Our Company

Quest Diagnostics is the world's leading provider of diagnostic testing, information and services, providing insights that enable patients and physicians to make better healthcare decisions. Our clinical testing business currently represents our one reportable business segment and accounted for greater than 90% of our net revenues from continuing operations in both 2012 and 2011. Our other operating segments consist of our risk assessment services, clinical trials testing, healthcare information technology and diagnostic products businesses. Our business segment information is disclosed in Note 13 to the interim consolidated financial statements.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect our reported financial results and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.

While many operational aspects of our business are subject to complex federal, state and local regulations, the accounting for most of our business is generally straightforward with net revenues primarily recognized upon completion of the testing process. Our revenues are primarily comprised of a high volume of relatively low dollar transactions, and about one-half of our total costs and expenses consist of employee compensation and benefits. Due to the nature of our business, several of our accounting policies involve significant estimates and judgments. There have been no significant changes to our critical accounting policies from those disclosed in our 2011 Annual Report on Form 10-K.

Initiatives to Improve Operating Efficiency

The diagnostic testing industry is labor intensive. Employee compensation and benefits constitute approximately one-half of our total costs and expenses. Cost of services consists principally of costs for obtaining, transporting and testing specimens. Selling, general and administrative expenses consist principally of the costs associated with our sales and marketing efforts, billing operations, bad debt expense and general management and administrative support. In addition, performing diagnostic testing involves significant fixed costs for facilities and other infrastructure required to obtain, transport and test specimens. Therefore, relatively small changes in volume can have a significant impact on profitability in the short-term.

On February 28, 2012, we committed to a course of action related to our multi-year program designed to reduce our cost structure by $500 million by the end of 2014. This effort is intended to address continued reimbursement pressures and labor and benefit cost increases, free up additional resources to invest in science and innovation, and enable us to improve operating profitability. We anticipate roughly one-third of the savings from client support/billing, procurement and supply chain; one-third from laboratory operations and specimen acquisition; and one-third from selling, general and administrative expenses, including information technology. Common themes across many of the opportunities include standardizing systems and processes and data bases, increased use of automation and technology, and centralizing and selective outsourcing of certain activities.
On April 27, 2012, we communicated to our employees the course of action and how employees might be affected. We have developed high-level estimates of the pre-tax charges expected to be incurred in connection with the course of action totaling $100 million to $175 million through 2014 consisting of: $40 million to $80 million of employee separation costs; $30 million to $45 million of facility-related costs; $10 million to $20 million of asset impairment charges; and $20 million to $30 million of systems conversion and integration costs. Of the total estimated pre-tax charges expected to be incurred, we estimate that $90 million to $155 million are anticipated to result in cash expenditures. The actual charges incurred in connection with the multi-year course of action could be materially different from these estimates. As detailed plans to implement the multi-year course of action are approved and executed, it will result in charges to earnings.

Recent Acquisitions

Acquisition of Athena Diagnostics

On February 24, 2011, we signed a definitive agreement to acquire Athena Diagnostics ("Athena") from Thermo Fisher Scientific, Inc., in an all-cash transaction valued at approximately $740 million. We completed the acquisition of Athena on April 4, 2011.

Acquisition of Celera Corporation

On March 17, 2011, we entered into a definitive merger agreement with Celera Corporation ("Celera") under which we agreed to acquire Celera for $8 per share, in a transaction valued at approximately $344 million, net of $326 million in acquired cash and short-term marketable securities. We completed the acquisition of Celera on May 17, 2011.

Acquisition of S.E.D. Medical Laboratories

On January 6, 2012, we completed the acquisition of S.E.D. Medical Laboratories ("S.E.D.") for approximately $50.5 million.

The acquisitions of Athena, Celera and S.E.D. (collectively "the acquisitions") are further described in Note 4 to the Consolidated Financial Statements in our 2011 Annual Report on Form 10-K and Note 7 to the interim consolidated financial statements.

Results of Operations

Three Months Ended March 31, 2012 Compared with Three Months Ended March 31,
2011

Continuing Operations
                                                                                     % Change:
                                                                                     Increase
                                                        2012             2011       (Decrease)
                                                  (dollars in millions, except per share data)

Net revenues                                      $      1,936.5     $  1,821.6           6.3 %
Income (loss) from continuing operations                   158.8          (53.5 )       396.8 %
Earnings (loss) per diluted share                 $         0.99     $    (0.33 )       400.0 %

Results for the three months ended March 31, 2012 were affected by certain items that impacted earnings per diluted share by $0.08. During the first quarter of 2012, we incurred costs of $13.1 million, or $0.05 per diluted share, primarily associated with professional fees and other costs associated with further restructuring and integrating our business. Results for the quarter also included $7.1 million, or $0.03 per diluted share, principally associated with severance and other separation benefits as well as accelerated vesting of certain equity awards in connection with the succession of our CEO.

Results for the three months ended March 31, 2011 were affected by a number of items which impacted earnings per share by $1.33. During the first quarter of 2011, we recorded the Medi-Cal charge of $236 million, or $1.19 per diluted share, in other operating (income) expense, net (see Note 5 to the interim consolidated financial statements for further details). In addition, results for the three months ended March 31, 2011 included $13.3 million of pre-tax charges, or $0.05 per diluted share, principally associated with workforce reductions. Results for the quarter also included $4.7 million of pre-tax transaction costs, or $0.02 per diluted share, associated with the acquisitions of Athena and Celera. Of these costs, $2.3 million, primarily related to professional fees, were recorded in selling, general and administrative expenses and $2.4 million of financing related costs were recorded in interest expense, net. In addition, we estimate that the impact of severe weather, which reduced revenues during the quarter, adversely affected operating income by $18.5 million, or $0.07 per diluted share.

Net Revenues

Net revenues for the three months ended March 31, 2012 were 6.3% above the prior year level with the Athena, Celera and S.E.D. acquisitions contributing 3.2% revenue growth in the quarter.

Clinical testing revenue, which accounted for over 90% of our consolidated revenues, increased by 6.4% for the three months ended March 31, 2012 over the prior year period. The acquisitions of Athena, Celera and S.E.D. contributed about 2.8% to clinical testing revenue growth in the quarter. Clinical testing volume, measured by the number of requisitions, increased 3.4% for the first quarter of 2012, compared to the prior year period. We estimate that the impact of weather favorably affected the year-over-year volume comparisons by about 2%, and acquisitions contributed about 0.5%. After considering the favorable impact of weather and acquisitions, underlying volume growth was about 1%. Pre-employment drug testing volume grew about 5% in the quarter.

Revenue per requisition for the three months ended March 31, 2012 was 2.9% above the prior year period. Revenue per requisition continues to benefit from an increased mix in gene-based and esoteric testing, particularly from the impact of the acquired operations of Athena and Celera. Partially offsetting this benefit was business and payor mix changes including: an increase in lower priced drugs-of-abuse testing and a decrease in higher priced anatomic pathology testing.

Our businesses other than clinical laboratory testing accounted for approximately 9% of our net revenues in both 2012 and 2011. These businesses contain most of our international operations and include our risk assessment services, clinical trials testing, healthcare information technology and diagnostic products businesses. For the three months ended March 31, 2012, combined revenues in these businesses grew by approximately 6%, primarily from the diagnostics products operations acquired as part of the Celera acquisition.

Operating Costs and Expenses
                                                                                 Change: Increase
                              2012                        2011                      (Decrease)
                                     % Net                       % Net                        % Net
                        $           Revenue          $          Revenue          $           Revenue
                                                  (dollars in millions)
Cost of services   $  1,116.5         57.7  %   $  1,097.0         60.2 %   $     19.5         (2.5 )%
Selling, general
and administrative
expenses (SG&A)         500.6         25.8  %        447.9         24.6 %         52.7          1.2  %
Amortization of
intangible assets        20.2          1.0  %          9.8          0.5 %         10.4          0.5  %
Other operating
(income) expense,
net                      (0.4 )          -  %        235.9         13.0 %       (236.3 )      (13.0 )%
Total operating
costs and expenses $  1,636.9         84.5  %   $  1,790.6         98.3 %   $   (153.7 )      (13.8 )%
Bad debt expense
(included in SG&A) $     80.7          4.2  %   $     77.4          4.2 %   $      3.3            -  %

Total Operating Costs and Expenses

For the first quarter of 2012, total operating costs and expenses decreased $154 million, compared to the prior year period, primarily driven by the impact in 2011 of the Medi-Cal charge and, to a lesser extent, actions we have taken to reduce our cost structure. This decrease was partially offset by an increase in operating expenses associated with the acquired operations of Athena, Celera and S.E.D., higher costs associated with employee compensation and benefits, and costs incurred in connection with the succession of our CEO. The decrease in total operating expenses as a percentage of net revenues compared to the prior year is principally due to the Medi-Cal charge recorded in 2011.

Results for the three months ended March 31, 2012 included costs of $13.1 million, primarily associated with professional fees and other costs incurred in connection with further restructuring and integrating our business ($4.0 million in cost of services and $9.1 million in selling, general and administrative expenses). In addition, $7.1 million of pre-tax charges, associated with severance and other separation benefits as well as accelerated vesting of certain equity awards in connection with the succession of our CEO, were recorded in selling, general and administrative expenses in the first quarter of 2012.

Results for the three months ended March 31, 2011 included the Medi-Cal charge of $236 million recorded in connection with the California Lawsuit. In addition, results for the three months ended March 31, 2011 included $13.3 million of pre-tax charges incurred in connection with further restructuring and integrating our business, principally associated with workforce reductions. Of these costs, $9.0 million and $4.3 million were included in cost of services and selling, general and administrative expenses, respectively. Selling, general and administrative expenses for the three months ended March 31, 2011 also included $2.3 million of pre-tax transaction costs, primarily related to professional fees associated with the acquisitions of Athena and Celera.

Also, year-over-year comparisons of operating costs were unfavorably impacted by approximately $3 million, associated with gains on investments in our supplemental deferred compensation plans. Under our supplemental deferred compensation plans, employee compensation deferrals, together with Company matching contributions, are invested in a

variety of investments held in trusts. Gains and losses associated with the investments are recorded in earnings within other income, net. A corresponding and offsetting adjustment is also recorded to the deferred compensation obligation to reflect investment gains and losses earned by the employee. Such adjustments to the deferred compensation obligation are recorded in earnings principally within selling, general and administrative expenses and offset the amount of investment gains and losses recorded in other income, net. Results for the three months ended March 31, 2012 and 2011 included an increase in operating costs of $4.8 million and $2.1 million, respectively, representing increases in the deferred compensation obligation to reflect investment gains earned by employees participating in our deferred compensation plans.

Cost of Services

The decrease in cost of services as a percentage of net revenues for the three months ended March 31, 2012, compared to the prior year period, reflects the impact of actions we have taken to reduce our cost structure and the impact of the acquired operations of Athena and Celera, which serve to reduce the percentage. In addition, severe weather in 2011, which served to reduce revenues and increase costs as a percentage of revenues, as well as higher restructuring and integration costs in 2011, contributed to higher cost of services as a percentage of revenues in 2011 compared to the current year period. These factors were partially offset by the impact of a legal settlement in the first quarter of 2012 which served to increase the percentage by approximately 0.3%.

Selling, General and Administrative Expenses

The increase in selling, general and administrative expenses as a percentage of net revenues for the three months ended March 31, 2012, compared to the prior year period, primarily reflects the impact of the acquired operations of Athena and Celera, higher costs associated with employee compensation and benefits, costs incurred in connection with the succession of our CEO, and a $4.8 million increase in pre-tax charges associated with restructuring and integration costs. These increases were partially offset by actions we have taken to reduce our cost structure and the favorable impact on the year over year comparisons due to the severe weather in 2011 and the transaction costs associated with the Athena and Celera acquisitions that were incurred during the first quarter of 2011.

For the three months ended March 31, 2012, bad debt expense as a percentage of net revenues remained unchanged, compared to the prior year period, reflecting continued strong performance in our billing operations and collection metrics.

Amortization of Intangible Assets

The increase in amortization of intangible assets for the three months ended March 31, 2012, compared to the prior year period, reflects primarily the impact of amortization of intangible assets acquired as part of the Athena and Celera acquisitions.

Other Operating (Income) Expense, net

Other operating (income) expense, net includes special charges, and
miscellaneous income and expense items related to operating activities. For the
three months ended March 31, 2011, other operating (income) expense, net
included the Medi-Cal charge of $236.0 million recorded in connection with the
California Lawsuit.

Operating Income

                                                             Change:
                                                            Increase
                                     2012        2011      (Decrease)
                                          (dollars in millions)
Operating income                   $ 299.6     $ 31.0     $     268.6
Operating income % of net revenues    15.5 %      1.7 %          13.8 %

The impacts of the Medi-Cal charge and severe weather in the first quarter of 2011 served to decrease operating income as a percentage of net revenues in 2011 and are the principal drivers of the improved operating income as a percentage of net revenues in 2012. Also contributing to the improvement are actions we have taken to reduce our cost structure. Partially offsetting these improvements are higher costs associated with employee compensation and benefits, costs incurred in connection with the succession of our CEO, costs associated with a legal settlement and costs associated with investment gains

on assets in our deferred compensation plans.

Interest Expense, net
                                             Change:
                                            Increase
                       2012      2011      (Decrease)
                            (dollars in millions)
Interest expense, net $ 42.3    $ 37.9    $        4.4

Interest expense, net for the three months ended March 31, 2012 increased from the prior year period primarily due to higher average outstanding debt balances in 2012, compared to the prior year period. This increase was partially offset by a $2.4 million reduction in financing commitment fees incurred in the prior year related to the acquisition of Celera.

Other Income, net

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 March 31, 2012 and
2011, other income, net consisted of the following:
                                                                                   Change:
                                                                                   Increase
                                                     2012            2011         (Decrease)
                                                             (dollars in millions)
Investment gains associated with our
supplemental deferred compensation plans         $       4.8     $      2.1     $       2.7
Other income items, net                                    -            0.1            (0.1 )
Total other income, net                          $       4.8     $      2.2     $       2.6



Income Tax Expense
                                          Change:
                                          Increase
                     2012      2011      (Decrease)
                         (dollars in millions)
Income tax expense $ 101.4    $ 49.2    $      52.2

The increase in income tax expense for the three months ended March 31, 2012 is primarily due to an increase in income from continuing operations before income taxes. The decrease in the effective income tax rate is due primarily to the Medi-Cal charge in the first quarter of 2011, a portion for which a tax benefit was not recorded.

Discontinued Operations

Income (loss) from discontinued operations, net of taxes, for the three months ended March 31, 2012 and 2011 was $0.3 million and $(0.4) million, respectively, with no impact on diluted earnings per share. See Note 12 to the interim consolidated financial statements for further details.