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.

We are engaged in a multi-year program designed to deliver $500 million in run rate cost savings versus 2011 by the time we exit 2014. We anticipate that this program, which we now call Invigorate, will deliver approximately 20% of our $500 million goal as we exit 2012, with the remainder in 2013 and 2014. This effort is intended to address continued 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 operating profitability and quality. 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.
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.
In connection with our Invigorate program, we launched a voluntary retirement program to certain eligible employees that qualified for the program. Of the total estimated pre-tax charges for employee separation costs noted above, we expect to incur approximately $50 million in connection with the voluntary retirement program over the next several quarters. We estimate that the voluntary retirement program will contribute approximately $40 million of annualized savings once fully implemented, which we expect in the first quarter of 2013.

Recent Acquisitions

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.

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.

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 and Six Months Ended June 30, 2012 Compared with Three and Six Months
Ended June 30, 2011

Continuing Operations
                                     Three Months Ended June 30,                    Six Months Ended June 30,
                                                               % Increase                                 % Increase
                                  2012             2011        (Decrease)        2012          2011       (Decrease)
                                                  (dollars in millions, except per share data)
Net revenues               $    1,906.8         $ 1,903.2          0.2 %     $  3,843.3     $ 3,724.8           3.2 %
Income from continuing
operations                        177.8             163.6          8.7 %          336.6         110.2         205.4 %
Earnings per diluted share $       1.11         $    1.02          8.8 %     $     2.10     $    0.68         208.8 %

Results for the three months ended June 30, 2012 were affected by certain items that impacted earnings per diluted share by $0.06. During the second quarter of 2012, we incurred costs of $12.6 million, or $0.05 per diluted share, primarily associated with professional fees and workforce reductions associated with further restructuring and integrating our business. Results for the quarter also included $3.0 million, or $0.01 per diluted share, principally associated with separation costs and accelerated vesting of certain equity awards in connection with the succession of our prior CEO.

Results for the six months ended June 30, 2012 were affected by certain items that impacted earnings per diluted share by $0.14. During the six months ended June 30, 2012, we incurred costs of $25.7 million, or $0.10 per diluted share, primarily associated with professional fees and workforce reductions associated with further restructuring and integrating our business. Results for the six months ended June 30, 2012 also included $10.1 million, or $0.04 per diluted share, principally associated with separation costs and accelerated vesting of certain equity awards in connection with the succession of our prior CEO.

Results for the three months ended June 30, 2011 included $15.1 million of pre-tax transaction costs, or $0.07 per diluted share, associated with the acquisitions of Athena and Celera. Of these costs, $14.3 million, primarily related to professional fees, were recorded in selling, general and administrative expenses and $0.8 million of financing related costs were included in interest expense, net. Results for the three months ended June 30, 2011 also included $6.1 million of pre-tax restructuring and integration charges, or $0.03 per diluted share, consisting principally of workforce reductions.

Results for the six months ended June 30, 2011 were affected by a number of items which impacted earnings per diluted share by $1.44. During the first quarter of 2011, we recorded the Medi-Cal charge of $236 million, or $1.20 per diluted share, in "other operating expense, net." Results for the six months ended June 30, 2011 also included $19.4 million of pre-tax restructuring and integration charges, or $0.07 per diluted share, principally associated with workforce reductions. In addition, results for the six months ended June 30, 2011 included pre-tax charges of $19.7 million, or $0.10 per diluted share, associated with the acquisitions of Athena and Celera. Of these costs $16.6 million, primarily related to professional fees, were recorded in selling, general and administrative expenses and $3.1 million of financing related costs were included in interest expense, net. In addition, we estimate that the impact of severe weather during the first quarter of 2011 adversely affected operating income for the six months ended June 30, 2011 by $18.5 million, or $0.07 per diluted share.

Net Revenues

Net revenues for the three months ended June 30, 2012 were 0.2% above the prior year level with the Celera and S.E.D. acquisitions contributing 0.8% revenue growth in the quarter.

Clinical testing revenue, which accounted for over 90% of our consolidated revenues, increased by 0.7% for the three months ended June 30, 2012 compared to the prior year period. The acquisitions of Celera and S.E.D. contributed about half a percent to clinical testing revenue growth in the quarter. Clinical testing volume, measured by the number of requisitions, increased 0.7% for the second quarter of 2012, compared to the prior year period. This increase was primarily driven by the acquisitions of Celera and S.E.D., and the continued growth of pre-employment drug testing, which increased about 5% in the quarter.

Revenue per requisition for the three months ended June 30, 2012 was essentially unchanged from the prior year level. Revenue per requisition benefited from an increase in the number of tests ordered per requisition, and was offset by reimbursement changes, and business and payor mix changes including an increase in lower priced drugs-of-abuse testing, and a decrease in higher priced anatomic pathology testing.

Net revenues for the six months ended June 30, 2012 were 3.2% above the prior year level with the Athena, Celera and S.E.D. acquisitions contributing approximately 2% to consolidated revenue growth.

Clinical testing revenue increased 3.5% for the six months ended June 30, 2012 compared to the prior year period. The acquisitions of Athena, Celera and S.E.D. contributed about 1.7% to clinical testing revenue growth during the period. Clinical testing volume, measured by the number of requisitions, increased 2.0% compared to the prior year period. We estimate that the impact of weather favorably affected the year-over-year volume comparisons by about 1%, and acquisitions contributed about 0.5%. After considering the favorable impact of weather and acquisitions, underlying volume growth was about 0.5%. Pre-employment drug testing volume grew about 5% during the six months ended June 30, 2012.

Revenue per requisition for the six months ended June 30, 2012 was 1.4% above the prior year period. Revenue per requisition continued 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 were reimbursement changes, and 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 for the three and six months ended June 30, 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 June 30, 2012, combined revenues in these businesses decreased by approximately 5%, compared to the prior year period. For the six months ended June 30, 2012, combined revenues in these businesses approximated the prior year level. Increased revenues associated with our diagnostics products operations acquired as part of the Celera acquisition offset an approximate 5% reduction in revenues among our other non-clinical testing businesses.

Operating Costs and Expenses

                                                     Three Months Ended June 30,
                                                                                        Increase
                                      2012                      2011                   (Decrease)
                                             % Net                     % Net                    % Net
                                  $         Revenue         $         Revenue        $         Revenue
                                                        (dollars in millions)
Cost of services             $ 1,110.5        58.2 %   $ 1,104.4        58.0 %   $    6.1         0.2  %
Selling, general and
administrative expenses
(SG&A)                           440.8        23.1         462.8        24.3        (22.0 )      (1.2 )
Amortization of intangible
assets                            20.2         1.1          18.6         1.0          1.6         0.1
Other operating expense, net       0.6           -           0.6         0.1            -        (0.1 )
Total operating costs and
expenses                     $ 1,572.1        82.4 %   $ 1,586.4        83.4 %   $  (14.3 )      (1.0 )%
Bad debt expense (included
in SG&A)                     $    66.5         3.5 %   $    68.6         3.6 %   $   (2.1 )      (0.1 )%



                                                      Six Months Ended June 30,
                                                                                        Increase
                                      2012                      2011                   (Decrease)
                                             % Net                     % Net                    % Net
                                  $         Revenue         $         Revenue        $         Revenue
                                                        (dollars in millions)
Cost of services             $ 2,227.1        57.9 %   $ 2,201.4        59.1 %   $   25.7        (1.2 )%
Selling, general and
administrative expenses
(SG&A)                           941.4        24.5         910.6        24.4         30.8         0.1
Amortization of intangible
assets                            40.4         1.1          28.5         0.8         11.9         0.3
Other operating expense, net       0.1           -         236.5         6.4       (236.4 )      (6.4 )
Total operating costs and
expenses                     $ 3,209.0        83.5 %   $ 3,377.0        90.7 %   $ (168.0 )      (7.2 )%
Bad debt expense (included
in SG&A)                     $   147.2         3.8 %   $   146.0         3.9 %   $    1.2        (0.1 )%

Total Operating Costs and Expenses

For the three months ended June 30, 2012, total operating costs and expenses were $14 million below the prior year level, primarily driven by actions we have taken to reduce our cost structure, and by the impact in 2011 of professional fees and integration charges associated with the acquisitions of Athena and Celera. This decrease was partially offset by higher professional fees and other costs associated with further restructuring and integrating our business and costs incurred in connection with the succession of our prior CEO.

Results for the three months ended June 30, 2012 included costs of $12.6 million, primarily associated with professional fees and workforce reductions incurred in connection with further restructuring and integrating our business ($4.6 million in cost of services and $8.0 million in selling, general and administrative expenses). In addition, $3.0 million of pre-tax charges, associated with separation costs and accelerated vesting of certain equity awards in connection with the succession of our prior CEO, were recorded in selling, general and administrative expenses.

Results for the three months ended June 30, 2011 included pre-tax transaction costs of $14.3 million associated with the acquisitions of Athena and Celera, primarily related to professional fees, which were recorded in selling, general and administrative expenses. Results for the three months ended June 30, 2011 also included $6.1 million of pre-tax restructuring and integration charges, principally associated with workforce reductions, which were recorded in selling, general and administrative expenses.

For the six months ended June 30, 2012, total operating costs and expenses were $168 million below the prior year level, primarily due to the impact of the 2011 Medi-Cal charge, transaction costs associated with the acquisitions of Athena and Celera in 2011 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 prior 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 six months ended June 30, 2012 included costs of $25.7 million, primarily associated with professional fees and workforce reductions incurred in connection with further restructuring and integrating our business ($8.6 million in cost of services and $17.1 million in selling, general and administrative expenses). In addition, $10.1 million of pre-tax charges, associated with separation costs and accelerated vesting of certain equity awards in connection with the succession of our prior CEO, were recorded in selling, general and administrative expenses in 2012.

Results for the six months ended June 30, 2011 included the Medi-Cal charge of $236 million recorded in connection with the California Lawsuit. In addition, results for the six months ended June 30, 2011 included $19.4 million of restructuring and integration charges, principally associated with workforce reductions ($9.0 million in cost of services and $10.4 million in selling, general and administrative expenses). Results for the six months ended June 30, 2011 also included pre-tax transaction costs of $16.6 million associated with the acquisitions of Athena and Celera, primarily related to professional fees, which were recorded in selling, general and administrative expenses.

Cost of Services

The increase in cost of services as a percentage of net revenues for the three months ended June 30, 2012, compared to the prior year period, is principally associated with costs associated with workforce reductions. Higher costs associated with employee compensation and benefits were essentially offset by the impact of actions we have taken to reduce our cost structure.

The decrease in cost of services as a percentage of net revenues for the six months ended June 30, 2012, compared to the prior year period, primarily 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, contributed to higher cost of services as a percentage of revenues in 2011 compared to the current year period.

Selling, General and Administrative Expenses

The decrease in selling, general and administrative expenses as a percentage of net revenues for the three months ended June 30, 2012, compared to the prior year period, primarily reflects the transaction costs associated with the Athena and Celera acquisitions that were incurred during the second quarter of 2011, and actions we have taken to reduce our cost structure. This improvement was partially offset by costs incurred in connection with the succession of our prior CEO and a $1.9 million increase in pre-tax charges associated with restructuring and integration costs.

The increase in selling, general and administrative expenses as a percentage of net revenues for the six months ended June 30, 2012, compared to the prior year period, primarily reflects the impact of the acquired operations of Athena and Celera, costs incurred in connection with the succession of our prior CEO, and a $6.7 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 2011.

Amortization of Intangible Assets

The increase in amortization of intangible assets for the three and six months ended June 30, 2012, compared to the prior year period, primarily reflects the impact of amortization of intangible assets acquired as part of the Athena, Celera and S.E.D. acquisitions.

Other Operating Expense, net

Other operating expense, net includes special charges, and miscellaneous income
and expense items related to operating activities. For the six months ended
June 30, 2011, other operating expense, net included the Medi-Cal charge of
$236.0 million recorded in connection with the California Lawsuit.

Operating Income

                                  Three Months Ended June 30,                  Six Months Ended June 30,
                                                           Increase                                  Increase
                               2012            2011       (Decrease)       2012          2011       (Decrease)
                                     (dollars in millions)
Operating income           $    334.7       $  316.9     $     17.8     $   634.3     $  347.8     $     286.5
Operating income % of net
revenues                         17.6 %         16.6 %          1.0 %        16.5 %        9.3 %           7.2 %

The primary driver of the increase in operating income as a percentage of net revenues for the three months ended June 30, 2012, compared to the prior year period, are actions we have taken to reduce our cost structure. In addition, the impact of transaction costs associated with the Athena and Celera acquisitions in 2011 served to decrease operating income as a percentage of net revenues in the second quarter of 2011. Partially offsetting these improvements are higher costs associated with employee compensation and benefits, higher costs associated with restructuring and integration activities and costs incurred in connection with the succession of our prior CEO.

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 for the six months ended June 30, 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 prior CEO, and costs associated with a legal settlement.

Interest Expense, net
                                 Three Months Ended June 30,                Six Months Ended June 30,
                                                        Increase                                  Increase
                              2012          2011       (Decrease)       2012          2011       (Decrease)
                                    (dollars in millions)
Interest expense, net      $    41.9     $   46.6     $     (4.7 )   $    84.3     $   84.5     $     (0.2 )

Interest expense, net for the three and six months ended June 30, 2012 decreased, compared to prior year periods, primarily due to lower average outstanding debt balances in 2012 and the financing commitment fees incurred in 2011 related to the acquisition of Celera.

Other (Expense) Income, net

Other (expense) 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 and six months ended
June 30, 2012 and 2011, other (expense) income, net consisted of the following:

                                  Three Months Ended June 30,                   Six Months Ended June 30,
                                                           Increase                                   Increase
                               2012           2011        (Decrease)       2012          2011        (Decrease)
                                                           (dollars in millions)
Investment gains (losses)
associated with our
supplemental deferred
compensation plans         $    (1.3 )     $     0.2     $     (1.5 )   $     3.5     $    2.3     $        1.2
Other (expense) income
items, net                         -            (0.5 )          0.5             -         (0.4 )            0.4
Total other (expense)
income, net                $    (1.3 )     $    (0.3 )   $     (1.0 )   $     3.5     $    1.9     $        1.6

Income Tax Expense

                                    Three Months Ended June 30,                   Six Months Ended June 30,
                                                            Increase                                    Increase
                               2012            2011        (Decrease)         2012          2011       (Decrease)
                                                            (dollars in millions)
Income tax expense         $    112.4       $  105.8     $      6.6        $   213.8     $  155.0     $     58.8
Effective income tax rate        37.6 %         38.1 %         (0.5 )%          37.6 %       55.2 %        (17.6 )%

. . .