UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number 000-19392
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DIANON Systems, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 06-1128081
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
200 Watson Boulevard, Stratford, Connecticut 06615
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 381-4000
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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None None
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Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of class)
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 such 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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) 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 or any amendment to this Form 10-K. [ ]
As of March 20, 2002, the aggregate market value of the voting Common Stock held
by non-affiliates of the registrant was $665,783,530.
Number of shares of Common Stock outstanding as of March 20, 2002: 12,049,942
DOCUMENTS INCORPORATED BY REFERENCE
None
EXPLANATORY NOTE
The Annual Report on Form 10-K of DIANON Systems, Inc. ("DIANON" or the
"Company") for the year ended December 31, 2001 is hereby amended solely to
correct the Net Revenues reported for Genetic Testing and Clinical Chemistry
Testing in the first table under "Item 1. Business." Dianon's 2001 Net Revenues
for Genetic Testing and Clinical Chemistry Testing were $19.8 million and $18.7
million, respectively. No other changes have been made to the Form 10-K as
originally filed.
Pursuant to Rule 12b-15 of the Securities Exchange Act of 1934, "Item 1.
Business" is amended and restated in its entirety as follows:
PART I
ITEM 1. BUSINESS
DIANON Systems, Inc. ("DIANON" or the "Company"), incorporated in 1984,
provides a full line of anatomic pathology testing services and a number of
genetic and clinical chemistry testing services to patients, physicians and
managed care organizations throughout the United States. The Company's principal
physician audience for these services includes approximately 50,000 clinicians
engaged in the fields of medical oncology, urology, dermatology, gynecology and
gastroenterology. The Company is one of the leading specialized providers of
anatomic pathology testing services in the United States.
The Company performs all testing at either its main facility in Stratford,
Connecticut or at its other facilities located in Tampa, Florida; New City, New
York; Woodbury, New York or Oklahoma City, Oklahoma (the latter acquired in
November 2001). The Company provides most test results to physicians within
forty-eight hours. In 1996, the Company opened a specimen processing facility at
the hub of its airfreight provider in Ohio in order to prepare certain specimens
for more rapid processing when they arrive in the appropriate laboratory and to
improve overall turnaround time to the physicians.
The business of the Company is subject to a number of risks and
uncertainties that could adversely affect the Company's ability to achieve its
objectives. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition - Risk Factors: Forward Looking Statements" for a
description of various factors that could have an adverse effect on the
performance of the Company.
MEDICAL TESTING MARKETS
The Company operates in one reportable segment, the medical laboratory
industry. Medical laboratories offer a broad range of testing services to the
medical profession. The Company's testing services are categorized based upon
the nature of the test: Anatomic Pathology, Genetic Testing and Clinical
Chemistry. These testing services are used by physicians in the diagnosis,
prognosis, monitoring and general management of diseases and other clinical
conditions. The tests included in such services generally detect
medically-significant abnormalities and visual patterns in blood, tissue samples
and other specimens.
Below are some of the major differences between the three testing services
offered by the Company:
ANATOMIC PATHOLOGY TESTING GENETIC TESTING CLINICAL CHEMISTRY TESTING
-------------------------- --------------- --------------------------
Type of Specimen Tissue or cells - usually Tissue or cells may be Blood or urine - usually
obtained by a physician from obtained by a physician collected by a nurse
a biopsy, pap smear, urine (bone marrow aspirate, (blood) or by the patient
specimen or surgery amniocentesis) or nurse (urine)
(blood, cheek swab)
Technology Employed Physician interpretation of Ph.D. interpretation of Highly automated blood
tissue slides supplemented results generated by chemistries and
by special antibody stains certified laboratory immunoassays
or genetic tests technologists
2001 DIANON Net Revenues $87.2 million $19.8 million $18.7 million
2
INFORMATION SERVICES
The Company has developed several proprietary information systems products
over the last 10 years. These products include a Laboratory Information System,
an Anatomic Pathology module to aid the pathologist in creating medical reports,
an accounts receivable and billing system, and the disease management program
(designed for patients, physicians, and managed care organizations) called
CarePath (TM). In addition, many supporting modules have been built to support
such areas as the delivery of medical reports through electronic interfaces and
the Internet and information products designed to better manage the business.
The Company's information services are used principally to assist the
physician in the analysis of test results and to help managed care organizations
by providing disease specific information to members. These services complement
the Company's current service offerings and are not a separate product category;
however, the Company's current information services are an important part of the
Company's marketing program, and the Company believes they provide important
value-added services which help the Company differentiate itself from
competitors. Patient specific reports aid the physician in analyzing multiple
prognostic tests and/or correlative trends in a patient's test results,
treatment and clinical condition. Summary reports on all patients in a
physician's practice allow the physician to compare test results on patients
with similar conditions, review multiple patient histories and compare his or
her experience with that of physicians across the country.
The Company will continue to review and develop its systems to bring
unique, timely and pertinent information to its customers.
QUALITY ASSURANCE
The Company utilizes a unique quality control program for anatomic
pathology which provides a reduced number of equivocal results reported to
clinicians. This program is applied to all anatomic pathology specimens. By
diminishing the number of indeterminate diagnoses and providing the unequivocal
diagnosis as soon as possible, the Company enables clinicians to treat patients
sooner and more effectively while reducing overall health care costs.
The Company's quality assurance program includes adherence by employees to
standard operating procedures, continuing education and technical training of
technologists, statistical quality control of all analytical processes,
instrument maintenance, and regular inspection by governmental agencies and the
College of American Pathologists.
REIMBURSEMENT
In 2001, 2000, and 1999, respectively, approximately 40%, 37% and 31% of
the Company's net revenues were derived from testing performed for beneficiaries
under the Medicare and Medicaid programs. These figures include the 20%
co-payment and deductible normally billed to the patient when anatomic pathology
services are involved. At least 97% of the Medicare and Medicaid net revenues
are derived from the Medicare program. Revenues from testing performed for other
patients are derived principally from other third-party payors, including
commercial insurers, Blue Cross Blue Shield plans, health maintenance and
preferred provider organizations, patients, physicians, hospitals, and other
laboratories (who in turn usually bill non-governmental third-party payors or
patients). For many of the tests performed for Medicare or Medicaid
beneficiaries (except clinical diagnostic laboratory tests for those
beneficiaries being treated by a hospital or, in some instances, by a skilled
nursing facility ("SNF")), laboratories are required to bill Medicare or
Medicaid directly for covered services and to accept Medicare or Medicaid
reimbursement as payment in full for such services. Management has elected, to
date, to accept reimbursement rates set by other third-party payors as payment
in full as well (apart from any co-payment or deductible that the payor has
established).
Reimbursement rates for some services of the type, or similar to the type,
performed by the Company have been established by Medicare, Medicaid and other
third-party payors, but have not been established for all services or by all
carriers with respect to any particular service. While most carriers, including
Medicare, do not cover services they determine to be investigational, or
otherwise not reasonable and necessary for diagnosis or treatment, a formal
coverage determination is made with respect to relatively few new procedures.
When such determinations do occur for Medicare purposes, they most commonly are
made by the local Medicare carrier which processes claims for reimbursement
within the carrier's geographic jurisdiction. The Company receives Medicare
reimbursement primarily through the Medicare carriers for Connecticut, New York,
Florida and Oklahoma. A positive coverage determination, or reimbursement
3
without such determination, by one or more third- party payors, or clearance for
marketing by the Food and Drug Administration ("FDA"), does not assure
reimbursement by other third-party payors. A few third-party payors have denied
payment for services for which the Company receives reimbursement from other
payors. On occasion, Medicare or other third-party payors have decided to cease
payment for one or more of the Company's services that historically have been
reimbursed by them because such services are performed using test kits or other
products which have not received FDA pre-market clearance or because such
services may otherwise be deemed investigational or for other reasons.
Furthermore, Medicare and other third-party payors have, on occasion, ceased
reimbursement when certain tests are ordered for patients with certain diagnoses
while maintaining reimbursement when tests are ordered for other diagnoses
deemed appropriate by the carrier. This practice recently has become more
prevalent with respect to Medicare.
The Balanced Budget Act of 1997 ("BBA") required the Secretary of the
Department of Health and Human Services ("the Secretary") to divide the country
into no more than five regions and designate a single Medicare carrier for each
region to process laboratory claims (except those performed by independent
physicians' offices) no later than January 1, 1999, and to adopt uniform
coverage, administration, and payment policies for lab tests using a negotiated
rulemaking process by July 1, 1998. However, the Centers for Medicare and
Medicaid Services ("CMS," formerly "HCFA") has not yet redesignated Medicare
carrier regions for lab claims. The clinical lab negotiated rulemaking committee
met periodically during 1998 and 1999, and a proposed rule reflecting the
consensus of the committee members was published on March 10, 2000. The final
rule was published on November 23, 2001. This rule establishes national coverage
policies for many of the most commonly ordered laboratory tests, replacing local
Medicare policies, which sometimes varied, and it establishes other uniform
requirements related to submission of claims for lab tests. Most of the changes
arising from the rule will not be effective until 12 months from the date the
final rule was published. The Company believes these rules will level the
playing field and result in more consistent reimbursement across the country.
In general, reimbursement denials by the various carriers, reductions or
delays in the establishment of reimbursement rates, and carrier limitations on
the insurance coverage of the Company's services or the use of the Company as a
service provider could have a material adverse effect on the Company's future
revenues.
MEDICARE PAYMENT FOR ANATOMIC PATHOLOGY SERVICES. Medicare reimbursement
for anatomic pathology services constituted approximately 40%, 38%, and 34% of
the Company's net anatomic pathology revenues in 2001, 2000, and 1999,
respectively. As of January 1, 1992, all physician services, including anatomic
pathology services, have been reimbursed by Medicare based on a methodology
known as the resource-based relative value scale ("RBRVS"), which was fully
phased in by the end of 1996. Overall, anatomic pathology reimbursement rates
declined during the fee schedule phase-in period, despite an increase in payment
rates for certain pathology services performed by the Company.
The Medicare RBRVS payment for each service is calculated by multiplying
the total relative value units ("RVUs") established for the service by a
conversion factor that is set by statute. The 2002 conversion factor is
$36.1992, a decrease of approximately 5.4% from the 2001 conversion factor. The
number of RVUs assigned to each service is in turn calculated by adding three
separate components: physician work, practice expense, and malpractice expense.
In 1997, there was an overall decrease of 5.7% in payments for pathology
services due to a five-year review of the work value component and a decrease in
the 1997 conversion factor applicable to pathology services, plus an additional
decrease in Connecticut, where the Company's primary operations are located,
because of CMS's reduction of the number of different payment localities
recognized for RBRVS purposes. Another five-year review of the work value
component was completed and was published in the Federal Register on June 8,
2001. The results of this review went into effect on January 1, 2002, but the
changes recommended are not expected to have any effect on payment for pathology
services.
On November 1, 1998, CMS recalculated the physician practice expense
component of the Medicare physician fee schedule to reflect resource consumption
rather than historical charge data. The resulting new practice expense values
are being phased in over the period 1999 to 2002. In the final 2002 physician
fee schedule, published in November 2001, CMS estimated that refinements and
changes in the RVUs for physician work and practice expense would result in a 3%
increase in payments for pathology services in 2002, compared to what would have
occurred in 2002 had the rule not been published, although the reduction in the
conversion factor used to calculate the fee schedule payments offsets the
increase in payments for certain pathology services. However, the net effect of
changes with respect to the most common pathology service currently provided by
Dianon will result in an increase in payments to Dianon in 2002.
4
CMS announced in the November 2, 1999 physician fee schedule that
effective January 1, 2001, independent labs would no longer be able to bill
Medicare or the patient for the technical component ("TC") of pathology services
furnished to Medicare beneficiaries who were hospital inpatients. Independent
labs would still be permitted to bill and be paid for the TC of pathology
services provided to beneficiaries who were in non-hospital settings, but for
the TC of services provided to a hospital inpatient, the independent lab would
have to make arrangements with the hospital in order to receive payment. CMS
also announced that beginning on January 1, 2001, under new rules for hospital
outpatient reimbursement, independent labs would be limited to billing the
hospital for the TC of any pathology services furnished to hospital outpatients.
In other words, independent laboratories that perform the technical component of
pathology services for hospital outpatient services would no longer be able to
bill Medicare for these services and would be required, instead, to bill the
hospital. However, the Medicare, Medicaid, and SCHIP Benefits Improvement and
Protection Act of 2000, ("BIPA"), signed into law on December 21, 2000, included
a "grandfathering" provision allowing independent labs to continue to be paid
for the TC of services provided to hospital inpatients and outpatients for an
additional two years, if the referring hospital had had such an arrangement with
an independent lab in effect on or before July 22, 1999, pending the completion
of a study by the General Accounting Office. Since the Company does only minimal
testing for hospital inpatients and outpatients, these changes are not expected
to have a material financial impact on the Company.
In the past, the Company has been able to offset a substantial portion of
the impact of any reduced Medicare reimbursement rates for anatomic pathology
services through the achievement of economies of scale and the introduction of
alternative technologies that do not depend on reimbursement through the RBRVS
system. While other potential legislative and market changes may have a negative
effect on the Company's average unit price, the Company is not able to predict
the exact nature or effect of any other potential changes affecting its
reimbursement for anatomic pathology services at this time.
MEDICARE FEE SCHEDULE PAYMENT FOR GENETIC LABORATORY SERVICES. The Company
provides a number of services which are characterized as genetic laboratory
testing services by the Medicare program. Medicare reimbursement for genetic
laboratory services constituted approximately 42%, 38%, and 20% of the Company's
genetic revenues in 2001, 2000, and 1999, respectively. There is no separate
Medicare reimbursement methodology for genetic testing. The genetic testing
performed by the Company is reimbursed under the RBRVS method, as is anatomic
pathology, or under the clinical chemistry laboratory fee schedule depending on
the specific test.
MEDICARE FEE SCHEDULE PAYMENT FOR CLINICAL CHEMISTRY LABORATORY SERVICES.
The Company provides a number of services, which are characterized as clinical
chemistry laboratory testing services by the Medicare program. Medicare
reimbursement for clinical chemistry laboratory services constituted
approximately 36%, 31%, and 26% of the Company's clinical chemistry revenues in
2001, 2000, and 1999, respectively. In 1984, Congress adopted legislation
establishing a locality-specific fee schedule reimbursement methodology with
Consumer Price Index ("CPI")-related updates for clinical diagnostic laboratory
testing for non-hospital patients and hospital outpatients under Medicare.
Payment for clinical chemistry laboratory services performed for Medicare
hospital and SNF inpatients is included within the prospectively determined
Diagnosis Related Group rate paid to the hospital and Resource Utilization Group
rate paid to the SNF. In addition, state Medicaid programs are prohibited from
paying more than the Medicare laboratory fee schedule amount.
Beginning with the Consolidated Omnibus Budget Reconciliation Act of 1985
("COBRA `85"), Congress instituted a national cap on Medicare clinical chemistry
laboratory fee schedules. This national cap has been lowered each year and now
is 74% of the national median. Moreover, the Omnibus Budget Reconciliation Act
of 1987 ("OBRA `87") eliminated the CPI update for 1988, and in succeeding years
Congress has often either limited or eliminated annual updates of Medicare
clinical chemistry laboratory fee schedules. After updates of 3.2% in 1996 and
approximately 2.7% in 1997, the BBA freezes fee schedule payments for the
1998-2002 period. The update limitations and changes in the national cap made to
date have not had, and are not expected by the Company to have, a material
adverse effect on the Company's results of operations. Any further significant
decrease in such fee schedules, however, could have a material adverse effect on
the Company's future revenues.
Beginning in 1998, Medicare began covering screening pap smears for
certain Medicare beneficiaries, and the Balanced Budget Refinement Act of 1999
("BBRA") required the Secretary to establish a national minimum payment amount
equal to $14.60 for diagnostic or screening pap smear laboratory tests furnished
on or after January 1, 2000. Previously, the national payment cap for a pap
smear was approximately $7.15. The BBRA also encouraged CMS to institute an
appropriate increase in the payment rate for new cervical cancer screening
5
technologies that have been approved by the FDA as significantly more effective
than a conventional pap smear, such as the technologies used by the Company.
Currently, no national payment rate has been set for new pap smear technology,
so each local carrier has established reimbursement independently. CMS is
expected to set a national median for such services by 2002. In any event, as a
result of the BIPA, these new lab tests will receive 100% of the national
median, rather than the 74% that applies to other tests. BIPA required the
Secretary of HHS to establish procedures that permit public consultation for
coding and payment determinations for new clinical laboratory tests, and a
notice was published in the Federal Register on November 23, 2001 announcing a
schedule of public meetings pursuant to this requirement. In addition, this
legislation included a provision changing the frequency of covered screening pap
smears from at least every three years to at least every two years. The
expansion of Medicare coverage for screening pap has provided, and is expected
to continue to provide in 2002, additional revenues for the Company.
In addition, consolidated billing, required under the BBA since 1998 for
laboratory and other services provided to residents of SNFs, has been eliminated
for specific Part B services (including lab services), effective January 1,
2001. Because the Company does only minimal clinical laboratory services for
nursing facility patients, these changes have not materially effected the
Company's business.
Other changes in government and other third-party payor reimbursement
which may result from the enactment of healthcare reform legislation likely will
continue the downward pressure on prices and make the market for clinical
laboratory services more competitive. For example, the BBA revised the Medicare
program substantially to permit beneficiaries to choose between traditional
fee-for-service Medicare and several non-traditional Medicare options, including
managed care plans and provider-sponsored organization plans. These
non-traditional Medicare plans have considerable discretion in determining
whether and how to cover and reimburse clinical laboratory services and to limit
the number of labs with which they deal. In addition, as a result of BIPA,
Medicare managed care organizations will receive an increase of approximately $9
billion in their payments and risk adjustments through 2005, further signifying
a push towards a managed care environment. The BBA also included provisions to
implement competitive bidding for certain Medicare items and services, including
laboratory services, on a three-site demonstration project basis. Thus far,
Medicare has implemented demonstration projects in Polk County, Florida and San
Antonio, Texas. If adopted on a widespread basis, these changes likely would
have an adverse impact on the Company's revenues.
Finally, the BBA also contained measures to establish market-oriented
purchasing for Medicare, including prospective payment systems ("PPS") for
outpatient hospital services, home health care, and nursing home care. All of
these systems have now been implemented. Since the Company does only minimal
clinical laboratory testing for home health care and nursing facility patients,
these changes are not expected to materially affect the Company's business.
Under the outpatient PPS rule, CMS would have carved out clinical laboratory
services from the outpatient PPS rates, but would have included the technical
component of surgical pathology services in the rate. However, as discussed
above, provisions in BIPA postponed implementation of this provision for two
years for hospitals that had in place an arrangement with an independent
laboratory under which the lab billed Medicare separately for the technical
component of pathology services provided to the hospital's patients.
In addition to federal legislative action, reforms may occur at the state
level and changes are occurring in the marketplace as a result of market
pressures, including the increasing number of patients covered by some form of
managed care. In general, these changes are likely to put a downward pressure on
price and also may act to limit access by some laboratories to some managed care
patient groups. Because of the uncertainties about the exact nature, extent, and
timing of any such changes, however, the Company currently is unable to predict
their ultimate impact on the clinical laboratory industry generally or on the
Company in particular.
COMPETITION
The Company provides services in a segment of the healthcare industry that
is intensely competitive. The Company estimates that there are over 10,820
laboratories in the United States, which might be deemed actual or potential
competitors for the testing business of cancer-treating or cancer-diagnosing
physicians.
The anatomic pathology segment is highly fragmented and has just begun to
experience industry consolidation to any significant degree. Competitors include
physician-owned laboratories, specialized commercial laboratories and hospital
laboratories. None of these competitors has a material share of the anatomic
pathology market.
6
Genetic testing is performed by a relatively small number of large
hospital systems, university medical centers and large commercial laboratories.
Genzyme, Laboratory Corporation of America and Quest Diagnostics are the primary
competitors with appreciable market share. Demand for this type of testing is
growing due to new therapeutic drug treatments for specific genetic conditions.
These drug treatments are often administered after genetic testing is complete
in order to maximize effectiveness. The number of tests and the demand for
existing tests will continue to grow as therapeutic treatments options expand.
We are continually evaluating our test offerings to capitalize on this growth.
In contrast, the clinical chemistry segment has been consolidated to a
large extent, and the two largest national clinical laboratories in the U.S.,
Quest Diagnostics and Laboratory Corporation of America, have a significant
market share in outpatient testing. In 1999, Quest Diagnostics acquired the
clinical laboratory operations of SmithKline Beecham Clinical Laboratories. The
clinical laboratories' product offerings are broader and the two companies have
more substantial financial and operational resources than the Company. Other
competitors in this segment include special-purpose clinical laboratories and
manufacturers of test kits and other diagnostic tools.
In addition to the competition for customers, there is increasing
competition for qualified personnel, particularly in the laboratory. To date,
such competition has not had an adverse impact on the Company's operations.
Significant factors that enhance the Company's ability to compete
effectively include the Company's highly-trained and knowledgeable sales force,
high quality laboratory operations, accurate and consistent test results,
quality of service to physicians, price and speed of turnaround for test
results.
PATENTS AND PROPRIETARY TECHNOLOGY
To date, the Company has not relied heavily on patents or licensed
technology in its business. Some of the tests or related diagnostic products
purchased and used by the Company may be patented. There can be no assurance
that such tests or related products do not infringe patent rights of others. Any
such infringement could give rise to claims against the Company. Typically, the
Company has no contractual right to be indemnified against such risks. There can
be no assurance that any issued patent upon which the Company relies directly or
indirectly will afford protection to the Company in the face of challenges to
the patent's validity.
Other private and public entities, including universities, have filed
applications for (or have been issued) patents in the Company's field and may
obtain additional patents and other proprietary rights to technology that may be
the same as or similar to those utilized by the Company. The scope and validity
of such patents, the extent to which the Company may wish or need to acquire
such rights, and the cost or availability of such rights are presently unknown.
There can be no assurance that others may not obtain access to the Company's
technology or independently develop the same or similar technology to that
utilized by the Company.
EMPLOYEES
As of December 31, 2001, the Company had 1,066 full-time equivalent
employees.
REGULATORY MATTERS
The Company's business is subject to government regulation at the federal,
state and local levels, some of which regulations are described under
"Laboratory Operations," "Anti-Fraud and Abuse," "Confidentiality of Health
Information," "Food and Drug Administration" and "Other" below.
LABORATORY OPERATIONS
The Company's laboratories are located in Connecticut, New York, Florida,
Texas and Oklahoma. Each laboratory is certified or licensed under the federal
Medicare program, the Clinical Laboratories Improvement Act of 1967, as amended
by the Clinical Laboratory Improvement Amendments of 1988 (collectively, "CLIA
`88"), and the respective clinical laboratory licensure laws of the state in
which they are located, where such licensure is required, except for Texas which
7
is in the process of being certified under the federal Medicare program and CLIA
'88. In addition, the Connecticut, Florida and Oklahoma laboratories are
accredited by the College of American Pathology. The Connecticut laboratory also
is certified to bill the Connecticut and various other state Medicaid programs
and is licensed by the federal Nuclear Regulatory Commission. The Company
believes it has obtained all material laboratory licenses required for its
operations.
The federal and state certification and licensure programs establish
standards for the operation of medical laboratories, including, but not limited
to, personnel and quality control. Compliance with such standards is verified by
periodic inspections by inspectors employed by federal or state regulatory
agencies. In addition, federal regulatory authorities require participation in a
proficiency testing program approved by HHS for many of the specialties and
subspecialties for which a laboratory seeks approval from Medicare or Medicaid
and certification under CLIA `88. Proficiency testing programs involve actual
testing of specimens that have been prepared by an entity running an approved
program for testing by the laboratory.
A final rule implementing CLIA `88, published by HHS on February 28, 1992,
became effective September 1, 1992. This rule has been revised on several
occasions and further revision is expected. The CLIA `88 rule applies to
virtually all laboratories in the United States, including the Company's
laboratories. The Company has reviewed its operations as they relate to CLIA
`88, including, among other things, the CLIA `88 rule's requirements regarding
laboratory administration, participation in proficiency testing, patient test
management, quality control, quality assurance and personnel for the types of
testing undertaken by the Company, and believes it is in compliance with these
requirements. However, no assurances can be given that the Company's
laboratories will pass all future inspections conducted to ensure compliance
with CLIA `88 or with any other applicable licensure or certification laws. The
sanctions for failure to comply with CLIA `88 or state licensure requirements
may be suspension, revocation or limitation of the labs' CLIA `88 certificate or
state license, as well as civil and/or criminal penalties.
ANTI FRAUD AND ABUSE LAWS
Existing federal laws governing Medicare and Medicaid, as well as some
other state and federal laws, also regulate certain aspects of the relationship
between healthcare providers, including clinical and anatomic laboratories, and
their referral sources, including physicians, hospitals and other laboratories.
One provision of these laws, known as the "anti-kickback law," contains
extremely broad proscriptions. Violation of this provision may result in
criminal penalties, exclusion from Medicare and Medicaid, and significant civil
monetary penalties.
Following a study of pricing practices in the clinical laboratory
industry, the Office of the Inspector General ("OIG") of HHS conducted a study
of pricing practices, and in January 1990 issued a report addressing how these
pricing practices relate to Medicare and Medicaid. The OIG reviewed the
industry's use of one fee schedule for physicians and other professional
accounts and another fee schedule for patients/third-party payors, including
Medicare, in billing for testing services, and focused specifically on the
pricing differential when profiles (or established groups of tests) are ordered.
Existing federal law authorizes the Secretary of HHS to exclude providers
from participation in the Medicare and Medicaid programs if they charge state
Medicaid programs or Medicare fees "substantially in excess" of their "usual
charges." On September 2, 1998, the OIG issued a final rule in which it
indicated that this provision has limited applicability to services for which
Medicare pays under a Prospective Payment System or a fee schedule, such as
anatomic pathology services and clinical laboratory services. In several
Advisory Opinions, the OIG has provided additional guidance regarding the
possible application of this law, as well as the applicability of the
anti-kickback laws to pricing arrangements. The OIG concluded in a 1999 Advisory
Opinion that an arrangement under which a laboratory offered substantial
discounts to physicians for laboratory tests billed directly to the physicians
could potentially trigger the "substantially in excess" provision and might
violate the anti-kickback law, because the discounts could be viewed as being
provided to the physician in exchange for the physician's referral to the
laboratory of non-discounted Medicare business, unless the discounts could
otherwise be justified. The Medicaid laws in some states also have prohibitions
related to discriminatory pricing.
The Company sometimes enters into discounting arrangements in billing for
its services. Depending upon the nature of any regulatory or enforcement action
taken or the content of legislation, if any, which might be adopted to address
this issue, the Company could experience a significant decrease in revenue which
could have a material adverse effect on the Company.
8
Under another federal law, known as the "Stark" law or "self-referral
prohibition," physicians who have an investment or compensation relationship
with an entity furnishing clinical laboratory services (including anatomic
pathology and clinical chemistry services) may not, subject to certain
exceptions, refer clinical laboratory testing for Medicare patients to that
entity. Similarly, laboratories may not bill Medicare or Medicaid or any other
party for services furnished pursuant to a prohibited referral. Violation of
these provisions may result in disallowance of Medicare and Medicaid claims for
the affected testing services, as well as the imposition of civil monetary
penalties. Some states also have laws similar to the Stark law.
The Company seeks to structure its arrangements with physicians and other
customers to be in compliance with the anti-kickback, Stark and state laws, and
to keep up-to-date on developments concerning their application by various
means, including consultation with legal counsel. The Company also has a
compliance committee which meets on a regular basis to review various operations
and relationships as well as adopt policies. However, the Company is unable to
predict how these laws will be applied in the future, and no assurances can be
given that its arrangements will not become subject to scrutiny under them.
In February 1997 (as revised in August 1998), the OIG released a model
compliance plan for laboratories that is based largely on corporate integrity
agreements negotiated with laboratories that had settled enforcement action
brought by the federal government related to allegations of submitting false
claims. The Company has adopted aspects of the model plan that it deems
appropriate to the conduct of its business. One key aspect of the corporate
integrity agreements and the model compliance plan is an emphasis on the
responsibilities of laboratories to notify physicians that Medicare covers only
medically necessary services. These requirements, and their likely effect on
physician test ordering habits, focus on chemistry tests, especially routine
tests, rather than on anatomic pathology services or the non-automated tests
which make up the majority of the Company's business measured in terms of net
revenues. Nevertheless, they potentially could affect physicians test ordering
habits more broadly. The Company is unable to predict whether, or to what
extent, these developments may have an impact or the utilization of the
Company's services.
Prior to 1998, the Medical Director of the Connecticut Medicare carrier to
whom the Company submits its Medicare claims, orally expressed the view that
some amount of money which the carrier has paid to the Company for certain
pathology services involving DNA measurements in prostate tumor cells
(morphometric analysis of tumor) potentially is recoverable by the carrier. The
carrier Medical Director has never reduced his view to writing or otherwise
asserted a claim. Accordingly, at this time, the Company cannot evaluate any
such possible claim, or the probability of assertion of any such claim.
During 1997, the Company was made aware that an agent based in the
Hartford, Connecticut branch of the U.S. Department of Health and Human Services
Office of the Inspector General ("OIG") was investigating the Company's practice
of supplying pathology specimen collection devices without charge to physician
customers as well as unspecified billing issues that had been raised by the
local Medicare carrier. The Company believes that its practices with respect to
specimen collection devices were proper, and a letter describing the Company's
actions and its views regarding applicable regulations was sent by the Company
to the OIG. That letter also requested information about any billing issues of
concern to the OIG so that the Company could address them. As of the date of
this report, the Company had not received a response from or otherwise been
contacted by the OIG regarding these matters, and has not received any formal
notification regarding the matter.
The Company has received a subpoena dated November 16, 2000, issued by the
United States Attorney's Office for Connecticut, requesting the production of a
variety of documents, with a particular focus on documents relating to billing
for tumor biomarkers, DNA testing and screening tests. The Company is
cooperating with the Department of Justice representatives handling this matter
and has substantially completed its production of documents under the subpoena.
CONFIDENTIALITY OF HEALTH INFORMATION
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
contains provisions that affect the handling of claims and other patient
information that are, or have been, transmitted electronically. These
provisions, which address security and confidentiality of patient information as
well as the administrative aspects of claims handling, have very broad
applicability and they specifically apply to healthcare providers, which include
physicians and clinical laboratories. Rules implementing various aspects of
HIPAA are continuing to be developed. National standards for electronic
9
healthcare transactions were published by HHS on August 17, 2000. The
regulations establish standard data content and formats for submitting
electronic claims and other administrative health transactions. All healthcare
providers will be able to use the electronic format to bill for their services
and all health plans and providers will be required to accept standard
electronic claims, referrals, authorizations, and other transactions. Under the
regulation, all electronic claims transactions must follow a single standardized
format. All health plans, providers and clearinghouses must comply with the
standards by October 2003. Failure to comply with this rule could result in
significant civil and/or criminal penalties. Despite the initial costs, the use
of uniform standards for all electronic transactions could lead to greater
efficiency in processing claims and in handling health care information.
On December 28, 2000, HHS published rules governing the use of
individually identifiable health information. The regulation protects certain
health information ("protected health information" or "PHI") transmitted or
maintained in any form or medium, and requires specific patient consent for the
use of PHI for purposes of treatment, payment or health care operations. For
most other uses or disclosures of PHI, the rule requires that covered entities
(healthcare plans, providers and clearinghouses) obtain a valid patient
authorization. For purposes of the criminal and civil penalties imposed under
Title XI of the Social Security Act, the current date for compliance is 2003.
Proposed security standards for electronic health data, published in August
1998, have not yet been finalized. Complying with the Standards, Security and
Privacy rules under HIPAA will require significant effort and expense for
virtually all entities that conduct healthcare transactions electronically and
handle patient health information, but the Company is unable to accurately
estimate the total cost or impact of the regulations at this time. Those costs,
however, are not expected to be material.
In addition to the HIPAA rules described above, the Company is subject to
state laws regarding the handling and disclosure of patient records and patient
health information. These laws vary widely, and many states are passing new laws
in this area. Penalties for violation include sanctions against a laboratory's
licensure as well as civil or criminal penalties. The Company believes it is in
compliance with applicable state law regarding the confidentiality of health
information.
FOOD AND DRUG ADMINISTRATION
The FDA does not currently regulate laboratory testing services, which is
the Company's principal business. However, the Company performs some testing
services using test kits purchased from manufacturers for which FDA premarket
clearance or approval for commercial distribution in the United States has not
been obtained by the manufacturers ("investigational test kits"). Under current
FDA regulations and policies, such investigational test kits may be sold by
manufacturers for investigational use only if certain requirements are met to
prevent commercial distribution. The manufacturers of these investigational test
kits are responsible for marketing them under conditions meeting applicable FDA
requirements. In January 1998, the FDA issued a revised draft Compliance Policy
Guide ("CPG") that sets forth FDA's intent to undertake a heightened enforcement
effort with respect to investigational test kits improperly commercialized prior
to receipt of FDA premarket clearance or approval. That draft CPG is not
presently in effect but, if implemented as written, would place greater
restrictions on the distribution of investigational test kits. If the Company
were to be substantially limited in or prevented from purchasing investigational
test kits by reason of the FDA finalizing the new draft CPG, there could be
adverse effects on the Company's ability to access new technology, which could
have a material adverse effect on the Company's business.
The Company also performs some testing services using reagents, known as
analyte specific reagents ("ASRs"), purchased from companies in bulk rather than
as part of a test kit. In November 1997, the FDA issued a new regulation placing
restrictions on the sale, distribution, labeling and use of ASRs, such as those
used by the Company. Most ASRs are treated by the FDA as low risk devices,
requiring the manufacturer to register with the agency, list its ASRs (and any
other devices), conform to good manufacturing practice requirements, and comply
with medical device reporting of adverse events. A smaller group of ASRs,
primarily those used in blood banking and/or screening for fatal contagious
diseases (e.g., HIV/AIDS), are treated as higher risk devices requiring
premarket clearance or approval from the FDA before commercial distribution is
permitted. The imposition of this regulatory framework on ASR sellers may reduce
the availability or raise the price of ASRs purchased by the Company. In
addition, when the Company performs a test developed in-house, using reagents
rather than a test kit cleared or approved by the FDA, it is required to
disclose those facts in the test report. However, by clearly declining to impose
any requirement for FDA premarket approval or clearance for most ASRs, the rule
10
removes one barrier to reimbursement for tests performed using these ASRs. To
date, this rule has not had a significant financial impact on the Company's
operations.
OTHER
Certain federal and state laws govern the handling and disposal of medical
specimens, infectious and hazardous wastes and radioactive materials. Failure to
comply with such laws could subject an entity covered by these laws to fines,
criminal penalties and/or other enforcement actions.
Pursuant to the Occupational Safety and Health Act, laboratories have a
general duty to provide a work place to their employees that is safe from
hazard. Over the past few years, the Occupational Safety and Health
Administration ("OSHA") has issued rules relevant to certain hazards that are
found in the laboratory. In addition, OSHA has promulgated regulations
containing requirements healthcare providers must follow to protect workers from
bloodborne pathogens. Failure to comply with these regulations, other applicable
OSHA rules or with the general duty to provide a safe work place could subject
employers, including a laboratory employer such as the Company, to substantial
fines and penalties.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on behalf of the undersigned, thereunto duly authorized.
DIANON Systems, Inc.
By: /s/ David R. Schreiber
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David R. Schreiber
Senior Vice President, Finance and
Chief Financial Officer