10-Q 1 dgx0930201710-q.htm 10-Q Document

Table of Contents                                             

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2017
Commission file number 001-12215

Quest Diagnostics Incorporated

500 Plaza Drive
Secaucus, NJ 07094
(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 12, 2017, there were outstanding 136,299,442 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 AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016
(unaudited)
(in millions, except per share data)


 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2017
 
2016
2017
 
2016
Net revenues
$
1,931

 
$
1,885

$
5,773

 
$
5,654

 
 
 
 
 
 
 
Operating costs and expenses and other operating income:
 

 
 

 

 
 

Cost of services
1,190

 
1,157

3,525

 
3,456

Selling, general and administrative
423

 
409

1,297

 
1,281

Amortization of intangible assets
19

 
18

54

 
54

Gain on disposition of business

 


 
(118
)
Other operating expense (income), net
1

 
(21
)
1

 
(20
)
Total operating costs and expenses, net
1,633

 
1,563

4,877

 
4,653

 
 
 
 
 
 
 
Operating income
298

 
322

896

 
1,001

 
 
 
 
 
 
 
Other income (expense):
 

 
 

 

 
 

Interest expense, net
(38
)
 
(37
)
(112
)
 
(107
)
Other (expense) income, net
(2
)
 
4

12

 
(50
)
Total 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

 
 
 
 
 
 
 
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

 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 

 
 

Basic
137

 
139

137

 
141

Diluted
140

 
142

140

 
143

 
 
 
 
 
 
 
Dividends per common share
$
0.45

 
$
0.40

$
1.35

 
$
1.20




The accompanying notes are an integral part of these statements.

2


Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016
(unaudited)
(in millions)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
175

 
$
205

 
$
557

 
$
529

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Currency translation
8

 
(5
)
 
20

 
(23
)
Investment adjustments, net of taxes
3

 

 
3

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

 

 
1

 
1

Other comprehensive income (loss)
12

 
(5
)
 
24

 
(23
)
 
 
 
 
 
 
 
 
Comprehensive income
187

 
200

 
581

 
506

Less: Comprehensive income attributable to noncontrolling interests
14

 
13

 
39

 
39

Comprehensive income attributable to Quest Diagnostics
$
173

 
$
187

 
$
542

 
$
467




















The accompanying notes are an integral part of these statements.

3


Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2017 AND DECEMBER 31, 2016
(unaudited)
(in millions, except per share data)
 
September 30,
2017
 
December 31,
2016
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
350

 
$
359

Accounts receivable, net of allowance for doubtful accounts of $286 and $265 as of September 30, 2017 and December 31, 2016, respectively
960

 
926

Inventories
100

 
82

Prepaid expenses and other current assets
134

 
164

Total current assets
1,544

 
1,531

Property, plant and equipment, net
1,097

 
1,029

Goodwill
6,164

 
6,000

Intangible assets, net
1,029

 
949

Investment in equity method investees
459

 
443

Other assets
146

 
148

Total assets
$
10,439

 
$
10,100

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
1,047

 
$
975

Current portion of long-term debt
5

 
6

Total current liabilities
1,052

 
981

Long-term debt
3,759

 
3,728

Other liabilities
722

 
654

Commitments and contingencies


 


Redeemable noncontrolling interest
78

 
77

Stockholders’ equity:
 

 
 

Quest Diagnostics stockholders’ equity:
 

 
 

Common stock, par value $0.01 per share; 600 shares authorized as of both September 30, 2017 and December 31, 2016; 216 shares issued as of both September 30, 2017 and December 31, 2016
2

 
2

Additional paid-in capital
2,585

 
2,545

Retained earnings
6,946

 
6,613

Accumulated other comprehensive loss
(48
)
 
(72
)
Treasury stock, at cost; 80 shares and 79 shares as of September 30, 2017 and December 31, 2016, respectively
(4,691
)
 
(4,460
)
Total Quest Diagnostics stockholders’ equity
4,794

 
4,628

Noncontrolling interests
34

 
32

Total stockholders’ equity
4,828

 
4,660

Total liabilities and stockholders’ equity
$
10,439

 
$
10,100




The accompanying notes are an integral part of these statements.

4


Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016
(unaudited)
(in millions)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 

 
 

Net income
$
557

 
$
529

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

 
 

Depreciation and amortization
197

 
186

Provision for doubtful accounts
241

 
242

Deferred income tax provision
90

 
19

Stock-based compensation expense
54

 
52

Gain on disposition of business

 
(118
)
Other, net
(5
)
 
(15
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(265
)
 
(316
)
Accounts payable and accrued expenses
(3
)
 
43

Income taxes payable

 
74

Termination of interest rate swap agreements

 
54

Other assets and liabilities, net
(14
)
 
15

Net cash provided by operating activities
852

 
765

 
 
 
 
Cash flows from investing activities:
 

 
 

Business acquisitions, net of cash acquired
(299
)
 
(139
)
Proceeds from disposition of businesses
1

 
270

Escrow proceeds associated with disposition of business
25

 

Capital expenditures
(170
)
 
(165
)
Decrease (increase) in investments and other assets
4

 
(11
)
Net cash used in investing activities
(439
)
 
(45
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from borrowings

 
1,869

Repayments of debt
(5
)
 
(1,722
)
Purchases of treasury stock
(350
)
 
(440
)
Exercise of stock options
125

 
63

Employee payroll tax withholdings on stock issued under stock-based compensation plans
(23
)
 
(10
)
Dividends paid
(186
)
 
(168
)
Distributions to noncontrolling interests
(38
)
 
(31
)
Other financing activities, net
55

 
(8
)
Net cash used in financing activities
(422
)
 
(447
)
 
 
 
 
Net change in cash and cash equivalents
(9
)
 
273

Cash and cash equivalents, beginning of period
359

 
133

Cash and cash equivalents, end of period
$
350

 
$
406





The accompanying notes are an integral part of these statements.

5


Table of Contents                                             

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016
(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, 2016
137

 
$
2

 
$
2,545

 
$
6,613

 
$
(72
)
 
$
(4,460
)
 
$
32

 
$
4,660

 
 
$
77

Net income


 


 


 
518

 


 


 
34

 
552

 
 
5

Other comprehensive income, net of taxes


 


 


 


 
24

 


 


 
24

 
 
 
Dividends declared


 


 


 
(185
)
 


 


 


 
(185
)
 
 
 
Distributions to noncontrolling interests


 


 


 


 


 


 
(34
)
 
(34
)
 
 
(4
)
Issuance of common stock under benefit plans


 


 
9

 


 


 
9

 


 
18

 
 
 
Stock-based compensation expense


 


 
51

 


 


 
3

 


 
54

 
 
 
Exercise of stock options
3

 


 
3

 


 


 
122

 


 
125

 
 
 
Shares to cover employee payroll tax withholdings on stock issued under stock-based compensation plans


 


 
(23
)
 


 


 


 


 
(23
)
 
 
 
Purchases of treasury stock
(4
)
 


 


 


 


 
(365
)
 


 
(365
)
 
 
 
Other


 


 


 


 


 


 
2

 
2

 
 


Balance, September 30, 2017
136

 
$
2

 
$
2,585

 
$
6,946

 
$
(48
)
 
$
(4,691
)
 
$
34

 
$
4,828

 
 
$
78

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015
143

 
$
2

 
$
2,481

 
$
6,199

 
$
(38
)
 
$
(3,960
)
 
$
29

 
$
4,713

 
 
$
70

Net income


 


 


 
490

 


 


 
33

 
523

 
 
6

Other comprehensive loss, net of taxes


 


 


 


 
(23
)
 


 


 
(23
)
 
 
 
Dividends declared


 


 


 
(169
)
 


 


 


 
(169
)
 
 
 
Distributions to noncontrolling interests


 


 


 


 


 


 
(31
)
 
(31
)
 
 


Issuance of common stock under benefit plans
1

 


 
5

 


 


 
11

 


 
16

 
 
 
Stock-based compensation expense


 


 
49

 


 


 
3

 


 
52

 
 
 
Exercise of stock options
1

 


 
1

 


 


 
62

 


 
63

 
 
 
Shares to cover employee payroll tax withholdings on stock issued under stock-based compensation plans


 


 
(10
)
 


 


 


 


 
(10
)
 
 
 
Purchases of treasury stock
(6
)
 


 

 


 


 
(440
)
 


 
(440
)
 
 
 
Balance, September 30, 2016
139

 
$
2

 
$
2,526

 
$
6,520

 
$
(61
)
 
$
(4,324
)
 
$
31

 
$
4,694

 
 
$
76




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 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

7

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.

8

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

9

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.


10

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.


11

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.    


12

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

13

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.


14

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.


15

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%.


16

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.        

17

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.


18

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.

19

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.

20

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.

21

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.


22

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.








23


Table of Contents                                             

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

Our Company

Diagnostic Information Services

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 a broad range of customers, including patients, clinicians, hospitals, integrated delivery networks ("IDNs"), health plans, employers and accountable care organizations ("ACOs"). We offer the broadest access in the United States to diagnostic information services through our nationwide network of laboratories, 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 testing, non-routine (including advanced diagnostics) 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.

Diagnostic Solutions

In our Diagnostic Solutions ("DS") businesses, which represents the balance of our consolidated net revenues, we offer a variety of solutions for life 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. Prior to the sale of our Focus Diagnostics products business on May 13, 2016 ("Focus Sale"), our diagnostics products business manufactured and marketed diagnostic products.

Third Quarter Highlights
    
Our total net revenues of $1.9 billion were 2.4% above the prior year period. We estimate that hurricanes negatively impacted revenue growth by approximately 1.3%.
In our DIS business:
Revenues of $1.9 billion increased by 2.8% compared to the prior year period.
Volume, measured by the number of requisitions, increased 1.6% compared to the prior year period.
Revenue per requisition increased by 1.2% compared to the prior year period.
DS revenues of $81 million were 5.1% below the prior year period primarily associated with our risk assessment services.
Operating income was $298 million in 2017, a decrease of $24 million compared to the prior year period, which included a gain on escrow recovery associated with an acquisition. We estimate that hurricanes negatively impacted operating income by $21 million.
Net income attributable to Quest Diagnostics' stockholders was $161 million, or $1.15 per diluted share, in 2017, compared to $192 million, or $1.34 per diluted share, in the prior year period. We estimate that hurricanes negatively impacted diluted earnings per share by approximately $0.09.
Net cash provided by operating activities was $852 million in 2017, compared to $765 million in the prior year period.

Centers for Medicare and Medicaid Services ("CMS"), recently proposed 2018 Medicare reimbursement rates for clinical laboratory tests under the Clinical Lab Fee Schedule ("CLFS") pursuant to Protecting Access to Medicare Act ("PAMA"). Under the proposal, Medicare would pay an amount determined under PAMA for tests on the CLFS. PAMA provides that for the first three years after implementation (2018 through 2020), payment rate reductions for most CLFS tests, which represents approximately 12% of our consolidated net revenues, cannot be more than 10% per year. We are currently reviewing the CMS proposal and sharing our perspective on the proposal with our industry trade association.

Two Point Strategy

Our two point strategy is described in detail in "Item 1. Business: Our Strategy and Strengths" in our 2016 Annual Report on Form 10-K. During the nine months ended September 30, 2017, we continued to execute on our strategy as follows:


24


Table of Contents                                             

Acquisition of the Outreach Laboratory Service Business of PeaceHealth Laboratories

On May 1, 2017, we completed the acquisition of the outreach laboratory services operations of PeaceHealth Laboratories ("PHL"), in an all-cash transaction for $101 million. The acquired outreach laboratory service business of PHL is included in our DIS business. Under a professional laboratory services agreement, Quest will also manage 11 laboratories, which PHL will continue to own.
  
Acquisition of Med Fusion and Clear Point

On July 14, 2017, we completed the acquisition of Med Fusion, LLC and ClearPoint Diagnostic Laboratories, LLC ("Med Fusion") in an all-cash transaction for $150 million. 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 acquired laboratory service businesses are included in our DIS business.

Acquisition of the Outreach Laboratory Service Business of The William W. Backus Hospital and The Hospital of Central Connecticut
    
On September 28, 2017, we completed the acquisition of the outreach laboratory service businesses of two hospitals of Hartford Healthcare, The William W. Backus Hospital and The Hospital of Central Connecticut in an all-cash transaction for $30 million. The acquired outreach laboratory service businesses are included in our DIS business.

Acquisition of Shiel Medical Laboratory
    
On September 27, 2017, we entered into a definitive agreement to acquire the assets and certain liabilities of Shiel Medical Laboratory ("Shiel") in an all-cash transaction for $170 million and up to $15 million of contingent consideration to be paid based on the achievement of certain volume benchmarks. Shiel is a clinical laboratory provider serving the New York-New Jersey metropolitan area. Closing of the transaction, which is expected to be completed in the fourth quarter of 2017, remains subject to customary closing conditions.

Acquisition of Cleveland HeartLab

On October 18, 2017, we 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 our 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.

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 2016 Annual Report on Form 10-K.

Collaboration with Wal-Mart     

In June 2017, we announced our collaboration with Wal-Mart Stores, Inc. ("Wal-Mart") to help improve access to care and, over time, help lower healthcare costs through providing basic healthcare services. The collaboration will initially launch with a select number of co-branded sites within Wal-Mart stores, which will initially provide laboratory testing services. Over time, service offerings are expected to expand to include other basic healthcare services.
    
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 total run-rate savings from the Invigorate program of $1.3 billion as we exit 2017, compared to 2011. We ended 2016 with more than $1.1 billion in run-rate savings and believe we are on track to achieve our $1.3 billion run-rate savings goal as we exit 2017. In November 2016, we announced that we expect to drive operational excellence and achieve additional cost savings beyond 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; field and customer service excellence; lab excellence; and revenue services excellence. In addition to these programs, we identified key themes to change how we operate in order to meet our goal of

25


Table of Contents                                             

delivering the $1.3 billion of run-rate savings as we exit 2017. These additional key themes 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 foster our efforts to strengthen our foundation for 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 and 2016, we incurred $89 million and $63 million, respectively, of charges in connection with the courses of action. In February 2017, we developed high-level estimates of the pre-tax charges expected to be incurred in connection with the new course of action under the program for 2017 totaling $60 million to $80 million, consisting of up to $10 million of employee separation costs and $60 million to $70 million of systems conversion and integration costs. For the nine months ended September 30, 2017, we incurred $52 million in connection with the course of action.

All of the total estimated pre-tax charges expected to be incurred in 2017 will result in cash expenditures. The actual charges incurred in connection with the course of action in 2017 could be materially different from these estimates. As detailed plans to implement the course of action are approved and executed, it will result in charges to earnings.

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 2015 through September 30, 2017, the cumulative charges incurred in connection with the Invigorate program were $204 million, including $56 million of cumulative pre-tax employee separation costs and other restructuring related costs.    

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 2016 Annual Report on Form 10-K.
    


26


Table of Contents                                             

Results of Operations    

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
2017
 
2016
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
(dollars in millions)
Net revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
DIS business
$
1,850

 
$
1,800

 
$
50

 
2.8
 %
 
$
5,517

 
$
5,365

 
$
152

 
2.8
 %
DS businesses
81

 
85

 
(4
)
 
(5.1
)
 
256

 
289

 
(33
)
 
(11.6
)
Total net revenues
$
1,931

 
$
1,885

 
$
46

 
2.4
 %
 
$
5,773

 
$
5,654

 
$
119

 
2.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating costs and expenses and other operating income:
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Cost of services
$
1,190

 
$
1,157

 
$
33

 
2.9
 %
 
$
3,525

 
$
3,456

 
$
69

 
2.0
 %
Selling, general and administrative
423

 
409

 
14

 
3.5

 
1,297

 
1,281

 
16

 
1.3

Amortization of intangible assets
19

 
18

 
1

 
NM

 
54

 
54

 

 

Gain on disposition of business

 

 

 
NM

 

 
(118
)
 
118

 
NM

Other operating expense (income), net
1

 
(21
)
 
22

 
NM

 
1

 
(20
)
 
21

 
NM

Total operating costs and expenses, net
$
1,633

 
$
1,563

 
$
70

 
4.5
 %
 
$
4,877

 
$
4,653

 
$
224

 
4.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
$
298

 
$
322

 
$
(24
)
 
(7.4
)%
 
$
896

 
$
1,001

 
$
(105
)
 
(10.5
)%


27


Table of Contents                                             

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
2017
 
2016
 
Increase
(Decrease)
 
% Increase
(Decrease)
 
(dollars in millions, except per share amounts)
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
$
(38
)

$
(37
)

$
1


4.8
 %