Quest Diagnostics 2006 Annual Report Download - page 79

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•continuously improving service levels and their consistency using Six Sigma;
•making specimen collection more convenient for patients by adding phlebotomists and expanding hours of
operation in our patient service centers;
•continuing to strengthen our medical and scientific capabilities by adding leading experts in various
disease states and emerging diagnostic areas; and
•enhancing our information technology infrastructure and development capabilities supporting our products
which enable healthcare providers to order and receive laboratory test results, order prescriptions
electronically, and create, collect, manage and exchange healthcare information.
Additionally, during the first quarter of 2006, we recorded $27 million of pre-tax charges in “other operating
expense, net” primarily associated with integration activities related to LabOne and our operations in California.
Cost of services, which includes the costs of obtaining, transporting and testing specimens, was 59% of net
revenues for the year ended December 31, 2006, consistent with the prior year.
Selling, general and administrative expenses, which include the costs of the sales force, billing operations,
bad debt expense and general management and administrative support, were 22.5% of net revenues during the
year ended December 31, 2006, compared to 22.3% in the prior year period. This increase was primarily due to
stock-based compensation expense recorded in accordance with SFAS 123R, which increased selling, general and
administrative expenses, as a percentage of net revenues by approximately 1%, offset by revenue growth, which
has allowed us to leverage our expense base, as well as continued benefits from our Six Sigma, standardization
and consolidation efforts. For the year ended December 31, 2006, bad debt expense was 3.9% of net revenues,
compared to 4.3% in the prior year period. This decrease primarily relates to the improved 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 expense, net represents miscellaneous income and expense items related to operating
activities, including gains and losses associated with the disposal of operating assets and provisions for
restructurings and other special charges. For the year ended December 31, 2006, other operating expense, net
included pre-tax charges of $27 million principally associated with integration activities related to LabOne and
our operations in California, which are more fully described in Note 4 to the Consolidated Financial Statements.
For the year ended December 31, 2005, other operating expense, net included a $6.2 million charge
primarily related to forgiving amounts owed by patients and physicians, and related property damage as a result
of hurricanes in the Gulf Coast.
Operating Income
Operating income for the year ended December 31, 2006 improved to $1.1 billion, or 18.0% of net
revenues, from $1.0 billion, or 18.5% of net revenues, in the prior year period. The increase in operating income
for the year ended December 31, 2006 was principally driven by the performance of our clinical testing business.
Partially offsetting these improvements was $27 million of special charges recorded in the first quarter of 2006,
primarily related to integration activities and increased investments in MedPlus. Additionally, operating income
for the year ended December 31, 2006 included $55 million of stock-based compensation expense recorded
pursuant to SFAS 123R.
Operating income as a percentage of net revenues for the year ended December 31, 2006 compared to the
prior year’s period was reduced by approximately 1% due to stock-based compensation expense, and by 0.6%
due to the results of the LabOne business, which we expect will continue to carry lower margins than the rest of
our operations until we have realized most of the expected $40 million in synergies. Operating income as a
percentage of net revenues for the year ended December 31, 2006 was also reduced by approximately 0.4% due
to special charges, primarily related to integration activities.
Other Income (Expense)
Interest expense, net for the year ended December 31, 2006 increased $34 million over the prior year. The
increase in interest expense, net was primarily due to additional interest expense associated with our $900 million
senior notes offering in October 2005 used to fund the LabOne acquisition, as described more fully in Note 10 to
the Consolidated Financial Statements.
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