Quest Diagnostics 2015 Annual Report Download - page 98

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(in millions unless otherwise indicated)
F- 23
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 and forward starting swaps are model-derived
valuations as of a given date in which all significant inputs are observable in active markets including certain financial
information and certain assumptions regarding past, present and future market conditions.
Investment in available-for-sale equity securities represents an investment in registered shares of a publicly-held
company listed on the Euronext Paris exchange. 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 connection with the acquisition of certain business assets of UMass (see Note 5), the Company granted to UMass a
call option and UMass granted to the Company a put option for UMass to acquire an 18.90% equity interest in a newly formed
entity. The put and call options were derivative instruments whose fair values were measured using a combination of
discounted cash flows and the Black-Scholes-Merton option pricing model. On July 1, 2015, UMass exercised its call option,
acquiring an 18.90% noncontrolling interest in a subsidiary of the Company that performs diagnostic information services in a
defined territory within the state of Massachusetts. In connection with the transaction, the Company paid the $50 million
deferred consideration associated with the January 2, 2013 acquisition of the Massachusetts-based clinical outreach and
anatomic pathology businesses from UMass and received $50 million associated with the call option exercise price. The put
option expired unexercised.
In April 2014, the Company completed the acquisitions of Summit Health and Steward (see Note 5). In connection
with these acquisitions the Company initially recorded an aggregate contingent consideration liability of $26 million. The
contingent consideration liability was classified within Level 3 measured at fair value using a probability weighted and
discounted cash flow method. These measurements are based on externally obtained inputs and management's probability
assessments of the occurrence of triggering events, appropriately discounted considering the uncertainties associated with the
obligations, as well as the likelihood of achieving financial targets. The initial probability estimate of the occurrence of such
triggering events associated with the amounts the Company could be obligated to pay in future periods for both Summit Health
and Steward was between 5% and 95%. The probability-weighted cash flows were then discounted using a discount rate of
1.5% to 2.8%. The estimated fair value of the contingent consideration associated with Summit Health was reduced to $13
million in the fourth quarter of 2014 and $0 in the second quarter of 2015. These reductions were a result of updated revenue
forecasts and actual results for 2015 compared to the earn-out target included in the contingent consideration arrangement. As a
result, other operating expense (income), net for the years ended December 31, 2015 and 2014 include gains of $13 million and
$9 million, respectively. The remaining contingent consideration associated with Steward is projected to be paid out in three
equal annual installments, with a maximum payout of $4 million.
The following table provides a reconciliation of the beginning and ending balances of assets using significant
unobservable inputs (Level 3):
Put Option
Derivative
Asset
Balance, December 31, 2013 $ 4
Total gains (losses) - realized/ unrealized:
Included in earnings (3)
Balance, December 31, 2014 1
Total gains (losses) - realized/ unrealized:
Included in earnings (1)
Balance, December 31, 2015 $ —
QUEST DIAGNOSTICS 2015 ANNUAL REPORT ON FORM 10-K