DGX 09.30.2013 10-Q
Table of Contents                                             

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013
Commission file number 001-12215

Quest Diagnostics Incorporated

Three Giralda Farms
Madison, NJ 07940
(973) 520-2700

Delaware
(State of Incorporation)

16-1387862
(I.R.S. Employer Identification Number)

 

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. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 18, 2013, there were outstanding 145,426,953 shares of the registrant’s common stock, $.01 par value.

Table of Contents                                             

PART I - FINANCIAL INFORMATION
 
 
Page
Item 1. Financial Statements
 
 
 
 
 
Index to consolidated financial statements filed as part of this report:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(unaudited)
(in thousands, except per share data)


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Net revenues
$
1,787,140

 
$
1,821,748

 
$
5,389,527

 
$
5,608,797

 
 
 
 
 
 
 
 
Operating costs and expenses:
 

 
 

 
 

 
 

Cost of services
1,088,503

 
1,081,017

 
3,274,013

 
3,292,105

Selling, general and administrative
422,963

 
416,854

 
1,289,370

 
1,324,191

Amortization of intangible assets
20,158

 
18,577

 
59,198

 
56,210

Gain on sale of royalty rights
(474,138
)
 
—

 
(474,138
)
 
—

Other operating expense, net
40,177

 
680

 
35,892

 
500

Total operating costs and expenses
1,097,663

 
1,517,128

 
4,184,335

 
4,673,006

 
 
 
 
 
 
 
 
Operating income
689,477

 
304,620

 
1,205,192

 
935,791

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Interest expense, net
(39,968
)
 
(40,809
)
 
(119,754
)
 
(124,661
)
Equity earnings in unconsolidated joint ventures
4,904

 
4,662

 
18,303

 
19,643

Other income, net
2,922

 
2,502

 
6,571

 
6,003

Total non-operating expenses, net
(32,142
)
 
(33,645
)
 
(94,880
)
 
(99,015
)
 
 
 
 
 
 
 
 
Income from continuing operations before taxes
657,335

 
270,975

 
1,110,312

 
836,776

Income tax expense
245,874

 
103,978

 
413,702

 
320,266

Income from continuing operations
411,461

 
166,997

 
696,610

 
516,510

Income from discontinued operations, net of taxes
2,406

 
4,541

 
35,497

 
10,016

Net income
413,867

 
171,538

 
732,107

 
526,526

 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
8,724

 
8,456

 
25,717

 
26,621

Net income attributable to Quest Diagnostics
$
405,143

 
$
163,082

 
$
706,390

 
$
499,905

 
 
 
 
 
 
 
 
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 
 

 
 

Income from continuing operations
$
402,737

 
$
158,541

 
$
670,893

 
$
489,889

Income from discontinued operations, net of taxes
2,406

 
4,541

 
35,497

 
10,016

Net income
$
405,143

 
$
163,082

 
$
706,390

 
$
499,905

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders - basic:
 

 
 

 
 

 
 

Income from continuing operations
$
2.68

 
$
0.99

 
$
4.36

 
$
3.07

Income from discontinued operations
0.02

 
0.03

 
0.23

 
0.07

Net income
$
2.70

 
$
1.02

 
$
4.59

 
$
3.14

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders - diluted:
 

 
 

 
 

 
 

Income from continuing operations
$
2.66

 
$
0.98

 
$
4.32

 
$
3.04

Income from discontinued operations
0.02

 
0.03

 
0.23

 
0.07

Net income
$
2.68

 
$
1.01

 
$
4.55

 
$
3.11

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
149,625

 
158,783

 
153,477

 
158,518

Diluted
150,920

 
160,702

 
154,795

 
160,064

 
 
 
 
 
 
 
 
Dividends per common share
$
0.30

 
$
0.17

 
$
0.90

 
$
0.51

The accompanying notes are an integral part of these statements.

2
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(unaudited)
(in thousands)

 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2013
 
2012
2013
 
2012
Net income
$
413,867

 
$
171,538

$
732,107

 
$
526,526

 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
Currency translation
4,592

 
22,288

(26,059
)
 
21,321

Market valuation, net of tax
(31
)
 
(161
)
274

 
84

Net deferred loss on cash flow hedges, net of tax
210

 
210

630

 
630

Other, net of tax
10

 
—

2,847

 
—

Other comprehensive income (loss)
4,781

 
22,337

(22,308
)
 
22,035

 
 
 
 
 
 
 
Comprehensive income
418,648

 
193,875

709,799

 
548,561

Less: Comprehensive income attributable to noncontrolling interests
8,724

 
8,456

25,717

 
26,621

Comprehensive income attributable to Quest Diagnostics
$
409,924

 
$
185,419

$
684,082

 
$
521,940

The accompanying notes are an integral part of these statements.


3
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2013 AND DECEMBER 31, 2012
(in thousands, except per share data)
 
September 30,
2013
 
December 31,
2012
 
(unaudited)
 
 
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
158,280

 
$
295,586

Accounts receivable, net of allowance for doubtful accounts of $238,865 and $235,747 at September 30, 2013 and December 31, 2012, respectively
920,833

 
867,010

Inventories
85,187

 
93,050

Deferred income taxes
152,831

 
174,209

Prepaid expenses and other current assets
108,517

 
90,950

Current assets held for sale
—

 
40,192

Total current assets
1,425,648

 
1,560,997

Property, plant and equipment, net
749,355

 
755,831

Goodwill
5,628,808

 
5,535,848

Intangible assets, net
903,899

 
872,172

Other assets
219,829

 
204,631

Non-current assets held for sale
—

 
354,384

Total assets
$
8,927,539

 
$
9,283,863

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
994,292

 
$
1,016,191

Short-term borrowings and current portion of long-term debt
244,703

 
9,404

Current liabilities held for sale
—

 
22,008

Total current liabilities
1,238,995

 
1,047,603

Long-term debt
3,122,208

 
3,354,173

Other liabilities
694,741

 
635,558

Non-current liabilities held for sale
—

 
60,800

Stockholders’ equity:
 

 
 

Quest Diagnostics stockholders’ equity:
 

 
 

Common stock, par value $0.01 per share; 600,000 shares authorized at both September 30, 2013 and December 31, 2012; 215,364 shares and 215,075 shares issued at September 30, 2013 and December 31, 2012, respectively
2,154

 
2,151

Additional paid-in capital
2,306,433

 
2,370,677

Retained earnings
5,259,665

 
4,690,378

Accumulated other comprehensive (loss) income
(7,988
)
 
14,320

Treasury stock, at cost; 69,972 shares and 56,744 shares at September 30, 2013 and December 31, 2012, respectively
(3,717,583
)
 
(2,914,479
)
Total Quest Diagnostics stockholders’ equity
3,842,681

 
4,163,047

Noncontrolling interests
28,914

 
22,682

Total stockholders’ equity
3,871,595

 
4,185,729

Total liabilities and stockholders’ equity
$
8,927,539

 
$
9,283,863

The accompanying notes are an integral part of these statements.

4
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(unaudited)
(in thousands)
 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 

 
 

Net income
$
732,107

 
$
526,526

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
210,983

 
215,300

Provision for doubtful accounts
204,101

 
208,360

Deferred income tax (benefit) provision
(3,098
)
 
139

Stock-based compensation expense
24,107

 
43,087

Excess tax benefits from stock-based compensation arrangements
(3,566
)
 
(3,810
)
Gain on sale of royalty rights
(474,138
)
 
—

Loss on sale of businesses, net
17,400

 
—

Other, net
(668
)
 
(5,350
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(252,441
)
 
(231,375
)
Accounts payable and accrued expenses
(76,798
)
 
(56,134
)
Income taxes payable
76,967

 
32,311

Termination of interest rate swap agreements
—

 
71,820

Other assets and liabilities, net
(13,308
)
 
5,881

Net cash provided by operating activities
441,648

 
806,755

Cash flows from investing activities:
 

 
 

Business acquisitions, net of cash acquired
(179,895
)
 
(50,574
)
Proceeds from sale of businesses
296,333

 
—

Proceeds from sale of royalty rights
474,279

 
—

Capital expenditures
(155,467
)
 
(122,318
)
Increase in investments and other assets
(1,610
)
 
(2,098
)
Net cash provided by (used in) investing activities
433,640

 
(174,990
)
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
789,623

 
715,000

Repayments of debt
(757,234
)
 
(1,222,036
)
Purchases of treasury stock
(994,102
)
 
(149,996
)
Exercise of stock options
98,057

 
143,945

Excess tax benefits from stock-based compensation arrangements
3,566

 
3,810

Dividends paid
(141,001
)
 
(81,034
)
Distributions to noncontrolling interests
(21,381
)
 
(24,112
)
Other financing activities, net
(7,356
)
 
9,542

Net cash used in financing activities
(1,029,828
)
 
(604,881
)
Net change in cash and cash equivalents
(154,540
)
 
26,884

Add: Decrease in cash and cash equivalents included in assets held for sale
17,234

 
—

Cash and cash equivalents, beginning of period
295,586

 
164,886

Cash and cash equivalents, end of period
$
158,280

 
$
191,770

The accompanying notes are an integral part of these statements.

5
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(unaudited)
(in thousands)
 
 
 
Quest Diagnostics Stockholders’ Equity
 
 
 
 
 
Shares of
Common Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive (Loss) Income
 
Treasury
Stock, at
Cost
 
Non-
controlling
Interests
 
Total Stock-
holders’
Equity
Balance, December 31, 2012
158,331

 
$
2,151

 
$
2,370,677

 
$
4,690,378

 
$
14,320

 
$
(2,914,479
)
 
$
22,682

 
$
4,185,729

Net income


 


 


 
706,390

 


 


 
25,717

 
732,107

Other comprehensive loss, net of tax


 


 


 


 
(22,308
)
 


 


 
(22,308
)
Dividends declared


 


 


 
(137,103
)
 


 


 


 
(137,103
)
Distributions to noncontrolling interests


 


 


 


 


 


 
(21,381
)
 
(21,381
)
Issuance of common stock under benefit plans
781

 
5

 
1,992

 


 


 
13,594

 


 
15,591

Stock-based compensation expense


 


 
21,355

 


 


 
2,752

 


 
24,107

Exercise of stock options
2,006

 


 
(6,602
)
 


 


 
104,652

 
7

 
98,057

Shares to cover employee payroll tax withholdings on stock issued under benefit plans
(176
)
 
(2
)
 
(10,083
)
 


 


 


 


 
(10,085
)
Tax benefits associated with stock-based compensation plans


 


 
(906
)
 


 


 


 


 
(906
)
Purchases of treasury stock
(15,550
)
 


 
(70,000
)
 


 


 
(924,102
)
 


 
(994,102
)
Other


 


 


 


 


 


 
1,889

 
1,889

Balance, September 30, 2013
145,392

 
$
2,154

 
$
2,306,433

 
$
5,259,665

 
$
(7,988
)
 
$
(3,717,583
)
 
$
28,914

 
$
3,871,595

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
Quest Diagnostics Stockholders’ Equity
 
 
 
 
 
Shares of
Common
Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
(Loss) Income
 
Treasury
Stock, at
Cost
 
Non-
controlling
Interests
 
Total Stock-
holders’
Equity
Balance, December 31, 2011
157,420

 
$
2,146

 
$
2,347,518

 
$
4,263,599

 
$
(8,067
)
 
$
(2,912,324
)
 
$
22,127

 
$
3,714,999

Net income
 

 
 

 
 

 
499,905

 
 

 
 

 
26,621

 
526,526

Other comprehensive income, net of tax


 


 


 


 
22,035

 


 


 
22,035

Dividends declared
 

 
 

 
 

 
(81,239
)
 
 

 
 

 
 

 
(81,239
)
Distributions to noncontrolling interests
 

 
 

 
 

 
 

 
 

 
 

 
(24,112
)
 
(24,112
)
Issuance of common stock under benefit plans
1,112

 
8

 
2,457

 
 

 
 

 
13,198

 
 

 
15,663

Stock-based compensation expense
 

 
 

 
40,322

 
 

 
 

 
2,765

 
 

 
43,087

Exercise of stock options
3,090

 
 

 
(13,809
)
 
 

 
 

 
157,754

 
 

 
143,945

Shares to cover employee payroll tax withholdings on stock issued under benefit plans
(344
)
 
(3
)
 
(19,856
)
 
 

 
 

 
 

 
 

 
(19,859
)
Tax benefits associated with stock-based compensation plans
 

 
 

 
4,845

 
 

 
 

 
 

 
 

 
4,845

Purchases of treasury stock
(2,561
)
 
 

 
 

 
 

 
 

 
(149,996
)
 
 

 
(149,996
)
Other
 

 
 

 
 

 
 

 
 

 
 

 
1,687

 
1,687

Balance, September 30, 2012
158,717

 
$
2,151

 
$
2,361,477

 
$
4,682,265

 
$
13,968

 
$
(2,888,603
)
 
$
26,323

 
$
4,197,581

The accompanying notes are an integral part of these statements.

6
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(dollars in thousands unless otherwise indicated)

1.    DESCRIPTION OF BUSINESS
    
Background
    
Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or the "Company") is the world's leading provider of diagnostic information services ("DIS") providing insights that empower and enable patients, physicians, hospitals, integrated delivery networks, health plans, employers and others to make better healthcare decisions. The Company offers the broadest access in the United States to DIS through its nationwide network of laboratories and Company-owned patient service centers and the Company is the leading provider of DIS, including routine testing, esoteric or gene-based testing and anatomic pathology testing. The Company provides interpretive consultation through the largest medical and scientific staff in the industry, with hundreds of M.D.s and Ph.D.s, primarily located in the United States, many of whom are recognized leaders in their fields. The Company's Diagnostic Solutions ("DS") businesses offers a variety of solutions for life insurers and healthcare providers. The Company is the leading provider of risk assessment services for the life insurance industry. In addition, the Company is a leading provider of testing for clinical trials. The Company's diagnostics products business manufactures and markets diagnostic products. In addition, the Company offers healthcare organizations and clinicians robust information technology solutions.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
    
The interim consolidated financial statements reflect all adjustments which in the opinion of management are necessary for a fair statement of results of operations, comprehensive income, financial condition, cash flows and stockholders' equity for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature. The interim consolidated financial statements have been compiled without audit. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s 2012 Annual Report on Form 10-K.
    
The year-end balance sheet data was derived from the audited financial statements as of December 31, 2012, but does not include all the disclosures required by accounting principles generally accepted in the United States (“GAAP”).

The Company completed the sale of its OralDNA salivary-diagnostics business ("OralDNA") during the fourth quarter of 2012. In April 2013, the Company completed the sale of its HemoCue diagnostics products business ("HemoCue"). During the third quarter of 2006, the Company completed its wind-down of NID, a test kit manufacturing subsidiary, and classified the operations of NID as discontinued operations. The accompanying consolidated statements of operations and related disclosures have been recast to report the results of OralDNA and HemoCue as discontinued operations for the three and nine months ended September 30, 2013 and 2012. See Note 14 for a further discussion of discontinued operations.

The Company completed the sale of its Enterix colorectal cancer screening test business (“Enterix”) in September 2013. The Enterix business has not been reclassified to discontinued operations due to the level of continuing involvement in the Enterix business subsequent to its sale.

Use of Estimates
    
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
    
Earnings Per Share

The Company's unvested restricted common stock and unvested restricted stock units that contain non-forfeitable rights to dividends are participating securities and, therefore, are included in the earnings allocation in computing earnings per

7
Table of Contents
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


share using the two-class method. Basic earnings per common share is calculated by dividing net income, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding. Diluted earnings per common share is calculated by dividing net income, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the dilutive effect of outstanding stock options and performance share units granted under the Company's Amended and Restated Employee Long-Term Incentive Plan and its Amended and Restated Non-Employee Director Long-Term Incentive Plan. Earnings allocable to participating securities include the portion of dividends declared as well as the portion of undistributed earnings during the period allocable to participating securities.

Adoption of New Accounting Standards
    
On January 1, 2013, the Company adopted a new accounting standard issued by the Financial Accounting Standards Board ("FASB") related to the testing of indefinite-lived intangible assets, other than goodwill, for impairment. Similar to the guidance related to the testing of goodwill for impairment, an entity testing an indefinite-lived intangible asset for impairment has the option to perform a qualitative assessment before calculating the fair value of the asset. If, after assessing the totality of events and circumstances an entity determines that it is not more-likely-than-not that the indefinite-lived intangible asset is impaired, the entity would not be required to perform the quantitative impairment test. However, if the qualitative assessment indicates that it is more-likely-than-not that the fair value of the asset is less than its carrying amount, then the quantitative assessment must be performed. An entity is permitted to perform the qualitative assessment on none, some or all of its indefinite-lived intangible assets and may also bypass the qualitative assessment and begin with the quantitative assessment of indefinite-lived intangible assets for impairment. The adoption of this new standard did not have a material impact on the Company’s consolidated financial statements.

On January 1, 2013, the Company adopted a new accounting standard issued by the FASB that adds new disclosure requirements for amounts reclassified out of accumulated other comprehensive income ("AOCI").  The total changes in AOCI must be disaggregated between reclassification adjustments and current period other comprehensive income. This new standard also requires an entity to present reclassification adjustments out of AOCI either on the face of the income statement or in the notes to the financial statements based on their source and the income statement line items affected by the reclassification. This standard is effective prospectively for the Company for interim and annual periods beginning on January 1, 2013. The adoption of this new standard did not have a material impact on the Company’s consolidated financial statements.

New Accounting Pronouncements

In March 2013, the FASB issued a new accounting standard on foreign currency matters that clarifies the guidance of a parent company's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. Under this new standard, a parent company that ceases to have a controlling financial interest in a foreign subsidiary or group of assets within a foreign entity shall release any related cumulative translation adjustment into net income only if a sale or transfer results in complete or substantially complete liquidation of the foreign entity. This standard shall be applied prospectively and will become effective for the Company on January 1, 2014. The Company expects that the adoption of this standard will not have a material effect on its consolidated financial statements.

In July 2013, the FASB issued a new accounting standard to permit the use of the Fed Funds Effective Swap Rate to be used as an alternative benchmark interest rate for hedge accounting purposes in interest rate derivatives. The new standard is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The new standard is not expected to have a material effect on the Company's consolidated financial statements.

In July 2013, the FASB issued a new accounting standard on the financial statement presentation of unrecognized tax benefits. The new standard provides that a liability related to an unrecognized tax benefit would be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. The new standard becomes effective for the Company on January 1, 2014 and it should be applied prospectively to unrecognized tax benefits that exist at the effective date with retrospective application permitted. The Company's analysis indicates that the adoption of this standard will not have a material effect on its consolidated financial statements.
    

8
Table of Contents
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


3.    EARNINGS PER SHARE

The computation of basic and diluted earnings per common share was as follows (in thousands, except per share data):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 
 

 
 

Income from continuing operations
$
402,737

 
$
158,541

 
$
670,893

 
$
489,889

Income from discontinued operations, net of taxes
2,406

 
4,541

 
35,497

 
10,016

Net income attributable to Quest Diagnostics’ common stockholders
$
405,143

 
$
163,082

 
$
706,390

 
$
499,905

 
 
 
 
 
 
 
 
Income from continuing operations
$
402,737

 
$
158,541

 
$
670,893

 
$
489,889

Less: Earnings allocated to participating securities
1,484

 
645

 
2,410

 
1,951

Earnings available to Quest Diagnostics’ common stockholders – basic and diluted
$
401,253

 
$
157,896

 
$
668,483

 
$
487,938

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
149,625

 
158,783

 
153,477

 
158,518

Effect of dilutive securities:
 

 
 

 
 

 
 

Stock options and performance share units
1,295

 
1,919

 
1,318

 
1,546

Weighted average common shares outstanding – diluted
150,920

 
160,702

 
154,795

 
160,064

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders – basic:
 

 
 

 
 

 
 

Income from continuing operations
$
2.68

 
$
0.99

 
$
4.36

 
$
3.07

Income from discontinued operations
0.02

 
0.03

 
0.23

 
0.07

Net income
$
2.70

 
$
1.02

 
$
4.59

 
$
3.14

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders – diluted:
 

 
 

 
 

 
 

Income from continuing operations
$
2.66

 
$
0.98

 
$
4.32

 
$
3.04

Income from discontinued operations
0.02

 
0.03

 
0.23

 
0.07

Net income
$
2.68

 
$
1.01

 
$
4.55

 
$
3.11


Earnings per common share are computed independently for each quarterly period. Therefore, the sum of quarterly earnings per common share will not equal earnings per common share for the nine months ended September 30, 2013.

The following securities were not included in the calculation of diluted earnings per share due to their antidilutive effect (shares in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Stock options and performance share units
1,527

 
1,317

 
1,690

 
1,925



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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


4.    INVIGORATE PROGRAM

During 2012, the Company committed to a course of action related to a multi-year program called Invigorate which is designed to reduce its cost structure. The Invigorate program is intended to address continued reimbursement pressures and labor and benefit cost increases, free up additional resources to invest in science, innovation and other growth initiatives, and enable the Company to improve operating profitability and quality. In connection with this program, the Company also launched a voluntary retirement program to certain eligible employees, which was essentially completed at the end of the first quarter of 2013. The Invigorate program is currently expected to be principally completed by the end of 2014.

As part of the Invigorate program, the Company launched a major management restructuring aimed at driving operational excellence and restoring growth. The key element of this organizational change is to eliminate the complexity associated with the Company's prior structure, including reducing management layers, so that the Company can better focus on customers and speed decision-making. The new organization is designed to align around future growth opportunities, improve execution and leverage company-wide infrastructure to maximize value and efficiency. The majority of the organizational changes became effective on January 1, 2013. The Company has completed the elimination of at least three layers from the organization, and has reduced approximately 450 management positions from the Company through the end of the third quarter of 2013 associated with this initiative. The Company expects to eliminate a total of approximately 500 management positions by the end of 2013.

The following table provides a summary of the Company's pre-tax restructuring and integration charges associated with the Invigorate program and other employee separation costs for the three and nine months ended September 30, 2013:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Employee separation costs
$
24,827

 
$
27,866

 
$
66,182

 
$
31,550

Facility-related costs
4,172

 
414

 
5,415

 
414

Asset impairment charges
—

 
1,147

 
—

 
1,147

Accelerated vesting of stock-based compensation
—

 
3,030

 
1,284

 
3,030

  Total restructuring charges
28,999

 
32,457

 
72,881

 
36,141

 
 
 
 
 
 
 
 
Other integration costs
$
7,945

 
$
2,431

 
$
21,202

 
$
5,241

Total restructuring and integration charges
$
36,944

 
$
34,888

 
$
94,083

 
$
41,382


Of the total employee separation costs incurred in the three and nine months ended September 30, 2013, $1.0 million and $19.5 million, respectively, represent costs associated with the Company's management layer reduction initiative, and $0.4 million and $4.7 million, respectively, represent costs incurred under the Company's voluntary retirement program. In connection with further restructuring efforts, the Company entered into agreements to outsource certain aspects of support functions. As a result of these agreements, the Company incurred approximately $16.5 million of employee separation costs in the three and nine months ended September 30, 2013 related to this initiative. The remaining employee separation costs incurred during the three and nine months ended September 30, 2013 represent other actions the Company has taken to restructure its business.

Of the total employee separation costs incurred in the three and nine months ended September 30, 2012, $20.6 million and $23.3 million, respectively, represent costs incurred under the Company's voluntary retirement program.

Of the total $36.9 million in restructuring and integration charges incurred during the three months ended September 30, 2013, $10.4 million and $26.5 million was recorded in cost of services and selling, general and administrative expenses, respectively. Of the total $94.1 million in restructuring and integration charges incurred during the nine months ended September 30, 2013, $37.1 million and $57.0 million was recorded in cost of services and selling, general and administrative expenses, respectively.


10
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Of the total $34.9 million in restructuring and integration charges incurred during the three months ended September 30, 2012, $19.8 million and $15.1 million was recorded in cost of services and selling, general and administrative expenses, respectively. Of the total $41.4 million in restructuring and integration charges incurred during the nine months ended September 30, 2012, $25.7 million and $15.7 million was recorded in cost of services and selling, general and administrative expenses, respectively.

In addition to the restructuring and integration charges noted above, the Company incurred approximately $2.4 million and $8.5 million in the three and nine months ended September 30, 2013, respectively, primarily associated with professional fees incurred in connection with further restructuring our business and integration costs associated with recent acquisitions.

The Company incurred approximately $9.7 million and $28.8 million in the three and nine months ended September 30, 2012, respectively, primarily associated with professional fees incurred in connection with further restructuring our business and integration costs associated with recent acquisitions.

These charges were primarily recorded in the Company's DIS business for all periods presented.

The following table summarizes activity in the restructuring liability as of September 30, 2013 and December 31, 2012:
 
Employee Separation Costs
 
Facility-Related Costs
 
Total
 
 
 
 
 
 
Balance, December 31, 2012
$
40,018

 
$
257

 
$
40,275

Current period charges
66,182

 
5,415

 
71,597

Other / adjustments
2,915

 
—

 
2,915

Less:
 
 
 
 
 
Cash payments
(59,229
)
 
(575
)
 
(59,804
)
Balance, September 30, 2013
$
49,886

 
$
5,097

 
$
54,983


5.     BUSINESS ACQUISITIONS

Acquisition of Businesses from UMass Memorial Medical Center

On January 2, 2013, the Company completed the acquisition of the clinical outreach and anatomic pathology businesses of UMass Memorial Medical Center ("UMass"). This purchase was the first step in a series of transactions between the parties whereby the two organizations expect to eventually have a financial stake in a new entity that will perform diagnostic information testing services in a defined territory within the state of Massachusetts. The assets acquired at the acquisition date primarily represent goodwill and intangible assets, principally comprised of customer-related intangibles (see Note 9). In addition the Company granted to UMass a call option and UMass granted to the Company a put option for UMass to acquire an 18.90% equity interest in a newly formed entity. The put and call options have a remaining vesting period of approximately 18 months (see Note 8).

Other Acquisitions

On May 15, 2013, the Company completed the acquisition of the toxicology and clinical laboratory business of Advanced Toxicology Network ("ATN") from Concentra, a subsidiary of Humana Inc. The assets acquired at the acquisition date primarily represent goodwill and intangible assets, principally comprised of customer-related intangibles (see Note 9).

On June 22, 2013, the Company completed the acquisition of certain lab-related clinical outreach service operations of Dignity Health ("Dignity"), a hospital system in California. The assets acquired at the acquisition date primarily represent goodwill and intangible assets, principally comprised of customer-related intangibles (see Note 9).
    
Pro Forma Combined Financial Information

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)



Supplemental pro forma combined financial information has not been presented as the combined impact of the above acquisitions are not material to the Company’s consolidated financial statements.
    
6.     DISPOSITIONS

Sale of Royalty Rights

As part of its acquisition of Celera in 2011, the Company gained rights to receive royalties on Ibrutinib, an experimental cancer therapy. In July 2013, the Company sold its right to receive royalties related to the commercialization of Ibrutinib for $485 million in cash. The Company has accounted for this transaction as a sale of royalty rights and recognized a pre-tax gain of $474 million, net of transaction costs, associated with this sale.

Sale of Enterix

In September 2013, the Company completed the sale of Enterix and recorded a pre-tax loss of approximately $40 million associated with the sale, which is included in other operating expense, net. The Enterix business has not been reclassified to discontinued operations due to the level of continuing involvement in the Enterix business subsequent to its sale.

7.     TAXES ON INCOME

Income tax expense for the three months ended September 30, 2013 and 2012 was $246 million and $104 million, respectively. Income tax expense for the nine months ended September 30, 2013 and 2012 was $414 million and $320 million, respectively. The increase in income tax expense for both the three and nine months ended September 30, 2013, compared to the prior year period, is primarily due to approximately $176 million of income tax expense associated with the gain on sale of royalty rights (see Note 6).

8.     FAIR VALUE MEASUREMENTS

The following table provides a summary of the recognized assets and liabilities that are measured at fair value on a recurring basis:
 
 
 
Basis of Fair Value Measurements
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets /
Liabilities
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
September 30, 2013
 

 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Trading securities
$
49,226

 
$
49,226

 
$
—

 
$
—

Cash surrender value of life insurance policies
27,842

 
—

 
27,842

 
—

Put option
5,300

 
—

 
—

 
5,300

Available-for-sale equity securities
1,062

 
—

 
—

 
1,062

Total
$
83,430

 
$
49,226

 
$
27,842

 
$
6,362

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
81,180

 
$
—

 
$
81,180

 
$
—

Interest rate swaps
26,982

 
—

 
26,982

 
—

Call option
7,770

 
—

 
—

 
7,770

Total
$
115,932

 
$
—

 
$
108,162

 
$
7,770


12
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


 
 
 
Basis of Fair Value Measurements
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets /
Liabilities
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
December 31, 2012
 

 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Trading securities
$
52,283

 
$
52,283

 
$
—

 
$
—

Cash surrender value of life insurance policies
25,018

 
—

 
25,018

 
—

Interest rate swaps
830

 
—

 
830

 
—

Available-for-sale equity securities
612

 
—

 
—

 
612

Foreign currency forward contracts
403

 
—

 
403

 
—

Total
$
79,146

 
$
52,283

 
$
26,251

 
$
612

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
82,218

 
$
—

 
$
82,218

 
$
—

Interest rate swaps
3,129

 
—

 
3,129

 
—

Total
$
85,347

 
$
—

 
$
85,347

 
$
—


A full description regarding the Company's fair value measurements is contained in Note 6 to the Consolidated Financial Statements in the Company's 2012 Annual Report on Form 10-K.    
    
Investments in available-for-sale equity securities consist of the revaluation of an existing investment in unregistered common shares of a publicly-held company. This investment is classified within Level 3 because the unregistered securities contain restrictions on their sale, and therefore, the fair value measurement reflects a discount for the effect of the restriction.

In connection with the acquisition of certain businesses of UMass, the Company granted to UMass a call option and UMass granted to the Company a put option for UMass to acquire an 18.90% equity interest in a newly formed entity. The put and call options are derivative instruments that have a remaining vesting period of approximately 18 months and their fair values have been measured using a combination of discounted cash flows and the Black-Scholes-Merton option pricing model (See Note 5).

The following table provides a reconciliation of the beginning and ending balances of assets and liabilities using significant unobservable inputs:
 
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
 
Available-for-Sale Equity Securities
 
Put Option Derivative Asset
 
Total
Balance, December 31, 2012
$
612

 
$
—

 
$
612

Purchases, additions and issuances
—

 
8,250

 
8,250

Total gains (losses) - realized/ unrealized:
 
 
 
 
 
Included in earnings
—

 
(2,950
)
 
(2,950
)
Included in other comprehensive income (loss)
450

 
—

 
450

Transfers in and out of Level 3
—

 
—

 
—

Balance, September 30, 2013
$
1,062

 
$
5,300

 
$
6,362



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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


 
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
 
 
Call Option Derivative Liability
Balance, December 31, 2012
 
$
—

Purchases, additions and issuances
 
10,808

Total (gains) losses - realized/ unrealized:
 
 
Included in earnings
 
(3,038
)
Transfers in and out of Level 3
 
—

Balance, September 30, 2013
 
$
7,770


The unrealized gains and losses included in earnings for the nine months ended September 30, 2013 are reported in other non-operating income.

The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable and accrued expenses approximate fair value based on the short maturities of these instruments. At September 30, 2013, the fair value of the Company’s debt was estimated at $3.6 billion, which exceeded the carrying value by $253 million. At December 31, 2012, the fair value of the Company's debt was estimated at $3.8 billion, which exceeded the carrying value by $481 million. Principally all of the Company's debt is classified within Level 1 of the fair value hierarchy because the fair value of the debt is estimated based on rates currently offered to the Company with identical terms and maturities, using quoted active market prices and yields, taking into account the underlying terms of the debt instruments.

9.    GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill for the nine months ended September 30, 2013 and for the year ended December 31, 2012 are as follows:
 
September 30,
2013
 
December 31,
2012
Balance at beginning of period
$
5,535,848

 
$
5,795,765

Goodwill acquired during the period
130,192

 
28,144

Goodwill impairment and write-off associated with sale of businesses during the period
(37,103
)
 
(85,173
)
Reclassification to non-current assets held for sale
—

 
(218,795
)
(Decrease) increase related to foreign currency translation
(129
)
 
15,907

Balance at end of period
$
5,628,808

 
$
5,535,848


Approximately 90% of the Company’s goodwill as of September 30, 2013 and December 31, 2012 was associated with its DIS business.

For the nine months ended September 30, 2013, goodwill acquired was principally associated with the UMass, Dignity and ATN acquisitions, which is deductible for tax purposes. These acquisitions also resulted in $94.9 million of intangible assets, principally comprised of customer-related intangibles (see Note 5).

For the nine months ended September 30, 2013, goodwill written-off was associated with the sale of Enterix. In addition, intangible assets associated with the sale of Enterix with a net book value of $5.6 million were written-off. For further details regarding the sale of Enterix, see Note 6.


14
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


For the year ended December 31, 2012, goodwill acquired was principally associated with the acquisition of S.E.D. Medical Laboratories. Approximately $28 million and $19 million, respectively, represented goodwill, which is deductible for tax purposes, and intangible assets, principally comprised of customer-related intangibles.

For the year ended December 31, 2012, goodwill impairment was associated with HemoCue and the write-off of goodwill was associated with the sale of OralDNA during the fourth quarter of 2012. For further details regarding goodwill included in non-current assets held for sale, see Note 18 to the Consolidated Financial Statements in the Company's 2012 Annual Report on Form 10-K.    
    
Intangible assets at September 30, 2013 and December 31, 2012 consisted of the following:

 
Weighted
Average
Amortization
Period
(in Years)
 
September 30, 2013
 
December 31, 2012
 
 
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 

 
 

 
 

 
 

 
 

 
 

Customer-related intangibles
18
 
$
657,901

 
$
(200,194
)
 
$
457,707

 
$
566,701

 
$
(173,516
)
 
$
393,185

Non-compete agreements
4
 
41,731

 
(24,405
)
 
17,326

 
38,551

 
(17,123
)
 
21,428

Technology
14
 
119,440

 
(25,714
)
 
93,726

 
131,040

 
(25,144
)
 
105,896

Other
8
 
143,807

 
(54,086
)
 
89,721

 
141,818

 
(37,634
)
 
104,184

Total
16
 
962,879

 
(304,399
)
 
658,480

 
878,110

 
(253,417
)
 
624,693

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 

 
 

 
 

 
 

 
 

Tradenames
 
 
244,000

 
—

 
244,000

 
246,200

 
—

 
246,200

In-process research and development
 
 
120

 
—

 
120

 
120

 
—

 
120

Other
 
 
1,299

 
—

 
1,299

 
1,159

 
—

 
1,159

Total intangible assets
 
$
1,208,298

 
$
(304,399
)
 
$
903,899

 
$
1,125,589

 
$
(253,417
)
 
$
872,172


Amortization expense related to intangible assets was $20.2 million and $18.6 million for the three months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, amortization expense related to intangible assets was $59.2 million and $56.2 million, respectively.
 
The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of September 30, 2013 is as follows:

Year Ending December 31,
 

Remainder of 2013
$
19,932

2014
76,657

2015
65,335

2016
58,980

2017
56,000

2018
48,751

Thereafter
332,825

Total
$
658,480



15
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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


10.    FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage its exposure to market risks for changes in interest rates and foreign currencies. This strategy includes the use of interest rate swap agreements, forward starting interest rate swap agreements, treasury lock agreements and foreign currency forward contracts to manage its exposure to movements in interest and currency rates. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. These policies prohibit holding or issuing derivative financial instruments for speculative purposes. The Company does not enter into derivative financial instruments that contain credit-risk-related contingent features or requirements to post collateral.

A summary of the fair values of derivative instruments in the consolidated balance sheets is stated in the table below:

 
September 30, 2013
 
December 31, 2012
 
Balance Sheet
Classification
 
Fair Value
 
Balance Sheet
Classification
 
Fair Value
Derivatives Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Interest rate swaps
Other assets
 
$
—

 
Other assets
 
$
830

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Interest rate swaps
Other liabilities
 
26,982

 
Other liabilities
 
3,129

 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Put option
Other assets
 
5,300

 
Other assets
 
—

Foreign currency forward contracts
Other current assets
 
—

 
Other current assets
 
403

 
 
 
5,300

 
 
 
403

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Call option
Other liabilities
 
7,770

 
Other liabilities
 
—

 
 
 
 
 
 
 
 
Total Net Derivatives Liabilities
 
 
$
(29,452
)
 
 
 
$
(1,896
)

A full description regarding the Company's use of derivative financial instruments is contained in Note 13 to the Consolidated Financial Statements in the Company's 2012 Annual Report on Form 10-K.    

Interest Rate Risk

The Company is exposed to interest rate risk on its cash and cash equivalents and its debt obligations. Interest income earned on cash and cash equivalents may fluctuate as interest rates change; however, due to their relatively short maturities, the Company does not hedge these assets or their investment cash flows and the impact of interest rate risk is not material. The Company's debt obligations consist of fixed-rate and variable-rate debt instruments. The Company's primary objective is to achieve the lowest overall cost of funding while managing the variability in cash outflows within an acceptable range. In order to achieve this objective, the Company has entered into interest rate swaps. Interest rate swaps involve the periodic exchange of payments without the exchange of underlying principal or notional amounts. Net settlements between the counterparties are recognized as an adjustment to interest expense.

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


    
Interest Rate Derivatives – Cash Flow Hedges
    
The Company has entered into various interest rate lock agreements and forward starting interest rate swap agreements to hedge part of the Company's interest rate exposure associated with the variability in future cash flows attributable to changes in interest rates. The total net loss, net of taxes, recognized in accumulated other comprehensive (loss) income, related to the Company's cash flow hedges as of September 30, 2013 and December 31, 2012 was $6.2 million and $6.8 million, respectively. The loss recognized on the Company's cash flow hedges for the three and nine months ended September 30, 2013 and 2012, as a result of ineffectiveness, was not material. The net amount of deferred losses on cash flow hedges that is expected to be reclassified from accumulated other comprehensive (loss) income into earnings within the next twelve months is $1.3 million.

Interest Rate Derivatives – Fair Value Hedges

The Company maintains various fixed-to-variable interest rate swaps to convert a portion of the Company's long-term debt into variable interest rate debt. These derivative financial instruments are accounted for as fair value hedges of a portion of the Senior Notes due 2015, 2016, 2020 and 2021. In prior years, the Company entered into various fixed-to-variable interest rate swap agreements with an aggregate notional amount of $550 million and variable interest rates based on six-month LIBOR plus 0.54% and one-month LIBOR plus 1.33%. In July 2012, the Company monetized the value of these interest rate swap assets by terminating the hedging instruments. The asset value, including accrued interest through the date of termination, was $71.8 million and the amount to be amortized as a reduction of interest expense over the remaining terms of the hedged debt instruments was $65.2 million. Immediately after the termination of these interest rate swaps, the Company entered into new fixed-to-variable interest rate swap agreements on the same Senior Notes. The fixed-to-variable interest rate swap agreements that the Company entered into in July 2012 have an aggregate notional amount of $550 million and variable interest rates based on six-month LIBOR plus 2.3% and one-month LIBOR plus 3.6%. During the fourth quarter of 2012, the Company entered into additional fixed-to-variable interest rate swap agreements with an aggregate notional amount of $400 million and variable interest rates based on one-month LIBOR plus a spread ranging from 3.4% to 5.1%. These derivative financial instruments are accounted for as fair value hedges on a portion of the Senior Notes due 2015 and a portion of the Senior Notes due 2021.

The interest rate swaps associated with the Senior Notes due 2015, 2016, 2020 and 2021 are classified as liabilities with an aggregate fair value of $27 million at September 30, 2013. The interest rate swaps associated with the Senior Notes due 2016 are classified as assets with a fair value of $0.8 million at December 31, 2012. The interest rate swaps associated with the Senior Notes due 2015, 2020, and 2021 are classified as liabilities with an aggregate fair value of $3.1 million at December 31, 2012. Since inception, the fair value hedges have been highly effective; therefore, there is no impact on earnings for the three and nine months ended September 30, 2013 and 2012 as a result of hedge ineffectiveness.

Foreign Currency Risk

The Company had previously been exposed to market risk for changes in foreign exchange rates primarily under certain intercompany receivables and payables. The Company historically used foreign exchange forward contracts to mitigate the exposure of the eventual net cash inflows or outflows resulting from these intercompany transactions. As a result of the HemoCue disposition, this foreign currency risk has largely been eliminated. The Company's remaining foreign exchange exposure is not material to the Company's consolidated financial condition.

11.    STOCKHOLDERS’ EQUITY
    
Components of Comprehensive Income

The market valuation adjustments represent unrealized holding gains (losses) on available-for-sale securities, net of taxes. The net deferred loss on cash flow hedges represents deferred losses on the Company’s interest rate related derivative financial instruments designated as cash flow hedges, net of amounts reclassified to interest expense (see Note 10). For the three and nine months ended September 30, 2013 and 2012, the tax effects related to the market valuation adjustments and deferred losses were not material. Foreign currency translation adjustments are not adjusted for income taxes since they relate to indefinite investments in non-U.S. subsidiaries.


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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Changes in Accumulated Other Comprehensive (Loss) Income by Component

The changes in accumulated other comprehensive (loss) income by component for the nine months ended September 30, 2013 and 2012 were as follows:
    
 
Foreign
Currency
Translation
Adjustment
 


Market Value
Adjustment
 
Deferred Loss
 
Accumulated Other Comprehensive (Loss) Income
 
 
 
 
 
 
 
 
Balance, December 31, 2012
$
25,463

 
$
(4,326
)
 
$
(6,817
)
 
$
14,320

 
 
 
 
 
 
 
 
Other comprehensive income before reclassifications
2,702

 
274

 
—

 
2,976

Amounts reclassified from accumulated other comprehensive (loss) income
(28,761
)
 
2,847

 
630

 
(25,284
)
 
 
 
 
 
 
 
 
Net current period other comprehensive (loss) income
(26,059
)
 
3,121

 
630

 
(22,308
)
 
 
 
 
 
 
 
 
Balance, September 30, 2013
$
(596
)
 
$
(1,205
)
 
$
(6,187
)
 
$
(7,988
)

 
Foreign
Currency
Translation
Adjustment
 


Market Value
Adjustment
 
Deferred Loss
 
Accumulated Other Comprehensive (Loss) Income
 
 
 
 
 
 
 
 
Balance, December 31, 2011
$
943

 
$
(1,355
)
 
$
(7,655
)
 
$
(8,067
)
 
 
 
 
 
 
 
 
Other comprehensive income before reclassifications
21,321

 
84

 
—

 
21,405

Amounts reclassified from accumulated other comprehensive (loss) income
—

 
—

 
630

 
630

 
 
 
 
 
 
 
 
Net current period other comprehensive income
21,321

 
84

 
630

 
22,035

 
 
 
 
 
 
 
 
Balance, September 30, 2012
$
22,264

 
$
(1,271
)
 
$
(7,025
)
 
$
13,968


For the nine months ended September 30, 2013, principally all of the gross foreign currency translation adjustment of $28.8 million and principally all of the gross market value adjustment of $3.8 million, associated with the completion of the sale of HemoCue, were reclassified from accumulated other comprehensive (loss) income to income from discontinued operations, net of taxes. The remaining gross foreign currency translation adjustment, associated with the completion of the sale of Enterix, was reclassified from accumulated other comprehensive (loss) income to other operating expense, net. The remaining gross market value adjustment and gross deferred loss were reclassified from accumulated other comprehensive (loss) income to interest expense, net on the accompanying consolidated statements of operations.

For the nine months ended September 30, 2012, the gross deferred loss was reclassified from accumulated other comprehensive (loss) income to interest expense, net on the accompanying consolidated statements of operations.

Dividend Program
    
During each of the first three quarters of 2012, the Company's Board of Directors declared a quarterly cash dividend of $0.17 per common share and in November 2012, declared an increase in the quarterly cash dividend from $0.17 per common share to $0.30 per common share. This 76% increase raises the annual dividend rate to $1.20 per common share from $0.68 per common share and represents a three-fold increase from the annual rate in effect in 2011. During each of the first three quarters of 2013, the Company's Board of Directors declared a quarterly cash dividend of $0.30 per common share.
    

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Share Repurchase Plan
    
In August 2013, the Company’s Board of Directors authorized the Company to repurchase an additional $1 billion of the Company’s common stock, increasing the total available authorization at that time to $1.3 billion. The share repurchase authorization has no set expiration or termination date.
    
On April 19, 2013, the Company entered into an accelerated share repurchase agreement ("ASR") with a financial institution to repurchase $450 million of the Company’s common stock as part of the Company’s Common Stock repurchase program. The ASR is structured as a combination of two transactions: (1) a treasury stock repurchase and (2) a forward contract which permits the Company to purchase shares immediately with the final purchase price of those shares determined by the volume weighted average price of the Company's common stock during the purchase period, less a fixed discount. Under the ASR agreement, the Company paid $450 million to the financial institution and received 7.6 million shares of common stock, resulting in a final price per share of $59.46. The Company initially received 7.2 million shares of its common stock during the second quarter of 2013 and an additional 0.4 million shares upon completion of the ASR agreement during the third quarter of 2013. As of June 30, 2013, the Company recorded this transaction as an increase to treasury stock of $405 million, and recorded the remaining $45 million as a decrease to additional paid-in capital in the Company's Consolidated Balance Sheets. Upon completion of the ASR agreement in the third quarter of 2013, the Company reclassified the $45 million to treasury stock from additional paid-in capital on our Consolidated Balance Sheets.

On September 4, 2013, the Company entered into an ASR agreement with a financial institution to repurchase $350 million of the Company’s common stock as part of the Company’s Common Stock repurchase program. The ASR is structured as a combination of two transactions: (1) a treasury stock repurchase and (2) a forward contract which permits the Company to purchase shares immediately with the final purchase price of those shares determined by the volume weighted average price of the Company's common stock during the purchase period, less a fixed discount. For the three and nine months ended September 30, 2013, the Company repurchased 4.7 million shares of its common stock under the ASR at an initial price of $59.93 per share for a total of $280 million, which represents approximately 80 percent of the total shares expected to be repurchased under the ASR. The forward contract will settle the remaining shares upon the completion of the ASR in the fourth quarter of 2013. The Company recorded this transaction as an increase to treasury stock of $280 million, and recorded the remaining $70 million as a decrease to additional paid-in capital in the Company's Consolidated Balance Sheets at September 30, 2013. The $70 million recorded in additional paid-in capital will be reclassified to treasury stock upon completion of the ASR.

In addition to the ASRs previously discussed, the Company repurchased shares of its common stock on the open market. For the three months ended September 30, 2013, the Company repurchased 2.2 million shares of its common stock at an average price of $59.06 per share for $132 million. For the nine months ended September 30, 2013, the Company repurchased 3.3 million shares of its common stock at an average price of $58.66 per share for $194 million.

At September 30, 2013, $871 million remained available under the Company’s share repurchase authorizations.

For the three and nine months ended September 30, 2013, the Company reissued 0.8 million and 2.3 million shares, respectively, for employee benefit plans.
    
For the three months ended September 30, 2012, the Company repurchased 832 thousand shares of its common stock at an average price of $60.12 per share for a total of $50 million. For the nine months ended September 30, 2012, the Company repurchased 2.6 million shares of its common stock at an average price of $58.57 per share for a total of $150 million. For the three and nine months ended September 30, 2012, the Company reissued 1.2 million and 3.4 million shares, respectively, for employee benefit plans.


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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


12.    SUPPLEMENTAL CASH FLOW & OTHER DATA

Supplemental cash flow data for the three and nine months ended September 30, 2013 and 2012 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Depreciation expense
$
48,810

 
$
51,310

 
$
151,705

 
$
154,939

Amortization expense
20,159

 
19,961

 
59,278

 
60,361

 
 
 
 
 
 
 
 
Interest paid
51,767

 
47,390

 
135,738

 
129,380

Income taxes paid
127,294

 
89,338

 
332,232

 
292,147

 
 
 
 
 
 
 
 
Assets acquired under capital leases
—

 
1,215

 
2,411

 
4,170

 
 
 
 
 
 
 
 
Businesses acquired:
 

 
 

 
 

 
 

Fair value of assets acquired
—

 
—

 
241,016

 
50,800

Fair value of liabilities assumed
—

 
—

 
10,962

 
269

Fair value of net assets acquired
—

 
—

 
230,054

 
50,531

Merger consideration paid (payable), net
(54
)
 
6

 
(50,159
)
 
43

Cash paid for business acquisitions
(54
)
 
6

 
179,895

 
50,574

Less: Cash acquired
—

 
—

 
—

 
—

Business acquisitions, net of cash acquired
$
(54
)
 
$
6

 
$
179,895

 
$
50,574


Supplemental continuing operations data for the statement of operations for the three and nine months ended September 30, 2013 and 2012 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Depreciation expense
$
48,810

 
$
50,627

 
$
151,481

 
$
152,882

 
 
 
 
 
 
 
 
Interest expense
(40,657
)
 
(41,451
)
 
(121,722
)
 
(126,583
)
Interest income
689

 
642

 
1,968

 
1,922

Interest expense, net
(39,968
)
 
(40,809
)
 
(119,754
)
 
(124,661
)

13.     COMMITMENTS AND CONTINGENCIES

The Company has a line of credit with a financial institution totaling $85 million for the issuance of letters of credit (the “Letter of Credit Line”). The Letter of Credit Line, which is renewed annually, matures on November 18, 2013.
    
In support of its risk management program, to ensure the Company’s performance or payment to third parties, $60 million in letters of credit were outstanding at September 30, 2013. The letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments.
    

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Contingent Lease Obligations
    
The Company is subject to contingent obligations under certain leases and other instruments incurred in connection with real estate activities and other operations associated with LabOne, Inc., which the Company acquired in 2005, and certain of its predecessor companies. No liability has been recorded for any of these potential contingent obligations. See Note 17 to the Consolidated Financial Statements contained in the Company’s 2012 Annual Report on Form 10-K for further details.

Other Legal Matters

The Company is involved in various legal proceedings. Some of the proceedings against the Company involve claims that could be substantial in amount.

In addition to the matters described below, in the normal course of business, we have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with our activities as a provider of diagnostic testing, information and services. These legal actions may include lawsuits alleging negligence or other similar legal claims. These actions could involve claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages, and could have an adverse impact on our client base and reputation.

We are also involved, from time to time, in other reviews, investigations and proceedings by governmental agencies regarding our business, including, among other matters, operational matters, which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. The number of these reviews, investigations and proceedings has increased in recent years with regard to many firms in the healthcare services industry, including our Company.

In November 2009, the U.S. District Court for the Southern District of New York partially unsealed a civil complaint, U.S. ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Incorporated, filed against the Company under the whistleblower provisions of the federal False Claims Act. The complaint alleged, among other things, violations of the federal Anti-Kickback Statute and the federal False Claims Act in connection with the Company's pricing of laboratory services. The complaint seeks damages for alleged false claims associated with laboratory tests reimbursed by government payers, treble damages and civil penalties. In March 2011, the district court granted the Company's motion to dismiss the relators' complaint and disqualified the relators and their counsel from pursuing an action based on the facts alleged in the complaint; the relators filed a notice of appeal. In July 2011, the government filed a notice declining to intervene in the action and the Court entered a final judgment in the Company's favor. The relators' appeal is pending.
    
In November 2010, a putative class action entitled Seibert v. Quest Diagnostics Incorporated, et al. was filed against the Company and certain former officers of the Company in New Jersey state court, on behalf of the Company's sales people nationwide who were over forty years old and who either resigned or were terminated after being placed on a performance improvement plan. The complaint alleges that the defendants' conduct violates the New Jersey Law Against Discrimination ("NJLAD"), and seeks, among other things, unspecified damages. The defendants removed the complaint to the United States District Court for the District of New Jersey. The plaintiffs filed an amended complaint that added claims under ERISA. The Company filed a motion seeking to limit the application of the NJLAD to only those members of the purported class who worked in New Jersey and to dismiss the individual defendants. The motion was granted. The only remaining NJLAD claim is that of the named plaintiff. Both parties have filed summary judgment motions. The defendants' motion was granted in part, but denied as to an ERISA claim, and the plaintiff's motion was denied. The plaintiff recently moved for class certification of the ERISA claim.

In 2010, a purported class action entitled In re Celera Corp. Securities Litigation was filed in the United States District Court for the Northern District of California against Celera Corporation and certain of its directors and current and former officers. An amended complaint filed in October 2010 alleges that from April 2008 through July 22, 2009, the defendants made false and misleading statements regarding Celera's business and financial results with an intent to defraud investors. The complaint was further amended in 2011 to add allegations regarding a financial restatement. The amended complaint seeks unspecified damages on behalf of an alleged class of purchasers of Celera's stock during the period in which the alleged misrepresentations were made. The Company's motion to dismiss the complaint was denied. The parties are engaged in discovery.