Our Services

Our laboratory testing business consists of routine testing, esoteric testing, and clinical trials testing. Routine testing generates approximately 83% of our net revenues, esoteric and gene-based testing generates approximately 13% of our net revenues, and clinical trials testing generates less than 3% of our net revenues. We derive less than 2% of our net revenues from foreign operations.

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:

•   blood cholesterol level tests;

•   complete blood cell counts;

•   pap smears;

•   HIV-related tests;

•   urinalyses;

•   pregnancy and other prenatal tests; and

•   alcohol and other substance-abuse tests.

We perform routine testing through our network of major laboratories, rapid response laboratories, or "stat" labs, and patient service centers. We also perform routine testing at the hospital laboratories we manage. Major laboratories offer a full line of routine clinical tests.  Rapid response laboratories are local facilities where we can quickly perform an abbreviated line of routine tests for customers that require rapid turnaround. Patient service centers are facilities where specimens are collected. These centers are typically located in or near a building used by medical professionals.

We operate 24 hours a day, 365 days a year. We perform and report most routine procedures within 24 hours. Most test results are delivered electronically.

Esoteric Testing

Esoteric tests are those tests that are performed less frequently than routine tests and require more sophisticated technology, equipment and materials, professional "hands-on" attention and more highly skilled professional and technical personnel. Because it is not cost-effective for most clinical laboratories to perform the low volume of esoteric tests in-house, they generally refer many esoteric tests to an esoteric clinical testing laboratory. Due to their complexity, esoteric tests are generally reimbursed at higher levels than routine tests.

Our Quest Diagnostics Nichols Institute is one of the leading esoteric clinical testing laboratories in the world. In 1998, Nichols Institute, located in San Juan Capistrano, California, became the first clinical laboratory in North America to achieve ISO-9001 certification. Our esoteric testing laboratory in Chantilly, Virginia, acquired as part of the AML acquisition, now enables us to provide full esoteric testing services, including gene-based testing, on the east coast.  Our two esoteric testing laboratories, which conduct business as Quest Diagnostics Nichols Institute, perform hundreds of esoteric tests that are not routinely performed by our regional laboratories. These esoteric tests are generally in the following fields:

•   endocrinology (the study of glands, their hormone secretions and their effects on body growth and metabolism);

•   genetics (the study of chromosomes, genes, and their protein products and effects);

•   immunology (the study of the immune system including antibodies, immune system cells and their effects);

•   microbiology (the study of microscopic forms of life including bacteria, viruses, fungi and other infectious agents);

•   oncology (the study of abnormal cell growth including benign tumors and cancer);

•   serology (a science dealing with the body fluids and their analysis, including antibodies, proteins and other characteristics);

•   special chemistry (more sophisticated testing requiring special expertise and technology); and

•   toxicology (the study of chemicals and drugs and their effects on the body's metabolism).

Through our relationship with members of the academic community and pharmaceutical and biotechnology firms, as well as our collaboration with emerging medical technology companies that develop and commercialize novel diagnostics, pharmaceutical and device technologies, we believe that we are one of the leaders in transferring technical innovation to the market. For example, through our relationships with Roche Diagnostics, Celera Diagnostics and Correlogic Systems, we have either introduced or gained access to new innovative tests that help provide insights to detect, treat and monitor various diseases and disorders.  In addition, Nichols Institute continues to introduce new tests, such as the CF Complete™ test, the most comprehensive genetic test available to sequence cystic fibrosis gene mutations (see “Business Strategy – Continue to Lead Innovation”).

Through our Academic Associates program, leading academics and biotechnology firms work directly with our staff scientists to monitor and consult on existing test procedures and develop new esoteric test methods. In addition, we have entered into licensing arrangements and co-development agreements with biotechnology companies and academic medical centers (see “Business Strategy – Continue to Lead Innovation”).

Clinical Trials Testing

We believe that we are the second largest provider of clinical laboratory testing performed in connection with clinical research trials on new drugs in the world. Clinical research trials are required by the Food and Drug Administration, or FDA, to assess the safety and efficacy of new drugs. We have clinical trials testing centers in the United States and in England. We also provide clinical trials testing in Australia, Singapore, and South Africa through arrangements with third parties. Clinical trials involving new drugs are increasingly being performed both inside and outside the United States. Approximately 40% of our net revenues from clinical trials testing in 2002 represented testing for GlaxoSmithKline plc (“GSK”).  We currently have a long-term contractual relationship with GSK, under which we are the primary provider of testing to support GSK’s clinical trials testing requirements worldwide.

Other Services and Products

We manufacture and market diagnostic test kits and systems primarily for esoteric testing under the Nichols Institute Diagnostics brand name. These are sold principally to hospitals and clinical laboratories, both domestically and internationally.   Our MedPlus subsidiary is a developer and integrator for clinical connectivity and data management solutions for healthcare organizations and clinicians primarily through its ChartMaxx™ electronic medical record system, and provides workflow and content management solutions to customers in a variety of industries.  Recently, Quest Diagnostics has begun deploying eMaxx™, a new state-of-the-art physician’s Internet portal across the United States.  The Internet portal was developed in conjunction with MedPlus and will give physicians greater access to laboratory testing and other clinical information on-line.

Payers and Customers

We provide testing services to a broad range of healthcare providers. We consider a "payer" as the party that pays for the test. Depending on the billing arrangement and applicable law, the payer may be (1) the physician or other party (such as another laboratory or an employer) who referred the testing to us, (2) the patient, or (3) a third party who pays the bill for the patient, such as an insurance company, Medicare or Medicaid. Some states, including New York, New Jersey and Rhode Island, prohibit us from billing physician clients. We generally consider a "customer" to be the party who refers tests to us. We also consider a managed care organization as both our customer and a payer, when it contracts with us on an exclusive or semi-exclusive basis on behalf of its patients.

During 2002, only two customers accounted for more than 5% of our net revenues, and no single customer accounted for more than 7% of our net revenues. We believe that the loss of any one of our customers would not have a material adverse effect on our financial condition, results of operations, or cash flow.

Payers

The following table shows current estimates of the breakdown of the percentage of our total volume of requisitions and total clinical laboratory revenues during 2002 applicable to each payer group:

Customers

Physicians

Physicians requiring testing for patients are the primary source of our clinical laboratory testing volume. We typically bill physician accounts on a fee-for-service basis. Fees billed to physicians are based on the laboratory's client fee schedule and are typically negotiated. Fees billed to patients and insurance companies are based on the laboratory's patient fee schedule, subject to any limitations on fees negotiated with the insurance companies or with physicians on behalf of their patients. Medicare and Medicaid reimbursements are based on fee schedules set by governmental authorities.

Managed Care Organizations and Other Insurance Providers

Managed care organizations and other insurance providers, which typically contract with a limited number of clinical laboratories for their members, represent approximately one half of our total testing volumes and one half of our net revenues. Larger managed care organizations and other insurance providers typically prefer to use large independent clinical laboratories because they can provide services on a national or regional basis and can manage networks of local or regional laboratories. In addition, larger laboratories are better able to achieve the low-cost structures necessary to profitably service large managed care organizations and can provide test utilization data across their various plans.  In certain markets, such as California, managed care organizations may delegate their covered members to independent physician associations, which in turn contract with laboratories for clinical laboratory services.  

While the growth in the number of patients participating in managed care plans has slowed in recent years, over the last decade, the managed care industry has been consolidating, resulting in fewer but larger managed care organizations with significant bargaining power in negotiating fee arrangements with healthcare providers, including clinical laboratories. Managed care organizations demand that clinical laboratory service providers accept discounted fee structures or assume all or a portion of the financial risk associated with providing testing services to their members through capitated payment contracts.  Under capitated payment contracts, clinical laboratories receive a fixed monthly fee per individual enrolled with the managed care organization for all laboratory tests performed during the month regardless of the number or cost of the tests actually performed. Some services, such as various esoteric tests, new technologies and anatomic pathology services, may be carved out from a capitated rate and, if carved out, are charged on a fee-for-service basis. 

In the last several years, there has been a shift in the way major managed care organizations contract with clinical laboratories. Managed care organizations have begun to offer more freedom of choice to their affiliated physicians, including greater freedom to determine which laboratory to use and which tests to order. Accordingly, most of our agreements with major managed care organizations are non-exclusive contracts. As a result, under these non-exclusive arrangements, physicians have more freedom of choice in selecting laboratories, and laboratories are likely to compete more on the basis of service and quality rather than price alone. Also, managed care organizations have been giving patients greater freedom of choice and patients have increasingly been selecting plans (such as preferred provider organizations) that offer a greater choice of providers. Pricing for these preferred provider organizations is typically negotiated on a fee-for-service basis, which generally results in higher revenue per requisition than under a capitated fee arrangement. Despite these trends, managed care organizations continue to aggressively seek cost reductions in order to keep their premiums to their customers competitive.  If we are unable to agree on pricing with a managed care organization, we would become a “non-participating” provider and could then only bill the ordering physician or the patient rather than the managed care organization.  This “non-participating” status could lead to loss of business since the physician is likely to refer testing to a participating provider whose testing is covered by the patient’s managed care benefit plan.  We cannot assure investors that we will continue to be successful in negotiating contracts with major managed care organizations.  Loss of multiple major managed care agreements could have a material adverse effect on our financial condition, results of operations and cash flow.

Quest Diagnostics offers QuestNet™, an innovative product to develop and manage a customized network of clinical laboratory providers for managed care organizations.  Through QuestNet™, physicians and members are provided multiple choices for clinical laboratory testing while managed care organizations realize cost reductions under a single capitated arrangement.

Hospitals

We provide services to hospitals throughout the United States that vary from esoteric testing to helping manage their laboratories. We believe that we are the industry's market leader in servicing hospitals. Testing for hospitals accounts for approximately 12% of our net revenues. Hospitals generally maintain an on-site laboratory to perform testing on patients and refer less frequently needed and highly specialized procedures to outside laboratories, which typically charge the hospitals on a negotiated fee-for-service basis. We believe that most hospital laboratories perform approximately 90% to 95% of their patients' clinical laboratory tests. In addition, many hospitals compete with independent clinical laboratories for outreach (non-hospital patients) testing.  Most physicians have admitting privileges or other relationships with hospitals as part of their medical practice.  Many hospitals leverage their relationships with community physicians and encourage the physicians to send their outreach testing to the hospital’s laboratory. In addition, hospitals that own physician practices generally require the physicians to refer tests to the hospital's affiliated laboratory. As a result, hospital-affiliated laboratories can be both customers and competitors for independent clinical laboratories.

During 2002, in conjunction with the acquisition of AML, we launched dedicated sales and service teams focused on serving the unique needs of hospital customers. We believe that the combination of full-service, bi-coastal esoteric testing capabilities, medical and scientific professionals for consultation, innovative connectivity products, focus on Six Sigma quality and dedicated sales and service professionals positions us to be the partner of choice for hospital customers. 

We have joint venture arrangements with leading integrated health delivery networks in several metropolitan areas. These joint venture arrangements, which provide testing for affiliated hospitals as well as for unaffiliated physicians and other healthcare providers in their geographic areas, serve as our principal laboratory facilities in their service areas. Typically, we have either a majority ownership interest in, or day-to-day management responsibilities for, our hospital joint venture relationships. We also manage the laboratories at a number of other hospitals.

Employers, Governmental Institutions and Other Clinical Laboratories

We provide testing services to governmental agencies, including the Department of Defense and state and federal prison systems, and to large employers. We believe that we are the leading provider of clinical laboratory testing to employers for substance abuse, occupational exposures, and comprehensive wellness programs.  Wellness programs enable employers to take an active role in lowering their overall healthcare costs.  Testing services for employers account for approximately 4% of our net revenues.  The volume of testing services for employers, which generally have relatively low profit margins, declined significantly during 2001 and 2002, driven by a general slowing of the economy and a corresponding slowdown in hiring.  We also perform esoteric testing services for other independent clinical laboratories that do not have the full range of our testing capabilities. All of these customers are charged on a fee-for-service basis.

Consumers

Consumers are becoming increasingly interested in managing their own health and health records.  Currently, almost all the testing we perform is ordered directly by a physician, who then receives the test results. However, over time, we believe that consumers will increasingly want to order clinical laboratory tests themselves.