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EX-31.2 - EXHIBIT 31.2 - QUEST DIAGNOSTICS INCdgx03312016ex312.htm
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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 March 31, 2016
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 April 14, 2016, there were outstanding 141,457,182 shares of the registrant’s common stock, $.01 par value.



Table of Contents                                             

PART I - FINANCIAL INFORMATION
 
 
Page
Item 1. Financial Statements
 
 
 
 
 
Index to unaudited 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 MONTHS ENDED MARCH 31, 2016 AND 2015
(unaudited)
(in millions, except per share data)


 
Three Months Ended March 31,
 
2016
 
2015
Net revenues
$
1,863

 
$
1,839

 
 
 
 
Operating costs, expenses and other income:
 

 
 

Cost of services
1,144

 
1,163

Selling, general and administrative
442

 
419

Amortization of intangible assets
19

 
21

Other operating expense, net
1

 
8

Total operating costs, expenses and other income, net
1,606

 
1,611

 
 
 
 
Operating income
257

 
228

 
 
 
 
Other income (expense):
 

 
 

Interest expense, net
(36
)
 
(45
)
Other expense, net
(49
)
 
(78
)
Total non-operating expenses, net
(85
)
 
(123
)
 
 
 
 
Income before income taxes and equity in earnings of equity method investees
172

 
105

Income tax expense
(68
)
 
(42
)
Equity in earnings of equity method investees, net of taxes
10

 
7

Net income
114

 
70

Less: Net income attributable to noncontrolling interests
12

 
9

Net income attributable to Quest Diagnostics
$
102

 
$
61

 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders:
 

 
 

Basic
$
0.71

 
$
0.42

 
 
 
 
Diluted
$
0.70

 
$
0.42

 
 
 
 
Weighted average common shares outstanding:
 

 
 

Basic
143

 
144

Diluted
144

 
146

 
 
 
 
Dividends per common share
$
0.40

 
$
0.38






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 MONTHS ENDED MARCH 31, 2016 AND 2015
(unaudited)
(in millions)

 
Three Months Ended March 31,
 
2016
 
2015
Net income
$
114

 
$
70

 
 
 
 
Other comprehensive (loss) income:
 
 
 
Currency translation
(3
)
 
(6
)
Market valuation, net of taxes

 
2

Net deferred loss on cash flow hedges, net of taxes
1

 
1

Other comprehensive loss
(2
)
 
(3
)
 
 
 
 
Comprehensive income
112

 
67

Less: Comprehensive income attributable to noncontrolling interests
12

 
9

Comprehensive income attributable to Quest Diagnostics
$
100

 
$
58





















The accompanying notes are an integral part of these statements.

3


Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2016 AND DECEMBER 31, 2015
(unaudited)
(in millions, except per share data)
 
March 31,
2016
 
December 31,
2015
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
128

 
$
133

Accounts receivable, net of allowance for doubtful accounts of $269 and $254 at March 31, 2016 and December 31, 2015, respectively
952

 
901

Inventories
82

 
84

Prepaid expenses and other current assets
138

 
207

Assets held for sale
193

 
176

Total current assets
1,493

 
1,501

Property, plant and equipment, net
925

 
925

Goodwill
5,996

 
5,905

Intangible assets, net
1,008

 
984

Investment in equity method investees
471

 
473

Other assets
204

 
174

Total assets
$
10,097

 
$
9,962

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
932

 
$
1,014

Current portion of long-term debt
158

 
159

Total current liabilities
1,090

 
1,173

Long-term debt
3,740

 
3,492

Other liabilities
529

 
514

Redeemable noncontrolling interest
72

 
70

Stockholders’ equity:
 

 
 

Quest Diagnostics stockholders’ equity:
 

 
 

Common stock, par value $0.01 per share; 600 shares authorized at both March 31, 2016 and December 31, 2015; 216 shares issued at both March 31, 2016 and December 31, 2015
2

 
2

Additional paid-in capital
2,493

 
2,481

Retained earnings
6,244

 
6,199

Accumulated other comprehensive loss
(40
)
 
(38
)
Treasury stock, at cost; 75 shares and 73 shares at March 31, 2016 and December 31, 2015, respectively
(4,063
)
 
(3,960
)
Total Quest Diagnostics stockholders’ equity
4,636

 
4,684

Noncontrolling interests
30

 
29

Total stockholders’ equity
4,666

 
4,713

Total liabilities and stockholders’ equity
$
10,097

 
$
9,962



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 THREE MONTHS ENDED MARCH 31, 2016 AND 2015
(unaudited)
(in millions)
 
Three Months Ended March 31,
 
2016
 
2015
Cash flows from operating activities:
 

 
 

Net income
$
114

 
$
70

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

 
 

Depreciation and amortization
62

 
78

Provision for doubtful accounts
86

 
79

Deferred income tax provision
8

 
14

Stock-based compensation expense
18

 
12

Excess tax benefits from stock-based compensation arrangements
(2
)
 
(2
)
Other, net
1

 
7

Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(145
)
 
(97
)
Accounts payable and accrued expenses
(77
)
 
(120
)
Income taxes payable
63

 
10

Other assets and liabilities, net
15

 
1

Net cash provided by operating activities
143

 
52

 
 
 
 
Cash flows from investing activities:
 

 
 

Business acquisitions, net of cash acquired
(135
)
 

Capital expenditures
(47
)
 
(56
)
(Increase) decrease in investments and other assets
(8
)
 
1

Net cash used in investing activities
(190
)
 
(55
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
665

 
1,389

Repayments of debt
(453
)
 
(440
)
Purchases of treasury stock
(115
)
 
(110
)
Exercise of stock options
7

 
35

Excess tax benefits from stock-based compensation arrangements
2

 
2

Dividends paid
(55
)
 
(48
)
Distributions to noncontrolling interests
(9
)
 
(10
)
Other financing activities, net

 
(33
)
Net cash provided by financing activities
42

 
785

 
 
 
 
Net change in cash and cash equivalents
(5
)
 
782

Cash and cash equivalents, beginning of period
133

 
192

Cash and cash equivalents, end of period
$
128

 
$
974





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 THREE MONTHS ENDED MARCH 31, 2016 AND 2015
(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
 
 
Redeemable Non-controlling Interest
Balance, December 31, 2015
143

 
$
2

 
$
2,481

 
$
6,199

 
$
(38
)
 
$
(3,960
)
 
$
29

 
$
4,713

 
 
$
70

Net income


 


 


 
102

 


 


 
10

 
112

 
 
2

Other comprehensive loss, net of taxes


 


 


 


 
(2
)
 


 


 
(2
)
 
 
 
Dividends declared


 


 


 
(57
)
 


 


 


 
(57
)
 
 
 
Distributions to noncontrolling interests


 


 


 


 


 


 
(9
)
 
(9
)
 
 


Issuance of common stock under benefit plans


 


 
1

 


 


 
4

 


 
5

 
 
 
Stock-based compensation expense


 


 
17

 


 


 
1

 


 
18

 
 
 
Exercise of stock options


 


 


 


 


 
7

 


 
7

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


 


 
(8
)
 


 


 


 


 
(8
)
 
 
 
Tax benefits associated with stock-based compensation plans


 


 
2

 


 


 


 


 
2

 
 
 
Purchases of treasury stock
(2
)
 


 


 


 


 
(115
)
 


 
(115
)
 
 
 
Balance, March 31, 2016
141

 
$
2

 
$
2,493

 
$
6,244

 
$
(40
)
 
$
(4,063
)
 
$
30

 
$
4,666

 
 
$
72

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2014
144

 
$
2

 
$
2,418

 
$
5,723

 
$
(27
)
 
$
(3,815
)
 
$
29

 
$
4,330

 
 
$

Net income


 


 


 
61

 


 


 
9

 
70

 
 


Other comprehensive loss, net of taxes


 


 


 


 
(3
)
 


 


 
(3
)
 
 
 
Dividends declared


 


 


 
(55
)
 


 


 


 
(55
)
 
 
 
Distributions to noncontrolling interests


 


 


 


 


 


 
(10
)
 
(10
)
 
 


Issuance of common stock under benefit plans
1

 


 
1

 


 


 
4

 


 
5

 
 
 
Stock-based compensation expense


 


 
11

 


 


 
1

 


 
12

 
 
 
Exercise of stock options
1

 


 


 


 


 
35

 


 
35

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


 


 
(6
)
 


 


 


 


 
(6
)
 
 
 
Tax benefits associated with stock-based compensation plans


 


 
3

 


 


 


 


 
3

 
 
 
Purchases of treasury stock
(2
)
 


 


 


 


 
(110
)
 


 
(110
)
 
 
 
Balance, March 31, 2015
144

 
$
2

 
$
2,427

 
$
5,729

 
$
(30
)
 
$
(3,885
)
 
$
28

 
$
4,271

 
 
$



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)
(in millions, except per share data)

1.    DESCRIPTION OF BUSINESS
    
Background
    
Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or the "Company") empower people to take action to improve health outcomes.  The Company uses its extensive database of clinical lab results to derive diagnostic insights that reveal new avenues to identify and treat disease, inspire healthy behaviors and improve healthcare management.  The Company's diagnostic information services business ("DIS") provides insights through clinical testing and related services to patients, physicians, hospitals, accountable care organizations ("ACOs"), integrated delivery networks ("IDNs"), health plans, employers and others. The Company offers the broadest access in the United States to diagnostic information services through its nationwide network of laboratories, Company-owned patient service centers and phlebotomists in physician offices. The Company is the world's leading provider of diagnostic information services, which includes providing clinical testing services such as routine (including drugs-of-abuse) testing, gene-based and esoteric testing, and anatomic pathology services, as well as related services and insights. The Company provides interpretive consultation with one of the largest medical and scientific staffs in the industry and hundreds of M.D.s and Ph.D.s, 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. The Company's diagnostics products business manufactures and markets diagnostic products (see Note 6 regarding the planned disposition of Focus Diagnostics). In addition, the Company offers healthcare organizations, clinicians and patients robust information technology solutions. Prior to the contribution of its clinical trials testing business to the Q2 Solutions joint venture on July 1, 2015, the Company's clinical trials testing business was a leading provider of central laboratory testing for clinical trials.

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 2015 Annual Report on Form 10-K. The year-end balance sheet data was derived from the audited financial statements as of December 31, 2015, but does not include all the disclosures required by accounting principles generally accepted in the United States (“GAAP”).
        
Reclassifications    

Prior to the Company's clinical trials central laboratory services joint venture, Q2 Solutions, the earnings of the Company's equity method investees consisted of earnings that were not directly taxable to the investees, in which case it was appropriate to present equity in earnings of equity method investees before income tax expense on the consolidated statements of operations. The earnings of Q2 Solutions, which closed on July 1, 2015, includes earnings that are directly taxable to the joint venture. As a result of the Q2 Solutions transaction, the current period presentation of equity in earnings of equity method investees is required to be presented below income tax expense on the consolidated statements of operations. The Company's equity in earnings of equity method investees on the consolidated statements of operations for the three months ended March 31, 2015 has been reclassified to conform with the current period presentation.

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.
    

7

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


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.

Property, Plant and Equipment

In connection with the Company’s annual review of the estimated useful lives of its property, plant and equipment completed during the first quarter of 2016, the Company revised the estimated useful lives of certain classes of its property, plant and equipment. In order to better reflect the Company's current expectations regarding the use of its assets, the recent operational improvements from its Invigorate program and considering historical and other data, the Company revised the estimated useful lives of its laboratory equipment from a range of five to seven years to a range of seven to ten years, furniture and fixtures from a range of three to seven years to a range of five to twelve years and computer software obtained for internal use from three years to five years. The change in estimated useful lives was accounted for prospectively as a change in accounting estimate effective in the first quarter of 2016. The impact of this change during the first quarter of 2016 was a decrease in depreciation expense and an increase in operating income of $10 million and an increase in net income of $6 million, or $0.04 per share on a basic and diluted basis. The full year impact for 2016 is expected to be a decrease in depreciation expense and an increase in operating income of $36 million and an increase in net income of $22 million, or $0.16 per share on a basic and diluted basis.

New Accounting Pronouncements
    
In May 2014, the Financial Accounting Standards Board ("FASB") issued an accounting standard update ("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. In August 2015, the FASB deferred the effective date of this ASU to the first quarter of 2018, with early adoption permitted beginning in the first quarter of 2017. The ASU can be applied using a full retrospective method or a modified retrospective method of adoption. 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.

On January 1, 2016, the Company adopted a new accounting standard issued by the FASB which makes targeted amendments to the current consolidation guidance for variable interest entities and limited partnerships and similar entities. The adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows.

On January 1, 2016, the Company prospectively adopted a new accounting standard issued by the FASB which provides guidance in determining whether a cloud computing arrangement includes a software license.  If it is determined that a cloud computing arrangement does include a software license, the software element of the arrangement should be accounted for consistent with the acquisition of other software licenses.  If the arrangement does not include a software license, it should be accounted for as a service contract.  The adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows.


8

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


On January 1, 2016, the Company prospectively adopted a new accounting standard issued by the FASB which requires that an acquirer recognize adjustments to provisional amounts in a business combination that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, including the cumulative effect of the change in provisional amount as if the accounting had been completed at the acquisition date.  The adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows.

During the first quarter of 2016, the Company prospectively adopted a new accounting standard issued by the FASB that clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows.

In January 2016, the FASB issued an ASU on the recognition and measurement of financial assets and financial liabilities. This ASU requires that all equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net income. However, companies may elect to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. In addition, the ASU eliminates the requirement to disclose the method and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. The ASU is effective for the Company in the first quarter of 2018. The Company does not expect the adoption of this ASU to have a material impact on its results of operations, financial position and cash flows.

In February 2016, the FASB issued an ASU that amends accounting for leases. Under the new guidance, a lessee will recognize assets and liabilities for most leases on its balance sheet but will recognize expense on its statement of operations similar to current lease accounting.  The ASU is effective for the Company in the first quarter of 2019 with early adoption permitted.  The new guidance must be adopted using a modified retrospective transition approach, and provides for certain practical expedients.  The adoption of this ASU will result in a significant increase to the Company’s balance sheet for lease liabilities and right-of-use assets, which has not yet been quantified. The Company is currently evaluating this and the other effects of adoption of this ASU on its consolidated financial statements.

In March 2016, the FASB issued an ASU that simplifies the transition to the equity method of accounting by requiring adoption as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence, no retroactive adjustment of the investment is required. The ASU is effective for the Company in the first quarter of 2017 with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its results of operations, financial position and cash flows.

In March 2016, the FASB issued an ASU that simplifies several aspects of the accounting for share-based payment award transactions, including the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and accounting for forfeitures. The ASU is effective for the Company in the first quarter of 2017 with early adoption permitted. The Company is currently evaluating the guidance to determine the Company's adoption method and the effect it will have on its results of operations, financial position and cash flows.


9

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


3.    EARNINGS PER SHARE

The computation of basic and diluted earnings per common share was as follows:

 
Three Months Ended March 31,
 
2016
 
2015
Amounts attributable to Quest Diagnostics’ stockholders:
 

 
 

Net income attributable to Quest Diagnostics
$
102

 
$
61

Less: Earnings allocated to participating securities

 

Earnings available to Quest Diagnostics’ common stockholders – basic and diluted
$
102

 
$
61

 
 
 
 
Weighted average common shares outstanding – basic
143

 
144

Effect of dilutive securities:
 

 
 

Stock options and performance share units
1

 
2

Weighted average common shares outstanding – diluted
144

 
146

 
 
 
 
Earnings per share attributable to Quest Diagnostics’ common stockholders:
 

 
 

Basic
$
0.71

 
$
0.42

 
 
 
 
Diluted
$
0.70

 
$
0.42


The following securities were not included in the calculation of diluted earnings per share due to their antidilutive effect:
 
Three Months Ended March 31,
 
2016
 
2015
Stock options and performance share units
3

 
1


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. Invigorate has consisted of several flagship programs, with structured plans in each, to drive savings and improve performance across the customer value chain. These flagship programs include: organization excellence; information technology excellence; procurement excellence; service excellence; lab excellence; and billing excellence. From 2012 through 2014, the Invigorate program was intended to partially offset reimbursement pressures and labor and benefit cost increases; free up additional resources to invest in science, innovation and other growth initiatives; and enable us to improve service quality and operating profitability.

In January 2015, the Company adopted a course of action related to its multi-year Invigorate program to further reduce its cost structure through 2017. This multi-year course of action continues to focus on the flagship program opportunities and new key opportunities such as: standardizing processes, information technology systems, equipment and data; enhancing electronic enabling services; and enhancing reimbursement for work performed.


10

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


Restructuring Charges

The following table provides a summary of the Company's pre-tax restructuring charges for the three months ended March 31, 2016 and 2015:

 
Three Months Ended March 31,
 
2016
 
2015
Employee separation costs
$
3

 
$
15


The restructuring charges incurred for the three months ended March 31, 2016 and 2015 are primarily associated with various workforce reduction initiatives as the Company continues to simplify and restructure its organization. Of the total restructuring charges incurred during the three months ended March 31, 2016, $1 million and $2 million were recorded in cost of services and selling, general and administrative expenses, respectively. Of the total restructuring charges incurred during the three months ended March 31, 2015, $13 million and $2 million were recorded in cost of services and selling, general and administrative expenses, respectively.

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

5.     BUSINESS ACQUISITIONS

On February 29, 2016, the Company completed the acquisition of the outreach laboratory service business of Clinical Laboratory Partners, LLC ("CLP"), a wholly-owned subsidiary of Hartford HealthCare Corporation, in an all-cash transaction for $135 million. CLP provides clinical testing services to physicians, hospitals, clinics and long-term care facilities in Connecticut. The assets acquired principally consist of $91 million of tax deductible goodwill and $43 million of customer-related intangible assets, which are being amortized over a useful life of 15 years. The goodwill recorded primarily includes the expected synergies resulting from combining the operations of CLP with those of the Company and the value associated with an assembled workforce and other intangible assets that do not qualify for separate recognition. The acquired outreach laboratory service business of CLP is included in the Company's DIS business. For further details regarding business segment information, see Note 14.

Supplemental pro forma combined financial information has not been presented as the impact of the CLP acquisition is not material to the Company's consolidated financial statements.

For details regarding the Company's 2015 acquisitions, see Note 5 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.    

6.     DISPOSITION AND HELD FOR SALE

Planned Disposition of Focus Diagnostics Products    

On March 29, 2016, the Company entered into a definitive agreement to sell the assets of its non-core Focus Diagnostics Products business ("Focus Diagnostics") to DiaSorin S.p.A for $300 million in cash, subject to working capital adjustments. The transaction is expected to close in the second quarter of 2016, subject to customary regulatory and other closing conditions, and is expected to result in a pre-tax gain. The pre-tax gain is expected to be material to the Company's results of operations and cash flows and will be recorded in the period in which the transaction closes. As of March 31, 2016, the assets to be disposed of consist of $113 million of goodwill, $30 million of intangible assets, with the remaining $41 million consisting of accounts receivable, inventories and property, plant and equipment. The assets to be disposed of as part of the transaction are classified as current assets held for sale in the consolidated balance sheets as of both March 31, 2016 and December 31, 2015.

The Focus Diagnostics products business is included in all other operating segments and has not been classified as a discontinued operation. For further details regarding business segment information, see Note 14.


11

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


For details regarding the Company's 2015 dispositions and assets held for sale, see Note 6 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.

7.     FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

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
March 31, 2016
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 

 
 

 
 

 
 

Interest rate swaps
$
53

 
$

 
$
53

 
$

Trading securities
48

 
48

 

 

Cash surrender value of life insurance policies
30

 

 
30

 

Available-for-sale equity securities
6

 
6

 

 

Total
$
137

 
$
54

 
$
83

 
$

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
85

 
$

 
$
85

 
$

Contingent consideration
3

 

 

 
3

Total
$
88

 
$

 
$
85

 
$
3


December 31, 2015
 
 
 
 
 
 
 
Assets:
 

 
 

 
 

 
 

Trading securities
$
49

 
$
49

 
$

 
$

Cash surrender value of life insurance policies
29

 

 
29

 

Interest rate swaps
23

 

 
23

 

Available-for-sale equity securities
6

 
6

 

 

Total
$
107

 
$
55

 
$
52

 
$

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Deferred compensation liabilities
$
85

 
$

 
$
85

 
$

Interest rate swaps
6

 

 
6

 

Contingent consideration
3

 

 

 
3

Total
$
94

 
$

 
$
91

 
$
3


A full description regarding the Company's fair value measurements is contained in Note 7 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.    

The Company offers certain employees the opportunity to participate in non-qualified supplemental deferred compensation plans. A participant's deferrals, together with Company matching credits, are invested in a variety of participant-

12

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


directed stock and bond mutual funds that are classified as trading securities. Changes in the fair value of these securities are measured using quoted prices in active markets based on the market price per unit multiplied by the number of units held exclusive of any transaction costs. A corresponding adjustment for changes in fair value of the trading securities is also reflected in the changes in fair value of the deferred compensation obligation. The deferred compensation liabilities are classified within Level 2 because their inputs are derived principally from observable market data by correlation to the trading securities.

The Company offers certain employees the opportunity to participate in a non-qualified deferred compensation program. A participant's deferrals, together with Company matching credits, are “invested” at the direction of the employee in a hypothetical portfolio of investments which are tracked by an administrator. The Company purchases life insurance policies, with the Company named as beneficiary of the policies, for the purpose of funding the program's liability. Changes in the cash surrender value of the life insurance policies are based upon earnings and changes in the value of the underlying investments. Changes in the fair value of the deferred compensation obligation are derived using quoted prices in active markets based on the market price per unit multiplied by the number of units. The cash surrender value and the deferred compensation obligations are classified within Level 2 because their inputs are derived principally from observable market data by correlation to the hypothetical investments.
    
The fair value measurements of the Company's interest rate 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.

Investment in available-for-sale equity securities represents an investment in registered shares of a publicly-held company. 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.
    
In April 2014, and as further detailed in Note 5 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K, the Company completed the acquisitions of Summit Health, Inc. ("Summit Health") and Steward Health Care Systems, LLC's laboratory outreach business ("Steward"). In connection with the acquisitions, the Company initially 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 initial probability estimate of the occurrence of such triggering events associated with the amounts the Company could be obligated to pay in future periods for both Summit and Steward was between 5% and 95%. The probability-weighted cash flows were then discounted using a discount rate of 1.5% to 2.8%. Based on actual 2015 results for Summit Health compared to the earn-out target included in the contingent consideration arrangement, no payment is required, and therefore, the fair value of the contingent consideration accrual associated with Summit Health was reduced to $0 in the second quarter of 2015. The remaining contingent consideration associated with Steward is projected to be paid out in three equal annual installments, with a maximum payout of $4 million.

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 March 31, 2016 and December 31, 2015, the fair value of the Company’s debt was estimated at $4.0 billion and $3.7 billion, respectively. 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.


13

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


8.    GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill for the three months ended March 31, 2016 and for the year ended December 31, 2015 are as follows:
 
March 31,
2016
 
December 31,
2015
Balance, beginning of period
$
5,905

 
$
6,032

Goodwill acquired during the period
91

 
33

Reclassification to assets held for sale

 
(160
)
Balance, end of period
$
5,996

 
$
5,905


Principally all of the Company’s goodwill as of March 31, 2016 and December 31, 2015 is associated with its DIS business.

For the three months ended March 31, 2016, goodwill acquired during the period was associated with the CLP acquisition (see Note 5). For the year ended December 31, 2015, goodwill acquired was principally associated with the acquisition of MemorialCare Health System's laboratory outreach business and the acquisition of the business assets of Superior Mobile Medics, Inc. The reclassification to assets held for sale was principally associated with the contribution of the Company's clinical trials testing business to the Q2 Solutions joint venture and the planned disposition of Focus Diagnostics (see Note 6).             

Intangible assets at March 31, 2016 and December 31, 2015 consisted of the following:

 
Weighted
Average
Amortization
Period
(in years)
 
March 31, 2016
 
December 31, 2015
 
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 

 
 

 
 

 
 

 
 

 
 

Customer-related
18
 
$
977

 
$
(309
)
 
$
668

 
$
936

 
$
(296
)
 
$
640

Non-compete agreements
6
 
6

 
(3
)
 
3

 
6

 
(3
)
 
3

Technology
18
 
93

 
(37
)
 
56

 
93

 
(35
)
 
58

Other
9
 
106

 
(61
)
 
45

 
106

 
(59
)
 
47

Total
18
 
1,182

 
(410
)
 
772

 
1,141

 
(393
)
 
748

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 

 
 

 
 

 
 

 
 

Trade names
 
 
235

 

 
235

 
235

 

 
235

Other
 
 
1

 

 
1

 
1

 

 
1

Total intangible assets
 
 
$
1,418

 
$
(410
)
 
$
1,008

 
$
1,377

 
$
(393
)
 
$
984


Amortization expense related to intangible assets was $19 million and $21 million for the three months ended March 31, 2016 and 2015, respectively.
 

14

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of March 31, 2016 is as follows:

Year Ending December 31,
 

Remainder of 2016
$
54

2017
69

2018
65

2019
65

2020
65

2021
58

Thereafter
396

Total
$
772


9.    DEBT
    
Long-Term Debt

Long-term debt at March 31, 2016 and December 31, 2015 consisted of the following:
 
March 31,
2016
 
December 31,
2015
 
 
 
 
Secured Receivables Credit Facility (1.20% at March 31, 2016)
$
410

 
$

3.20% Senior Notes due April 2016
150

 
150

2.70% Senior Notes due April 2019
300

 
300

4.75% Senior Notes due January 2020
526

 
522

2.50% Senior Notes due March 2020
299

 
299

4.70% Senior Notes due April 2021
566

 
554

4.25% Senior Notes due April 2024
324

 
313

3.50% Senior Notes due March 2025
609

 
601

6.95% Senior Notes due July 2037
174

 
247

5.75% Senior Notes due January 2040
244

 
368

4.70% Senior Notes due March 2045
300

 
300

Other
19

 
22

Debt issuance costs
(23
)
 
(25
)
Total long-term debt
3,898

 
3,651

Less: Current portion of long-term debt
158

 
159

Total long-term debt, net of current portion
$
3,740

 
$
3,492


Retirement of Debt

In March 2016, the Company completed a cash tender offer to purchase up to $200 million aggregate principal amount of its 6.95% Senior Notes due July 2037 ("Senior Notes due 2037") and 5.75% Senior Notes due January 2040 ("Senior Notes due 2040"). The Company purchased $73 million of its Senior Notes due 2037 and $127 million of its Senior Notes due 2040.

In March 2015, the Company completed a cash tender offer to purchase up to $250 million aggregate principal amount of its Senior Notes due 2037 and Senior Notes due 2040. The Company purchased $176 million of its Senior Notes due 2037 and $74 million of its Senior Notes due 2040.


15

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


In connection with the March 2016 and 2015 cash tender offers, the Company recorded losses on retirement of debt, principally comprised of premiums paid, of $48 million and $79 million in other expense, net for the three months ended March 31, 2016 and 2015, respectively.
        
Maturities of Long-Term Debt    

As of March 31, 2016, long-term debt matures as follows:

Year Ending December 31,
 
Remainder of 2016
$
156

2017
416

2018
4

2019
302

2020
801

2021
550

Thereafter
1,625

Total maturities of long-term debt
3,854

Unamortized discount
(12
)
Debt issuance costs
(23
)
Fair value basis adjustments attributable to hedged debt
79

Total long-term debt
3,898

Less: Current portion of long-term debt
158

Total long-term debt, net of current portion
$
3,740


For further discussion regarding the Company's debt, see Note 13 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.    

10.    FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage its exposure to market risks for changes in interest rates and, from time to time, 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.

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, net.


16

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


Interest Rate Derivatives – Cash Flow Hedges
    
From time to 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.
    
During the fourth quarter of 2013 and first quarter of 2014, the Company entered into various forward starting interest rate swap agreements for an aggregate notional amount of $150 million which were accounted for as cash flow hedges. In connection with the issuance of the 2015 senior notes offering, all of these agreements were settled and the Company paid $17 million. These losses are deferred in stockholders’ equity, net of income taxes, as a component of accumulated other comprehensive loss, and amortized as an adjustment to interest expense, net over the term of the Senior Notes due 2025.

In March 2015, the Company entered into interest rate lock agreements with several financial institutions for a total notional amount of $350 million which were accounted for as cash flow hedges. These agreements were entered into to hedge a portion of the Company’s interest rate exposure associated with variability in future cash flows attributable to changes in the five-year, ten-year and thirty-year treasury rates related to the planned debt issuance in 2015. In connection with the 2015 senior notes offering, these agreements were settled and the Company received $3 million. These gains are deferred in stockholders’ equity, net of income taxes, as a component of accumulated other comprehensive loss, and amortized as an adjustment to interest expense, net over the term of the respective senior notes.

The total net loss, net of taxes, recognized in accumulated other comprehensive loss, related to the Company's cash flow hedges as of March 31, 2016 and December 31, 2015 was $11 million and $12 million, respectively. The loss recognized on the Company's cash flow hedges for the three months ended March 31, 2016 and 2015, 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, net within the next twelve months is $3 million.

Interest Rate Derivatives – Fair Value Hedges

The Company maintains various fixed-to-variable interest rate swaps to convert a portion of the Company's long-term debt into variable interest rate debt. A summary of the notional amounts of these interest rate swaps as of March 31, 2016 and December 31, 2015 is as follows:    
 
 
 
 
Notional Amount
Debt Instrument
 
Floating Rate Paid by the Company
 
March 31, 2016
 
December 31, 2015
 
 
 
 
 
 
 
4.75% Senior Notes due January 2020
 
One-month LIBOR plus a 3.6% spread
 
350

 
350

4.70% Senior Notes due April 2021
 
One-month LIBOR plus a 2.45% to 3.39% spread
 
400

 
400

4.25% Senior Notes due April 2024
 
One-month LIBOR plus a 1.54% to 1.59% spread
 
250

 
250

3.50% Senior Notes due March 2025
 
One-month LIBOR plus a 1.44% spread
 
200

 
200

 
 
 
 
$
1,200

 
$
1,200

    
Since inception, the fair value hedges have been effective or highly effective; therefore, there is no impact on earnings for the three months ended March 31, 2016 and 2015 as a result of hedge ineffectiveness.

Interest Rate Derivatives - Economic Hedges

In March 2016, in connection with the retirement of debt discussed in Note 9, the Company entered into reverse interest rate lock agreements with several financial institutions which were not designated for hedge accounting. The Company entered into these agreements to hedge the variability in cash flows associated with $75 million of the $200 million principal amount of debt that was retired in the first quarter of 2016. These agreements were settled during the first quarter of 2016 which resulted in a gain of $1 million which was recognized in other expense, net.

17

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


In March 2015, in connection with the 2015 retirement of debt discussed in Note 9, the Company entered into reverse interest rate lock agreements with several financial institutions which were not designated for hedge accounting. The Company entered into these agreements to hedge the variability in cash flows associated with $280 million of the $1.3 billion principal amount of debt that was retired in the first and second quarters of 2015. Certain of these agreements were settled during the first quarter of 2015, which resulted in a gain of $3 million which was recognized in other expense, net.

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

 
March 31, 2016
 
December 31, 2015
 
Balance Sheet
Classification
 
Fair Value
 
Balance Sheet
Classification
 
Fair Value
Derivatives Designated as Hedging Instruments
 
 
 

 
 
 
 

Asset Derivatives:
 
 
 

 
 
 
 

Interest rate swaps
Other assets
 
$
53

 
Other assets
 
$
23

 
 
 
 
 
 
 
 
Liability Derivatives:
 
 
 
 
 
 
 
Interest rate swaps

 

 
Other liabilities
 
6

 
 
 
 
 
 
 
 
Total Net Derivatives Assets
 
 
$
53

 
 
 
$
17


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 2015 Annual Report on Form 10-K.        

11.    STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST
    
Stockholders' Equity    

Components of Comprehensive Income

The market value 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, net of taxes on the Company’s interest rate related derivative financial instruments designated as cash flow hedges, net of amounts reclassified to interest expense (see Note 10). For the three months ended March 31, 2016 and 2015, 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.

Dividend Program
    
During the first quarter of 2016, the Company's Board of Directors declared a quarterly cash dividend of $0.40 per common share. During each of the quarters of 2015, the Company's Board of Directors declared a quarterly cash dividend of $0.38 per common share.
    
Share Repurchase Program
        
At March 31, 2016, $857 million remained available under the Company’s share repurchase authorizations. The share repurchase authorization has no set expiration or termination date.    

Shares Reissued from Treasury Stock

For the three months ended March 31, 2016 and 2015, the Company reissued 0.2 million shares and 0.7 million shares, respectively, from treasury stock for employee benefit plans.


18

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


Redeemable Noncontrolling Interest

In connection with the sale of an 18.9% noncontrolling interest in a subsidiary to UMass Memorial Medical Center ("UMass") on July 1, 2015, the Company granted UMass the right to require the Company to purchase all of its interest in the subsidiary at fair value commencing July 1, 2020. The subsidiary performs diagnostic information services in a defined territory within the state of Massachusetts. In 2015, the Company received consideration of $68 million, including $50 million associated with the call option exercise price. Since the redemption of the noncontrolling interest is outside of the Company's control, it has been presented outside of stockholders' equity at the greater of its carrying amount or its fair value. The Company will record changes in the fair value of the noncontrolling interest immediately as they occur. At March 31, 2016, the redeemable noncontrolling interest was $72 million and was presented at its fair value.

12.    SUPPLEMENTAL CASH FLOW & OTHER DATA

Supplemental cash flow and other data for the three months ended March 31, 2016 and 2015 is as follows:
 
Three Months Ended March 31,
 
2016
 
2015
Depreciation expense
$
43

 
$
57

Amortization expense
19

 
21

Depreciation and amortization expense
$
62

 
$
78

 
 
 
 
Interest expense
$
(36
)
 
$
(45
)
 
 
 
 
Interest paid
$
53

 
$
54

Income taxes paid
4

 
19

 
 
 
 
Accounts payable associated with capital expenditures
13

 
11

Dividends payable
$
57

 
$
55

 
 
 
 
Businesses acquired:
 

 
 

Fair value of assets acquired
$
135

 
$

Fair value of liabilities assumed

 

Fair value of net assets acquired
135

 

Merger consideration paid (payable), net

 

Cash paid for business acquisitions
135

 

Less: Cash acquired

 

Business acquisitions, net of cash acquired
$
135

 
$


13.     COMMITMENTS AND CONTINGENCIES

Letters of Credit    

The Company can issue letters of credit totaling $100 million under its secured receivables credit facility and $150 million under its senior unsecured revolving credit facility. For further discussion regarding the Company's secured receivables credit facility and senior unsecured revolving credit facility, see Note 13 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.    
    
In support of its risk management program, to ensure the Company’s performance or payment to third parties, $68 million in letters of credit, principally under the secured receivables credit facility, were outstanding at March 31, 2016. The

19

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments.
    
Contingent Lease Obligations
    
The Company remains subject to contingent obligations under certain real estate leases that were entered into by certain predecessor companies of a subsidiary prior to the Company's acquisition of the subsidiary. No liability has been recorded for any of these potential contingent obligations. For further details, see Note 17 to the consolidated financial statements in the Company’s 2015 Annual Report on Form 10-K.

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, the Company has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with the Company's 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 the Company's client base and reputation.

The Company is also involved, from time to time, in other reviews, investigations and proceedings by governmental agencies regarding the Company's 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 the Company.
    
In June 2010, the Company received a subpoena from the Florida Attorney General's Office seeking documents relating to the Company's pricing and billing practices as they relate to Florida’s Medicaid program. The Company cooperated with the requests. In November 2013, the State of Florida intervened as a plaintiff in a civil lawsuit, Florida ex rel. Hunter Laboratories LLC v. Quest Diagnostics Incorporated, et al., filed in Florida Circuit Court. The suit, originally filed by a competitor laboratory, alleges that the Company overcharged Florida’s Medicaid program. The Company's motion to dismiss the state's amended complaint was denied.         

In April 2015, a qui tam civil lawsuit entitled United States ex rel. Mayes v. Berkeley HeartLab, Inc., et al., filed in the U.S. District Court for the District of South Carolina, was unsealed. The complaint alleges that certain alleged business practices of the defendants violated the False Claims Act, and seeks monetary relief. The United States intervened as a plaintiff as to Berkeley HeartLab, Inc., a subsidiary of the Company and filed a complaint in intervention; the United States did not intervene as a plaintiff as to Quest Diagnostics Incorporated.
    
The federal or state governments may bring claims based on the Company's current practices, which it believes are lawful. 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 lawsuits, and from time to time has received subpoenas, related to billing practices based on the qui tam provisions of the Civil False Claims Act 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 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 March 31, 2016, the Company does

20

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


not believe that material losses related to the legal matters described above are probable. While the Company believes that a reasonable possibility exists that losses may have been incurred related to the legal matters described above for which an accrual has not been recorded, based on the nature and status of these matters, potential losses, if any, cannot be estimated.

Reserves for Legal Matters
    
Reserves for legal matters, other than those described above, totaled $3 million and $9 million at March 31, 2016 and December 31, 2015, respectively.

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 $129 million and $124 million at March 31, 2016 and December 31, 2015, 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.

14.    BUSINESS SEGMENT INFORMATION
The Company's DIS business provides insights through clinical testing and related services to patients, physicians, hospitals, ACOs, IDNs, health plans, employers and others. The Company is the world's leading provider of diagnostic information services, which includes providing clinical testing services such as routine (including drugs-of-abuse) testing, gene-based and esoteric testing, and anatomic pathology services, as well as related services and insights. The DIS business accounted for greater than 90% of net revenues in 2016 and 2015.

All other operating segments include the Company's DS businesses, which consists of its risk assessment services, diagnostic products (see Note 6 regarding the planned disposition of Focus Diagnostics), healthcare information technology and clinical trials testing (prior to July 1, 2015) businesses. The Company's DS businesses offer a variety of solutions for life insurers, healthcare providers and others.

In addition to the planned disposition of Focus Diagnostics, the Company is winding down its Celera Products business, which did not have a material impact on the Company's consolidated financial statements.
        
At March 31, 2016, substantially all of the Company’s services are provided within the United States, and substantially all of the Company’s assets are located within the United States.

The following table is a summary of segment information for the three months ended March 31, 2016 and 2015. Segment asset information is not presented since it is not used by the chief operating decision maker at the operating segment level. Operating earnings (loss) of each segment represents net revenues less directly identifiable expenses to arrive at operating income (loss) for the segment. General corporate activities included in the table below are comprised of general management and administrative corporate expenses, amortization and impairment of intangibles assets, other operating income and expenses net of certain general corporate activity costs that are allocated to the DIS and DS businesses. The accounting policies of the segments are the same as those of the Company as set forth in Note 2 to the consolidated financial statements contained in the Company’s 2015 Annual Report on Form 10-K and Note 2 to the interim unaudited consolidated financial statements.

21

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)


 
Three Months Ended March 31,
 
2016
 
2015
Net revenues:
 

 
 

DIS business
$
1,756

 
$
1,692

All other operating segments
107

 
147

Total net revenues
$
1,863

 
$
1,839

 
 
 
 
Operating earnings (loss):
 

 
 

DIS business
$
278

 
$
242

All other operating segments
21

 
26

General corporate activities
(42
)
 
(40
)
Total operating income
257

 
228

Non-operating expenses, net
(85
)
 
(123
)
Income before income taxes and equity in earnings of equity method investees
172

 
105

Income tax expense
(68
)
 
(42
)
Equity in earnings of equity method investees, net of taxes
10

 
7

Net income
114

 
70

Less: Net income attributable to noncontrolling interests
12

 
9

Net income attributable to Quest Diagnostics
$
102

 
$
61


15.    RELATED PARTIES

The Company's equity method investees primarily consist of its clinical trials central laboratory services joint venture and its diagnostic information services joint ventures, which are accounted for under the equity method of accounting. During the three months ended March 31, 2016 and 2015, the Company recognized net revenues of $8 million and $7 million, respectively, associated with diagnostic information services provided to its equity method investees. As of March 31, 2016 and December 31, 2015, there was $6 million and $5 million, respectively, of accounts receivable from equity method investees related to such services.
      
During the three months ended March 31, 2016 and 2015, the Company recognized income of $5 million and $2 million, respectively, associated with the performance of certain corporate services, including transition services, for its equity method investees, classified within selling, general and administrative expenses. As of March 31, 2016 and December 31, 2015, there was $15 million and $32 million, respectively, of other receivables from equity method investees included in prepaid expenses and other current assets related to these service agreements and other transition related items. In addition, accounts payable and accrued expenses as of March 31, 2016 and December 31, 2015 included $11 million and $9 million, respectively, due to equity method investees.

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Table of Contents                                             

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our Company

Quest Diagnostics empowers people to take action to improve health outcomes. We use our extensive database of clinical lab results to derive diagnostic insights that reveal new avenues to identify and treat disease, inspire healthy behaviors and improve healthcare management. Our diagnostic information services business ("DIS") provides insights through clinical testing and related services to patients, physicians, hospitals, accountable care organizations ("ACOs"), integrated delivery networks ("IDNs"), health plans, employers and others. We offer the broadest access in the United States to diagnostic information services through our nationwide network of laboratories, Company-owned patient service centers and phlebotomists in physician offices. We are the world's leading provider of diagnostic information services, which includes providing clinical testing services such as routine (including drugs-of-abuse) testing, gene-based and esoteric testing, and anatomic pathology services, as well as related services and insights. We provide interpretive consultation with one of the largest medical and scientific staffs in the industry. Our DIS business makes up over 90% of our consolidated net revenues.

In our Diagnostic Solutions ("DS") businesses, which represents the balance of our consolidated net revenues, we offer a variety of solutions to insurers and healthcare providers. We are the leading provider of risk assessment services for the life insurance industry. In addition, we offer healthcare organizations and clinicians robust information technology solutions and diagnostic products (see "Planned Disposition of Focus Diagnostics Products" below and Note 6 to the interim unaudited consolidated financial statements for details regarding the planned disposition of Focus Diagnostics Products). Prior to the contribution of our clinical trials testing business to the Q2 Solutions joint venture on July 1, 2015, our clinical trials testing business was a leading provider of central laboratory testing for clinical trials.

First Quarter Highlights

Highlights of our results of operations for the first quarter of 2016 are as follows:
    
Our total net revenues of $1.9 billion were 1.3% above the prior year period. The contribution of our clinical trials testing business to the Q2 Solutions joint venture on July 1, 2015 (the "Clinical Trials Contribution") negatively impacted net revenues by 2.3%.
DIS revenues of $1.8 billion increased by 3.8% compared to the prior year period. DIS volume, measured by the number of requisitions, increased 2.6% compared to the prior year period. Revenue per requisition increased 1.1% compared to the prior year period.
DS revenues of $107 million were 26.9% below the prior year period due to the Clinical Trials Contribution and the winding down of our Celera Products business.
Net income attributable to Quest Diagnostics' stockholders was $102 million, or $0.70 per diluted share.

Pursuant to the federal Protecting Access to Medicare Act of 2014 ("PAMA"), it is expected that the Centers for Medicare and Medicaid Services will revise reimbursement schedules for clinical laboratory testing services provided under Medicare. Although the revised reimbursement schedules, as a result of PAMA, could become effective as early as 2017, we believe the delays in the rule making process will make that timeline very challenging.
    
Five-point Strategy

Our five-point strategy is described in detail in "Item 1. Business" in our 2015 Annual Report on Form 10-K. During the first quarter of 2016, we continued to make progress on the execution of our five-point strategy as follows:

Acquisition of the Outreach Laboratory Service Business of Clinical Laboratory Partners

On February 29, 2016, we completed the acquisition of the outreach laboratory service business of Clinical Laboratory Partners, LLC ("CLP"), a wholly-owned subsidiary of Hartford HealthCare Corporation, in an all-cash transaction for $135 million. The acquired outreach laboratory service business of CLP is included in our DIS business.

For details regarding our acquisitions, see Note 5 to the interim unaudited consolidated financial statements and Note 5 to the consolidated financial statements in our 2015 Annual Report on Form 10-K.    


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Table of Contents                                             

Planned Disposition of Focus Diagnostics Products
    
During the first quarter of 2016, we signed a definitive agreement to sell the assets of our non-core Focus Diagnostics Products business ("Focus Diagnostics") to DiaSorin S.p.A for $300 million in cash, subject to working capital adjustments. The transaction is expected to close in the second quarter of 2016, subject to customary regulatory and other closing conditions, and is expected to result in a pre-tax gain. The pre-tax gain is expected to be material to our result of operations and cash flows and will be recorded in the period in which the transaction closes. Upon closing of the transaction, we will have disposed of our remaining diagnostics products business. The disposition of Focus Diagnostics is consistent with our five-point strategy, specifically to refocus on diagnostic information services.

For further details regarding our dispositions and assets held for sale, see Note 6 to the interim unaudited consolidated financial statements and Note 6 to the consolidated financial statements in our 2015 Annual Report on Form 10-K.    
    
Retirement of Debt
    
In March 2016, we completed a cash tender offer (the "2016 Tender Offer") to purchase up to $200 million aggregate principal amount of our 6.95% Senior Notes due July 2037 ("Senior Notes due 2037") and 5.75% Senior Notes due January 2040 ("Senior Notes due 2040"). We purchased $73 million of our Senior Notes due 2037 and $127 million of our Senior Notes due 2040 using a combination of cash on-hand and borrowing under our secured receivables credit facility. The retirement of debt is expected to reduce future interest expense. For the three months ended March 31, 2016, we recorded a pre-tax loss on retirement of debt of $48 million, principally comprised of premiums paid.

For further details regarding our debt and related transactions, see Note 9 to the interim unaudited consolidated financial statements and Note 13 to the consolidated financial statements in the Company's 2015 Annual Report on Form 10-K.
    
Invigorate Program
    
We are engaged in a multi-year program called Invigorate, which is designed to reduce our cost structure. We delivered more than $700 million in run-rate savings as we exited 2014. In November 2014, we announced our goal to deliver an additional $600 million in run-rate savings as we exit 2017. Achieving this goal would bring the total savings from the Invigorate program to $1.3 billion in run-rate savings, compared to 2011. In 2015, we delivered realized savings of more than $200 million and believe we are on track to achieve our $1.3 billion run-rate savings goal by the end of 2017.

Invigorate has consisted of several flagship programs, with structured plans in each, to drive savings and improve performance across the customer value chain. These flagship programs include: organization excellence; information technology excellence; procurement excellence; service excellence; lab excellence; and billing excellence. In addition to these programs, we identified new key opportunities to change how we operate in order to meet our goal of delivering the additional $600 million in run-rate savings as we exit 2017. These new key opportunities include: standardizing our processes, information technology systems, equipment and data; enhancing electronic enabling services; and enhancing reimbursement for work we perform. We believe that our efforts to standardize our information technology systems, equipment and data also will foster our efforts to restore growth and support the value creation initiatives of our clinical franchises by enhancing our operational flexibility, empowering and enhancing the customer experience, facilitating the delivery of actionable insights and bolstering our large data platform.

In January 2015, we adopted a course of action related to this multi-year program. We developed a high-level estimate of the total pre-tax charges expected to be incurred in 2015 through 2017 in connection with the course of action for the program: $300 million. During 2015, we incurred $89 million of charges in connection with the course of action. In February 2016, we developed high-level estimates of the pre-tax charges expected to be incurred in connection with the course of action for 2016 totaling $80 million to $100 million, consisting of up to $10 million of employee separation costs and $80 million to $90 million of systems conversion and integration costs. During the first quarter of 2016, we incurred $13 million in connection with the course of action. As detailed plans to implement the course of action are approved and executed, it will result in charges to earnings. Principally all of the total estimated pre-tax charges expected to be incurred in 2016 are anticipated to result in cash expenditures. The actual charges incurred in connection with the course of action in 2016 could be materially different from these estimates.

From 2012 through 2014, the cumulative charges incurred in connection with the Invigorate program were $266 million, including $178 million of cumulative pre-tax employee separation costs and other restructuring related costs. From the beginning of 2015 through March 31, 2016, the cumulative charges incurred in connection with the Invigorate program were $102 million, including approximately $42 million of cumulative pre-tax employee separation costs and other restructuring related costs.

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Table of Contents                                             


For further details of the Invigorate program and associated costs, see Note 4 to the interim unaudited consolidated financial statements.    

Critical Accounting Policies
    
There have been no significant changes to our critical accounting policies from those disclosed in our 2015 Annual Report on Form 10-K.    

Results of Operations    

The following tables sets forth certain results of operations data for the periods presented:

 
Three Months Ended March 31,
 
2016
 
2015
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
(dollars in millions)
Net revenues:
 
 
 
 
 
 
 
DIS business
$
1,756

 
$
1,692

 
$
64

 
3.8
 %
DS businesses
107

 
147

 
(40
)
 
(26.9
)
Total net revenues
$
1,863

 
$
1,839

 
$
24

 
1.3
 %
 
 
 
 
 
 
 
 
Operating costs, expenses and other income:
 

 
 

 
 
 
 
Cost of services
$
1,144

 
$
1,163

 
$
(19
)
 
(1.6
)%
Selling, general and administrative
442

 
419

 
23

 
5.5

Amortization of intangible assets
19

 
21

 
(2
)
 
(12.5
)
Other operating expense, net
1

 
8

 
(7
)
 
NM

Total operating costs, expenses and other income, net
$
1,606

 
$
1,611

 
$
(5
)
 
(0.3
)%
 
 
 
 
 
 
 
 
Operating income
$
257

 
$
228

 
$
29

 
12.9
 %
 
 
 
 
 
 
 
 
NM - Not Meaningful
 
 
 
 
 
 
 



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Table of Contents                                             

 
Three Months Ended March 31,
 
2016
 
2015
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
(dollars in millions, except per share amounts)
Other income (expense):
 
 
 
 
 
 
 
Interest expense, net
$
(36
)
 
$
(45
)
 
$
(9
)
 
(19.1
)%
Other expense, net
(49
)
 
(78
)
 
(29
)
 
NM

Total non-operating expenses, net
$
(85
)
 
$
(123
)
 
$
(38
)
 
(30.2
)%
 
 
 
 
 
 
 
 
Income tax expense
$
(68
)
 
$
(42
)
 
$
26

 
63.4
 %
Effective income tax rate
39.8
%
 
39.7
%
 
0.1
%
 
NM

 
 
 
 
 
 
 
 
Equity in earnings of equity method investees, net of taxes
$
10

 
$
7

 
$
3

 
55.4
 %
 
 
 
 
 
 
 
 
Net income attributable to Quest Diagnostics
$
102

 
$
61

 
$
41

 
66.7
 %
 
 
 
 
 
 
 
 
Diluted earnings per common share attributable to Quest Diagnostics’ common stockholders
$
0.70

 
$
0.42

 
$
0.28

 
66.7
 %
 
 
 
 
 
 
 
 
NM - Not Meaningful
 
 
 
 
 
 
 

The following table sets forth certain results of operations data as a percentage of net revenues for the periods presented:
 
Three Months Ended March 31,
 
2016
 
2015
Net revenues:
 
 
 
DIS business
94.2
%
 
92.0
%
DS businesses
5.8

 
8.0

Total net revenues
100.0
%
 
100.0
%
 
 
 
 
Operating costs, expenses and other income:
 

 
 

Cost of services
61.4
%
 
63.2
%
Selling, general and administrative
23.7

 
22.8

Amortization of intangible assets
1.0

 
1.1

Other operating expense, net
0.1

 
0.5

Total operating costs, expenses and other income, net
86.2
%
 
87.6
%
 
 
 
 
Operating income
13.8
%
 
12.4
%
 
 
 
 
Bad debt expense
4.6
%
 
4.3
%

Operating Results    
 
Results for the three months ended March 31, 2016 were affected by certain items that reduced diluted earnings per share by $0.32 as follows:
    
pre-tax charges of $48 million, or $0.21 per diluted share, related to the 2016 Tender Offer recorded in other expense, net;

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Table of Contents                                             

pre-tax charges of $21 million ($7 million in cost of services, $12 million in selling, general and administrative expenses and $2 million in equity in earnings of equity method investees, net of taxes), or $0.09 per diluted share, primarily associated with systems conversions and integration costs in connection with further restructuring and integrating our business; and
pre-tax costs of $6 million ($3 million in selling, general and administrative expenses, $2 million in other operating expense, net and $1 million in other expense, net), or $0.02 per diluted share, related to winding down subsidiaries, non-cash asset impairment charges and costs incurred related to legal matters.

Results for the three months ended March 31, 2015 were affected by certain items that reduced diluted earnings per share by $0.54 as follows:

pre-tax charges of $84 million ($5 million in interest expense, net and $79 million in other expense, net), or $0.36 per diluted share, related to the loss on early retirement of debt and related refinancing charges in connection with the March 2015 cash tender offer ("2015 Tender Offer"), in which we purchased $250 million aggregate principal amount of our Senior Notes due 2037 and Senior Notes due 2040;
pre-tax charges of $31 million ($20 million in cost of services and $11 million in selling, general and administrative expenses), or $0.13 per diluted share, primarily associated with workforce reductions and professional fees incurred in connection with further restructuring and integrating our business; and
pre-tax costs of $10 million ($2 million in selling, general and administrative expenses and $8 million in other operating expense, net), or $0.05 per diluted share, primarily associated with non-cash asset impairment charges associated with our Celera Products business and costs incurred related to legal matters.
 
Net Revenues

Net revenues for the three months ended March 31, 2016 were 1.3% above the prior year period. The Clinical Trials Contribution negatively impacted net revenues by 2.3%.

DIS revenues increased by 3.8% for the three months ended March 31, 2016 compared to the prior year period. Our performance reflects continued focus on gene-based and esoteric testing and expanding hospital relationships. Acquisitions contributed approximately 0.3% to DIS revenue growth. DIS volume, measured by the number of requisitions, increased 2.6% for the three months ended March 31, 2016 compared to the prior year period. Acquisitions contributed approximately 0.2% to DIS volume growth. Revenue per requisition for the three months ended March 31, 2016 increased 1.1% compared to the prior year period, benefiting from favorable test mix.

For the three months ended March 31, 2016, combined revenues in our DS businesses decreased by 26.9% compared to the prior year period due to the Clinical Trials Contribution and the winding down of our Celera Products business.
    
Cost of Services

Cost of services consists principally of costs for obtaining, transporting and testing specimens as well as facility costs used for the delivery of our services.

Cost of services decreased $19 million for the three months ended March 31, 2016 compared to the prior year period. This decrease was primarily driven by lower costs as a result of the Clinical Trials Contribution, net cost reductions under the Invigorate program, lower restructuring and integration charges and lower depreciation expense. For further details regarding the impact of the change in estimated useful lives of our property, plant and equipment on depreciation expense, see Note 2 to the interim unaudited consolidated financial statements.

Selling, General and Administrative Expenses ("SG&A")
    
SG&A consist principally of the costs associated with our sales and marketing efforts, billing operations, bad debt expense and general management and administrative support as well as administrative facility costs.
    
SG&A for the three months ended March 31, 2016 increased $23 million compared to the prior year period. The increase in SG&A was primarily driven by higher compensation and benefits and higher bad debt expense, partially offset by net cost reductions under the Invigorate program and lower depreciation expense. The increase in bad debt expense was primarily due to increased patient responsibility associated with coinsurance and deductible requirements.


27


Table of Contents                                             

Other Operating Expense, net

Other operating expense, net includes miscellaneous income and expense items related to operating activities. For the three months ended March 31, 2015, other operating expense, net principally includes non-cash asset impairment charges associated with our Celera Products business.
    
Interest Expense, net

Interest expense, net, for the three months ended March 31, 2016, decreased $9 million compared to the prior year period. The decrease in interest expense, net was primarily a result of lower interest rates as a result of the debt refinancing in 2015.

Other Expense, net

Other expense, net represents miscellaneous income and expense items related to non-operating activities, such as gains and losses associated with investments and other non-operating assets and losses on early retirement of debt. For the three months ended March 31, 2016 and 2015, other expense, net includes losses on early retirement of debt of $48 million and $79 million, respectively, associated with the 2016 Tender Offer and 2015 Tender Offer.

    Income Tax Expense

The $26 million increase in income tax expense for the three months ended March 31, 2016 compared to the prior year period, was primarily a result of the increase in pre-tax income. The increase in pre-tax income was primarily a result of a $29 million increase in operating income and a $31 million decrease in the loss on early retirement of debt. The effective tax rate for the three months ended March 31, 2016, compared to the prior year period, was essentially unchanged.
  
Quantitative and Qualitative Disclosures About Market Risk

We address our exposure to market risks, principally the market risk of changes in interest rates, through a controlled program of risk management that includes the use of derivative financial instruments. We do not hold or issue derivative financial instruments for speculative purposes. We seek to mitigate the variability in cash outflows that result from changes in interest rates by maintaining a balanced mix of fixed-rate and variable-rate debt obligations. In order to achieve this objective, we have 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 are recognized as an adjustment to interest expense. We believe that our exposures to foreign exchange impacts and changes in commodity prices are not material to our consolidated financial condition or results of operations.
    
At March 31, 2016 and December 31, 2015, the fair value of our debt was estimated at approximately $4.0 billion and $3.7 billion, respectively, using quoted prices in active markets and yields for the same or similar types of borrowings, taking into account the underlying terms of the debt instruments. At March 31, 2016 and December 31, 2015, the estimated fair value exceeded the carrying value of the debt by $123 million and $82 million, respectively. A hypothetical 10% increase in interest rates (representing 35 basis points at March 31, 2016 and 39 basis points at December 31, 2015) would potentially reduce the estimated fair value of our debt by approximately $91 million and $112 million at March 31, 2016 and December 31, 2015, respectively.

Borrowings under our secured receivables credit facility and our senior unsecured revolving credit facility are subject to variable interest rates. Interest on our secured receivables credit facility is based on rates that are intended to approximate commercial paper rates for highly rated issuers. Interest on our senior unsecured revolving credit facility is subject to a pricing schedule that can fluctuate based on changes in our credit ratings. As such, our borrowing cost under this credit arrangement will be subject to both fluctuations in interest rates and changes in our credit ratings. At March 31, 2016, the borrowing rates under these debt instruments were: for our secured receivables credit facility, 1.20%; and for our senior unsecured revolving credit facility, LIBOR plus 1.125%. At March 31, 2016, the weighted average LIBOR was 0.4%. As of March 31, 2016, there were $410 million of borrowings outstanding under our $600 million secured receivables credit facility and no borrowings outstanding under our $750 million senior unsecured revolving credit facility.
    
The notional amount of fixed-to-variable interest rate swaps outstanding at both March 31, 2016 and December 31, 2015 was $1.2 billion. The aggregate fair value of the fixed-to-variable interest rate swaps is $53 million, in an asset position, at March 31, 2016. There were no forward starting interest rate swaps outstanding at March 31, 2016 and December 31, 2015.


28


Table of Contents                                             

Based on our net exposure to interest rate changes, a hypothetical 10% change in interest rates on our variable rate indebtedness (representing 5 basis points) would not impact annual interest expense materially, assuming no changes to the debt outstanding at March 31, 2016. A hypothetical 10% change in the forward one-month LIBOR curve (representing a 12 basis point change in the weighted average yield) would potentially change the fair value of our derivative assets by $8 million.

For further details regarding our outstanding debt, see Note 9 to the interim unaudited consolidated financial statements and Note 13 to the consolidated financial statements included in our 2015 Annual Report on Form 10-K. For details regarding our financial instruments and hedging activities, see Note 10 to the interim unaudited consolidated financial statements and Note 14 to the consolidated financial statements included in our 2015 Annual Report on Form 10-K.

Risk Associated with Investment Portfolio

Our investment portfolio includes equity investments comprised primarily of strategic equity holdings in privately and publicly held companies. These securities are exposed to price fluctuations and are generally concentrated in the life sciences industry. The carrying value of our equity investments (excluding investments accounted for under the equity method) was $14 million at March 31, 2016.
    
We regularly evaluate the fair value measurements of our equity investments to determine if losses in value are other than temporary and if an impairment loss has been incurred. The evaluation considers whether the security has the ability to recover and, if so, the estimated recovery period. Other factors that are considered in this evaluation include the amount of the other-than-temporary decline and its duration, the issuer’s financial condition and short-term prospects, and whether the market decline was caused by overall economic conditions or conditions specific to the individual security.

We do not hedge our equity price risk. The impact of an adverse movement in equity prices on our holdings in privately held companies cannot be easily quantified, as our ability to realize returns on investments depends on, among other things, the enterprises’ ability to raise additional capital or derive cash inflows from continuing operations or through liquidity events such as initial public offerings, mergers or private sales.

Liquidity and Capital Resources
 
Three Months Ended March 31,
 
2016
 
2015
 
(dollars in millions)
Net cash provided by operating activities
$
143

 
$
52

Net cash used in investing activities
(190
)
 
(55
)
Net cash provided by financing activities
42

 
785

Net change in cash and cash equivalents
$
(5
)
 
$
782


Cash and Cash Equivalents

Cash and cash equivalents consist of cash and highly liquid short-term investments. Cash and cash equivalents at March 31, 2016 totaled $128 million, compared to $133 million at December 31, 2015.

Cash Flows from Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2016 was $143 million, compared to $52 million for the three months ended March 31, 2015. This $91 million increase was primarily a result of an additional payroll cycle in the first quarter of 2015 and a $31 million decrease in cash charges associated with retirement of debt in March 2016 as compared to March 2015.

Days sales outstanding, a measure of billing and collection efficiency, was 44 days at March 31, 2016, 47 days at December 31, 2015 and 45 days at March 31, 2015.


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Table of Contents                                             

Cash Flows from Investing Activities

Net cash used in investing activities for the three months ended March 31, 2016 was $190 million, compared to $55 million for the three months ended March 31, 2015. This $135 million increase was a result of a $135 million increase in cash paid for business acquisitions in 2016 compared to 2015, principally a result of the CLP acquisition in 2016.

Cash Flows from Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2016 was $42 million, compared to $785 million for the three month ended March 31, 2015. This $743 million decrease in cash provided by financing activities was primarily a result of a $737 million decrease in net borrowings (proceeds from borrowings less repayments of debt), a $33 million decrease in other financing activities, net and a $29 million decrease in proceeds from the exercise of stock options.

The decrease in net borrowings primarily relates to the $1.2 billion senior notes offering in March 2015, partially offset by a $410 million increase in net borrowings under our secured receivables credit facility in 2016. In addition, we completed the 2016 Tender Offer and 2015 Tender Offer.

The CLP acquisition and 2016 Tender Offer were funded using a combination of cash on-hand and borrowings under our secured receivables credit facility.

Dividends
    
During the first quarter of 2016, our Board of Directors declared a quarterly cash dividend of $0.40 per common share. During each of the quarters of 2015, our Board of Directors declared a quarterly cash dividend of $0.38 per common share. We expect to fund future dividend payments with cash flows from operations and do not expect the dividend to have a material impact on our ability to finance future growth.
    
Share Repurchases

At March 31, 2016, $857 million remained available under our share repurchase authorizations. The share repurchase authorization has no set expiration or termination date.

For the three months ended March 31, 2016, we repurchased 1.7 million shares of our common stock for $115 million. For the three months ended March 31, 2015, we repurchased 1.5 million shares of our common stock for $110 million.
    
Contractual Obligations and Commitments

The following table summarizes certain of our contractual obligations as of March 31, 2016:

 
 
Payments due by period
 
 
(in millions)
Contractual Obligations
 
Total
 
Remainder of 2016
 
1-3 years
 
3-5 years
 
After 5 years
Outstanding debt
 
$
3,835

 
$
150

 
$
410

 
$
1,100

 
$
2,175

Capital lease obligations
 
19

 
6

 
10

 
3

 

Interest payments on outstanding debt
 
1,518

 
106

 
246

 
219

 
947

Operating leases
 
666

 
140

 
251

 
122

 
153

Purchase obligations
 
206

 
71

 
91

 
23

 
21

Merger consideration obligations
 
4

 
2

 
2