Quest Diagnostics Incorporated and Subsidiaries

Consolidated Statements of Operations

For the Three and Twelve Months Ended December 31, 2014 and 2013

(in millions, except per share data)

(unaudited)

Three Months Ended
December 31,

Twelve Months Ended
December 31,

2014

2013

2014

2013

Net revenues

$

1,883

$

1,756

$

7,435

$

7,146

Operating costs and expenses:

Cost of services

1,184

1,051

4,637

4,326

Selling, general and administrative

427

415

1,728

1,704

Amortization of intangible assets

23

20

94

79

Gain on sale of royalty rights

—

—

—

(474)

Other operating (income) expense, net

(8)

—

(7)

36

Total operating costs and expenses

1,626

1,486

6,452

5,671

Operating income

257

270

983

1,475

Other income (expense):

Interest expense, net

(42)

(39)

(164)

(159)

Equity in earnings of equity method investees

7

6

26

24

Other income, net

1

1

4

8

Total non-operating expenses, net

(34)

(32)

(134)

(127)

Income from continuing operations before taxes

223

238

849

1,348

Income tax expense

28

87

262

500

Income from continuing operations

195

151

587

848

Income (loss) from discontinued operations, net of taxes

5

—

5

35

Net income

200

151

592

883

Less: Net income attributable to noncontrolling interests

10

8

36

34

Net income attributable to Quest Diagnostics

$

190

$

143

$

556

$

849

Amounts attributable to Quest Diagnostics' common stockholders:

Income from continuing operations

$

185

$

143

$

551

$

814

Income (loss) from discontinued operations, net of taxes

5

—

5

35

Net income

$

190

$

143

$

556

$

849

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

Income from continuing operations

$

1.27

$

0.98

$

3.80

$

5.35

Income (loss) from discontinued operations

0.03

(0.01)

0.03

0.23

Net income

$

1.30

$

0.97

$

3.83

$

5.58

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

Income from continuing operations

$

1.26

$

0.97

$

3.78

$

5.31

Income (loss) from discontinued operations

0.03

—

0.03

0.23

Net income

$

1.29

$

0.97

$

3.81

$

5.54

Weighted average common shares outstanding:

Basic

145

146

145

152

Diluted

146

146

145

153

Quest Diagnostics Incorporated and Subsidiaries

Consolidated Balance Sheets

December 31, 2014 and 2013

(in millions, except per share data)

(unaudited)

December 31, 2014

December 31, 2013

Assets

Current assets:

Cash and cash equivalents

$

192

$

187

Accounts receivable, net

932

852

Inventories

110

91

Deferred income taxes

169

148

Prepaid expenses and other current assets

200

105

Total current assets

1,603

1,383

Property, plant and equipment, net

933

805

Goodwill

6,032

5,649

Intangible assets, net

1,071

896

Other assets

238

215

Total assets

$

9,877

$

8,948

Liabilities and Stockholders' Equity

Current liabilities:

Accounts payable and accrued expenses

$

1,191

$

920

Current portion of long-term debt

518

212

Total current liabilities

1,709

1,132

Long-term debt

3,244

3,120

Other liabilities

594

723

Stockholders' equity:

Quest Diagnostics stockholders' equity:

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

2

2

Additional paid-in capital

2,418

2,379

Retained earnings

5,723

5,358

Accumulated other comprehensive loss

(27)

(8)

Treasury stock, at cost; 71 shares at both December 31, 2014 and 2013

(3,815)

(3,783)

Total Quest Diagnostics stockholders' equity

4,301

3,948

Noncontrolling interests

29

25

Total stockholders' equity

4,330

3,973

Total liabilities and stockholders' equity

$

9,877

$

8,948

Quest Diagnostics Incorporated and Subsidiaries

Consolidated Statements of Cash Flows

For the Twelve Months Ended December 31, 2014 and 2013

(in millions)

(unaudited)

Twelve Months Ended
December 31,

2014

2013

Cash flows from operating activities:

Net income

$

592

$

883

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

Depreciation and amortization

314

283

Provision for doubtful accounts

296

270

Deferred income tax provision

23

19

Stock-based compensation expense

51

28

Excess tax benefits from stock-based compensation arrangements

—

(4)

Gain on sale of royalty rights

—

(474)

Asset impairment and loss on sale of businesses, net

—

17

Other, net

(12)

2

Changes in operating assets and liabilities:

Accounts receivable

(312)

(247)

Accounts payable and accrued expenses

68

(21)

Income taxes payable

(84)

(93)

Other assets and liabilities, net

2

(11)

Net cash provided by operating activities

938

652

Cash flows from investing activities:

Business acquisitions, net of cash acquired

(728)

(213)

Proceeds from sale of businesses

—

296

Proceeds from sale of royalty rights

—

474

Capital expenditures

(308)

(231)

Decrease in investments and other assets

11

2

Net cash (used in) provided by investing activities

(1,025)

328

Cash flows from financing activities:

Proceeds from borrowings

2,018

896

Repayments of debt

(1,647)

(900)

Purchases of treasury stock

(132)

(1,037)

Exercise of stock options

78

138

Excess tax benefits from stock-based compensation arrangements

—

4

Dividends paid

(187)

(185)

Distributions to noncontrolling interests

(31)

(32)

Other financing activities, net

(7)

10

Net cash provided by (used in) financing activities

92

(1,106)

Net change in cash and cash equivalents

5

(126)

Change in cash and cash equivalents included in assets held for sale

—

17

Cash and cash equivalents, beginning of period

187

296

Cash and cash equivalents, end of period

$

192

$

187

Cash paid during the period for:

Interest

$

170

$

167

Income taxes

$

327

$

568

Notes to Financial Tables

1) The computation of basic and diluted earnings per common share is as follows:

Three Months Ended
December 31,

Twelve Months Ended
December 31,

2014

2013

2014

2013

(in millions, except per share data)

Amounts attributable to Quest Diagnostics' common stockholders:

Income from continuing operations

$

185

$

143

$

551

$

814

Income (loss) from discontinued operations, net of taxes

5

—

5

35

Net income available to common stockholders

$

190

$

143

$

556

$

849

Income from continuing operations

$

185

$

143

$

551

$

814

Less: Earnings allocated to participating securities

—

1

2

3

Earnings available to Quest Diagnostics' common stockholders - basic and diluted

$

185

$

142

$

549

$

811

Weighted average common shares outstanding - basic

145

146

145

152

Effect of dilutive securities:

Stock options and performance share units

1

—

—

1

Weighted average common shares outstanding - diluted

146

146

145

153

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

Income from continuing operations

$

1.27

$

0.98

$

3.80

$

5.35

Income (loss) from discontinued operations

0.03

(0.01)

0.03

0.23

Net income

$

1.30

$

0.97

$

3.83

$

5.58

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

Income from continuing operations

$

1.26

$

0.97

$

3.78

$

5.31

Income (loss) from discontinued operations

0.03

—

0.03

0.23

Net income

$

1.29

$

0.97

$

3.81

$

5.54

Earnings per common share are computed independently for each quarterly period.  Therefore, the sum of quarterly earnings per common share may not equal earnings per common share for the twelve months ended December 31, 2014 and 2013.

2)       Adjusted amounts for operating income, income from continuing operations attributable to Quest Diagnostics' stockholders, and diluted EPS represent the Company's results before the impact of the gain on sale of ibrutinib royalty rights, restructuring and integration charges, favorable resolution of tax contingencies, loss on sale of the Enterix business and other.  Adjusted diluted EPS excluding amortization expense represents the Company's results before the impact of special items and amortization expense.  Adjusted measures are presented because management believes those measures are useful adjuncts to reported results under accounting principles generally accepted in the United States when comparing results of operations from period to period.  Adjusted measures should not be considered as an alternative to the corresponding measures determined under accounting principles generally accepted in the United States.  The following tables reconcile reported results to adjusted results:

Three Months Ended
December 31,

Twelve Months Ended
December 31,

2014

2013

2014

2013

(dollars in millions, except per share data)

Adjusted operating income:

Operating income

$

257

$

270

$

983

$

1,475

Gain on sale of ibrutinib royalty rights (a)

—

—

—

(474)

Restructuring and integration charges (b)

30

12

121

115

Loss on sale of Enterix

—

—

—

40

Other (c)

(4)

—

15

—

Adjusted operating income

$

283

$

282

$

1,119

$

1,156

Adjusted operating income as a percentage of net revenues:

Operating income as a percentage of net revenues

13.7

%

15.3

%

13.2

%

20.6

%

Gain on sale of ibrutinib royalty rights (a)

—

—

—

(6.6)

Restructuring and integration charges (b)

1.5

0.8

1.6

1.6

Loss on sale of Enterix

—

—

—

0.6

Other (c)

(0.2)

—

0.2

—

Adjusted operating income as a percentage of net revenues

15.0

%

16.1

%

15.0

%

16.2

%

Adjusted income from continuing operations:

Income from continuing operations attributable to Quest Diagnostics' stockholders

$

185

$

143

$

551

$

814

Gain on sale of ibrutinib royalty rights (d)

—

—

—

(298)

Restructuring and integration charges (d)

18

8

77

71

Favorable resolution of tax contingencies

(44)

—

(44)

—

Loss on sale of Enterix (d)

—

—

—

25

Other (d)

(1)

—

14

—

Adjusted income from continuing operations

$

158

$

151

$

598

$

612

Adjusted diluted EPS:

Diluted earnings per common share

$

1.26

$

0.97

$

3.78

$

5.31

Gain on sale of ibrutinib royalty rights (a)

—

—

—

(1.95)

Restructuring and integration charges (b)

0.13

0.06

0.53

0.47

Favorable resolution of tax contingencies

(0.30)

—

(0.30)

—

Loss on sale of Enterix

—

—

—

0.17

Other (c)

(0.01)

—

0.09

—

Adjusted diluted EPS

1.08

1.03

4.10

4.00

Amortization expense (e)

0.10

0.08

0.40

0.32

Adjusted diluted EPS excluding amortization expense

$

1.18

$

1.11

$

4.50

$

4.32

(a)       

Represents the gain, net of transaction costs, associated with the sale of the Company's ibrutinib royalty rights.

(b)       

Represents costs primarily associated with workforce reductions and professional fees incurred in connection with further restructuring and integrating our business.

 (c)

For the three months ended December 31, 2014, represents a gain of $9 million associated with a decrease in the fair value of the contingent consideration accrual associated with the Summit Health acquisition, partially offset by costs incurred related to legal matters. For the twelve months ended December 31, 2014, represents costs incurred related to legal matters, partially offset by a gain of $9 million associated with a decrease in the fair value of the contingent consideration accrual associated with the Summit Health acquisition.

(d)       

For the gain on sale of ibrutinib royalty rights, income tax expense was calculated using a combined federal and state rate of 37.1%.  For the restructuring and integration charges and other, income tax impacts, where recorded, were calculated using a combined federal and state rate of 38.2%.  For the loss on sale of Enterix, income tax benefits were calculated using combined federal and state rates of 35.9%.

(e)       

Represents the impact of amortization expense, net of the estimated tax benefit, on diluted EPS. The income tax benefit was calculated using a combined federal and state rate of 38.2%.

3)       For the twelve months ended December 31, 2013, gain on sale of royalty rights represents the sale of the Company's ibrutinib royalty rights for $474 million, net of transaction costs.  For the twelve months ended December 31, 2013, income tax expense includes $176 million associated with the gain on sale of royalty rights.

4)       Other operating (income) expense, net includes miscellaneous income and expense items related to operating activities.  For the three and twelve months ended December 31, 2014, other operating (income) expense, net includes a gain of $9 million associated with a decrease in the fair value of the contingent consideration accrual associated with the Summit Health acquisition.  For the twelve months ended December 31, 2013, other operating (income) expense, net includes the pre-tax loss on sale of Enterix of $40 million.  In addition, other operating (income) expense, net, for the twelve months ended December 31, 2013, includes a gain of $6 million resulting from consideration associated with certain non-compete agreements. 

5)       Other income, net represents miscellaneous income and expense items related to non-operating activities, such as gains and losses associated with investments and other non-operating assets. For the three months ended December 31, 2014 and 2013, other income, net includes gains of $2 million and $4 million, respectively, associated with investments held in trusts pursuant to our supplemental deferred compensation plans.  Other income, net for the twelve months ended December 31, 2014 and 2013, includes gains of $4 million and $10 million, respectively, associated with investments held in trusts pursuant to our supplemental deferred compensation plans.

6)       On April 9, 2013, the Company completed the sale of its HemoCue diagnostic products business.  As a result, income (loss) from discontinued operations, net of taxes, for the twelve months ended December 31, 2013, includes a gain of $14 million (including foreign currency translation adjustments, partially offset by income tax expense and transaction costs) associated with the sale of HemoCue.  In addition, income (loss) from discontinued operations, net of taxes for the twelve months ended December 31, 2013, includes discrete tax benefits of $20 million associated with favorable resolution of certain tax contingencies related to our NID business, which was wound down in 2006.

7)       For the three months ended December 31, 2014, the Company repurchased 0.8 million shares of its common stock at an average price of $64.44 per share for a total of $50 million.  For the twelve months ended December 31, 2014, the Company repurchased 2.2 million shares of its common stock at an average price of $59.49 per share for a total of $132 million.  At December 31, 2014, $696 million remained available under the Company's share repurchase authorizations.

8)       The outlook for adjusted diluted EPS excluding amortization expense represents management's estimates for the full year 2015 before the impact of special items and amortization expense. This measure is presented because management believes it is a useful adjunct to the corresponding amount determined under accounting principles generally accepted in the United States since it is meaningful to evaluate the Company's ongoing operating performance. Adjusted diluted EPS excluding amortization expense is not a measure of financial performance under accounting principles generally accepted in the United States and should not be considered as an alternative to the corresponding amount determined under accounting principles generally accepted in the United States.

The following table reconciles our 2015 outlook for adjusted diluted EPS excluding amortization expense to the corresponding amount determined under accounting principles generally accepted in the United States.

Low

High

Diluted earnings per common share

$

4.34

$

4.49

Amortization expense, net of tax (a)

0.36

0.36

Adjusted diluted EPS excluding amortization expense

$

4.70

$

4.85

(a)       

Represents the impact of amortization expense, estimated at approximately $85 million or $52 million, net of an estimated tax benefit, on diluted earnings per common share.