and
timely. CLIA does not preempt state laws that are more stringent than federal
law. For example, state laws may require additional personnel qualifications,
quality control, record maintenance and/or proficiency testing. 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 to both
physicians and patients test kits approved by the FDA for home use. 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 under CLIA as well as by patients in their
homes.
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 these employees. All laboratories that perform such
testing must be certified as meeting SAMHSA standards. All of our laboratories
that perform such testing are 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 must be licensed by the
DEA. All of our 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 such
waste.
FDA. The FDA has regulatory responsibility over instruments, test kits,
reagents and other devices used to perform diagnostic testing by clinical
laboratories. In the past, the FDA has claimed regulatory authority over
laboratory-developed tests, but has exercised enforcement discretion in not
regulating most laboratory-developed tests performed by high complexity
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 be the lead federal agency to regulate 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 made any final recommendations. In the meantime, the FDA is considering
revising its regulations on analyte specific reagents, which are used in
laboratory-developed tests, including laboratory-developed genetic testing.
Representatives of clinical laboratories (including Quest Diagnostics) and the
American Clinical Laboratory Association (our industry trade association) have
communicated industry concerns to representatives of the FDA regarding potential
FDA regulation of genetic testing in general and issues with regard to the
impact of potential increased oversight over analyte specific reagents. We
expect those discussions to continue. Increased FDA regulation of the reagents
used in laboratory-developed testing could lead to increased costs and delays in
introducing new tests, including genetic tests.
12
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
requirements to develop and implement multi-faceted programs to protect workers
from exposure to blood-borne pathogens, such as HIV and hepatitis B and C,
including preventing or minimizing any exposure through sharps or needle stick
injuries.
Specimen Transportation. Transportation of most clinical laboratory
specimens and some laboratory supplies are considered hazardous materials
subject to regulation by the Department of Transportation, the Public Health
Service, the United States Postal Service and the International Air Transport
Association (IATA).
Corporate Practice of Medicine. Many states, including some 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 in certain states to prohibit corporations from employing licensed
healthcare professionals to provide services on the corporation's behalf. The
scope of the doctrine, and how it applies, varies from state to state. In
certain states these restrictions affect our ability to directly provide
anatomic pathology services and/or to provide clinical laboratory services
directly to consumers.
Healthcare Information Technology
Clinical laboratories use information technology to obtain laboratory
orders and to communicate results and provide other reporting. Innovations in
healthcare information technology (HCIT) have the potential to improve patient
care, promote efficiency and reduce expense. Both at the federal and state
levels, there are public and private efforts to bring together healthcare
providers, information technology vendors, and other stakeholders to coordinate
federal healthcare information systems and develop a national healthcare
network, including developing standards for electronic interoperability
(standards for the exchange and use of electronic healthcare data).
Both the Company and MedPlus, its HCIT subsidiary, could be impacted by
any national healthcare information network and the adoption of standards for
HCIT interoperability, because of substantial existing investments in software
and hardware and the potential for having to make substantial future investments
to comply with new or different standards. The Company and ACLA, its trade
association, are monitoring and providing relevant information to policy makers
to ensure that issues important to medical laboratories are reflected in any
interoperability standards and that the voice of the industry and the Company
are heard.
Privacy and Security of Health Information; Standard Transactions
Pursuant to HIPAA, the Secretary of HHS has issued final regulations
designed to improve the efficiency and effectiveness of the healthcare system by
facilitating the electronic exchange of information in certain financial and
administrative transactions while protecting the privacy and security of the
information exchanged. Three principal regulations have been issued in final
form: privacy regulations, security regulations, and standards for electronic
transactions.
The HIPAA privacy regulations, which fully came into effect in April
2003, establish comprehensive federal standards with respect to the uses and
disclosures of protected health information by health plans, healthcare
providers and healthcare 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, including but not limited to treatment
purposes, activities to obtain payment for our services, and our
healthcare operations activities;
o a patient's rights to access, amend and receive an accounting of
certain disclosures 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.
We have implemented the HIPAA privacy regulations, as required by
law. The HIPAA 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 need to
comply with the laws of other countries. The federal privacy regulations
restrict our ability to use or
13
disclose patient-identifiable laboratory data, without patient authorization,
for purposes other than payment, treatment or healthcare operations (as defined
by HIPAA) except for disclosures for various public policy purposes and other
permitted purposes outlined in the final privacy regulations. The privacy
regulations provide for significant fines and other penalties for wrongful use
or disclosure of protected health information, including potential civil and
criminal fines and penalties. Although the HIPAA statute and regulations do not
expressly provide for a private right of damages, we also could incur damages
under state laws to private parties for the wrongful use or disclosure of
confidential health information or other private personal information.
The final HIPAA security regulations, which establish requirements for
safeguarding electronic patient information, were published on February 20, 2003
and became effective on April 21, 2003, although healthcare providers have until
April 20, 2005 to comply. We have conducted analyses and have been implementing
policies and standards to implement security measures to reasonably and
appropriately comply with the regulations' requirements by the compliance
deadline of April 20, 2005.
The final HIPAA regulations for electronic transactions, which we refer
to as the transaction standards, establish uniform standards for electronic
transactions and code sets, including the electronic transactions and code sets
used for claims, remittance advices, enrollment and eligibility. HHS issued
guidance on July 24, 2003 stating that it would not penalize a covered entity
for post-implementation date transactions that are not fully compliant with the
transactions standards, if the covered entity could demonstrate its good faith
efforts to comply with the standards.
Many of our payers were not ready to implement the transaction
standards by the October 2003 compliance deadline or were not ready to test or
trouble-shoot claims submissions. Since that time, significant progress has been
made in implementing the transaction standards with our payers. As of December
31, 2004, greater than 95% of our electronic fee-for-service claim transactions
are submitted in the new standard format and greater than 85% of our electronic
fee-for-service remittance transactions are received in the new standard format.
We are working in good faith with payers that have not converted to the new
standards to reach agreement on each payer's data requirements and to test
claims submissions.
The HIPAA transaction standards are complex, and subject to differences
in interpretation by payers. For instance, some payers may interpret the
standards to require us to provide certain types of information, including
demographic information not usually provided to us by physicians. We are working
closely with our payers to establish acceptable protocols for claims submissions
and with our trade association and an industry coalition to present issues and
problems as they arise to the appropriate regulators and standards setting
organizations.
Regulation of Reimbursement for Clinical Laboratory Services
Overview. The healthcare industry has experienced significant changes
in reimbursement practices during the past several years. Government payers,
such as Medicare (which principally serves patients 65 years and older) and
Medicaid (which principally serves indigent patients), as well as private payers
and large employers, have taken steps and may continue to take steps to control
the cost, utilization and delivery of healthcare services, including clinical
laboratory services. If we cannot offset additional reductions in the payments
we receive for our services by reducing costs, increasing test volume and/or
introducing new procedures, it could have a material adverse impact on our net
revenues and profitability.
Principally as a result of government reimbursement reductions and
measures adopted by CMS to reduce utilization described below, the percentage of
our net revenues derived from Medicare and Medicaid programs is lower that it
was prior to these measures being implemented. The cost to comply with Medicare
administrative requirements is disproportionately higher than our cost to bill
other payers, making the Medicare business generally less profitable. Medicaid
also pays substantially less, on an average per-requisition basis, than other
third party payers. However, we believe that our other business may depend, in
part, on continued participation in the Medicare and Medicaid programs, because
certain customers may want a single laboratory capable of performing 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 fines
and penalties; 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.
14
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 national ceiling applies to tests
for which limitation amounts were established before January 1, 2001. For more
recent tests (tests for which a limitation amount is first established on or
after January 1, 2001), the limitation amount is set at 100% of the median of
all the local fee schedules established for that test in accordance with the
Social Security Act. The MMA eliminated for five years (beginning January 1,
2004) the provision for annual increases to the Medicare national fee schedule
based on the consumer price index, including the adjustment (which would have
been 2.6%) that had been scheduled for January 1, 2004. Thus, by law an
adjustment to the national fee schedule for clinical laboratory services based
on the consumer price index cannot occur before January 1, 2009. However, the
MMA added coverage for certain cardiovascular screening tests and diabetes
screening tests, subject to certain frequency limitations. The MMA evaluates new
diagnostic tests for coverage as they are introduced. In addition, the 2005
Physician Fee Schedule rule proposes to lower Medicare's payment rates for flow
cytometry services in 2005. Quest Diagnostics believes that CMS failed to
properly value these services and is commenting on this proposed change through
ACLA. Pathology services are reimbursed by Medicare based on a resource-based
relative value scale, or RBRVS, that is periodically updated by CMS.
Approximately 1% of our net revenues are derived from pathology services
reimbursed by Medicare based on RBRVS.
With regard to the rest of our laboratory services performed on behalf
of Medicare beneficiaries, we must bill the Medicare program directly and must
accept the carrier's fee schedule amount as payment in full. 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 for tests billed on a
fee-for-service basis:
o "Client" fees charged to physicians, hospitals, and institutions for
which a clinical laboratory performs testing 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 fees 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 laboratory industry believes that the term "usual charges"
specifically applies to amounts charged to similarly-situated third-party payers
and to patients and that client fees should not be included in "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.
In September 2003, the OIG published a Notice of Proposed Rulemaking
that would amend the OIG's exclusion regulations addressing excessive claims.
Under the proposed exclusion rule, the OIG would have the authority to exclude a
provider for submitting claims to Medicare that contain charges that are
substantially in excess of the provider's usual charges. The proposal would
define "usual charges" as the average payment from non-government entities, on a
test by test basis, excluding capitated payments; and would define
"substantially in excess" to be an amount that is more than 20% greater than the
usual charge. We believe that the rule is unnecessary for the clinical
laboratory industry because Congress has already established fee schedules for
the services that the rule proposes to regulate. We also believe that the rule
is unworkable and overly burdensome. Through our industry trade association, we
filed comments opposing the proposed rule and we are working with our trade
association and a coalition of other healthcare providers who also oppose this
proposed regulation as drafted. If this regulation is adopted as proposed, it
could potentially reduce the amounts we bill and collect from Medicare and other
federal payers, affect the fees we charge to other payers, or subject the
Company to penalties for non-compliance, and could also be costly for us to
administer.
15
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. CMS is expected to issue instructions to carriers on
implementation of the inherent reasonableness authority. Upon receipt of those
instructions, the carriers can then implement the final rule. 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, Medicare does not require the beneficiary to pay a
co-payment for clinical laboratory testing. When co-payments were last in effect
before adoption of the clinical laboratory services fee schedules 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 re-enacted, a co-payment requirement
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-payments are not established and followed. The Medicare
reform bill approved by the United State Senate in June 2003 included a
co-payment provision, under which clinical laboratories would receive from
Medicare carriers only 80% of the Medicare allowed amount for clinical
laboratory tests and would be required to bill Medicare beneficiaries for the
20% balance of the Medicare allowed amount. The co-payment provision was dropped
from the bill as passed (known as the Medicare Prescription Drug, Improvement,
and Modernization Act of 2003). We cannot provide any assurances to investors
that Congress would not seek to re-impose a copayment requirement payable by
Medicare beneficiaries for clinical laboratory services. Certain Medicaid
programs already require Medicaid recipients to pay co-payment amounts for
clinical laboratory testing.
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 diagnosis 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. Moreover, regulations adopted in accordance with
HIPAA require submission of diagnosis codes as part of the standard claims
transaction.
We are generally permitted to bill patients directly for some
statutorily excluded clinical laboratory services. If a patient signs an advance
beneficiary notice, or ABN, we are also generally permitted to bill patients for
clinical laboratory tests that Medicare does not cover due to "medical
necessity" limitations (these tests include limited coverage tests for which the
ordering physician did not provide an appropriate diagnosis code and certain
tests ordered on a patient at a frequency greater than covered by Medicare). An
ABN is a notice signed by the beneficiary which documents the patient's informed
decision to personally assume financial liability for laboratory tests which are
likely to be denied and not reimbursed 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 provided to
the beneficiary or is not completed properly, we may end up performing tests
that we cannot subsequently bill to the patient if they are not reimbursable by
Medicare due to coverage limitations.
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 fee schedule
limitations). Inconsistent carrier rules and policies have 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 to replace the current local carriers with no
more than five regional carriers. Although HHS has finalized a number of uniform
test coverage/diagnosis coding policies, it has not taken any final action to
replace the local carriers with five regional carriers.
Carrier Jurisdiction Changes for Lab-to-lab Referrals. On October 31,
2003, CMS announced its intention to change the manner in which Medicare
contractors currently process claims for lab-to-lab referrals of clinical
laboratory tests. While laboratories are, under certain criteria, permitted to
directly bill Medicare for clinical laboratory tests they refer to other
laboratories, they must be reimbursed at the correct fee schedule amount based
on the Medicare fee schedule in effect in the Medicare carrier region in which
the test was actually performed. Historically, laboratories needed to enroll
with and file claims to multiple carriers in order to bill for such out-of-area
test referrals, to ensure receipt of the appropriate payment amount. This has
proven to be an administratively difficult process, with many obstacles to
obtaining accurate claims payment,
16
including applying the correct fee schedule. On July 1, 2004, CMS implemented a
change that mandated that the laboratory's "home" carrier maintain and apply the
clinical laboratory fee schedule applicable to the carrier region where the test
was performed. This streamlined process allows a laboratory to file all of its
clinical laboratory claims to its "home" carrier.
CMS also has announced a parallel change with regard to purchased
diagnostic interpretations (pathology services). A previously announced change
in Medicare carrier jurisdiction rules required laboratories to bill the carrier
where a purchased diagnostic interpretation service was performed. This would
have required carriers to issue Medicare provider numbers to the billing
laboratory. In October 2004, CMS posted a "change notice" permitting
laboratories to temporarily bill their local carriers for purchased diagnostic
tests or interpretations regardless of the location where the service was
furnished. The final change notice was issued on October 29, 2004, effective
April 1, 2005. The final notice requires carriers to implement a new edit to
check for duplicate claims for referred clinical diagnostic laboratory and
purchased diagnostic services submitted by physicians/suppliers to more than one
carrier.
Competitive Bidding. The MMA requires CMS to conduct a demonstration
project on the application of competitive acquisition to clinical laboratory
tests. CMS awarded the clinical laboratory competitive bidding demonstration
design and implementation contract to RTI International, Research Triangle Park,
North Carolina, and its subcontractor, Palmetto GBA. Palmetto is a Part B
carrier and previously conducted for CMS a competitive bidding demonstration for
Durable Medical Equipment (DME). A timeline in the bid package for the design
and implementation phase of the competitive bidding demonstration calls for
distribution of bid packages in December 2005. The clinical laboratory
competitive bidding demonstration project is expected to take place in two
separate locations, but other key details of the demonstration have not been
determined. Quest Diagnostics and ACLA, its trade association, will monitor the
design and implementation phase carefully because of industry concerns that the
competitive bidding demonstrations will not take into account all of the factors
involved in the timely delivery of high quality clinical laboratory testing to a
broad range of clients in diverse geographic settings.
Early in 2004, the State of Florida issued but later withdrew a Request
for Proposals for competitive bidding of clinical laboratory testing for its
Medicaid program. However, in December 2004, Florida issued an Invitation to
Negotiate (ITN) seeking competitive bids for the provision of clinical
laboratory tests on a capitated-basis for some Medicaid recipients and on a
reduced fee-for-service basis for other Medicaid recipients. The ITN
contemplates that the Florida Medicaid Agency (AHCA) will negotiate with the
three highest-scoring bidders for an exclusive statewide contract of at least
three years plus a potential renewal period. ACLA, the trade association for
clinical laboratories, filed two petitions with AHCA challenging the ITN on
public policy and legal grounds. In addition, Quest Diagnostics and another
large laboratory independently filed bid protests with AHCA. On February 18,
2005, AHCA announced, without further explanation, that it was withdrawing the
ITN. 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
17
have also applied to Medicaid-covered services. Many states have similar
anti-"self-referral" and other laws that are not limited to Medicare and
Medicaid referrals and could also affect investment and compensation
arrangements with physicians. We cannot predict if some of the state laws will
be interpreted contrary to our practices.
In April 2003, the OIG issued a Special Advisory Bulletin addressing
what it described as "questionable contractual arrangements" in contractual
joint ventures. The OIG Bulletin focused on arrangements where a healthcare
provider, or Owner, expands into a related healthcare business by contracting
with a healthcare provider, or Manager, that already is engaged in that line of
business for the Manager to provide related healthcare items or services to the
patients of the Owner in return for a share of the profits of the new line of
business. While we believe that the Bulletin is directed at "sham" arrangements
intended to induce referrals, we cannot predict whether the OIG might choose to
investigate all contractual joint ventures, including our joint ventures with
various hospitals or hospital systems.
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 cases of fraud and abuse. 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 damages, including the loss of licenses or our ability
to participate in Medicare, Medicaid and other federal and state healthcare
programs. In addition, certain federal and state statues, including the qui tam
provisions of the federal False Claim Act, allow private individuals to bring
lawsuits against healthcare companies on behalf of government or private payers
alleging inappropriate billing practices.
During the mid-1990s, Quest Diagnostics and SBCL settled significant
government claims that primarily involved industry-wide billing and marketing
practices that both companies believed to be lawful. 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 damages 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 17% of our net revenues during 2004.
There are certain pending lawsuits regarding our billing practices
filed under the qui tam provisions of the federal false claims statute and other
federal and state statutes. Some of the cases involve claims that are
substantial in amount. We have also received subpoenas from the United States
Attorney's Office for the Eastern District of New York requiring the production
of various business records including documents related to parathyroid hormone
testing and parathyroid hormone test kits manufactured by our subsidiary Nichols
Institute Diagnostics. We are cooperating with the government's investigation.
Although management believes that established reserves for claims are
sufficient, including qui tam cases, of which management is aware, 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.
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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 established 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 & Compliance Committee of the Board of Directors requires
periodic reporting of compliance operations from management.
We seek to conduct our business in compliance with all statutes and
regulations applicable to our operations. Many of these statutes and regulations
have not been interpreted by the courts. We cannot assure investors that
applicable statutes or regulations will not 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, which could
have a material adverse effect on our business.
Intellectual Property Rights
Other companies or individuals, including our competitors, may obtain
patents or other property rights that would prevent, limit or interfere with our
ability to develop, perform or sell our tests or operate our business. As a
result, we may be involved in intellectual property litigation and we may be
found to infringe on the proprietary rights of others, which could force us to
do one or more of the following:
o cease developing, performing or selling products or services that
incorporate the challenged intellectual property;
o obtain and pay for licenses from the holder of the infringed
intellectual property right;
o redesign or reengineer our tests;
o change our business processes; or
o pay substantial damages, court costs and attorneys' fees, including
potentially increased damages for any infringement held to be
willful.
Patents generally are not issued until several years after an
application is filed. The possibility that, before a patent is issued to a third
party, we may be performing a test or other activity covered by the patent is
not a defense to an infringement claim. Thus, even tests that we develop could
become the subject of infringement claims if a third party obtains a patent
covering those tests.
Infringement and other intellectual property claims, regardless of
their merit, can be expensive and time-consuming to litigate. In addition, any
requirement to reengineer our tests or change our business processes could
substantially increase our costs, force us to interrupt product sales or delay
new test releases. In the past, we have settled several disputes regarding our
alleged infringement of intellectual property rights of third parties. We are
currently involved in settling several additional disputes. We do not believe
that resolution of these disputes will have a material adverse effect on our
results of operations, cash flows or financial condition. However, infringement
claims could arise in the future as patents could be issued on tests or
processes that we may be performing, particularly in such emerging areas as
gene-based testing and other specialty testing.
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 coverages 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 considers actuarially determined losses based upon our
historical and projected loss experience. Management believes that present
insurance coverage and reserves are
19
sufficient to cover currently estimated exposures. Although management cannot
predict the outcome of any claims made against the Company, management does not
anticipate that the ultimate outcome of any such proceedings or claims will have
a material adverse effect on our financial position but may be material to our
results of operations and cash flows in the period in which such claims are
resolved. 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, 2004, we employed approximately 38,600 people. This
total excludes employees of the joint ventures where we do not have a majority
interest. We have no collective bargaining agreements with any unions covering
any employees in the United States, and we believe that our overall relations
with our employees are good.
20
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, or the Litigation Reform Act, provides
a "safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies without fear of litigation.
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
fee-for-service to capitated fee arrangements. See "Business -
Payers and Customers - Healthcare Insurers".
(c) Adverse actions by government or other third-party payers,
including unilateral reduction of fee schedules payable to us,
competitive bidding, or an increase in the practice of negotiating
for exclusive arrangements that involve aggressively priced
capitated payments by healthcare insurers or other payers. See
"Business - Regulation of Reimbursement for Clinical Laboratory
Services" and "Business - Payers and Customers - Healthcare
Insurers".
(d) The impact upon our testing 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 possibility 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;
(4) inability to obtain from patients an advance beneficiary
notice form for tests that cannot be billed without prior
receipt of the form; and
(5) the potential need to monitor charges and lower certain fees
to Medicare to comply with the OIG's proposed rule pertaining
to exclusion of providers for submitting claims to Medicare
containing charges that are substantially in excess of the
provider's usual charges.
See "Business - Regulation of Reimbursement for Clinical
Laboratory Services" and "Business - Billing".
(e) Adverse results from pending or future government investigations,
lawsuits or private actions. These include, in particular
significant monetary damages, loss or suspension of licenses,
and/or suspension or exclusion from the Medicare and Medicaid
programs and/or other significant litigation matters. See
"Business - Government Investigations and Related Claims".
21
(f) Failure to obtain new customers at profitable pricing or failure
to retain existing customers, and a reduction in tests ordered or
specimens submitted by existing customers. Failure to negotiate
reimbursements with major healthcare insurers or other third party
payers on favorable terms.
(g) Failure to efficiently integrate acquired businesses, or to
efficiently integrate clinical laboratory businesses from joint
ventures and alliances with hospitals. See "Business - Corporate
Strategy and Growth Opportunities - Growth".
(h) Inability to obtain professional liability or other insurance
coverage or a material increase in premiums for such coverage or
reserves for self-insurance. See "Business - Insurance".
(i) Denial of CLIA certification or other licenses for any of our
clinical laboratories under the CLIA standards, revocation or
suspension of the right to bill the Medicare and Medicaid programs
or other adverse regulatory actions by federal, state and local
agencies. See "Business - Regulation of Clinical Laboratory
Operations".
(j) Changes in federal, state or local laws or regulations, including
changes that result in new or increased federal or state
regulation of commercial clinical laboratories, including
regulation by the FDA.
(k) Inability to achieve expected benefits from our acquisitions of
other businesses. See "Business - Corporate Strategy and Growth
Opportunities - Growth".
(l) Inability to achieve additional benefits from our Six Sigma and
standardization initiatives.
(m) Adverse publicity and news coverage about the clinical laboratory
industry or us.
(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 the standardization of
our IT systems and other system conversions, 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 or conveni