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Results of Operations
Year Ended December 31, 2003 Compared with Year Ended December 31, 2002
Net income for the year
ended December 31, 2003 increased to $437 million from $322 million for the
prior year period. This increase in earnings was primarily attributable to revenue growth and improved efficiencies
generated from our Six Sigma and standardization initiatives.
Net Revenues
Net revenues for the year ended
December 31, 2003 grew by 15.3% over the prior year level and include the
results of Unilab, which was acquired on February 28, 2003, for ten
months. Net revenues for 2003 also included twelve months of results for AML, which was acquired on April 1,
2002. Pro forma revenue growth, assuming that the Unilab and AML acquisitions and the related Divestiture had
been completed on January 1, 2002, was 4.3% for the year ended December 31,
2003.
For the
year ended December 31, 2003, clinical testing volume, measured by the number
of requisitions, increased 11.3% compared to 2002. On a pro forma basis, assuming that the Unilab and AML
acquisitions and the Divestiture had been completed on January 1, 2002, testing
volume declined 1.2%. The combined
effect of the severe winter storms and the New Jersey physicians’ strike during
the first quarter of 2003 and Hurricane Isabel and the blackout in the third
quarter of 2003 reduced testing volume by approximately 0.5% for the year ended
December 31, 2003. In addition, our
drugs-of-abuse testing business, which is most directly impacted by economic
conditions and accounts for approximately 3% of our net revenues and 6% of our
testing volume, declined during 2003, reducing company-wide testing volume
growth by approximately 0.5%. Both
reported and pro forma testing volume have been impacted by general economic
conditions, which have increased the number of uninsured and unemployed and, we
believe, have reduced utilization of healthcare services in 2003.
For the year ended December 31,
2003, average revenue per requisition improved 3.6%, or 5.1% on a pro forma
basis, assuming that the Unilab and AML acquisitions and the Divestiture had
been completed on January 1, 2002. These improvements in average revenue per requisition were primarily
attributable to a continuing shift in test mix to higher value testing,
including gene-based and esoteric testing. Gene-based testing net revenues exceeded $500 million for 2003, and grew
over 20% compared to the prior year. In addition, a shift in payer mix to
higher priced fee-for-service reimbursement contributed a portion of the
increase in average revenue per requisition. The inclusion of Unilab’s results subsequent to February 28, 2003 served
to reduce average revenue per requisition, reflecting Unilab’s lower revenue
per requisition.
Our businesses, other than clinical laboratory
testing, which represent approximately 4% of our consolidated net revenues,
grew approximately 16% during the year and contributed about 0.5% to the
reported growth in net revenues. Operating Costs and Expenses
Total operating costs
and expenses for 2003 increased $426 million from 2002 primarily due to
increases in our clinical testing volume (largely as a result of the Unilab
acquisition), employee compensation and benefits, testing supply costs and
depreciation expense. While our cost
structure has been favorably impacted by the improved efficiencies generated
from our Six Sigma and standardization initiatives, we continue to make
investments to enhance our infrastructure to pursue our overall business
strategy. These investments include:
• Skills training for all employees, which together with our
competitive pay and benefits, helps to increase employee satisfaction and
performance, which we believe will result in better service to our customers;
• Our information technology strategy, which is designed to improve our
efficiency and provide better service to our customers; and
• Our strategic growth opportunities.
Cost of services, which includes
the costs of obtaining, transporting and testing specimens, was 58.4% of net
revenues for 2003, compared to 59.2% in the prior year. This improvement was primarily the result of
efficiency gains resulting from our Six Sigma and standardization initiatives
and the increase in average revenue per requisition. This improvement was partially
offset by initial installation costs of deploying our Internet-based orders and
results systems in physicians’ offices and our patient service centers. The increase in the number of orders and
test results reported via our Internet-based systems is improving the initial
collection of billing information which is reducing the cost of billing and bad
debt expense, both of which are components of selling, general and
administrative expenses. At December
31, 2003, approximately 25% of our orders and approximately 35% of our test
results were being transmitted via the Internet. Additionally, we are seeing an increase in the number of
physicians who no longer draw blood in their office, which is resulting in an
increase in the number of blood draws in our patient service centers or by our
phlebotomists placed in physicians’ offices. This shift has increased our operating costs associated with our blood
draws, but is reducing costs in accessioning and other parts of our operations
due to improved billing information and a reduction in the number of inadequate
patient samples obtained by our trained phlebotomists compared to samples
collected by physician employed phlebotomists.
Selling,
general and administrative expenses, which include the costs of the sales
force, billing operations, bad debt expense and general management and
administrative support, decreased during 2003, as a percentage of net revenues,
to 24.6% from 26.2% in the prior year. This improvement was primarily due to efficiencies from our Six Sigma
and standardization initiatives and the improvement in average revenue per
requisition. During 2003, bad debt
expense improved to 4.8% of net revenues, compared to 5.3% in 2002. The
reduction in bad debt expense as a percentage of net revenues occurred despite
the addition of Unilab, which has higher levels of bad debt than the rest of
Quest Diagnostics. This improvement
primarily relates to the collection of diagnosis, patient and insurance
information necessary to more effectively bill for services performed. We believe that our Six Sigma and
standardization initiatives and the increased use of electronic ordering by our
customers will provide additional opportunities to further improve our overall
collection experience and cost structure.
Other operating (income) expense, net represents
miscellaneous income and expense items related to operating activities, and
includes gains and losses associated with the disposal of operating assets. Operating Income
Operating
income for the year ended December 31, 2003 improved to $796 million, or 16.8%
of net revenues, from $592 million, or 14.4% of net revenues, in 2002. The increase in operating income was
primarily due to revenue growth and improved efficiencies generated from our
Six Sigma and standardization initiatives.
Other Income (Expense)
Net interest expense for
the year ended December 31, 2003 increased from 2002 by $6 million and was primarily
attributable to the amounts borrowed to finance the acquisition of Unilab and to repay
substantially all of Unilab’s outstanding debt, partially offset by decreased
amounts borrowed under our secured receivables credit facility.
Other income (expense), net represents miscellaneous
income and expense items related to non-operating activities such as gains and
losses associated with investments and other non-operating assets.
Year Ended December 31, 2002 Compared with
Year Ended December 31, 2001
Net
income for the year ended December 31, 2002 increased to $322 million from $162
million for the year ended December 31, 2001. Assuming that the provisions of SFAS 142 related to accounting for
goodwill amortization had been in effect in 2001, net income for the year ended
December 31, 2001 would have been $198 million. The increase in earnings was primarily attributable to revenue
growth, improved efficiencies generated from our Six Sigma and standardization
initiatives, and a reduction in net interest expense, partially offset by
increases in employee compensation and supply costs, depreciation expense and
investments in our information technology strategy and strategic growth
opportunities. In addition, results for
the year ended December 31, 2001 included a loss on debt extinguishment of $42
million, which was incurred in conjunction with our debt refinancing in the
second quarter of 2001.
Net Revenues
Net
revenues for the year ended December 31, 2002 grew by 13.2% compared with the
prior year. The acquisition of AML,
which was completed on April 1, 2002, contributed approximately one-half of the
increase in net revenues. For the year
ended December 31, 2002, clinical testing volume, measured by the number of
requisitions, increased 9.7% compared with the prior year. Assuming AML had been part of Quest
Diagnostics in 2001, clinical testing volume would have increased above the
prior year level by 3.4% on a pro forma basis. Other smaller acquisitions completed in 2001 contributed approximately
1.5% to testing volume growth in 2002. Partially offsetting these increases was
a decline in testing volumes associated with our drugs of abuse testing
business, which reduced total Company testing volume for the year ended
December 31, 2002 by about one-half of a percent Drugs of abuse testing, which accounted for approximately 7% of
our testing volume and 4% of our net revenues, was impacted by a general
slowing of the economy and a corresponding slowdown in hiring. Average revenue per requisition increased
3.2% for the year ended December 31, 2002, compared with the prior year. The improvement in average revenue per
requisition was primarily attributable to a continuing shift in test mix to
higher value testing, including gene-based testing, which contributed over
one-half of the improvement, and a shift in payer mix to higher priced
fee-for-service reimbursement. We continued to see strong growth in our
gene-based and esoteric testing with gene-based testing net revenues, which
approached $400 million for the year, growing at more than 20% compared with
the prior year. Our businesses, other than clinical laboratory testing, which
accounted for approximately 4% of our total net revenues in 2002, grew about
15% over the prior year and accounted for 0.6% of the 13.2% increase in net
revenues, or approximately $20 million. Most of this increase was from our MedPlus subsidiary, which we acquired
in November 2001, which develops clinical connectivity products designed to
enhance patient care.
Operating Costs and Expenses
Total
operating costs for the year ended December 31, 2002 increased $300 million
from the prior year primarily due to increases in our clinical testing volume,
largely as a result of the AML acquisition, employee compensation and supply
costs and depreciation expense; partially offset by reductions in amortization
of goodwill and bad debt expense. While
our cost structure has been favorably impacted by the synergies realized as a
result of the integration of SBCL and the improved efficiencies generated from
our Six Sigma and standardization initiatives, we continue to make investments
to enhance our infrastructure to pursue our overall business strategy.
These investments include those related to:
• Skills
training for all employees, which together with our competitive pay and benefits,
helps to increase employee satisfaction and performance, which we believe will
result in better service to our customers;
• Our
information technology strategy, which is designed to improve our efficiency
and provide better service to our customers; and
• Our
strategic growth opportunities.
Cost of services, which
includes the costs of obtaining, transporting and testing specimens, was 59.2%
of net revenues for the year ended December 31, 2002, decreasing slightly from
59.3% in the prior year. The positive
impact of our Six Sigma and standardization initiatives and the increase in
average revenue per requisition, which reduced cost of services as a percentage
of net revenues, was partially offset by the addition of AML’s higher cost of
services as of April 1, 2002. Cost of
services has also increased due to a greater percentage of patients having
their blood drawn in our patient service centers or by our phlebotomists placed
in physicians’ offices. During 2002, in
an effort to reduce their costs, many physicians took action to simplify
activities in their offices by ceasing blood draws by physician staff. Additionally, reflected in the cost of
services are the one-time installation costs of deploying our Internet-based
orders and results systems in physicians’ offices. As of December 31, 2002, approximately 10% of all orders and 15%
of all test results were being transmitted via the Internet. Both the reduction of blood draws in the
physicians’ offices and the increased use of the Internet for ordering and
resulting are improving the initial collection of billing information and
generating savings in the cost of billing and bad debt expense, both of which
are components of selling, general and administrative expense. Increased blood draws by Company-trained
employee phlebotomists also improve the overall preparation of the blood
sample, which can improve efficiency of the testing process.
Selling,
general and administrative expenses, which include the costs of the sales
force, billing operations, bad debt expense and general management and
administrative support, decreased during the year ended December 31, 2002 as a
percentage of net revenues to 26.2% from 28.1% in the prior year. This decrease was primarily due to
efficiencies from our Six Sigma and standardization initiatives, in particular
bad debt expense, the improvement in average revenue per requisition and the
impact of AML’s cost structure as of April 1, 2002. During 2002, bad debt expense improved to 5.3% of net revenues,
compared to 6.0% of net revenues in 2001. The improvements in bad debt expense were principally attributable to
the continued progress that we have made in our overall collection experience
through process improvements, driven by our Six Sigma and standardization
initiatives. These improvements
primarily relate to the collection of diagnosis, patient and insurance
information necessary to effectively bill for services performed. We believe that our Six Sigma and
standardization initiatives will provide additional opportunities to further
improve our overall collection experience.
Amortization
of goodwill for the year ended December 31, 2002 decreased from the prior year
by $38 million as the result of adopting SFAS 142, effective January 1,
2002. See Note 2 to the Consolidated
Financial Statements for further details regarding the impact of SFAS 142.
Other operating (income) expense, net represents
miscellaneous income and expense items related to operating activities, such as
gains and losses associated with the disposal of operating assets. Operating Income
Operating
income for the year ended December 31, 2002 improved to $592 million, or 14.4%
of net revenues, from $412 million, or 11.3% of net revenues, in 2001. The increase in operating income was
primarily due to revenue growth, improved efficiencies generated from our Six
Sigma and standardization initiatives and a reduction in amortization of
goodwill, partially offset by increases in employee compensation and supply
costs, depreciation expense and investments in our information technology
strategy and strategic growth opportunities.
Other Income (Expense)
Net
interest expense for the year ended December 31, 2002 decreased from the prior
year by $17 million. The reduction was primarily due to
the
favorable impact of our debt refinancings in 2001 and a favorable interest rate
environment.
In
2001, we refinanced a majority of our long-term debt on a senior unsecured
basis. Specifically, we completed a
$550 million senior notes offering, or the Senior Notes, and entered into a new
$500 million senior unsecured credit facility, or the Credit Agreement, which
included a five-year $325 million revolving credit agreement and a $175 million
term loan. We used the net proceeds from the senior notes offering and the term
loan, together with cash on hand, to repay all of the $584 million which was
outstanding under our then existing senior secured credit agreement, including
the costs to settle existing interest rate swap agreements, and to consummate a
cash tender offer of our 10¾% senior subordinated notes due 2006, or the
Subordinated Notes. In conjunction with
our debt refinancing, we recorded a loss on debt extinguishment of $42 million,
$36 million of which represented the write-off of $23 million of deferred
financing costs, associated with the debt which was refinanced, and $13 million
of payments related primarily to the tender premium incurred in connection with
our cash tender offer for our Subordinated Notes. The remaining $6 million of losses represented amounts incurred
in conjunction with the cancellation of certain interest rate swap agreements,
which were terminated in connection with the debt that was refinanced. Prior to our debt refinancing, our secured
credit agreement required us to maintain interest rate swap agreements to
mitigate the risk of changes in interest rates associated with a portion of our
variable interest rate indebtedness.
Other
income (expense), net, represents miscellaneous income and expense items
related to non-operating activities, such as gains and losses associated with
investments and other non-operating assets. For the year ended December 31, 2002, other income (expense), net
includes a $4.9 million pretax gain on the sale of certain assets, partially
offset by losses on miscellaneous non-operating assets. For the year ended December 31, 2001, other
income (expense), net includes the net impact of writing-off $9.6 million of
certain impaired assets, partially offset by a $6.3 million gain on the sale of
an investment.
Income Taxes
During 2001, our effective tax rate was
significantly impacted by goodwill amortization, the majority of which was not
deductible for tax purposes, and had the effect of increasing the overall tax
rate. The reduction in the effective
tax rate for the year ended December 31, 2002 was primarily due to the
elimination of amortization of goodwill (as a result of adopting SFAS 142,
effective January 1, 2002) the majority of which was not deductible for tax
purposes.
Impact of Contingent Convertible Debentures on Diluted Earnings per Common Share
On November 26, 2001, we completed our $250
million offering of 1¾% contingent convertible debentures due 2021, or the
Debentures. Each one thousand dollar
principal amount of Debentures is convertible into 11.429 shares of our common
stock, which represents an initial conversion price of $87.50 per share. Holders may surrender the Debentures for
conversion into shares of our common stock under any of the following
circumstances: (i) if the sales price
of our common stock is above 120% of the conversion price (or $105 per share)
for specified periods; (ii) if we call the Debentures; or (iii) if specified
corporate transactions have occurred. See Note 11 to the Consolidated Financial Statements for a further
discussion of the Debentures.
The if-converted method is used in
determining the dilutive effect of the Debentures in periods when the holders
of such securities are permitted to exercise their conversion rights. As of and for each of the years ended
December 31, 2003 and 2002, the holders of our Debentures did not have the
ability to exercise their conversion rights. Had the requirements to allow the holders to exercise their conversion
rights been met and the Debentures remained outstanding for the entire period,
diluted earnings per common share would have been reduced by approximately 2% during
each of the years ended December 31, 2003 and 2002.
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