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 a broad range of customers, including patients, clinicians, hospitals, integrated delivery networks ("IDNs"), health plans, employers and accountable care organizations ("ACOs"). The Company offers the broadest access in the United States to diagnostic information services through its nationwide network of laboratories, 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 testing, non-routine (including advanced diagnostics) 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 and healthcare providers. The Company is the leading provider of risk assessment services for the life insurance industry. In addition, the Company offers healthcare organizations and clinicians robust information technology solutions. Prior to the sale of the Focus Diagnostics products business on May 13, 2016, the Company's diagnostics products business manufactured and marketed diagnostic products.
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
2016
Annual Report on Form 10-K. The year-end balance sheet data was derived from the audited financial statements as of
December 31, 2016
, but does not include all the disclosures required by accounting principles generally accepted in the United States (“GAAP”).
The accounting policies of the Company are the same as those set forth in Note 2 to the consolidated financial statements contained in the Company’s
2016
Annual Report on Form 10-K except for the impact of the adoption of new accounting standards discussed under
New Accounting Pronouncements.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings Per Share
The Company's unvested restricted stock units that contain non-forfeitable rights to dividends are participating securities and, therefore, are included in the earnings allocation in computing earnings per share using the two-class method. Basic earnings per common share is calculated by dividing net income, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding. Diluted earnings per common share is calculated by dividing net income, adjusted for earnings allocated to participating securities, by the weighted average number of common shares outstanding after giving effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the dilutive effect of outstanding stock options and performance share units granted under the
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
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.
New Accounting Pronouncements
Adoption of New Accounting Standards
On January 1, 2017, the Company adopted a new accounting standard issued by the Financial Accounting Standards Board ("FASB") 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 adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows.
In August 2017, the FASB issued an accounting standards update (“ASU”) that amends and simplifies existing hedge accounting guidance and allows for more hedging strategies to be eligible for hedge accounting. In addition, the ASU amends disclosure requirements and how hedge effectiveness is assessed. In the third quarter of 2017, the Company elected to early adopt this standard, effective January 1, 2017. The adoption of this standard did not have a material impact on the Company's results of operations, financial position and cash flows. For further details regarding the Company's derivative financial instruments, see Note 8.
New Accounting Standards To Be Adopted
In May 2014, the FASB issued an ASU on revenue recognition. This ASU outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers. This standard supersedes existing revenue recognition requirements and eliminates most industry-specific guidance from GAAP. The core principle of the revenue recognition standard is to require an entity to recognize as revenue the amount that reflects the consideration to which it expects to be entitled in exchange for goods or services as it transfers control to its customers. 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 will adopt the ASU in the first quarter of 2018 using the full retrospective method. The Company continues to assess the impact of this ASU on its results of operations, financial position, cash flows and disclosures. Based on the Company's preliminary assessment of this ASU, the majority of the amounts that were historically classified as bad debt expense, primarily related to patient responsibility, will be considered an implicit price concession in determining net revenues. Accordingly, the Company will report uncollectible balances associated with patient responsibility as a reduction of the transaction price and therefore as a reduction in net revenues when historically these amounts were classified as bad debt expense within selling, general and administrative expenses. As a result of this change, the Company preliminarily estimates the following impact to its statement of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2016
|
|
As Reported
|
|
Adjustment for ASU on Revenue Recognition
|
|
As Adjusted
|
Net revenues
|
$
|
7,515
|
|
|
$
|
(301
|
)
|
|
$
|
7,214
|
|
Selling, general and administrative expenses
|
$
|
1,681
|
|
|
$
|
(301
|
)
|
|
$
|
1,380
|
|
Net income attributable to Quest Diagnostics
|
$
|
645
|
|
|
$
|
—
|
|
|
$
|
645
|
|
The Company continues to assess the impact of the reclassification on its statement of operations for 2017.
In addition, the adoption of this ASU will result in increased disclosure, including qualitative and quantitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
However, the adoption of this ASU is not expected to have a material impact on the Company's 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 assessing the impact of the adoption of this ASU on the Company’s results of operations, financial position and cash flows. Significant implementation
matters being addressed by the Company include implementing an integrated third-party lease accounting application, assessing the impact to its internal controls over financial reporting and documenting the new lease accounting process.
In June 2016, the FASB issued an ASU that changes the impairment model for most financial instruments, including trade receivables, from an incurred loss method to a new forward-looking approach, based on expected losses. The estimate of expected credit losses will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. This ASU is effective for the Company in the first quarter of 2020 and must be adopted using a modified retrospective transition approach. 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.
In August 2016, the FASB issued an ASU that clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU is effective for the Company in the first quarter of 2018 with early adoption permitted and must be applied retrospectively to all periods presented. Upon adoption cash payments for debt retirement costs would be reclassified from operating cash outflows to financing cash outflows in the consolidated statements of cash flows.
In November 2016, the FASB issued an ASU that clarifies the presentation and classification of restricted cash in the statement of cash flows. The ASU requires that amounts generally described as restricted cash and restricted cash equivalents be presented with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The ASU is effective for the Company in the first quarter of 2018 with early adoption permitted and must be applied retrospectively to all periods presented. The Company does not expect the adoption of this ASU to have a material impact on its cash flows.
In January 2017, the FASB issued an ASU that provides guidance on evaluating when a set of transferred assets and activities (set) is a business. If an entity determines that substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, then the asset is not a business. If this threshold is not met, then the entity needs to evaluate whether the asset includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. The ASU is effective for the Company in the first quarter of 2018 with early adoption permitted and must be applied prospectively. The future impact of the adoption of this ASU on the Company’s results of operations, financial position and cash flows will be dependent upon the nature of any future acquisitions or dispositions made by the Company.
In January 2017, the FASB issued an ASU that simplifies the quantitative test for goodwill impairment. The guidance eliminates step two in the current two-step process so that any goodwill impairment is measured as the amount by which the reporting unit’s carrying amount exceeds its fair value. The ASU is effective for the Company in the first quarter of 2020 with
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
early adoption permitted and must be applied prospectively. 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.
3. EARNINGS PER SHARE
The computation of basic and diluted earnings per common share was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Amounts attributable to Quest Diagnostics’ common stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Quest Diagnostics
|
$
|
161
|
|
|
$
|
192
|
|
|
$
|
518
|
|
|
$
|
490
|
|
Less: Earnings allocated to participating securities
|
1
|
|
|
2
|
|
|
2
|
|
|
3
|
|
Earnings available to Quest Diagnostics’ common stockholders – basic and diluted
|
$
|
160
|
|
|
$
|
190
|
|
|
$
|
516
|
|
|
$
|
487
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding – basic
|
137
|
|
|
139
|
|
|
137
|
|
|
141
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
Stock options and performance share units
|
3
|
|
|
3
|
|
|
3
|
|
|
2
|
|
Weighted average common shares outstanding – diluted
|
140
|
|
|
142
|
|
|
140
|
|
|
143
|
|
|
|
|
|
|
|
|
|
Earnings per share attributable to Quest Diagnostics’ common stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
$
|
1.18
|
|
|
$
|
1.37
|
|
|
$
|
3.77
|
|
|
$
|
3.46
|
|
|
|
|
|
|
|
|
|
Diluted
|
$
|
1.15
|
|
|
$
|
1.34
|
|
|
$
|
3.68
|
|
|
$
|
3.42
|
|
The following securities were not included in the calculation of diluted earnings per share due to their antidilutive effect:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Stock options
|
2
|
|
|
—
|
|
|
1
|
|
|
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.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
In January 2015, the Company adopted a program to further reduce its cost structure through 2017. This multi-year program continues to focus on the flagship program themes and additional key themes such as: standardizing processes, information technology systems, equipment and data; enhancing electronic enabling services; and enhancing reimbursement for work performed.
Restructuring Charges
The following table provides a summary of the Company's pre-tax restructuring charges for the
three and nine
months ended
September 30, 2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Employee separation costs
|
$
|
4
|
|
|
$
|
1
|
|
|
$
|
9
|
|
|
$
|
7
|
|
Facility-related costs
|
1
|
|
|
2
|
|
|
2
|
|
|
2
|
|
Total restructuring charges
|
$
|
5
|
|
|
$
|
3
|
|
|
$
|
11
|
|
|
$
|
9
|
|
The restructuring charges incurred for the
three and nine
months ended
September 30, 2017
were 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
September 30, 2017
,
$4 million
and
$1 million
were recorded in cost of services and selling, general and administrative expenses, respectively. Of the total restructuring charges incurred during the
nine
months ended
September 30, 2017
,
$8 million
and
$3 million
were recorded in cost of services and selling, general and administrative expenses, respectively.
The restructuring charges incurred for the
three and nine
months ended
September 30, 2016
were primarily associated with various workforce reduction initiatives as the Company continued to simplify and restructure its organization. Of the total restructuring charges incurred during the
three
months ended
September 30, 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
nine
months ended
September 30, 2016
,
$4 million
and
$5 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.
The restructuring liability as of
September 30, 2017
and
December 31, 2016
, which is included in accounts payable and accrued expenses, was
$8 million
and
$9 million
, respectively.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
5. BUSINESS ACQUISITIONS
On May 1, 2017, the Company completed the acquisition of the outreach laboratory service business of PeaceHealth Laboratories ("PHL"), in an all-cash transaction for
$101 million
. PHL is a healthcare system that provides clinical testing services to physicians, hospitals, and clinics in Oregon, Washington and Alaska. The assets acquired principally consist of
$71 million
of tax deductible goodwill and
$30 million
of customer-related intangible assets. The intangible assets are being amortized over a useful life of
15
years.
On July 14, 2017, the Company completed the acquisitions of Med Fusion, LLC and Clearpoint Diagnostic Laboratories, LLC ("Med Fusion"), in an all-cash transaction for
$150 million
. The final consideration paid is subject to post closing adjustments related to working capital. Through the acquisition, the Company acquired all of Med Fusion's operations. Med Fusion provides precision medicine diagnostics to aid cancer treatment nationwide and the acquired businesses form the Company's center of excellence in precision diagnostics for oncology. The assets acquired principally consist of
$84 million
of customer-related intangible assets,
$62 million
of tax deductible goodwill and
$31 million
of property, plant and equipment. The liabilities assumed principally consist of a
$28 million
capital lease obligation. The intangible assets are being amortized over a useful life of
15
years.
On September 28, 2017, the Company completed the acquisition of the outreach laboratory service businesses of two hospitals of Hartford Health Care ("HHC"), The William W. Backus Hospital and The Hospital of Central Connecticut, in an all-cash transaction for
$30 million
. The assets acquired principally consist of tax deductible goodwill and customer-related intangible assets.
The acquisitions during the quarter were accounted for under the acquisition method of accounting. As such, the assets acquired and liabilities assumed are recorded based on their estimated fair values as of the closing date. Supplemental pro forma combined financial information has not been presented as the impact of the acquisitions is not material to the Company's consolidated financial statements. The goodwill recorded primarily includes the expected synergies resulting from combining the operations of the acquired entities with those of the Company and the value associated with an assembled workforce and other intangible assets that do not qualify for separate recognition. All of the goodwill acquired in connection with these acquisitions has been allocated to the Company's DIS business. For further details regarding business segment information, see Note 12.
For details regarding the Company's
2016
acquisitions, see Note 5 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
6. 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
|
September 30, 2017
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities
|
$
|
56
|
|
|
$
|
56
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cash surrender value of life insurance policies
|
36
|
|
|
—
|
|
|
36
|
|
|
—
|
|
Available-for-sale equity securities
|
2
|
|
|
2
|
|
|
—
|
|
|
—
|
|
Total
|
$
|
94
|
|
|
$
|
58
|
|
|
$
|
36
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Deferred compensation liabilities
|
$
|
99
|
|
|
$
|
—
|
|
|
$
|
99
|
|
|
$
|
—
|
|
Interest rate swaps
|
76
|
|
|
—
|
|
|
76
|
|
|
—
|
|
Contingent consideration
|
1
|
|
|
—
|
|
|
—
|
|
|
1
|
|
Total
|
$
|
176
|
|
|
$
|
—
|
|
|
$
|
175
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basis of Fair Value Measurements
|
December 31, 2016
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities
|
$
|
51
|
|
|
$
|
51
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cash surrender value of life insurance policies
|
32
|
|
|
—
|
|
|
32
|
|
|
—
|
|
Available-for-sale equity securities
|
3
|
|
|
3
|
|
|
—
|
|
|
—
|
|
Total
|
$
|
86
|
|
|
$
|
54
|
|
|
$
|
32
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Deferred compensation liabilities
|
$
|
91
|
|
|
$
|
—
|
|
|
$
|
91
|
|
|
$
|
—
|
|
Interest rate swaps
|
88
|
|
|
—
|
|
|
88
|
|
|
—
|
|
Contingent consideration
|
3
|
|
|
—
|
|
|
—
|
|
|
3
|
|
Total
|
$
|
182
|
|
|
$
|
—
|
|
|
$
|
179
|
|
|
$
|
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
2016
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-directed stock and bond mutual funds that are classified as trading securities. The trading securities are classified within Level 1 because the 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
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
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 classified within Level 2 of the fair value hierarchy 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 discussed in Note 5 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K, the Company completed the acquisition of Steward Health Care Systems, LLC's laboratory outreach business. In connection with the acquisition, the Company initially recorded a contingent consideration liability of
$4 million
. The contingent consideration liability was classified within Level 3 of the fair value hierarchy measured at fair value using a probability weighted and discounted cash flow method. The remaining
$1 million
is expected to be paid in 2018.
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. As of
September 30, 2017
and
December 31, 2016
, the fair value of the Company’s debt was estimated at
$4.0 billion
and
$3.9 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.
7. GOODWILL AND INTANGIBLE ASSETS
The changes in goodwill for the
nine
months ended
September 30, 2017
and for the year ended
December 31, 2016
were as follows:
|
|
|
|
|
|
|
|
|
|
September 30,
2017
|
|
December 31,
2016
|
Balance, beginning of period
|
$
|
6,000
|
|
|
$
|
5,905
|
|
Goodwill acquired during the period
|
164
|
|
|
95
|
|
Balance, end of period
|
$
|
6,164
|
|
|
$
|
6,000
|
|
Principally all of the Company’s goodwill as of
September 30, 2017
and
December 31, 2016
was associated with its DIS business.
For the
nine
months ended
September 30, 2017
, goodwill acquired during the period was principally associated with the Med Fusion, PHL, and HHC acquisitions (see Note 5). For the year ended
December 31, 2016
, goodwill acquired was principally associated with the acquisition of the outreach laboratory service business of Clinical Laboratory Partners, LLC. For details regarding the Company's 2016 acquisitions, see Note 5 to the consolidated financial statements in the Company's 2016 Annual Report on Form 10-K.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
Intangible assets at
September 30, 2017
and
December 31, 2016
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average
Amortization
Period
(in years)
|
|
September 30, 2017
|
|
December 31, 2016
|
|
|
Cost
|
|
Accumulated
Amortization
|
|
Net
|
|
Cost
|
|
Accumulated
Amortization
|
|
Net
|
Amortizing intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer-related
|
18
|
|
$
|
1,103
|
|
|
$
|
(388
|
)
|
|
$
|
715
|
|
|
$
|
971
|
|
|
$
|
(346
|
)
|
|
$
|
625
|
|
Non-compete agreements
|
7
|
|
7
|
|
|
(5
|
)
|
|
2
|
|
|
6
|
|
|
(4
|
)
|
|
2
|
|
Technology
|
18
|
|
94
|
|
|
(43
|
)
|
|
51
|
|
|
93
|
|
|
(40
|
)
|
|
53
|
|
Other
|
9
|
|
103
|
|
|
(78
|
)
|
|
25
|
|
|
103
|
|
|
(70
|
)
|
|
33
|
|
Total
|
17
|
|
1,307
|
|
|
(514
|
)
|
|
793
|
|
|
1,173
|
|
|
(460
|
)
|
|
713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets not subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade names
|
|
|
235
|
|
|
—
|
|
|
235
|
|
|
235
|
|
|
—
|
|
|
235
|
|
Other
|
|
|
1
|
|
|
—
|
|
|
1
|
|
|
1
|
|
|
—
|
|
|
1
|
|
Total intangible assets
|
|
|
$
|
1,543
|
|
|
$
|
(514
|
)
|
|
$
|
1,029
|
|
|
$
|
1,409
|
|
|
$
|
(460
|
)
|
|
$
|
949
|
|
Amortization expense related to intangible assets was
$19 million
and
$18 million
for the three months ended
September 30, 2017
and
2016
, respectively. For both the
nine
months ended
September 30, 2017
and
2016
, amortization expense related to intangible assets was
$54 million
.
The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of
September 30, 2017
is as follows:
|
|
|
|
|
Year Ending December 31,
|
|
|
Remainder of 2017
|
$
|
19
|
|
2018
|
74
|
|
2019
|
73
|
|
2020
|
73
|
|
2021
|
67
|
|
2022
|
64
|
|
Thereafter
|
423
|
|
Total
|
$
|
793
|
|
8
. 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.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
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.
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.
In May 2016, the Company entered into interest rate lock agreements with several financial institutions for a total notional amount of
$250 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 ten-year treasury rates related to the planned issuance of senior notes in 2016. In connection with the issuance of senior notes in 2016, these agreements were settled, and the Company paid
$1 million
. These losses are deferred in stockholders’ equity, net of 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
September 30, 2017
and
December 31, 2016
was
$9 million
and
$10 million
, respectively. 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. For an interest rate derivative instrument that has been formally designated as a fair value hedge, fair value gains or losses on the derivative instrument are reported in earnings together with offsetting fair value gains or losses on the hedged item (the long-term debt) that are attributable to the risk being hedged. A summary of the notional amounts of these interest rate swaps as of
September 30, 2017
and
December 31, 2016
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount
|
Debt Instrument
|
|
September 30, 2017
|
|
December 31, 2016
|
|
|
|
|
|
4.25% Senior Notes due April 2024
|
|
$
|
250
|
|
|
$
|
250
|
|
3.50% Senior Notes due March 2025
|
|
600
|
|
|
600
|
|
3.45% Senior Notes due June 2026
|
|
350
|
|
|
350
|
|
|
|
$
|
1,200
|
|
|
$
|
1,200
|
|
The fixed-to-variable interest rate swap agreements in the table above have variable interest rates ranging from one-month LIBOR plus
2.2%
to one-month LIBOR plus
3.0%
.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
As of December 31, 2015, the Company had entered into various fixed-to-variable interest rate swap agreements with an aggregate notional amount of
$1.2 billion
and variable interest rates ranging from one-month LIBOR plus
1.4%
to one-month LIBOR plus
3.6%
. In July 2016, the Company terminated those interest rate swaps agreements. As a result of the termination, the Company received proceeds of
$60 million
, which included
$6 million
of accrued interest. The remaining basis adjustment on the respective debt obligation of
$54 million
will be amortized as a reduction of interest expense over the remaining terms of the hedged debt instrument. Immediately after the termination of these interest rate swaps, the Company entered into new fixed-to-variable interest rate swap agreements, which are reflected in the table above.
As of
September 30, 2017
and
December 31, 2016
, the following amounts were recorded on the consolidated balance sheet related to cumulative basis adjustments for fair value hedges:
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet Classification
|
|
Carrying Amount of Hedged Long-Term Debt
|
Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Long-Term Debt
|
|
|
September 30, 2017
|
|
September 30, 2017
|
|
Long-term debt
|
|
$
|
1,146
|
|
|
$
|
(16
|
)
|
(a)
|
(a) The balance includes
$60 million
of hedging adjustment on a discontinued relationship as of
September 30, 2017
.
The following table presents the effect of fair value hedge accounting on the statement of operations for the
three and nine
months ended
September 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Hedges Impact on Statement of Operations
|
|
Statement of Operations Classification
|
|
Three Months Ended September 30, 2017
|
|
Nine Months Ended September 30, 2017
|
Hedged items (Long-term debt)
|
|
Other (expense) income, net
|
|
$
|
(1
|
)
|
|
$
|
(12
|
)
|
Derivatives designated as hedging instruments
|
|
Other (expense) income, net
|
|
$
|
1
|
|
|
$
|
12
|
|
Interest Rate Derivatives - Economic Hedges
In connection with the retirement of debt in the first quarter of 2016, which is further discussed in Note 13 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K, 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 resulting in a gain of
$1 million
which was recognized in other (expense) income, net.
A summary of the fair values of derivative instruments in the consolidated balance sheets was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Derivatives Designated as Hedging Instruments
|
|
Balance Sheet
Classification
|
|
Fair Value
|
|
Balance Sheet
Classification
|
|
Fair Value
|
Interest rate swaps
|
|
Other liabilities
|
|
$
|
76
|
|
|
Other liabilities
|
|
$
|
88
|
|
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
2016
Annual Report on Form 10-K.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
9
. STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST
Stockholders' Equity
Components of Comprehensive Income (Loss)
Comprehensive income (loss) includes:
|
|
•
|
Foreign currency translation adjustments;
|
|
|
•
|
Investment adjustments, which represent unrealized holding gains (losses), net of tax on available for sale securities, net of other than temporary impairment amounts reclassified to other (expense) income, net;
|
|
|
•
|
Net deferred loss on cash flow hedges, which represents deferred losses, net of tax on interest rate related derivative financial instruments designated as cash flow hedges, net of amounts reclassified to interest expense (see Note
8
).
|
For the
three and nine
months ended
September 30, 2017
and
2016
, the tax effects related to the deferred losses on cash flow hedges and investment adjustments were not material. Foreign currency translation adjustments are not adjusted for taxes since they relate to indefinite investments in non-U.S. subsidiaries.
Dividend Program
During each of the quarters of
2017
, the Company's Board of Directors declared a quarterly cash dividend of
$0.45
per common share. During each of the first three quarters of
2016
, the Company's Board of Directors declared a quarterly cash dividend of
$0.40
per common share. During the fourth quarter of
2016
, the Company's Board of Directors declared a quarterly cash dividend of
$0.45
per common share.
Share Repurchase Program
As of
September 30, 2017
,
$1.0 billion
remained available under the Company’s share repurchase authorizations. The share repurchase authorization has no set expiration or termination date.
Share Repurchases
For the
nine
months ended
September 30, 2017
, the Company repurchased
3.6 million
shares of its common stock for
$365 million
, which includes an accrual of
$15 million
recorded in accounts payable and accrued expenses in the consolidated balance sheet for share repurchases not settled.
For the
nine
months ended
September 30, 2016
, the Company repurchased
5.7 million
shares of its common stock for
$440 million
, including
3.1 million
shares repurchased under an accelerated share repurchase agreement ("ASR") as follows:
In May 2016, the Company entered into an ASR with a financial institution to repurchase
$250 million
of the Company's common stock as part of the Company's share repurchase program. The ASR was structured as a combination of two transactions: (1) a treasury stock repurchase; and (2) a forward contract, which permitted the Company to purchase shares immediately with the final purchase price of those shares determined by the volume weighted average price of the Company's common stock during the repurchase period, less a fixed discount. Under the ASR, the Company paid
$250 million
to the financial institution and received
3.1 million
shares of common stock, resulting in a final price per share of
$81.04
. The Company initially received
2.8 million
shares of its common stock during the second quarter of 2016 and received an additional
0.3 million
shares upon completion of the ASR during the third quarter of 2016.
Shares Reissued from Treasury Stock
For the
nine
months ended
September 30, 2017
and
2016
, the Company reissued
2.3 million
shares and
1.4 million
shares, respectively, from treasury stock for shares issued under the Employee Stock Purchase Plan and stock option plans. For details regarding the Company's stock ownership and compensation plans, see Note 16 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K.
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. 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 records changes in the fair value of the noncontrolling interest immediately as they occur. As of
September 30, 2017
, the redeemable noncontrolling interest was presented at its fair value.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
10. SUPPLEMENTAL CASH FLOW & OTHER DATA
Supplemental cash flow and other data for the
three and nine
months ended
September 30, 2017
and
2016
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Depreciation expense
|
$
|
50
|
|
|
$
|
45
|
|
|
$
|
143
|
|
|
$
|
132
|
|
Amortization expense
|
19
|
|
|
18
|
|
|
54
|
|
|
54
|
|
Depreciation and amortization expense
|
$
|
69
|
|
|
$
|
63
|
|
|
$
|
197
|
|
|
$
|
186
|
|
|
|
|
|
|
|
|
|
Interest expense
|
$
|
(39
|
)
|
|
$
|
(37
|
)
|
|
$
|
(114
|
)
|
|
$
|
(108
|
)
|
Interest income
|
1
|
|
|
—
|
|
|
2
|
|
|
1
|
|
Interest expense, net
|
$
|
(38
|
)
|
|
$
|
(37
|
)
|
|
$
|
(112
|
)
|
|
$
|
(107
|
)
|
|
|
|
|
|
|
|
|
Interest paid
|
$
|
27
|
|
|
$
|
41
|
|
|
$
|
104
|
|
|
$
|
116
|
|
Income taxes paid
|
$
|
64
|
|
|
$
|
141
|
|
|
$
|
177
|
|
|
$
|
262
|
|
|
|
|
|
|
|
|
|
Accounts payable associated with capital expenditures
|
$
|
14
|
|
|
$
|
11
|
|
|
$
|
14
|
|
|
$
|
11
|
|
Accounts payable associated with purchases of treasury stock
|
$
|
15
|
|
|
$
|
—
|
|
|
$
|
15
|
|
|
$
|
—
|
|
Dividends payable
|
$
|
62
|
|
|
$
|
56
|
|
|
$
|
62
|
|
|
$
|
56
|
|
|
|
|
|
|
|
|
|
Businesses acquired:
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of assets acquired
|
$
|
229
|
|
|
$
|
4
|
|
|
$
|
343
|
|
|
$
|
139
|
|
Fair value of liabilities assumed
|
40
|
|
|
—
|
|
|
40
|
|
|
—
|
|
Fair value of net assets acquired
|
$
|
189
|
|
|
$
|
4
|
|
|
$
|
303
|
|
|
$
|
139
|
|
Merger consideration paid (payable), net
|
(2
|
)
|
|
—
|
|
|
(4
|
)
|
|
—
|
|
Cash paid for business acquisitions
|
187
|
|
|
4
|
|
|
299
|
|
|
139
|
|
Less: Cash acquired
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Business acquisitions, net of cash acquired
|
$
|
187
|
|
|
$
|
4
|
|
|
$
|
299
|
|
|
$
|
139
|
|
The escrow proceeds associated with disposition of business received in 2017 related to the sale of the Company's Focus Diagnostics products business on May 13, 2016. A full description regarding the Company's dispositions is contained in Note 6 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K.
11
. 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
2016
Annual Report on Form 10-K.
In support of its risk management program, to ensure the Company’s performance or payment to third parties,
$71 million
in letters of credit under the secured receivables credit facility were outstanding as of
September 30, 2017
. The letters of credit primarily represent collateral for current and future automobile liability and workers’ compensation loss payments.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
Contingent Lease Obligations
The Company remains subject to contingent obligations under certain real estate leases, including 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
2016
Annual Report on Form 10-K.
Settlements
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. The Company filed a motion for summary judgment on the primary claim in the case; the motion was granted. The court found that the Company had properly billed the Medicaid program the Company’s “usual and customary charge.” The Company had filed a motion for summary judgment on the state’s remaining claim. The Company previously reported that the parties had reached an agreement in principle to resolve these matters. The parties have finalized the settlement agreement and the matter is resolved.
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 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.
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
September 30, 2017
, the Company does not believe that material losses related to legal matters are probable.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
Reserves for legal matters totaled
$2 million
and
$5 million
as of
September 30, 2017
and
December 31, 2016
, 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
$120 million
and
$117 million
as of
September 30, 2017
and
December 31, 2016
, respectively. Management believes that established reserves and present insurance coverage are sufficient to cover currently estimated exposures. Management cannot predict the outcome of any claims made against the Company. Although management does not anticipate that the ultimate outcome of any such proceedings or claims will have a material adverse effect on the Company's financial condition, given the high degree of judgment involved in establishing accruals for loss estimates related to these types of matters, the outcome may be material to the Company's results of operations or cash flows in the period in which the impact of such claims is determined or paid.
12. BUSINESS SEGMENT INFORMATION
The Company's DIS business provides insights through clinical testing and related services to a broad range of customers, including patients, clinicians, hospitals, IDNs, health plans, employers and ACOs. The Company is the world's leading provider of diagnostic information services, which includes providing clinical testing services such as routine testing, non-routine (including advanced diagnostics) testing, and anatomic pathology services, as well as related services and insights. The DIS business accounted for greater than
90%
of net revenues in
2017
and
2016
.
All other operating segments include the Company's DS businesses, which consists of its risk assessment services, healthcare information technology and diagnostic products (prior to disposition on May 13, 2016) businesses. The Company's DS businesses offer a variety of solutions for life insurers and healthcare providers.
As of
September 30, 2017
, substantially all of the Company’s services were provided within the United States, and substantially all of the Company’s assets were located within the United States.
The following table is a summary of segment information for the
three and nine
months ended
September 30, 2017
and
2016
. 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, gain on the disposition of business, and 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
2016
Annual Report on Form 10-K and Note 2 to the interim unaudited consolidated financial statements.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net revenues:
|
|
|
|
|
|
|
|
|
|
|
|
DIS business
|
$
|
1,850
|
|
|
$
|
1,800
|
|
|
$
|
5,517
|
|
|
$
|
5,365
|
|
All other operating segments
|
81
|
|
|
85
|
|
|
256
|
|
|
289
|
|
Total net revenues
|
$
|
1,931
|
|
|
$
|
1,885
|
|
|
$
|
5,773
|
|
|
$
|
5,654
|
|
|
|
|
|
|
|
|
|
Operating earnings (loss):
|
|
|
|
|
|
|
|
|
|
|
|
DIS business
|
$
|
334
|
|
|
$
|
329
|
|
|
$
|
987
|
|
|
$
|
935
|
|
All other operating segments
|
10
|
|
|
12
|
|
|
40
|
|
|
50
|
|
General corporate activities
|
(46
|
)
|
|
(19
|
)
|
|
(131
|
)
|
|
16
|
|
Total operating income
|
298
|
|
|
322
|
|
|
896
|
|
|
1,001
|
|
Non-operating expenses, net
|
(40
|
)
|
|
(33
|
)
|
|
(100
|
)
|
|
(157
|
)
|
Income before income taxes and equity in earnings of equity method investees
|
258
|
|
|
289
|
|
|
796
|
|
|
844
|
|
Income tax expense
|
(92
|
)
|
|
(95
|
)
|
|
(264
|
)
|
|
(345
|
)
|
Equity in earnings of equity method investees, net of taxes
|
9
|
|
|
11
|
|
|
25
|
|
|
30
|
|
Net income
|
175
|
|
|
205
|
|
|
557
|
|
|
529
|
|
Less: Net income attributable to noncontrolling interests
|
14
|
|
|
13
|
|
|
39
|
|
|
39
|
|
Net income attributable to Quest Diagnostics
|
$
|
161
|
|
|
$
|
192
|
|
|
$
|
518
|
|
|
$
|
490
|
|
13
. 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 each of the three months ended
September 30, 2017
and
2016
, the Company recognized net revenues of
$8 million
associated with diagnostic information services provided to its equity method investees. During the nine months ended September 30, 2017 and 2016, the Company recognized net revenues of
$28 million
and
$24 million
, respectively, associated with such services. As of
September 30, 2017
and
December 31, 2016
, there was
$6 million
and
$10 million
, respectively, of accounts receivable from equity method investees related to such services.
During the three months ended
September 30, 2017
and
2016
, the Company recognized income of
$3 million
and
$4 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. During the nine months ended September 30, 2017 and 2016, the Company recognized income of
$12 million
and
$13 million
, respectively, associated with the performance of such services classified within selling, general and administrative expenses. As of
September 30, 2017
and
December 31, 2016
, there was
$4 million
and
$5 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
September 30, 2017
and
December 31, 2016
included
$1 million
and
$9 million
, respectively, due to equity method investees.
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(unaudited)
(in millions, except per share data)
14. TAXES ON INCOME
For the three months ended
September 30, 2017
and
2016
, the effective income tax rate was
35.7%
and
33.1%
, respectively. The effective tax rate for the three months ended
September 30, 2017
and
2016
benefited from
$7 million
and
$3 million
, respectively, of excess tax benefits associated with stock-based compensation arrangements. For the three months ended
September 30, 2016
, the effective income tax rate was also impacted by a non-taxable gain on an escrow recovery associated with an acquisition and other discrete tax benefits.
For the nine months ended
September 30, 2017
and
2016
, the effective income tax rate was
33.2%
and
40.9%
, respectively. The effective tax rate for the nine months ended
September 30, 2017
and
2016
benefited from
$36 million
and
$7 million
, respectively, of excess tax benefits associated with stock-based compensation arrangements. For the nine months ended
September 30, 2016
, the effective tax rate was also impacted by the higher tax rate associated with the sale of the Focus Diagnostics products business, partially offset by a non-taxable gain on an escrow recovery associated with an acquisition and other discrete tax benefits. The income tax expense from the sale of the Focus Diagnostics products business resulted in a combined tax rate of
71.4%
, which was significantly in excess of the statutory rate primarily due to a lower tax basis in the assets sold, specifically the goodwill associated with the disposition.
A full description regarding the Company's adoption of the ASU that simplified several aspects of the accounting for stock-based compensation 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 is contained in Note 2 to the consolidated financial statements in the Company's
2016
Annual Report on Form 10-K.
15. SUBSEQUENT EVENTS
On October 18, 2017, the Company entered into a definitive agreement to acquire Cleveland HeartLab, Inc. ("CHL") in an all-cash transaction for
$94 million
. CHL is a specialty clinical laboratory and disease management company, which will form the basis for the Company’s advanced diagnostics center of excellence in cardiovascular testing. The final consideration is subject to post closing adjustments related to working capital. Closing of the transaction remains subject to customary closing conditions.