DGX 06.30.2014 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 June 30, 2014
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 July 24, 2014, there were outstanding 144,414,683 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 SIX MONTHS ENDED JUNE 30, 2014 AND 2013
(unaudited)
(in millions, except per share data)


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net revenues
$
1,902

 
$
1,815

 
$
3,648

 
$
3,602

 
 
 
 
 
 
 
 
Operating costs and expenses:
 

 
 

 
 

 
 

Cost of services
1,174

 
1,094

 
2,275

 
2,186

Selling, general and administrative
440

 
418

 
855

 
866

Amortization of intangible assets
25

 
20

 
47

 
39

Other operating expense (income), net
1

 
(6
)
 
1

 
(5
)
Total operating costs and expenses
1,640

 
1,526

 
3,178

 
3,086

 
 
 
 
 
 
 
 
Operating income
262

 
289

 
470

 
516

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Interest expense, net
(42
)
 
(40
)
 
(81
)
 
(80
)
Equity in earnings of equity method investees
6

 
7

 
12

 
13

Other income, net
3

 
—

 
4

 
4

Total non-operating expenses, net
(33
)
 
(33
)
 
(65
)
 
(63
)
 
 
 
 
 
 
 
 
Income from continuing operations before taxes
229

 
256

 
405

 
453

Income tax expense
87

 
95

 
152

 
168

Income from continuing operations
142

 
161

 
253

 
285

Income from discontinued operations, net of taxes
—

 
13

 
—

 
33

Net income
142

 
174

 
253

 
318

 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
9

 
9

 
16

 
17

Net income attributable to Quest Diagnostics
$
133

 
$
165

 
$
237

 
$
301

 
 
 
 
 
 
 
 
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 
 

 
 

Income from continuing operations
$
133

 
$
152

 
$
237

 
$
268

Income from discontinued operations, net of taxes
—

 
13

 
—

 
33

Net income
$
133

 
$
165

 
$
237

 
$
301

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

 
 

 
 

 
 

Income from continuing operations
$
0.92

 
$
0.99

 
$
1.64

 
$
1.72

Income from discontinued operations
—

 
0.08

 
—

 
0.21

Net income
$
0.92

 
$
1.07

 
$
1.64

 
$
1.93

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

 
 

 
 

 
 

Income from continuing operations
$
0.92

 
$
0.99

 
$
1.63

 
$
1.71

Income from discontinued operations
—

 
0.08

 
—

 
0.21

Net income
$
0.92

 
$
1.07

 
$
1.63

 
$
1.92

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
144

 
153

 
144

 
155

Diluted
145

 
154

 
145

 
157

 
 
 
 
 
 
 
 
Dividends per common share
$
0.33

 
$
0.30

 
$
0.66

 
$
0.60

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 SIX MONTHS ENDED JUNE 30, 2014 AND 2013
(unaudited)
(in millions)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
142

 
$
174

 
$
253

 
$
318

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Currency translation
3

 
(26
)
 
2

 
(30
)
Market valuation, net of tax
3

 
—

 
3

 
—

Net deferred loss on cash flow hedges, net of tax
(3
)
 
—

 
(5
)
 
—

Other, net of tax
—

 
3

 
—

 
3

Other comprehensive income (loss)
3

 
(23
)
 
—

 
(27
)
 
 
 
 
 
 
 
 
Comprehensive income
145

 
151

 
253

 
291

Less: Comprehensive income attributable to noncontrolling interests
9

 
9

 
16

 
17

Comprehensive income attributable to Quest Diagnostics
$
136

 
$
142

 
$
237

 
$
274

The accompanying notes are an integral part of these statements.


3
Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2014 AND DECEMBER 31, 2013
(unaudited)
(in millions, except per share data)
 
June 30,
2014
 
December 31,
2013
 
 
 
 
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
144

 
$
187

Accounts receivable, net of allowance for doubtful accounts of $271 and $236 at June 30, 2014 and December 31, 2013, respectively
963

 
852

Inventories
109

 
91

Deferred income taxes
164

 
148

Prepaid expenses and other current assets
125

 
105

Total current assets
1,505

 
1,383

Property, plant and equipment, net
884

 
805

Goodwill
6,024

 
5,649

Intangible assets, net
1,117

 
896

Other assets
227

 
215

Total assets
$
9,757

 
$
8,948

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
1,038

 
$
920

Short-term borrowings and current portion of long-term debt
220

 
212

Total current liabilities
1,258

 
1,132

Long-term debt
3,738

 
3,120

Other liabilities
642

 
723

Stockholders’ equity:
 

 
 

Quest Diagnostics stockholders’ equity:
 

 
 

Common stock, par value $0.01 per share; 600 shares authorized at both June 30, 2014 and December 31, 2013; 215 shares issued at both June 30, 2014 and December 31, 2013
2

 
2

Additional paid-in capital
2,394

 
2,379

Retained earnings
5,500

 
5,358

Accumulated other comprehensive loss
(8
)
 
(8
)
Treasury stock, at cost; 71 shares at both June 30, 2014 and December 31, 2013
(3,796
)
 
(3,783
)
Total Quest Diagnostics stockholders’ equity
4,092

 
3,948

Noncontrolling interests
27

 
25

Total stockholders’ equity
4,119

 
3,973

Total liabilities and stockholders’ equity
$
9,757

 
$
8,948

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 SIX MONTHS ENDED JUNE 30, 2014 AND 2013
(unaudited)
(in millions)
 
Six Months Ended June 30,
 
2014
 
2013
Cash flows from operating activities:
 

 
 

Net income
$
253

 
$
318

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

 
 

Depreciation and amortization
156

 
142

Provision for doubtful accounts
148

 
139

Deferred income tax benefit
(26
)
 
(11
)
Stock-based compensation expense
25

 
17

Excess tax benefits from stock-based compensation arrangements
—

 
(3
)
Gain on sale of business
—

 
(22
)
Other, net
(2
)
 
(1
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(191
)
 
(213
)
Accounts payable and accrued expenses
(39
)
 
(68
)
Income taxes payable
44

 
(35
)
Other assets and liabilities, net
(4
)
 
(8
)
Net cash provided by operating activities
364

 
255

 
 
 
 
Cash flows from investing activities:
 

 
 

Business acquisitions, net of cash acquired
(723
)
 
(180
)
Proceeds from sale of businesses
—

 
266

Capital expenditures
(117
)
 
(105
)
Increase in investments and other assets
(1
)
 
—

Net cash used in investing activities
(841
)
 
(19
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
1,738

 
578

Repayments of debt
(1,159
)
 
(415
)
Purchases of treasury stock
(57
)
 
(512
)
Exercise of stock options
30

 
63

Excess tax benefits from stock-based compensation arrangements
—

 
3

Dividends paid
(91
)
 
(95
)
Distributions to noncontrolling interests
(14
)
 
(13
)
Other financing activities, net
(13
)
 
(10
)
Net cash provided by (used in) financing activities
434

 
(401
)
Net change in cash and cash equivalents
(43
)
 
(165
)
Change in cash and cash equivalents included in assets held for sale
—

 
17

Cash and cash equivalents, beginning of period
187

 
296

Cash and cash equivalents, end of period
$
144

 
$
148

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 SIX MONTHS ENDED JUNE 30, 2014 AND 2013
(unaudited)
(in millions)
 
 
 
Quest Diagnostics Stockholders’ Equity
 
 
 
 
 
Shares of
Common Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive Loss
 
Treasury
Stock, at
Cost
 
Non-
controlling
Interests
 
Total Stock-
holders’
Equity
Balance, December 31, 2013
144

 
$
2

 
$
2,379

 
$
5,358

 
$
(8
)
 
$
(3,783
)
 
$
25

 
$
3,973

Net income


 


 


 
237

 


 


 
16

 
253

Dividends declared


 


 


 
(95
)
 


 


 


 
(95
)
Distributions to noncontrolling interests


 


 


 


 


 


 
(14
)
 
(14
)
Issuance of common stock under benefit plans
1

 


 


 


 


 
9

 


 
9

Stock-based compensation expense


 


 
23

 


 


 
2

 


 
25

Exercise of stock options


 


 
(3
)
 


 


 
33

 


 
30

Shares to cover employee payroll tax withholdings on stock issued under benefit plans


 


 
(5
)
 


 


 


 


 
(5
)
Purchases of treasury stock
(1
)
 


 


 


 


 
(57
)
 


 
(57
)
Balance, June 30, 2014
144

 
$
2

 
$
2,394

 
$
5,500

 
$
(8
)
 
$
(3,796
)
 
$
27

 
$
4,119

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
Quest Diagnostics Stockholders’ Equity
 
 
 
 
 
Shares of
Common
Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
Income (Loss)
 
Treasury
Stock, at
Cost
 
Non-
controlling
Interests
 
Total Stock-
holders’
Equity
Balance, December 31, 2012
158

 
$
2

 
$
2,371

 
$
4,690

 
$
14

 
$
(2,914
)
 
$
23

 
$
4,186

Net income
 

 
 

 
 

 
301

 
 

 
 

 
17

 
318

Other comprehensive loss, net of tax


 


 


 


 
(27
)
 


 


 
(27
)
Dividends declared
 

 
 

 
 

 
(93
)
 
 

 
 

 
 

 
(93
)
Distributions to noncontrolling interests
 

 
 

 
 

 
 

 
 

 
 

 
(13
)
 
(13
)
Issuance of common stock under benefit plans
1

 


 
1

 
 

 
 

 
9

 
 

 
10

Stock-based compensation expense
 

 
 

 
15

 
 

 
 

 
2

 
 

 
17

Exercise of stock options
1

 
 

 
(5
)
 
 

 
 

 
68

 
 

 
63

Shares to cover employee payroll tax withholdings on stock issued under benefit plans


 


 
(10
)
 
 

 
 

 
 

 
 

 
(10
)
Purchases of treasury stock
(8
)
 
 

 
(45
)
 
 

 
 

 
(467
)
 
 

 
(512
)
Balance, June 30, 2013
152

 
$
2

 
$
2,327

 
$
4,898

 
$
(13
)
 
$
(3,302
)
 
$
27

 
$
3,939

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 millions 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 offer a variety of solutions for life insurers, healthcare providers and others. 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 unaudited 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. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. These interim unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s 2013 Annual Report on Form 10-K. The year-end balance sheet data was derived from the audited financial statements as of December 31, 2013, but does not include all the disclosures required by accounting principles generally accepted in the United States (“GAAP”).
    
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 stock units that contain non-forfeitable rights to dividends are participating securities and, therefore, are included in the earnings allocation in computing earnings per 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.


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


Adoption of New Accounting Standards
    
On January 1, 2014, the Company adopted a new accounting standard issued by the Financial Accounting Standards Board ("FASB") 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 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. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.
    
On January 1, 2014, the Company adopted a new accounting standard issued by the FASB on the financial statement presentation of unrecognized tax benefits. The 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 adoption of this standard did not have a material impact on the Company's consolidated financial statements.

New Accounting Pronouncements
    
In April 2014, the FASB issued an accounting standard update ("ASU") related to the presentation and reporting of discontinued operations, including the disposals of components of an entity. The ASU changes the criteria for reporting discontinued operations and requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The new guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. This ASU is effective for the Company in the first quarter of 2015 and early adoption is permitted. The impact of the adoption of this ASU on the Company’s results of operations, financial position, cash flows and disclosures will be assessed as part of any future disposal activity.

In May 2014, the FASB issued an ASU on revenue recognition. This ASU outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers. This standard supersedes existing revenue recognition requirements and eliminates most industry-specific guidance from GAAP. The core principle of the revenue recognition standard is to require an entity to recognize as revenue the amount that reflects the consideration to which it expects to be entitled in exchange for goods or services as it transfers control to its customers. The standard requires additional disclosures including those that are qualitative and quantitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This ASU is effective for the Company in the first quarter of 2017 with the option of using a full retrospective method or a modified retrospective method. The Company is currently assessing the impact of the adoption of this ASU on the Company’s results of operations, financial position and cash flows.

    


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


3.    EARNINGS PER SHARE

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 
 

 
 

Income from continuing operations
$
133

 
$
152

 
$
237

 
$
268

Income from discontinued operations, net of taxes
—

 
13

 
—

 
33

Net income attributable to Quest Diagnostics’ common stockholders
$
133

 
$
165

 
$
237

 
$
301

 
 
 
 
 
 
 
 
Income from continuing operations
$
133

 
$
152

 
$
237

 
$
268

Less: Earnings allocated to participating securities
—

 
—

 
1

 
1

Earnings available to Quest Diagnostics’ common stockholders – basic and diluted
$
133

 
$
152

 
$
236

 
$
267

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
144

 
153

 
144

 
155

Effect of dilutive securities:
 

 
 

 
 

 
 

Stock options and performance share units
1

 
1

 
1

 
2

Weighted average common shares outstanding – diluted
145

 
154

 
145

 
157

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

 
 

 
 

 
 

Income from continuing operations
$
0.92

 
$
0.99

 
$
1.64

 
$
1.72

Income from discontinued operations
—

 
0.08

 
—

 
0.21

Net income
$
0.92

 
$
1.07

 
$
1.64

 
$
1.93

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

 
 

 
 

 
 

Income from continuing operations
$
0.92

 
$
0.99

 
$
1.63

 
$
1.71

Income from discontinued operations
—

 
0.08

 
—

 
0.21

Net income
$
0.92

 
$
1.07

 
$
1.63

 
$
1.92


The following securities were not included in the calculation of diluted earnings per share due to their antidilutive effect (shares in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Stock options and performance share units
3

 
1

 
4

 
2


4.    RESTRUCTURING ACTIVITIES

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 mitigate the impact of 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.

9
Table of Contents
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in millions unless otherwise indicated)


    
The following table provides a summary of the Company's pre-tax restructuring charges associated with its Invigorate program and other restructuring activities for the three and six months ended June 30, 2014 and 2013:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Employee separation costs
$
6

 
$
8

 
$
14

 
$
42

Facility-related costs
3

 
1

 
4

 
1

Asset impairment charges
1

 
—

 
1

 
—

Accelerated vesting of stock-based compensation
—

 
—

 
—

 
1

 
 
 
 
 
 
 
 
  Total restructuring charges
$
10

 
$
9

 
$
19

 
$
44


Total restructuring charges incurred for the three and six months ended June 30, 2014 are primarily associated with
various workforce reduction initiatives as the Company continues to simplify and restructure its organization. Of the total $10 million in restructuring charges incurred during the three months ended June 30, 2014, $4 million and $6 million were recorded in cost of services and selling, general and administrative expenses, respectively. Of the total $19 million in restructuring charges incurred during the six months ended June 30, 2014, $12 million and $7 million were recorded in cost of services and selling, general and administrative expenses, respectively.

Total restructuring charges incurred during the three months ended June 30, 2013 included $8 million of employee separation costs primarily associated with various workforce reduction initiatives. Of the total $9 million in restructuring charges incurred during the three months ended June 30, 2013, $4 million and $5 million were recorded in cost of services and selling, general and administrative expenses, respectively. Total restructuring charges incurred during the six months ended June 30, 2013 included $19 million of employee separation costs primarily associated with the Company's management layer reduction initiative and $4 million under the Company's voluntary retirement program. The remaining restructuring costs incurred for the six months ended June 30, 2013 were associated with other workforce reduction initiatives. Of the total $44 million in restructuring charges incurred during the six months ended June 30, 2013, $17 million and $27 million were recorded in cost of services and selling, general and administrative expenses, respectively.

Charges for both periods presented were primarily recorded in the Company's DIS business.

The following table summarizes activity in the restructuring liability as of June 30, 2014:
 
Employee Separation Costs
 
Facility-Related Costs
 
Total
 
 
 
 
 
 
Balance, December 31, 2013
$
31

 
$
5

 
$
36

Current period charges
14

 
4

 
18

Less:
 
 
 
 
 
Cash payments
(24
)
 
(2
)
 
(26
)
 
 
 
 
 
 
Balance, June 30, 2014
$
21

 
$
7

 
$
28



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


5.     BUSINESS ACQUISITIONS

Acquisition of Solstas Lab Partners Group

On March 7, 2014, the Company completed its acquisition of Solstas Lab Partners Group and its subsidiaries ("Solstas") in an all-cash transaction valued at $572 million, or $563 million net of cash acquired. The Company financed the acquisition with borrowings under its secured receivables credit facility and senior unsecured revolving credit facility. The final consideration paid is subject to post closing adjustments related to working capital. Through the acquisition, the Company acquired all of Solstas' operations. Solstas is a full-service commercial laboratory based in Greensboro, North Carolina and operates in nine states throughout the Southeastern United States, including the Carolinas, Virginia, Tennessee, Georgia and Alabama.
    
For the three and six months ended June 30, 2014, Solstas contributed $97 million and $122 million, respectively, to the Company's consolidated net revenues and $97 million and $122 million, respectively, to operating expenses which includes approximately $3 million and $5 million of integration and transaction related costs, respectively, recorded in selling, general and administrative expenses.
    
Acquisition of Summit Health, Inc.

On April 18, 2014, the Company completed its acquisition of Summit Health, Inc. ("Summit Health") for $151 million, which consisted of cash consideration of $124 million (which includes $9 million of working capital adjustments), or $123 million net of cash acquired, estimated contingent consideration of $22 million, and $5 million associated with certain transaction related costs due to the sellers of Summit Health. The contingent consideration arrangement is dependent on the achievement of certain revenue targets in 2015 and the Company could pay up to $25 million in 2016 based on the achievement of such targets. The final consideration paid is subject to post closing adjustments related to working capital. Through the acquisition, the Company acquired all of Summit Health's operations. Summit is a provider of on-site prevention and wellness programs. For further details regarding the fair value of the estimated contingent consideration associated with the Summit Health acquisition, see Note 6.
    
Acquisition of Steward Health Care Systems, LLC

On April 16, 2014, the Company completed the acquisition of the outreach laboratory service operations of Steward Health Care Systems, LLC ("Steward") for $34 million, which consisted of cash consideration of $30 million and contingent consideration of $4 million. The assets acquired primarily represent goodwill and intangible assets, principally comprised of customer-related intangibles (see Note 7). The deferred consideration arrangement secures the seller's compliance with a non-compete agreement under which the Company will pay up to $5 million, ratably, over the next four years provided the non-compete agreement is not violated through 2018. For further details regarding the fair value of the estimated contingent consideration associated with the Steward acquisition, see Note 6.

These acquisitions were accounted for under the acquisition method of accounting. As such, the assets acquired and liabilities assumed are recorded based on their estimated fair values as of the closing date. The purchase price allocations related to the Solstas and Summit Health acquisitions are based upon the Company's preliminary estimates and assumptions that are subject to change within the measurement period. Management is currently in the process of verifying data and finalizing information related to this valuation and recording of identifiable intangible assets, certain other assets and liabilities and the corresponding effect on the amount of goodwill. All of the goodwill acquired in connection with the Solstas, Summit Health and Steward acquisitions has been allocated to the Company's DIS business.
    

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


The following tables summarizes the consideration paid and the preliminary amounts of assets acquired and liabilities assumed at the acquisition date for the Solstas and Summit Health acquisitions described above:
 
Solstas
 
 
 
Summit Health
 
 
Cash
$
572

 
 
 
$
124

 
 
Estimated fair value of contingent consideration
—

 
 
 
22

 
 
Transaction related costs due to sellers
—

 
 
 
5

 
 
Total consideration
$
572

 
 
 
$
151

 
 
 
 
 
 
 
 
 
 
 
Solstas
 
Summit Health
Allocation of purchase price:
Fair Value
 
Weighted Average Useful Life (in years)
 
Fair Value
 
Weighted Average Useful Life (in years)
Cash and cash equivalents
$
9

 
 
 
$
1

 
 
Accounts receivable, net
48

 
 
 
11

 
 
Current deferred income taxes
7

 
 
 
—

 
 
Other current assets
13

 
 
 
16

 
 
Property, plant and equipment, net
48

 
 
 
6

 
 
Goodwill
266

 
 
 
89

 
 
Intangible assets:
 
 
 
 
 
 
 
Customer relationships
203

 
20
 
33

 
15
Software
—

 
 
 
3

 
4
Trade name
7

 
2
 
2

 
1
Total intangible assets
210

 
 
 
38

 
 
Non-current deferred income taxes
42

 
 
 
—

 
 
 
 
 
 
 
 
 
 
Total assets acquired
643

 
 
 
161

 
 
 
 
 
 
 
 
 
 
Current liabilities
59

 
 
 
10

 
 
Non-current deferred income taxes
4

 
 
 
—

 
 
Other non-current liabilities
8

 
 
 
—

 
 
 
 
 
 
 
 
 
 
Total liabilities assumed
71

 
 
 
10

 
 
 
 
 
 
 
 
 
 
Net assets acquired
$
572

 
 
 
$
151

 
 
    
The goodwill recorded as part of the Solstas and Summit Health acquisitions includes the expected synergies resulting from combining the operations of the acquired business with those of the Company and the value associated with an assembled workforce that has a historical track record of identifying opportunities.

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


    
Pro Forma Combined Financial Information

The following unaudited pro forma combined financial information reflects the consolidated statement of operations of the Company as if the acquisitions of Solstas and Summit Health had occurred as of January 1, 2013. The pro forma information includes adjustments primarily related to the amortization of intangible assets acquired, interest expense associated with debt extinguished prior to the acquisitions, and integration and transaction costs related to the Solstas and Summit Health acquisitions. The pro forma combined financial information does not include the estimated annual synergies expected to be realized upon completion of the integration of Solstas and Summit Health and is not indicative of the results of operations as they would have been had the transaction been effected on the assumed date. Financial information for Steward has not been included in the table below as this acquisition is not material to the Company’s interim unaudited consolidated financial statements.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Pro forma net revenues
$
1,906

 
$
1,929

 
$
3,733

 
$
3,829

 
 
 
 
 
 
 
 
Pro forma income from continuing operations
$
143

 
$
163

 
$
252

 
$
286

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders - basic:
 
 
 
 
 
 
 
Pro forma income from continuing operations
$
0.92

 
$
0.99

 
$
1.63

 
$
1.72

 
 
 
 
 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders - diluted:
 
 
 
 
 
 
 
Pro forma income from continuing operations
$
0.92

 
$
1.00

 
$
1.62

 
$
1.71



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


6.     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
June 30, 2014
 

 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Trading securities
$
50

 
$
50

 
$
—

 
$
—

Cash surrender value of life insurance policies
30

 
—

 
30

 
—

Available-for-sale equity securities
12

 
12

 
—

 
—

Interest rate swaps
8

 
—

 
8

 
—

Put option
4

 
—

 
—

 
4

Total
$
104

 
$
62

 
$
38

 
$
4

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
84

 
$
—

 
$
84

 
$
—

Contingent consideration
26

 
—

 
—

 
26

Interest rate swaps
18

 
—

 
18

 
—

Call option
8

 
—

 
—

 
8

Forward starting interest rate swaps
8

 
—

 
8

 
—

Total
$
144

 
$
—

 
$
110

 
$
34

 
 
 
Basis of Fair Value Measurements
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets /
Liabilities
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
December 31, 2013
 

 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Trading securities
$
50

 
$
50

 
$
—

 
$
—

Cash surrender value of life insurance policies
29

 
—

 
29

 
—

Put option
4

 
—

 
—

 
4

Forward starting interest rate swaps
2

 
—

 
2

 
—

Total
$
85

 
$
50

 
$
31

 
$
4

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
84

 
$
—

 
$
84

 
$
—

Interest rate swaps
34

 
—

 
34

 
—

Call option
8

 
—

 
—

 
8

Total
$
126

 
$
—

 
$
118

 
$
8



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


A full description regarding the Company's fair value measurements is contained in Note 7 to the consolidated financial statements in the Company's 2013 Annual Report on Form 10-K.    
    
The fair value measurements of the Company's interest rate swaps and forward starting swaps are model-derived valuations as of a given date in which all significant inputs are observable in active markets including certain financial information and certain assumptions regarding past, present and future market conditions.
    
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 9 months and their fair values have been measured using a combination of discounted cash flows and the Black-Scholes-Merton option pricing model. There were no material changes in the fair value measurements using significant unobservable inputs associated with the UMass put option derivative asset or the call option derivative liability at June 30, 2014.

In April 2014, and as further detailed in Note 5, the Company completed the acquisitions of Steward and Summit Health. In connection with these acquisitions the Company recorded an aggregate contingent consideration liability of $26 million. The contingent consideration liability was classified within Level 3 measured at fair value using a probability weighted and discounted cash flow method. These measurements are based on externally obtained inputs and management's probability assessments of the occurrence of triggering events, appropriately discounted considering the uncertainties associated with the obligations, as well as the likelihood of achieving financial targets. The current probability estimate of the occurrence of such triggering events associated with the amounts the Company could be obligated to pay in future periods is between 5% and 95%. The probability-weighted cash flows were then discounted using a discount rate between 1.5% and 2.8%. The contingent consideration associated with Summit Health is projected to be paid in the first quarter of 2016, with a maximum payment of $25 million. The contingent consideration associated with Steward is projected to be paid out in four equal annual installments beginning in 2015, with a maximum payout of $5 million in total.

Investment in available-for-sale equity securities represents an investment that the Company previously accounted for under the cost method as it consisted of common shares of a privately held entity. In April 2014, the Company's investee registered its shares through an initial public offering on the Euronext Paris exchange. As a result of the initial public offering, the Company reclassified the shares to an investment in available-for-sale equity securities. The Company's investment in available-for-sale equity securities is classified within Level 1 of the fair value hierarchy because the fair value is obtained from quoted prices in an active market.

The following table provides a reconciliation of the beginning and ending balances of the contingent consideration measured using significant and unobservable inputs:
 
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
 
Contingent Consideration
Balance, December 31, 2013
$
—

Purchases, additions and issuances
26

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

Transfers in and out of Level 3
—

Balance, June 30, 2014
$
26

    
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 June 30, 2014, the fair value of the Company’s debt was estimated at $4.3 billion, which exceeded the carrying value by $342 million. At December 31, 2013, the fair value of the Company's debt was estimated at $3.5 billion, which exceeded the carrying value by $184 million. Principally all of the

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


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.

7.    GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill for the six months ended June 30, 2014 and for the year ended December 31, 2013 are as follows:
 
June 30,
2014
 
December 31,
2013
Balance at beginning of period
$
5,649

 
$
5,536

Goodwill acquired during the period
375

 
150

Write-off associated with sale of a business during the period
—

 
(37
)
Balance at end of period
$
6,024

 
$
5,649


Principally all of the Company’s goodwill as of June 30, 2014 and December 31, 2013 is associated with its DIS business.

For the six months ended June 30, 2014, goodwill acquired was principally associated with the Solstas, Summit Health and Steward acquisitions, of which $104 million is deductible for tax purposes. Acquisitions during the year also resulted in $268 million of intangible assets, principally comprised of customer-related intangibles and trade names. For further details regarding business acquisitions, see Note 5.

For the year ended December 31, 2013, goodwill acquired was principally associated with the UMass, ATN, Dignity and ConVerge acquisitions, of which $135 million is deductible for tax purposes. These acquisitions also resulted in $108 million of intangible assets, principally comprised of customer-related intangibles. For further details regarding the Company's 2013 acquisitions, see Note 5 to the consolidated financial statements in the Company's 2013 Annual Report on Form 10-K.    

For the year ended December 31, 2013, $37 million of goodwill was written-off in conjunction with the sale of Enterix. For further details regarding the sale of Enterix, see Note 6 to the consolidated financial statements in the Company's 2013 Annual Report on Form 10-K.    
    

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


Intangible assets at June 30, 2014 and December 31, 2013 consisted of the following:

 
Weighted
Average
Amortization
Period
(in years)
 
June 30, 2014
 
December 31, 2013
 
 
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 

 
 

 
 

 
 

 
 

 
 

Customer-related intangibles
18
 
$
927

 
$
(233
)
 
$
694

 
$
670

 
$
(210
)
 
$
460

Non-compete agreements
4
 
43

 
(32
)
 
11

 
43

 
(27
)
 
16

Technology
14
 
119

 
(33
)
 
86

 
119

 
(28
)
 
91

Other
8
 
152

 
(71
)
 
81

 
141

 
(57
)
 
84

Total
16
 
1,241

 
(369
)
 
872

 
973

 
(322
)
 
651

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 

 
 

 
 

 
 

 
 

Trade names
 
 
244

 
—

 
244

 
244

 
—

 
244

Other
 
 
1

 
—

 
1

 
1

 
—

 
1

Total intangible assets
 
$
1,486

 
$
(369
)
 
$
1,117

 
$
1,218

 
$
(322
)
 
$
896


Amortization expense related to intangible assets was $25 million and $20 million for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014 and 2013, amortization expense related to intangible assets was $47 million and $39 million, respectively.
 
The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of June 30, 2014 is as follows:

Year Ending December 31,
 

Remainder of 2014
$
47

2015
84

2016
74

2017
71

2018
64

2019
62

Thereafter
470

Total
$
872



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


8.    DEBT

Long-term debt at June 30, 2014 and December 31, 2013 consisted of the following:
 
June 30,
2014
 
December 31,
2013
 
 
 
 
Floating Rate Senior Notes due March 2014
$
—

 
$
200

5.45% Senior Notes due November 2015
500

 
500

3.20% Senior Notes due April 2016
306

 
307

6.40% Senior Notes due July 2017
375

 
375

2.70% Senior Notes due April 2019
300

 
—

4.75% Senior Notes due January 2020
525

 
520

4.70% Senior Notes due April 2021
544

 
533

4.25% Senior Notes due April 2024
304

 
—

6.95% Senior Notes due July 2037
421

 
421

5.75% Senior Notes due January 2040
439

 
439

Other
49

 
37

 
 
 
 
Total long-term debt
3,763

 
3,332

Less: current portion of long-term debt
25

 
212

 
 
 
 
Total long-term debt, net of current portion
$
3,738

 
$
3,120


2014 Senior Notes Offering

In March 2014, the Company completed a $600 million senior notes offering (the “2014 Senior Notes”) that was sold in two tranches: (a) $300 million aggregate principal amount of 2.70% senior notes due April 2019; and (b) $300 million aggregate principal amount of 4.25% senior notes due April 2024, issued at a discount of $1 million. These senior notes are unsecured obligations of the Company and rank equally with the Company's other senior unsecured obligations. None of the Company's senior notes have a sinking fund requirement.

The Company incurred $5 million of costs associated with the 2014 Senior Notes, which is included in other assets and is being amortized over the term of the related debt.
    

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


Senior Unsecured Revolving Credit Facility

In April 2014, the Company amended and restated the agreement for the $750 million senior unsecured revolving credit facility (the “Credit Facility”) entered into in September 2011. The amended and restated Credit Facility matures in April 2019. Under the Credit Facility, the Company can issue letters of credit totaling $150 million. At June 30, 2014, letters of credit totaling less than $1 million were issued under the Credit Facility. Interest on the Credit Facility is based on certain published rates plus an applicable margin that will vary over a range from 75 basis points to 163 basis points based on changes in the Company's public debt ratings. At the option of the Company, it may elect to lock into LIBOR-based interest rates for periods up to six months. Interest on any outstanding amounts not covered under LIBOR-based interest rate contracts is based on an alternate base rate, which is calculated by reference to the prime rate, the federal funds rate or an adjusted LIBOR rate. At both June 30, 2014 and December 31, 2013, the Company's borrowing rate for LIBOR-based loans under the Credit Facility was LIBOR plus 1.125%. The Credit Facility contains various covenants, including the maintenance of certain financial ratios, which could impact the Company's ability to, among other things, incur additional indebtedness. At both June 30, 2014 and December 31, 2013, there were no outstanding borrowings under the Company’s senior unsecured revolving credit facility.
    
Maturities of Long-Term Debt    

As of June 30, 2014, long-term debt matures as follows:

Year Ending December 31,
 
Remainder of 2014
$
9

2015
521

2016
309

2017
382

2018
3

2019
301

Thereafter
2,225

 
 
Total maturities of long-term debt
3,750

Unamortized discount
(21
)
Fair value basis adjustments attributable to hedged debt
34

 
 
Total long-term debt
3,763

Current portion of long-term debt
25

 
 
Total long-term debt, net of current portion
$
3,738


For further discussion regarding the Company's debt, see Note 13 to the consolidated financial statements in the Company's 2013 Annual Report on Form 10-K.    

9.    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.

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


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

 
June 30, 2014
 
December 31, 2013
 
Balance Sheet
Classification
 
Fair Value
 
Balance Sheet
Classification
 
Fair Value
Derivatives Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Interest rate swaps
Other assets
 
$
8

 
Other assets
 
$
—

Forward starting interest rate swaps
Other assets
 
—

 
Other assets
 
2

  Total Asset Derivatives
 
 
8

 
 
 
2

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Interest rate swaps
Other liabilities
 
18

 
Other liabilities
 
34

Forward starting interest rate swaps
Other liabilities
 
8

 
Other liabilities
 
—

Total Liability Derivatives
 
 
26

 
 
 
34

 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Put option
Prepaid expenses and other current assets
 
4

 
Other assets
 
4

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Call option
Accounts payable and accrued expenses
 
8

 
Other liabilities
 
8

 
 
 
 
 
 
 
 
Total Net Derivatives Liabilities
 
 
$
(22
)
 
 
 
$
(36
)

A full description regarding the Company's use of derivative financial instruments is contained in Note 14 to the consolidated financial statements in the Company's 2013 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 millions unless otherwise indicated)


    
Interest Rate Derivatives – Cash Flow Hedges
    
In March 2014, the Company entered into interest rate lock agreements with several financial institutions for a total notional amount of $175 million (the "Treasury Lock Agreements"). The Treasury Lock Agreements, which had an original maturity date of March 28, 2014, were entered into to hedge part of the Company's interest rate exposure associated with the variability in future cash flows attributable to changes in the five-year U.S. treasury rates related to the planned issuance of debt securities. In connection with the Company's senior notes offering in March 2014 (see note 8), the Company settled the Treasury Lock Agreements, which were accounted for as cash flow hedges. The loss on settlement of the Treasury Lock Agreements was not material. During the fourth quarter of 2013 and the first quarter of 2014, the Company entered into various forward starting interest rate swap agreements (the "Forward Starting Interest Rate Swap Agreements") for an aggregate notional amount of $150 million. The Forward Starting Interest Rate Swap Agreements have fixed interest rates ranging from 3.570% to 3.788%. The Forward Starting Interest Rate Swap Agreements are 21 to 24 month forward agreements that cover a ten-year hedging period and were entered into to hedge part of the Company's interest rate exposure associated with forecasted new debt issuances related to the refinancing of certain debt maturing through 2016. Through time 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, related to the Company's cash flow hedges as of June 30, 2014 and December 31, 2013 was $10 million and $5 million, respectively. The loss recognized on the Company's cash flow hedges for the three and six months ended June 30, 2014 and 2013, 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 into interest expense within the next twelve months is $1 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. In July 2012, the Company entered into fixed-to-variable interest rate swap agreements on a portion of the Senior Notes due 2016 and 2020. These interest rate swap agreements 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. In November 2013, the Company terminated the interest rate swaps associated with the Senior Notes due 2015 and concurrently entered into additional fixed-to-variable interest rate swaps agreements. The fixed-to-variable interest rate swap agreements entered into in November 2013 have an aggregate notional amount of $200 million and variable interest rates based on one-month LIBOR plus a spread ranging from 2.45% to 2.46% and are accounted for as fair value hedges on a portion of the Senior Notes due 2021. In March 2014, the Company entered into various fixed-to-variable interest rate swap agreements which have a notional amount of $250 million and variable interest rates based on one-month LIBOR plus a spread ranging from 1.54% to 1.59% and are accounted for as fair value hedges of a portion of the Senior Notes due 2024.

The interest rate swaps associated with the Senior Notes due 2020 and those associated with a portion of the Senior Notes due 2021 are classified as liabilities with an aggregate fair value of $18 million at June 30, 2014. The interest rate swaps associated with the Senior Notes due 2016, the Senior Notes due 2024, and those associated with an additional portion of Senior Notes due 2021 are classified as assets with an aggregate fair value of $8 million at June 30, 2014. The interest rate swaps associated with the Senior Notes due 2016, 2020, and 2021 are classified as liabilities with an aggregate fair value of $34 million at December 31, 2013. Since inception, the fair value hedges have been highly effective; therefore, there is no impact on earnings for the three and six months ended June 30, 2014 and 2013 as a result of hedge ineffectiveness.


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


10.    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 9). For the three and six months ended June 30, 2014 and 2013, the tax effects related to the market valuation adjustments, deferred losses and other were not material. Foreign currency translation adjustments are not adjusted for income taxes since they relate to indefinite investments in non-U.S. subsidiaries.

Dividend Program
    
During each of the first two quarters of 2014, the Company's Board of Directors declared a quarterly cash dividend of $0.33 per common share. During each of the quarters of 2013, the Company's Board of Directors declared a quarterly cash dividend of $0.30 per common share.
    
Share Repurchase Program
    
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.

For the three months ended June 30, 2014, the Company repurchased 0.4 million shares of its common stock at an average price of $57.74 per share for $25 million. For the six months ended June 30, 2014, the Company repurchased 1.0 million shares of its common stock at an average price of $54.84 per share for $57 million. For the three and six months ended June 30, 2014, the Company reissued 0.4 million shares and 0.8 million shares, respectively, for employee benefit plans. At June 30, 2014, $771 million remained available under the Company’s share repurchase authorizations.    
    
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 was structured as a combination of two transactions: (1) a treasury stock repurchase and (2) a forward contract which permitted 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 months ended June 30, 2013, the Company repurchased 7.2 million shares of its common stock under the ASR at a price of $55.92 per share for a total of $405 million, which represented approximately 90 percent of the total shares expected to be repurchased under the ASR. The forward contract settled the remaining shares upon the completion of the ASR in the third quarter of 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 sheet at June 30, 2013. The $45 million recorded in additional paid-in capital was reclassified to treasury stock upon completion of the ASR in the third quarter of 2013.

In addition to the ASR previously discussed, the Company repurchased shares of its common stock on the open market. For the six months ended June 30, 2013, the Company repurchased 1.1 million shares of its common stock at an average price of $57.81 per share for a total of $62 million. For the three and six months ended June 30, 2013, the Company reissued 1.1 million shares and 1.5 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 millions unless otherwise indicated)


11.    SUPPLEMENTAL CASH FLOW & OTHER DATA

Supplemental cash flow data for the three and six months ended June 30, 2014 and 2013 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Depreciation expense
$
56

 
$
52

 
$
109

 
$
103

Amortization expense
25

 
20

 
47

 
39

 
 
 
 
 
 
 
 
Interest paid
30

 
32

 
82

 
84

Income taxes paid
129

 
121

 
138

 
205

 
 
 
 
 
 
 
 
Assets acquired under capital leases
8

 
2

 
10

 
2

Increase in accounts payable associated with capital expenditures
33

 
—

 
12

 
—

 
 
 
 
 
 
 
 
Businesses acquired:
 

 
 

 
 

 
 

Fair value of assets acquired
199

 
90

 
845

 
241

Fair value of liabilities assumed
12

 
—

 
82

 
11

 
 
 
 
 
 
 
 
Fair value of net assets acquired
187

 
90

 
763

 
230

Merger consideration paid (payable), net
(30
)
 
—

 
(30
)
 
(50
)
 
 
 
 
 
 
 
 
Cash paid for business acquisitions
157

 
90

 
733

 
180

Less: Cash acquired
1

 
—

 
10

 
—

 
 
 
 
 
 
 
 
Business acquisitions, net of cash acquired
$
156

 
$
90

 
$
723

 
$
180


Supplemental continuing operations data for the statement of operations for the three and six months ended June 30, 2014 and 2013 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014