DGX 06.30.2013 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 June 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 July 19, 2013, there were outstanding 151,886,161 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, 2013 AND 2012
(unaudited)
(in thousands, except per share data)


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net revenues
$
1,815,740

 
$
1,878,352

 
$
3,602,387

 
$
3,787,049

 
 
 
 
 
 
 
 
Operating costs and expenses:
 

 
 

 
 

 
 

Cost of services
1,093,666

 
1,101,924

 
2,185,510

 
2,211,088

Selling, general and administrative
418,548

 
424,085

 
866,407

 
907,337

Amortization of intangible assets
19,756

 
18,808

 
39,040

 
37,633

Other operating (income) expense, net
(4,951
)
 
183

 
(4,285
)
 
(180
)
Total operating costs and expenses
1,527,019

 
1,545,000

 
3,086,672

 
3,155,878

 
 
 
 
 
 
 
 
Operating income
288,721

 
333,352

 
515,715

 
631,171

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Interest expense, net
(39,921
)
 
(41,750
)
 
(79,786
)
 
(83,852
)
Equity earnings in unconsolidated joint ventures
7,253

 
7,372

 
13,399

 
14,981

Other income (expense), net
258

 
(1,255
)
 
3,649

 
3,501

Total non-operating expenses, net
(32,410
)
 
(35,633
)
 
(62,738
)
 
(65,370
)
 
 
 
 
 
 
 
 
Income from continuing operations before taxes
256,311

 
297,719

 
452,977

 
565,801

Income tax expense
94,491

 
113,726

 
167,828

 
216,288

Income from continuing operations
161,820

 
183,993

 
285,149

 
349,513

Income from discontinued operations, net of taxes
12,803

 
2,480

 
33,091

 
5,475

Net income
174,623

 
186,473

 
318,240

 
354,988

 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
9,155

 
8,768

 
16,993

 
18,165

Net income attributable to Quest Diagnostics
$
165,468

 
$
177,705

 
$
301,247

 
$
336,823

 
 
 
 
 
 
 
 
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 
 

 
 

Income from continuing operations
$
152,665

 
$
175,225

 
$
268,156

 
$
331,348

Income from discontinued operations, net of taxes
12,803

 
2,480

 
33,091

 
5,475

Net income
$
165,468

 
$
177,705

 
$
301,247

 
$
336,823

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

 
 

 
 

 
 

Income from continuing operations
$
0.99

 
$
1.10

 
$
1.72

 
$
2.08

Income from discontinued operations
0.08

 
0.02

 
0.21

 
0.04

Net income
$
1.07

 
$
1.12

 
$
1.93

 
$
2.12

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

 
 

 
 

 
 

Income from continuing operations
$
0.99

 
$
1.09

 
$
1.71

 
$
2.06

Income from discontinued operations
0.08

 
0.02

 
0.21

 
0.04

Net income
$
1.07

 
$
1.11

 
$
1.92

 
$
2.10

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
152,708

 
158,477

 
155,403

 
158,385

Diluted
154,059

 
159,784

 
156,733

 
159,745

 
 
 
 
 
 
 
 
Dividends per common share
$
0.30

 
$
0.17

 
$
0.60

 
$
0.34

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, 2013 AND 2012
(unaudited)
(in thousands)

 
Three Months Ended June 30,
Six Months Ended June 30,
 
2013
 
2012
2013
 
2012
Net income
$
174,623

 
$
186,473

$
318,240

 
$
354,988

 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
Currency translation
(26,264
)
 
(19,183
)
(30,651
)
 
(967
)
Market valuation, net of tax
363

 
44

305

 
245

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

 
210

420

 
420

Other, net of tax
2,827

 

2,837

 

Other comprehensive loss
(22,864
)
 
(18,929
)
(27,089
)
 
(302
)
 
 
 
 
 
 
 
Comprehensive income
151,759

 
167,544

291,151

 
354,686

Less: Comprehensive income attributable to noncontrolling interests
9,155

 
8,768

16,993

 
18,165

Comprehensive income attributable to Quest Diagnostics
$
142,604

 
$
158,776

$
274,158

 
$
336,521

The accompanying notes are an integral part of these statements.


3

Table of Contents                                             

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

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
148,342

 
$
295,586

Accounts receivable, net of allowance for doubtful accounts of $245,975 and $235,747 at June 30, 2013 and December 31, 2012, respectively
946,753

 
867,010

Inventories
89,442

 
93,050

Deferred income taxes
158,786

 
174,209

Prepaid expenses and other current assets
126,376

 
90,950

Current assets held for sale

 
40,192

Total current assets
1,469,699

 
1,560,997

Property, plant and equipment, net
751,814

 
755,831

Goodwill
5,665,845

 
5,535,848

Intangible assets, net
929,421

 
872,172

Other assets
219,406

 
204,631

Non-current assets held for sale

 
354,384

Total assets
$
9,036,185

 
$
9,283,863

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
915,927

 
$
1,016,191

Short-term borrowings and current portion of long-term debt
374,764

 
9,404

Current liabilities held for sale

 
22,008

Total current liabilities
1,290,691

 
1,047,603

Long-term debt
3,121,601

 
3,354,173

Other liabilities
685,327

 
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 June 30, 2013 and December 31, 2012; 215,358 shares and 215,075 shares issued at June 30, 2013 and December 31, 2012, respectively
2,154

 
2,151

Additional paid-in capital
2,326,926

 
2,370,677

Retained earnings
4,898,331

 
4,690,378

Accumulated other comprehensive (loss) income
(12,769
)
 
14,320

Treasury stock, at cost; 63,538 shares and 56,744 shares at June 30, 2013 and December 31, 2012, respectively
(3,302,686
)
 
(2,914,479
)
Total Quest Diagnostics stockholders’ equity
3,911,956

 
4,163,047

Noncontrolling interests
26,610

 
22,682

Total stockholders’ equity
3,938,566

 
4,185,729

Total liabilities and stockholders’ equity
$
9,036,185

 
$
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 SIX MONTHS ENDED JUNE 30, 2013 AND 2012
(unaudited)
(in thousands)

 
Six Months Ended June 30,
 
2013
 
2012
Cash flows from operating activities:
 

 
 

Net income
$
318,240

 
$
354,988

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

 
 

Depreciation and amortization
142,014

 
144,029

Provision for doubtful accounts
139,449

 
147,183

Deferred income tax benefit
(10,991
)
 
(11,305
)
Stock-based compensation expense
16,515

 
34,178

Excess tax benefits from stock-based compensation arrangements
(2,736
)
 
(3,929
)
Other, net
(23,522
)
 
264

Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(213,312
)
 
(181,918
)
Accounts payable and accrued expenses
(68,198
)
 
(87,698
)
Income taxes payable
(34,547
)
 
28,648

Other assets and liabilities, net
(7,588
)
 
(12,306
)
Net cash provided by operating activities
255,324

 
412,134

 
 
 
 
Cash flows from investing activities:
 

 
 

Business acquisitions, net of cash acquired
(179,949
)
 
(50,568
)
Proceeds from sale of business
266,041

 

Capital expenditures
(104,718
)
 
(77,408
)
Increase in investments and other assets
(736
)
 
(2,565
)
Net cash used in investing activities
(19,362
)
 
(130,541
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
578,082

 
685,000

Repayments of debt
(414,792
)
 
(899,646
)
Purchases of treasury stock
(511,630
)
 
(100,000
)
Exercise of stock options
63,257

 
90,579

Excess tax benefits from stock-based compensation arrangements
2,736

 
3,929

Dividends paid
(95,267
)
 
(53,981
)
Distributions to noncontrolling interests
(13,447
)
 
(15,795
)
Other financing activities, net
(9,379
)
 
17,177

Net cash used in financing activities
(400,440
)
 
(272,737
)
 
 
 
 
Net change in cash and cash equivalents
(164,478
)
 
8,856

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
$
148,342

 
$
173,742

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, 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


 


 


 
301,247

 


 


 
16,993

 
318,240

Other comprehensive loss, net of tax


 


 


 


 
(27,089
)
 


 


 
(27,089
)
Dividends declared


 


 


 
(93,294
)
 


 


 


 
(93,294
)
Distributions to noncontrolling interests


 


 


 


 


 


 
(13,447
)
 
(13,447
)
Issuance of common stock under benefit plans
664

 
5

 
1,256

 


 


 
8,922

 


 
10,183

Stock-based compensation expense


 


 
14,718

 


 


 
1,797

 


 
16,515

Exercise of stock options
1,306

 


 
(4,454
)
 


 


 
67,704

 
7

 
63,257

Shares to cover employee payroll tax withholdings on stock issued under benefit plans
(172
)
 
(2
)
 
(9,881
)
 


 


 


 


 
(9,883
)
Tax benefits associated with stock-based compensation plans


 


 
(390
)
 


 


 


 


 
(390
)
Purchases of treasury stock
(8,309
)
 


 
(45,000
)
 


 


 
(466,630
)
 


 
(511,630
)
Other


 


 


 


 


 


 
375

 
375

Balance, June 30, 2013
151,820

 
$
2,154

 
$
2,326,926

 
$
4,898,331

 
$
(12,769
)
 
$
(3,302,686
)
 
$
26,610

 
$
3,938,566

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
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
 

 
 

 
 

 
336,823

 
 

 
 

 
18,165

 
354,988

Other comprehensive loss, net of tax


 


 


 


 
(302
)
 


 


 
(302
)
Dividends declared
 

 
 

 
 

 
(54,115
)
 
 

 
 

 
 

 
(54,115
)
Distributions to noncontrolling interests
 

 
 

 
 

 
 

 
 

 
 

 
(15,795
)
 
(15,795
)
Issuance of common stock under benefit plans
996

 
8

 
1,523

 
 

 
 

 
8,582

 
 

 
10,113

Stock-based compensation expense
 

 
 

 
32,393

 
 

 
 

 
1,785

 
 

 
34,178

Exercise of stock options
1,950

 
 

 
(8,845
)
 
 

 
 

 
99,424

 
 

 
90,579

Shares to cover employee payroll tax withholdings on stock issued under benefit plans
(342
)
 
(3
)
 
(19,721
)
 
 

 
 

 
 

 
 

 
(19,724
)
Tax benefits associated with stock-based compensation plans
 

 
 

 
4,780

 
 

 
 

 
 

 
 

 
4,780

Purchases of treasury stock
(1,729
)
 
 

 
 

 
 

 
 

 
(100,000
)
 
 

 
(100,000
)
Other
 

 
 

 
 

 
 

 
 

 
 

 
1,434

 
1,434

Balance, June 30, 2012
158,295

 
$
2,151

 
$
2,357,648

 
$
4,546,307

 
$
(8,369
)
 
$
(2,902,533
)
 
$
25,931

 
$
4,021,135

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 our 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 six months ended June 30, 2013 and 2012. See Note 12 for a further discussion of discontinued operations.

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 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

7

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


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 is currently assessing the impacts of this new standard.
    

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 June 30,
Six Months Ended June 30,
 
2013
 
2012
2013
 
2012
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

 

 
 

Income from continuing operations
$
152,665

 
$
175,225

$
268,156

 
$
331,348

Income from discontinued operations, net of taxes
12,803

 
2,480

33,091

 
5,475

Net income attributable to Quest Diagnostics’ common stockholders
$
165,468

 
$
177,705

$
301,247

 
$
336,823

 
 
 
 
 
 
 
Income from continuing operations
$
152,665

 
$
175,225

$
268,156

 
$
331,348

Less: Earnings allocated to participating securities
562

 
712

927

 
1,306

Earnings available to Quest Diagnostics’ common stockholders – basic and diluted
$
152,103

 
$
174,513

$
267,229

 
$
330,042

 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
152,708

 
158,477

155,403

 
158,385

Effect of dilutive securities:
 

 
 

 

 
 

Stock options and performance share units
1,351

 
1,307

1,330

 
1,360

Weighted average common shares outstanding – diluted
154,059

 
159,784

156,733

 
159,745

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

 
 

 

 
 

Income from continuing operations
$
0.99

 
$
1.10

$
1.72

 
$
2.08

Income from discontinued operations
0.08

 
0.02

0.21

 
0.04

Net income
$
1.07

 
$
1.12

$
1.93

 
$
2.12

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

 
 

 

 
 

Income from continuing operations
$
0.99

 
$
1.09

$
1.71

 
$
2.06

Income from discontinued operations
0.08

 
0.02

0.21

 
0.04

Net income
$
1.07

 
$
1.11

$
1.92

 
$
2.10


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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Stock options and performance share units
1,457

 
2,463

 
1,771

 
2,229


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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)



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 second 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 six months ended June 30, 2013:

 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
Employee separation costs
$
7,762

 
$
41,355

Facility-related costs
1,234

 
1,243

Accelerated vesting of stock-based compensation

 
1,284

  Total restructuring charges
8,996

 
43,882

 
 
 
 
Other integration costs
$
8,413

 
$
13,257

Total restructuring and integration charges
$
17,409

 
$
57,139


Of the total employee separation costs incurred during the three and six months ended June 30, 2013, $0.3 million and $18.5 million, respectively, represent costs associated with the Company's management layer reduction initiative, and $1.4 million and $4.4 million, respectively, represent costs incurred under the Company's voluntary retirement program. The remaining employee separation costs incurred during the three and six months ended June 30, 2013 represent other actions the Company has taken to restructure its business.

Of the total $17.4 million in restructuring and integration charges incurred during the three months ended June 30, 2013, $5.6 million and $11.8 million was recorded in cost of services and selling, general and administrative expenses, respectively. Of the total $57.1 million in restructuring and integration charges incurred during the six months ended June 30, 2013, $22.3 million and $34.8 million was recorded in cost of services and selling, general and administrative expenses, respectively. These charges were primarily recorded in the Company's DIS business for both periods presented.

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

 
$
257

 
$
40,275

Current period charges
41,355

 
1,243

 
42,598

Other / adjustments
2,915

 

 
2,915

Less:
 
 
 
 
 
Cash payments
(36,775
)
 

 
(36,775
)
Balance, June 30, 2013
$
47,513

 
$
1,500

 
$
49,013


In addition to the restructuring and integration charges noted above, the Company incurred approximately $1.4 million and $6.1 million during the three and six months ended June 30, 2013, respectively, primarily associated with professional fees

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


incurred in connection with further restructuring and integration of the Company's business. The remainder for both periods represent costs related to the integration of recent acquisitions with the Company's operations.

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 7). 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 vesting period of approximately two years (see Note 6).

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 7).

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 7).
    
Pro Forma Combined Financial Information

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.
    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands 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, 2013
 

 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Trading securities
$
47,362

 
$
47,362

 
$

 
$

Cash surrender value of life insurance policies
27,004

 

 
27,004

 

Put option
7,400

 

 

 
7,400

Available-for-sale equity securities
1,113

 

 

 
1,113

Foreign currency forward contracts
134

 

 
134

 

Total
$
83,013

 
$
47,362

 
$
27,138

 
$
8,513

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
79,410

 
$

 
$
79,410

 
$

Interest rate swaps
30,694

 

 
30,694

 

Call option
9,940

 

 

 
9,940

Total
$
120,044

 
$

 
$
110,104

 
$
9,940

 
 
 
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.    
    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


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 vesting period of approximately two years 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

 
(850
)
 
(850
)
Included in other comprehensive income (loss)
501

 

 
501

Transfers in and out of Level 3

 

 

Balance, June 30, 2013
$
1,113

 
$
7,400

 
$
8,513


 
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
 
(868
)
Transfers in and out of Level 3
 

Balance, June 30, 2013
 
$
9,940


The unrealized gains and losses included in earnings for the six months ended June 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 June 30, 2013, the fair value of the Company’s debt was estimated at $3.8 billion, which exceeded the carrying value by $262 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.


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


7.    GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill for the six months ended June 30, 2013 and for the year ended December 31, 2012 are as follows:
 
June 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 business during the period

 
(85,173
)
Reclassification to non-current assets held for sale

 
(218,795
)
(Decrease) increase related to foreign currency translation
(195
)
 
15,907

Balance at end of period
$
5,665,845

 
$
5,535,848


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

For the six months ended June 30, 2013, goodwill acquired was principally associated with the UMass, Dignity and ATN acquisitions, which is deductible for tax purposes. These acquisitions resulted in $94.9 million of intangible assets, principally comprised of customer-related intangibles.

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.    
    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Intangible assets at June 30, 2013 and December 31, 2012 consisted of the following:

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

 
 

 
 

 
 

 
 

 
 

Customer-related intangibles
18
 
$
657,901

 
$
(190,909
)
 
$
466,992

 
$
566,701

 
$
(173,516
)
 
$
393,185

Non-compete agreements
4
 
41,651

 
(21,893
)
 
19,758

 
38,551

 
(17,123
)
 
21,428

Technology
14
 
131,040

 
(31,002
)
 
100,038

 
131,040

 
(25,144
)
 
105,896

Other
8
 
143,806

 
(48,652
)
 
95,154

 
141,818

 
(37,634
)
 
104,184

Total
16
 
974,398

 
(292,456
)
 
681,942

 
878,110

 
(253,417
)
 
624,693

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 

 
 

 
 

 
 

 
 

Tradenames
 
 
246,200

 

 
246,200

 
246,200

 

 
246,200

In-process research and development
 
 
120

 

 
120

 
120

 

 
120

Other
 
 
1,159

 

 
1,159

 
1,159

 

 
1,159

Total intangible assets
 
$
1,221,877

 
$
(292,456
)
 
$
929,421

 
$
1,125,589

 
$
(253,417
)
 
$
872,172


Amortization expense related to intangible assets was $19.8 million and $18.8 million for the three months ended June 30, 2013 and 2012, respectively. For the six months ended June 30, 2013 and 2012, amortization expense related to intangible assets was $39.0 million and $37.6 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, 2013 is as follows:

Year Ending December 31,
 

Remainder of 2013
$
40,539

2014
77,376

2015
65,963

2016
58,922

2017
55,168

2018
48,428

Thereafter
335,546

Total
$
681,942


8.    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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands 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, 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
 
30,694

 
Other liabilities
 
3,129

 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Put option
Other assets
 
7,400

 
Other assets
 

Foreign currency forward contracts
Other current assets
 
134

 
Other current assets
 
403

 
 
 
7,534

 
 
 
403

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Call option
Other liabilities
 
9,940

 
Other liabilities
 

 
 
 
 
 
 
 
 
Total Net Derivatives Liabilities
 
 
$
(33,100
)
 
 
 
$
(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.

    
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 June 30, 2013 and December 31, 2012 was $6.4 million and $6.8 million, respectively. The loss recognized on the Company's cash flow hedges for the three and six months ended June 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.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


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 $30.7 million at June 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 six months ended June 30, 2013 and 2012 as a result of hedge ineffectiveness.

Foreign Currency Risk

The Company is exposed to market risk for changes in foreign exchange rates primarily under certain intercompany receivables and payables. Foreign exchange forward contracts are used to mitigate the exposure of the eventual net cash inflows or outflows resulting from these intercompany transactions. The objective is to hedge a portion of the forecasted foreign currency risk over a rolling 12-month time horizon to mitigate the eventual impacts of changes in foreign exchange rates on the cash flows of the intercompany transactions. The Company does not designate these derivative instruments as hedges under current accounting standards unless the benefits of doing so are material. The Company's foreign exchange exposure is not material to the Company's consolidated financial condition or results of operations. The Company does not hedge its net investment in non-U.S. subsidiaries because it views those investments as long-term in nature.

9.    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 8). For the three and six months ended June 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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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 six months ended June 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 (loss) income before reclassifications
(1,358
)
 
305

 

 
(1,053
)
Amounts reclassified from accumulated other comprehensive (loss) income
(29,293
)
 
2,837

 
420

 
(26,036
)
 
 
 
 
 
 
 
 
Net current period other comprehensive (loss) income
(30,651
)
 
3,142

 
420

 
(27,089
)
 
 
 
 
 
 
 
 
Balance, June 30, 2013
$
(5,188
)
 
$
(1,184
)
 
$
(6,397
)
 
$
(12,769
)

 
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 (loss) income before reclassifications
(967
)
 
245

 

 
(722
)
Amounts reclassified from accumulated other comprehensive (loss) income

 

 
420

 
420

 
 
 
 
 
 
 
 
Net current period other comprehensive (loss) income
(967
)
 
245

 
420

 
(302
)
 
 
 
 
 
 
 
 
Balance, June 30, 2012
$
(24
)
 
$
(1,110
)
 
$
(7,235
)
 
$
(8,369
)

For the six months ended June 30, 2013, the gross foreign currency translation adjustment of $29.3 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 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 six months ended June 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 two quarters of 2013, the Company's Board of Directors declared a quarterly cash dividend of $0.30 per common share.
    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Share Repurchase Plan
    
In January 2012, 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 $1.1 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. 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 represents approximately 90 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 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 will be reclassified to treasury stock upon completion of the ASR. For the six months ended June 30, 2013, the Company repurchased 8.3 million shares of its common stock at an average price of $56.16 per share for a total of $467 million, including 7.2 million shares purchased in the second quarter of 2013 under the ASR. For the three and six months ended June 30, 2013, the Company reissued 1.1 million and 1.5 million shares, respectively, for employee benefit plans. At June 30, 2013, $353 million remained available under the Company’s share repurchase authorizations.
    
For the three months ended June 30, 2012, the Company repurchased 882 thousand shares of its common stock at an average price of $56.70 per share for a total of $50 million. For the six months ended June 30, 2012, the Company repurchased 1.7 million shares of its common stock at an average price of $57.83 per share for a total of $100 million. For the three and six months ended June 30, 2012, the Company reissued 0.7 million and 2.2 million shares, respectively, for employee benefit plans.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


10.    SUPPLEMENTAL CASH FLOW & OTHER DATA

Supplemental cash flow data for the three and six months ended June 30, 2013 and 2012 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Depreciation expense
$
52,037

 
$
51,686

 
$
102,895

 
$
103,629

Amortization expense
19,759

 
20,169

 
39,119

 
40,400

 
 
 
 
 
 
 
 
Interest paid
32,180

 
32,208

 
83,971

 
81,990

Income taxes paid
120,981

 
192,556

 
204,938

 
202,809

 
 
 
 
 
 
 
 
Assets acquired under capital leases
1,995

 
1,763

 
2,411

 
2,955

 
 
 
 
 
 
 
 
Businesses acquired:
 

 
 

 
 

 
 

Fair value of assets acquired
89,473

 

 
241,016

 
50,800

Fair value of liabilities assumed
154

 

 
10,962

 
269

Fair value of net assets acquired
89,319

 

 
230,054

 
50,531

Merger consideration paid (payable), net
237

 
12

 
(50,105
)
 
37

Cash paid for business acquisitions
89,556

 
12

 
179,949

 
50,568

Less: Cash acquired

 

 

 

Business acquisitions, net of cash acquired
$
89,556

 
$
12

 
$
179,949

 
$
50,568


Supplemental continuing operations data for the statement of operations for the three and six months ended June 30, 2013 and 2012 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Depreciation expense
$
52,037

 
$
51,019

 
$
102,671

 
$
102,255

 
 
 
 
 
 
 
 
Interest expense
(40,579
)
 
(42,371
)
 
(81,065
)
 
(85,132
)
Interest income
658

 
621

 
1,279

 
1,280

Interest expense, net
(39,921
)
 
(41,750
)
 
(79,786
)
 
(83,852
)

11.     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 June 30, 2013. The letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments.
    

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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; the ERISA claim remains in the case. Both parties have filed summary judgment motions. The defendants' motion was granted in part and denied in part and the plaintiff's motion was denied. The plaintiff recently moved for class certification of the remaining 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 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.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


In August 2011, the Company received a subpoena from the U.S. Attorney for the Northern District of Georgia seeking various business records, including records related to the Company's compliance program, certain marketing materials, certain product offerings, and test ordering and other policies. The Company is cooperating with the request.

In January 2012, a putative class action entitled Beery v. Quest Diagnostics Incorporated was filed in the United States District Court for the District of New Jersey against the Company and a subsidiary, on behalf of all female sales representatives employed by the defendants from February 17, 2010 to the present. The amended complaint alleges that the defendants discriminate against these female sales representatives on account of their gender, in violation of the federal civil rights and equal pay acts, and seeks, among other things, injunctive relief and monetary damages. The Company has filed motions to dismiss the complaint, to strike the class allegations and to compel arbitration with the named plaintiffs. The company's motion to compel arbitration was granted and the case was dismissed.

In September 2009, the Company received a subpoena from the Michigan Attorney General's Office seeking documents relating to the Company's pricing and billing practices as they relate to Michigan's Medicaid program. The Company cooperated with the requests. In January 2012, the State of Michigan intervened as a plaintiff in a civil lawsuit, Michigan ex rel. Hunter Laboratories LLC v. Quest Diagnostics Incorporated, et al., filed in Michigan Superior Court. The suit, originally filed by a competitor laboratory, alleges that the Company overcharged Michigan's Medicaid program. The Company's motion to dismiss the complaint was denied.

In March 2011, prior to the Company's acquisition of Celera, several putative class action lawsuits were filed by shareholders of Celera against the Company, Celera, and the directors of Celera in the Court of Chancery of Delaware and in California.  The suits allege that Celera's directors breached their fiduciary duties in connection with the Company's proposed acquisition of Celera, and that the Company aided and abetted those alleged breaches.  The parties reached a settlement, and the Court of Chancery of Delaware certified a settlement class and approved the settlement over the objection of a Celera shareholder, BVF Partners L.P. On appeal of the Court of Chancery's decision, the Supreme Court of the State of Delaware affirmed the certification of the settlement class and approval of the settlement, but determined that BVF Partners L.P. should have been afforded the right to “opt out” of the settlement and pursue its claims.  Following this decision, in July 2013, Biotechnology Value Fund, L.P. and others filed a lawsuit in the United States District Court for the Northern District of California against the Company, Celera, former directors of Celera and Credit Suisse Securities (USA) LLC (“Credit Suisse”) alleging federal securities laws violations and breach of fiduciary duty claims against Celera, its directors and Credit Suisse. The complaint also alleges that the Company and Credit Suisse aided and abetted those breaches. The Company has not yet responded to the complaint.

In July 2012, a putative class action entitled Mt. Lookout Chiropractic Center Inc. v. Quest Diagnostics Incorporated, et al. ("Mt. Lookout") was filed in the United States District Court for the District of New Jersey against the Company, two of its subsidiaries and others. In June 2013, the plaintiff voluntarily dismissed the action and filed a new complaint in state court in Illinois. The new complaint alleges that the defendants violated the federal Telephone Consumer Protection Act by sending fax advertisements without permission and without the required opt-out notice, and seeks monetary damages and injunctive relief. The parties have reached a settlement that requires court approval.
 
In addition, the Company and certain of its subsidiaries have received subpoenas from state agencies. The Company and the subsidiaries continue responding to subpoenas from state agencies in two states and are cooperating with their requests.

The federal or state governments may bring claims based on new theories as to the Company's practices which management believes to be in compliance with law. In addition, certain federal and state statutes, including the qui tam provisions of the federal False Claims Act, allow private individuals to bring lawsuits against healthcare companies on behalf of government or private payers. The Company is aware of certain pending individual or class action lawsuits, and has received several subpoenas, related to billing practices filed under the qui tam provisions of the Civil False Claims Act and/or other federal and state statutes, regulations or other laws. The Company understands that there may be other pending qui tam claims    brought by former employees or other "whistle blowers" as to which the Company cannot determine the extent of any potential liability.

Management cannot predict the outcome of such matters. Although management does not anticipate that the ultimate outcome of such matters will have a material adverse effect on the Company's financial condition, given the high degree of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


judgment involved in establishing loss estimates related to these types of matters, the outcome of such matters may be material to the Company's results of operations or cash flows in the period in which the impact of such matters is determined or paid.

These matters are in different stages. Some of these matters are in their early stages. Matters may involve responding to and cooperating with various government investigations and related subpoenas. As of June 30, 2013, the Company believes that there are no losses related to the Other Legal Matters described above that are probable, or, if a loss is probable, it cannot be reasonably estimated. While the Company believes that a reasonable possibility exists that losses may have been incurred related to the Other Legal Matters described above, based on the nature and status of these matters, potential losses, if any, cannot be estimated.

Reserves for Legal Matters
    
Reserves for legal matters, unrelated to those described in "Other Legal Matters", totaled less than $5 million at both June 30, 2013 and December 31, 2012.

Reserves for General and Professional Liability Claims
    
As a general matter, providers of clinical testing services may be subject to lawsuits alleging negligence or other similar legal claims. These suits could involve claims for substantial damages. Any professional liability litigation could also have an adverse impact on the Company's client base and reputation. The Company maintains various liability insurance coverages for, among other things, claims that could result from providing, or failing to provide, clinical testing services, including inaccurate testing results, and other exposures. The Company's insurance coverage limits its maximum exposure on individual claims; however, the Company is essentially self-insured for a significant portion of these claims. Reserves for such matters, including those associated with both asserted and incurred but not reported claims, are established by considering actuarially determined losses based upon the Company's historical and projected loss experience. Such reserves totaled approximately $118 million and $110 million as of June 30, 2013 and December 31, 2012, respectively. Management believes that established reserves and present insurance coverage are sufficient to cover currently estimated exposures. Management cannot predict the outcome of any claims made against the Company. Although management does not anticipate that the ultimate outcome of any such proceedings or claims will have a material adverse effect on the Company's financial condition, given the high degree of judgment involved in establishing accruals for loss estimates related to these types of matters, the outcome may be material to the Company's results of operations or cash flows in the period in which the impact of such claims is determined or paid.

12.    DISCONTINUED OPERATIONS
    
The Company completed the sale of OralDNA in December 2012 and completed the sale of HemoCue in April 2013. Results of operations for OralDNA, HemoCue and NID have been reported as discontinued operations for the three and six months ended June 30, 2013 and 2012. The Company recorded a $29.2 million receivable, included in prepaid expenses and other current assets, associated with the agreed upon cash on-hand at closing and other customary adjustments, which was received in July 2013 related to the sale of HemoCue.

Discontinued operations, net of taxes, for the three and six months ended June 30, 2013 includes a gain of $13.3 million (including foreign currency translation adjustments, partially offset by income tax expense and transaction costs) associated with the sale of HemoCue. In addition, income from discontinued operations, net of taxes for the six months ended June 30, 2013, includes discrete tax benefits of $19.8 million associated with favorable resolution of certain tax contingencies related to our NID business.
        

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(dollars in thousands unless otherwise indicated)


Summarized financial information for the discontinued operations is set forth below:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net revenues
$
2,563

 
$
28,459

 
$
27,562

 
$
56,218

 
 
 
 
 
 
 
 
Income from discontinued operations before taxes
21,083

 
1,635

 
22,074

 
4,152

Income tax (expense) benefit
(8,280
)
 
845

 
11,017

 
1,323

Income from discontinued operations, net of taxes
$
12,803

 
$
2,480

 
$
33,091

 
$
5,475

    
The remaining balance sheet information related to OralDNA and NID was not material at June 30, 2013 and December 31, 2012. The remaining balance sheet information related to HemoCue was not material at June 30, 2013.

13.    BUSINESS SEGMENT INFORMATION

Clinical testing is an essential element in the delivery of healthcare services. Physicians use clinical testing to assist in the detection, diagnosis, evaluation, monitoring and treatment of diseases and other medical conditions. The Company's DIS business inc