QUEST DIAGNOSTICS INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

[QUEST DIAGNOSTICS LOGO]

Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2003
Commission File Number 1-12215

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QUEST DIAGNOSTICS INCORPORATED
One Malcolm Avenue, Teterboro, NJ 07608
(201) 393-5000

DELAWARE
(State of Incorporation)

16-1387862
(I.R.S. Employer Identification Number)

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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of Each Class Name of Each Exchange on Which Registered
Common Stock
with attached Preferred Share Purchase Right New York Stock Exchange

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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

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 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
----- -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
----- -----

As of June 30, 2003, the aggregate market value of the approximately 83 million
shares of voting and non-voting common equity held by non-affiliates of the
registrant was approximately $5.3 billion, based on the closing price on such
date of the registrant's Common Stock on the New York Stock Exchange.

As of February 23, 2004, there were outstanding 103,604,635 shares of Common
Stock, $.01 par value.

Documents Incorporated by Reference

Such Proxy Statement, except for portions thereof, which have been specifically
incorporated by reference, shall not be deemed "filed" as part of this report on
Form 10-K.

PART I

ITEM 1. BUSINESS

OVERVIEW

We are the nation's leading provider of diagnostic testing, information and
related services, providing insights that enable physicians, hospitals, managed
care organizations and other healthcare professionals to make decisions to
improve health. We offer patients and physicians the broadest access to
diagnostic laboratory services through our national network of laboratories and
patient service centers. We provide interpretive consultation through the
largest medical and scientific staff in the industry, with over 300 physicians
and Ph.D.'s around the country. We are the leading provider of esoteric testing,
including gene-based testing, and testing for drugs of abuse. We are also a
leading provider of anatomic pathology services and testing for clinical trials.
We empower healthcare organizations and clinicians with state-of-the-art
information technology solutions that can improve practice management and
patient care.

During 2003, we generated net revenues of $4.7 billion and processed over
130 million requisitions for testing. Each requisition form accompanies a
patient specimen, indicating the tests to be performed and the party to be
billed for the tests. Our customers include physicians, hospitals, managed care
organizations, employers, governmental institutions and other commercial
clinical laboratories.

We currently operate a nationwide network of approximately 1,925 patient
service centers, principal laboratories located in more than 30 major
metropolitan areas throughout the United States, and approximately 155 smaller
"rapid response" laboratories (including, in each case, facilities operated at
our joint ventures). We are the only company in our industry to provide full
esoteric testing services, including gene-based testing, on both coasts through
our Quest Diagnostics Nichols Institute facilities, located in San Juan
Capistrano, California and Chantilly, Virginia. We also have laboratory
facilities in Mexico City, Mexico and San Juan, Puerto Rico and near London,
England.

We are a Delaware corporation. We sometimes refer to our subsidiaries and
ourselves as the "Company". We are the successor to MetPath Inc., a New York
corporation that was organized in 1967. From 1982 to 1996, we were a subsidiary
of Corning Incorporated, or Corning. On December 31, 1996, Corning distributed
all of the outstanding shares of our common stock to the stockholders of
Corning. In August 1999, we completed the acquisition of SmithKline Beecham
Clinical Laboratories, Inc., or SBCL, which operated the clinical laboratory
business of SmithKline Beecham plc, or SmithKline Beecham.

Our principal executive offices are located at One Malcolm Avenue,
Teterboro, New Jersey 07608, telephone number: (201) 393-5000. Our filings with
the Securities and Exchange Commission, or the SEC, including our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports, are available free of charge on our website as soon
as reasonably practicable after they are filed with, or furnished to, the SEC.
Our Internet website is located at http://www.questdiagnostics.com.

THE UNITED STATES CLINICAL LABORATORY TESTING MARKET

Clinical laboratory testing is an essential element in the delivery of
healthcare services. Physicians use laboratory tests to assist in the detection,
diagnosis, evaluation, monitoring and treatment of diseases and other medical
conditions. Clinical laboratory testing is generally categorized as clinical
testing and anatomic pathology testing. Clinical testing is performed on body
fluids, such as blood and urine. Anatomic pathology testing is performed on
tissues and other samples, such as human cells. Most clinical laboratory tests
are considered routine and can be performed by most commercial clinical
laboratories. Tests that are not routine and that require more sophisticated
equipment and highly skilled personnel are considered esoteric tests. Esoteric
tests, including gene-based tests, are generally referred to laboratories that
specialize in performing those tests.

We believe that the United States diagnostic testing industry had
over $37 billion in annual revenues in 2003. Most laboratory tests are
performed by one of three types of laboratories: commercial clinical
laboratories; hospital-affiliated laboratories; and physician-office
laboratories. In 2003, we believe that hospital-affiliated laboratories
performed over one-half of the clinical laboratory tests in the United States,
commercial clinical laboratories performed approximately one-third of those
tests, and physician-office laboratories performed the balance.

The underlying fundamentals of the diagnostic testing industry have improved
since the early to mid-1990s, which was a period of declining reimbursement and
reduced test utilization. During the early 1990s, the

industry was negatively impacted by changes in government regulation and
investigations into various billing practices. In addition, the rapid growth of
managed care, as a result of the need to reduce overall healthcare costs, and
excess laboratory testing capacity, led to revenue and profit declines across
the diagnostic testing industry, which in turn led to industry consolidation,
particularly among commercial laboratories. As a result of these dynamics, fewer
but larger commercial laboratories have emerged, which have greater economies of
scale, rigorous programs designed to assure compliance with government billing
regulations and other laws, and a more disciplined approach to pricing services.
These changes have resulted in improved profitability and a reduced risk of
non-compliance with complex government regulations. At the same time, a slowdown
in the growth of managed care and decreasing influence by managed care
organizations on the ordering of clinical laboratory testing by physicians has
contributed to renewed growth in testing volumes and further improvements in
profitability since 1999. Partially offsetting these favorable trends have been
changes in the United States economy during the last several years, which have
resulted in an increase in the number of unemployed and uninsured. In addition,
in an attempt to slow the rapidly rising costs of healthcare, employers and
healthcare insurers have made design changes to healthcare plans which shift a
larger portion of healthcare costs to consumers. We believe these factors have
reduced the utilization of healthcare services in general. Orders for laboratory
testing are generated from physician offices, hospitals and employers. As such,
factors such as the number of unemployed and uninsured and design changes in
healthcare plans, which impact the level of employment or the number of
physicians' office and hospital visits, will impact the utilization of
laboratory testing.

We believe the diagnostic testing industry has continued to grow during the
last several years despite the slowdown in the United States economy and the
changes in healthcare plan design, and that growth will accelerate as the
economy improves. In addition, over the longer term, growth is expected to
accelerate as a result of the following factors:

o general expansion and aging of the United States population;

o continuing research and development in the area of genomics and
proteomics, which is expected to yield new, more sophisticated and
specialized diagnostic tests;

o increasing recognition by consumers and payers of the value of early
detection and prevention, which can be provided through laboratory
testing, as a means to improve health and reduce the overall cost of
healthcare; and

o increasing affordability of tests due to advances in technology and cost
efficiencies.

BUSINESS STRATEGY

Our mission is to be recognized by our customers and employees as the best
provider of comprehensive and innovative diagnostic testing, information and
related services. The principal components of this strategy are to:

o COMPETE THROUGH PROVIDING THE HIGHEST QUALITY SERVICES: We intend to
become recognized as the quality leader in the healthcare services
industry. We continue to implement our Six Sigma and standardization
initiatives throughout all aspects of our organization. Six Sigma is
a management approach that requires a thorough understanding of customer
needs and requirements, root cause analysis, process improvements and
rigorous tracking and measuring. We have integrated our Six Sigma
initiative with our initiative to standardize operations and processes
across the Company by adopting identified Company best practices. We
plan to continue these initiatives during the next several years and
expect that successful implementation of these initiatives will result
in measurable improvements in customer satisfaction as well as
significant economic benefits.

o CAPITALIZE ON OUR LEADING POSITION WITHIN THE LABORATORY TESTING MARKET:
We are the leader in the core clinical laboratory testing business
offering the broadest national access to clinical laboratory testing
services, with facilities in substantially all of the major metropolitan
areas in the United States. We currently operate a nationwide network of
approximately 1,925 patient service centers, principal laboratories
located in more than 30 major metropolitan areas throughout the United
States and about 155 smaller "rapid response" laboratories that enable
us to serve physicians, managed care organizations, hospitals, employers
and other healthcare providers and their patients throughout the United
States. We believe that customers will increasingly seek to utilize
laboratory testing providers that have a nationwide presence and offer
a comprehensive range of services and that, as a result, we will be
able to profitably enhance our market position.

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o CONTINUE TO LEAD INNOVATION: We intend to build upon our reputation as a
leading innovator in the clinical laboratory industry by continuing to
introduce new tests, technology and services. As the industry leader with
the largest and broadest network and the leading provider of esoteric
testing, including gene-based testing, we believe that we are the best
partner for developers of new technology and tests to introduce their
products to the marketplace. Through our relationship with members of the
academic community, pharmaceutical and biotechnology firms, and emerging
medical technology companies that develop and commercialize novel
diagnostics, pharmaceutical and device technologies, we believe that we
are one of the leaders in transferring technical innovation to the
market (see "Our Services -- New Test Introductions").

We believe that, with the unveiling of the human genome, new genes and
the linkages of genes with disease will continue to be discovered at an
accelerating pace, leading to research that will result in ever more
complex and thorough predictive, diagnostic and therapeutic testing. We
believe that we are well positioned to capture much of this growth.

We continue to invest in the development and improvement of our
information technology products for customers and providers by developing
differentiated products that will provide friendlier, easier access to
ordering and resulting of laboratory tests and patient-centric
information. In February 2003, we launched our proprietary eMaxx'r'
Internet portal to physicians nationwide, which enables doctors to order
diagnostic tests and review laboratory results online, as well as check
patients' insurance eligibility in real time and view clinical
information from many sources.

o PURSUE STRATEGIC GROWTH OPPORTUNITIES: We intend to continue to leverage
our network in order to capitalize on targeted strategic growth
opportunities both inside and outside our core clinical laboratory
testing business. These opportunities are more fully described under
"Strategic Growth Opportunities" and include expanding our gene-based
and specialty testing capabilities, developing information technology
products for customers and providers, expanding our geographic presence
across the United States, and continuing to make selective acquisitions.

o LEVERAGE OUR SATISFACTION MODEL: Our approach to conducting business
states that satisfied employees lead to satisfied customers, which in
turn benefits our stockholders. We regularly survey our employees and
customers and follow up on their concerns. We emphasize skills training
for all employees and leadership training for our supervisory employees,
which includes Six Sigma training to manage high-impact quality
improvement projects throughout our organization, and annual compliance
training. We are committed to engaging each of our employees with
dignity and respect and expect them to treat our customers the same way.
We believe that our treatment and training of employees, together with
our competitive pay and benefits, helps increase employee satisfaction
and performance, thereby enabling us to provide better services to
our customers.

RECENT ACQUISITIONS

On February 28, 2003, we completed the acquisition of Unilab Corporation, or
Unilab, the leading commercial clinical laboratory in California. In connection
with the acquisition, we issued approximately 7.4 million shares of Quest
Diagnostics common stock (including 0.3 million shares of Quest Diagnostics
common stock reserved for outstanding stock options of Unilab which were
converted upon the completion of the acquisition into options to acquire shares
of Quest Diagnostics common stock), paid $297 million in cash and repaid $220
million of debt, representing substantially all of Unilab's then existing
outstanding indebtedness.

In connection with the acquisition of Unilab, as part of a settlement
agreement with the United States Federal Trade Commission, we entered into an
agreement to sell to Laboratory Corporation of America Holdings, Inc., or
LabCorp, certain assets in northern California for $4.5 million, including the
assignment of agreements with four independent physician associations, or IPA,
and leases for 46 patient service centers (five of which also serve as rapid
response laboratories). Approximately $27 million in annual net revenues were
generated by capitated fees under the IPA contracts and associated
fee-for-service testing for physicians whose patients use these patient service
centers, as well as from specimens received directly from the IPA physicians. We
completed the transfer of assets and assignment of the IPA agreements to LabCorp
during the third quarter of 2003.

As part of the Unilab acquisition, we acquired all of Unilab's operations,
including its primary testing facilities in Los Angeles, San Jose and
Sacramento, California, approximately 365 patient service centers, 35 rapid
response laboratories and approximately 4,100 employees. Following the sale of
certain assets to LabCorp, we closed our previously owned clinical laboratory in
the San Francisco Bay area and completed the integration

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of remaining customers in the northern California area to Unilab's laboratories
in San Jose and Sacramento. We continue to have two laboratories in the Los
Angeles metropolitan area (our facilities in Van Nuys and Tarzana). We plan to
open a new regional laboratory in the Los Angeles metropolitan area and then
integrate our business in the Los Angeles metropolitan area into the new
facility. We expect to incur up to $20 million of costs through 2005 to
integrate Unilab and our existing California operations. Upon completion of the
Unilab integration, we expect to realize approximately $25 million to $30
million of annual synergies. We expect to achieve this annual rate of synergies
by the end of 2005.

On April 1, 2002, we acquired American Medical Laboratories, Incorporated,
or AML, and an affiliated company of AML, LabPortal, Inc., a provider of
electronic connectivity products, in an all-cash transaction valued at
approximately $500 million, which included the assumption of approximately $160
million in debt. AML was a national provider of esoteric testing to hospitals
and specialty physicians and a leading provider of diagnostic testing services
in the Nevada and metropolitan Washington, D.C. markets. The Company's
Chantilly, Virginia laboratory, acquired as part of the AML acquisition, has
become our primary esoteric testing laboratory and hospital service center for
the eastern United States, complementing our Nichols Institute esoteric testing
facility in San Juan Capistrano, California. Esoteric testing volumes have been
redirected within our national network to provide customers with improved
turnaround time and customer service. We have completed the transition of
certain routine clinical laboratory testing previously performed in the
Chantilly, Virginia laboratory to other testing facilities within our regional
laboratory network.

Following an acquisition, the integration process requires the dedication of
significant management resources, which could result in a loss of momentum in
the activities of our business and may cause an interruption of, or
deterioration in, our services as a result of the following difficulties, among
others:

o a loss of key customers or employees;

o inconsistencies in standards, controls, procedures and policies between
the acquired company and our existing operations may make it more
difficult to implement and harmonize company-wide financial, accounting,
billing, information and other systems;

o failure to maintain the quality of services that the Company has
historically provided;

o diversion of management's attention from the day-to-day business of our
Company as a result of the need to deal with the foregoing disruptions
and difficulties; and

o the added costs of dealing with such disruptions.

Since most of our clinical laboratory testing is performed under
arrangements that are terminable at will or on short notice, any interruption
of, or deterioration in, our services may also result in a customer's decision
to stop using us for clinical laboratory testing. These events could have a
material adverse impact on our business. However, management believes that the
successful implementation of our integration plans and our value proposition
based on expanded patient access, our broad testing capabilities and most
importantly, the quality of the services we provide, will mitigate customer
attrition.

OUR SERVICES

Our laboratory testing business consists of routine testing, esoteric
testing, and clinical trials testing. Routine testing generates approximately
80% of our net revenues, esoteric and gene-based testing generates approximately
16% of our net revenues, and clinical trials testing generates less than 3% of
our net revenues. We derive less than 2% of our net revenues from foreign
operations.

ROUTINE TESTING

Routine tests measure various important bodily health parameters such as the
functions of the kidney, heart, liver, thyroid and other organs. Commonly
ordered tests include:

o blood cholesterol level tests;

o complete blood cell counts;

o Pap tests;

o HIV-related tests;

o urinalyses;

o pregnancy and other prenatal tests; and

o alcohol and other substance-abuse tests.

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We perform routine testing through our network of major laboratories, rapid
response laboratories, or "stat" labs, and patient service centers. We also
perform routine testing at the hospital laboratories we manage. Major
laboratories offer a full line of routine clinical tests. Rapid response
laboratories are local facilities where we can quickly perform an abbreviated
group of routine tests for customers that require rapid turnaround times.
Patient service centers are facilities where specimens are collected. These
centers are typically located in or near a building used by medical
professionals.

We operate 24 hours a day, 365 days a year. We perform and report most
routine procedures within 24 hours. Most test results are delivered
electronically.

ESOTERIC TESTING

Esoteric tests are those tests that require more sophisticated technology,
equipment and materials, professional "hands-on" attention and more highly
skilled professional and technical personnel, and may be performed less
frequently than routine tests. Because it is not cost-effective for most
clinical laboratories to perform a low volume of esoteric tests in-house, they
generally refer many of these tests to an esoteric clinical testing laboratory
that specializes in performing these more complex tests. Due to their
complexity, esoteric tests are generally reimbursed at higher levels than
routine tests.

Our two esoteric testing laboratories, which conduct business as Quest
Diagnostics Nichols Institute, are among the leading esoteric clinical testing
laboratories in the world. In 1998, our esoteric testing laboratory in San Juan
Capistrano, California, became the first clinical laboratory in North America to
achieve ISO-9001 certification. Our esoteric testing laboratory in Chantilly,
Virginia, acquired as part of the AML acquisition, now enables us to provide
full esoteric testing services, including gene-based testing, on the east coast.
Our two esoteric testing laboratories perform hundreds of esoteric tests that
are not routinely performed by our regional laboratories. These esoteric tests
are generally in the following fields:

o endocrinology and metabolism (the study of glands, their hormone
secretions and their effects on body growth and metabolism);

o genetics (the study of chromosomes, genes and their protein products and
effects);

o hematology (the study of blood and bone marrow cells) and coagulation
(the process of blood clotting);

o immunology (the study of the immune system including antibodies, immune
system cells and their effects);

o microbiology and infectious diseases (the study of microscopic forms of
life including bacteria, viruses, fungi and other infectious agents);

o oncology (the study of abnormal cell growth including benign tumors and
cancer);

o serology (a science dealing with the body fluids and their analysis,
including antibodies, proteins and other characteristics);

o special chemistry (more sophisticated testing requiring special expertise
and technology); and

o toxicology (the study of chemicals and drugs and their effects on the
body's metabolism).

NEW TEST INTRODUCTIONS

We intend to build upon our reputation as a leading innovator in the
clinical laboratory industry by continuing to introduce new diagnostic tests. As
the industry leader with the largest and broadest network and the leading
provider of esoteric testing, including gene-based testing, we believe that we
are the best partner for developers of new technology and tests to introduce
their products to the marketplace.

During 2003, we continued to be a leading innovator in the industry through
both tests that we developed at Nichols Institute, the largest provider of
molecular diagnostic testing in the United States, as well as through
relationships with technology developers. During 2003, we developed and
introduced:

o more than 15 comprehensive panels utilizing our menu of over 100 tests to
assist physicians with diagnosis and management of patients with bleeding
or blood clotting disorders;

o over 15 new infectious disease tests including DNA assays for West Nile
and SARS infection; and

o a biomarker assay that provides information on recurrence risk and
biologic behavior of node negative breast cancer to guide therapy for
the 30% of women with node negative disease.

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During 2003, we inaugurated a molecular endocrinology laboratory, with
introduction of the first commercial DNA tests for central and nephrogenic
Diabetes Insipidus (DI), Congenital Adrenal Hyperplasia (CAH), and Thyroid
Hormone Resistance (THR). The DI tests bypass the complicated perturbation tests
used for differential diagnosis of the several disorders. CAH testing is offered
as a DNA analysis for the most common mutations and as a CAH complete gene
sequencing for the 60 deleterious mutations known to be associated with this
wide spectrum of adrenal function disorders. The THR testing provides definitive
diagnosis for children with hypothyroidism of variable extent associated with
the defective hormone receptor.

Through our relationship with members of the academic community and
pharmaceutical and biotechnology firms, as well as our collaboration with
emerging medical technology companies that develop and commercialize novel
diagnostics, pharmaceutical and device technologies, we believe that we are one
of the leaders in transferring technical innovation to the market. During 2003,
we entered into a variety of strategic technology arrangements including:

o an agreement with Enterix, Inc. under which we have begun to offer the
Insure'TM' test, an FDA-cleared fecal immunochemical screening test for
colorectal cancer. Unlike other non-invasive colorectal cancer screening
technologies, the Insure'TM' test is easy for patients to use and
requires no handling of fecal matter;

o an agreement with diaDexus under which we are expanding our heart disease
test offering through the Lp-PLA2 test, which enables physicians to
detect a new risk factor for cardiovascular disease by measuring
levels of the enzyme lipoprotein-associated phospholipase A2; and

o a relationship with Thermo Electron under which we are developing a
biochip-based test for the detection of cystic fibrosis (CF) gene
mutations during prenatal screening.

Through our research and development, marketing and commercial alliance with
Roche Diagnostics, we were the first laboratory to offer several new tests
developed by Roche, including its Elecsys NT-proBNP test (which aids in the
diagnosis of congestive heart failure). Our relationship with Celera Diagnostics
gives us access to potentially significant markers for the risk of
cardiovascular disease, the leading cause of death in the United States, and
diabetes. Our relationship with Correlogic Systems has gained access to its new
ovarian cancer blood test, which we hope will be available to the marketplace in
2004 and will be the first protein pattern recognition blood test to detect
ovarian cancer in women who are already considered high risk.

We believe that, with the unveiling of the human genome, new genes and the
linkages of genes with disease will continue to be discovered at an accelerating
pace, leading to research that will result in ever more complex and thorough
predictive, diagnostic and therapeutic testing. We believe that we are well
positioned to capture much of this growth.

CLINICAL TRIALS TESTING

We believe that we are the world's second largest provider of clinical
laboratory testing performed in connection with clinical research trials on new
drugs in the world. Clinical research trials are required by the Food and Drug
Administration, or FDA, and other international regulatory authorities to assess
the safety and efficacy of new drugs. We have clinical trials testing centers in
the United States and in England. We also provide clinical trials testing in
Australia, Singapore, and South Africa through arrangements with third parties.
Clinical trials involving new drugs are increasingly being performed both inside
and outside the United States. Approximately 45% of our net revenues from
clinical trials testing in 2003 represented testing for GlaxoSmithKline plc, or
GSK. We currently have a long-term contractual relationship with GSK, under
which we are the primary provider of testing to support GSK's clinical trials
testing requirements worldwide.

OTHER SERVICES AND PRODUCTS

We manufacture and market diagnostic test kits and systems primarily for
esoteric testing under the Nichols Institute Diagnostics brand name. These are
sold principally to hospitals, clinical laboratories and dialysis centers,
both domestically and internationally. Our MedPlus subsidiary is a developer and
integrator of clinical connectivity and data management solutions for healthcare
organizations and clinicians primarily through its ChartMaxx'r' electronic
medical record system. During 2003, we began deploying eMaxx'r', a new
physician's Internet portal across the United States. The Internet portal was
developed by MedPlus and can provide physicians a "patient-centric" view of
laboratory test results and other clinical information on-line.

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PAYERS AND CUSTOMERS

We provide testing services to a broad range of healthcare providers. We
consider a "payer" as the party that pays for the test and a "customer" as the
party who refers the test to us. Depending on the billing arrangement and
applicable law, the payer may be (1) the physician or other party (such as
another laboratory or an employer) who referred the testing to us, (2) the
patient, or (3) a third party who pays the bill for the patient, such as an
insurance company, Medicare or Medicaid. Some states, including New York, New
Jersey and Rhode Island, prohibit us from billing physician clients. We consider
a managed care organization as both our customer and a payer, when it contracts
with us on an exclusive or semi-exclusive basis on behalf of its patients.

During 2003, only two customers accounted for more than 5% of our net
revenues, and no single customer accounted for more than 7% of our net revenues.
We believe that the loss of any one of our customers would not have a material
adverse effect on our financial condition, results of operations or cash flows.

PAYERS

The following table shows current estimates of the breakdown of the
percentage of our total volume of requisitions and total clinical laboratory net
revenues during 2003 applicable to each payer group:

CUSTOMERS

Physicians

Physicians requiring testing for patients are the primary source of our
clinical laboratory testing volume. We typically bill physician accounts on a
fee-for-service basis. Fees billed to physicians are based on the laboratory's
client fee schedule and are typically negotiated. Fees billed to patients and
insurance companies are based on the laboratory's patient fee schedule, subject
to any limitations on fees negotiated with the insurance companies or with
physicians on behalf of their patients. Medicare and Medicaid reimbursements are
based on fee schedules set by governmental authorities.

Managed Care Organizations and Other Insurance Providers

Health insurers, which typically contract with a limited number of clinical
laboratories for their members, represent approximately one-half of our total
testing volumes and one-half of our net revenues. Larger health insurers
typically prefer to use large commercial clinical laboratories because they can
provide services on a national or regional basis and can manage networks of
local or regional laboratories to provide even broader access to their members
and physicians. In addition, larger laboratories are better able to achieve the
low-cost structures necessary to profitably service large health insurers and
can provide test utilization data across their various plans in a consistent
format. In certain markets, such as California, many health insurers delegate
their covered members to independent physician associations, which in turn
contract with laboratories for clinical laboratory services.

Over the last decade, health insurers have been consolidating, resulting in
fewer but larger insurers with significant bargaining power in negotiating fee
arrangements with healthcare providers, including clinical laboratories. These
health insurers demand that clinical laboratory service providers accept
discounted fee structures or assume all or a portion of the financial risk
associated with providing testing services to their members through capitated
payment contracts. Under these capitated payment contracts, the Company and
health insurers agree to a predetermined monthly contractual rate for each
member of the health insurer's plan regardless of the number or cost of services
provided by the Company. Some services, such as various esoteric tests, new
technologies and anatomic pathology services, may be carved out from a capitated
rate and, if carved

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out, are charged on a fee-for-service basis. We work closely with health
insurers as they evaluate new tests; however, as innovation in the testing
area increases, there is no guarantee that health insurers will agree to carve
out these services or reimburse them at rates that reflect the true cost or
value associated with such services.

In recent years, there has been a shift in the way major insurers contract
with clinical laboratories. Health insurers have begun to offer more freedom of
choice to their affiliated physicians, including greater freedom to determine
which laboratory to use and which tests to order. Accordingly, most of our
agreements with major health insurers are non-exclusive contracts. As a result,
under these non-exclusive arrangements, physicians have more freedom of choice
in selecting laboratories, and laboratories are likely to compete more on the
basis of service and quality rather than price alone. Also, health insurers have
been giving patients greater freedom of choice and patients have increasingly
been selecting plans (such as preferred provider organizations and consumer
driven plans) that offer a greater choice of providers. Pricing for these
preferred provider organizations is typically negotiated on a fee-for-service
basis, which generally results in higher revenue per requisition than under a
capitated fee arrangement. Despite these trends, health insurers continue to
aggressively seek cost reductions in order to keep their premiums to their
customers competitive. If we are unable to agree on pricing with a health
insurer, we would become a "non-participating" provider and could then only
bill the ordering physician or the patient rather than the health insurer.
This "non-participating" status could lead to loss of business since the
physician is likely to refer testing to a participating provider whose testing
is covered by the patient's health insurance benefit plan. We cannot assure
investors that we will continue to be successful in negotiating contracts
with major insurers. Loss of multiple major insurer or other payer agreements
could have a material adverse effect on our financial condition, results of
operations and cash flows.

We offer QuestNet'TM', an innovative product to develop and manage a
customized network of clinical laboratory providers for health insurers. Through
QuestNet'TM', physicians and members are provided multiple choices for clinical
laboratory testing while health insurers realize cost reductions under a single
capitated arrangement.

Hospitals

We provide services to hospitals throughout the United States that vary from
esoteric testing to helping manage their laboratories. We believe that we are
the industry's market leader in servicing hospitals. Our hospital customers
account for approximately 13% of our net revenues, the majority of which
represents services billed to the hospitals under reference testing
arrangements, based on negotiated fee schedules, for certain testing that the
hospitals do not perform internally. Hospitals generally maintain an on-site
laboratory to perform testing on patients and refer less frequently needed and
highly specialized procedures to outside laboratories, which typically charge
the hospitals on a negotiated fee-for-service basis. We believe that most
hospital laboratories perform approximately 90% to 95% of their patients'
clinical laboratory tests. In addition, many hospitals compete with commercial
clinical laboratories for outreach (non-hospital patients) testing. Most
physicians have admitting privileges or other relationships with hospitals as
part of their medical practice. Many hospitals leverage their relationships with
community physicians and encourage the physicians to send their outreach testing
to the hospital's laboratory. In addition, hospitals that own physician
practices generally require the physicians to refer tests to the hospital's
affiliated laboratory. As a result, hospital-affiliated laboratories can be both
customers and competitors for commercial clinical laboratories.

During 2002, in conjunction with the acquisition of AML, we launched
dedicated sales and service teams focused on serving the unique needs of
hospital customers. We believe that the combination of full-service, bi-coastal
esoteric testing capabilities, medical and scientific professionals for
consultation, innovative connectivity products, focus on Six Sigma quality and
dedicated sales and service professionals has positioned us to be a partner of
choice for hospital customers.

We have joint venture arrangements with leading integrated health delivery
networks in several metropolitan areas. These joint venture arrangements, which
provide testing for affiliated hospitals as well as for unaffiliated physicians
and other healthcare providers in their geographic areas, serve as our principal
laboratory facilities in their service areas. Typically, we have either a
majority ownership interest in, or day-to-day management responsibilities for,
our hospital joint venture relationships. We also manage the laboratories at a
number of other hospitals.

8

Employers, Governmental Institutions and Other Clinical Laboratories

We provide testing services to federal, state and local governmental
agencies and to large employers. We believe that we are the leading provider of
clinical laboratory testing to employers for drugs of abuse. We also provide
wellness testing to employers to enable employees to take an active role in
improving their health. Testing services for employers account for approximately
3% of our net revenues. The volume of testing services for employers, which
generally have relatively low profit margins, has declined significantly during
2001 through 2003 driven by a slowdown in hiring. We also perform esoteric
testing services for other commercial clinical laboratories that do not have a
full range of testing capabilities. All of these customers are charged on a
fee-for-service basis.

Consumers

Consumers are becoming increasingly interested in managing their own health
and health records. Currently, almost all the testing we perform is ordered
directly by a physician, who then receives the test results. However, over time,
we believe that consumers will increasingly want to order clinical laboratory
tests themselves. To that end, we offer a focused menu of clinical laboratory
testing directly to consumers in certain states. Consumers pay for and receive
the test results directly. In each case, a physician reviews the order and
result. We believe this market will continue to grow over time.

SALES AND MARKETING

We market to and service our customers through our direct sales force,
customer service and patient service representatives and couriers.

We focus our sales efforts on obtaining and retaining profitable accounts.
We have an active account management process to evaluate the profitability of
all of our accounts. Where appropriate, we change the service levels, terminate
accounts that are not profitable or adjust pricing.

Our sales force is organized by customer type with the majority of
representatives focused on marketing laboratory services to physicians,
including specialty physicians such as oncologists, cardiologists and
gastroenterologists. Additionally, we have a managed care sales organization
that maintains relationships with regional and national insurance and managed
care organizations. We also have a hospital sales organization that focuses on
meeting the unique needs of hospitals and leverages the specialized capabilities
of our Nichols Institute esoteric testing laboratories. Supporting our hospital
and physician sales teams are genomics and esoteric testing specialists, who are
specially trained and focused on marketing and selling more complex tests to our
customers. A smaller portion of our sales force focuses on selling substance-of-
abuse testing to employers.

Customer service representatives perform a number of services for patients
and customers. They monitor services, answer questions and help resolve
problems. Our couriers pick up specimens from most clients daily.

Our corporate marketing function is organized by customer and is responsible
for developing and executing marketing strategies, new product launches, and
promotional and advertising support. The marketing function is also responsible
for customer satisfaction surveys, market research, tradeshow administration,
database marketing tools, and marketplace trending and analysis.

STRATEGIC GROWTH OPPORTUNITIES

In addition to expanding our core clinical laboratory business through
internal growth and pursuing our strategy to become a leading provider of
medical information, we intend to continue to leverage our network in order to
capitalize on targeted growth opportunities both inside and outside our core
laboratory testing business. These opportunities include:

o GENE-BASED AND OTHER ESOTERIC TESTS: We intend to remain a leading
innovator in the clinical laboratory industry by continuing to introduce
new tests, technology and services. We estimate that the current United
States market in esoteric testing, including gene-based testing, is $3
billion to $4 billion per year. We believe that we have the largest
gene-based testing business in the United States, with greater than
$500 million in net revenues during 2003, and that this business has been
growing by more than 20% per year. We believe that the unveiling of the
human genome, the discovery of new genes and the linkages of these genes
with disease will result in more complex and thorough predictive,
diagnostic and therapeutic testing. We believe that we are well
positioned to realize this growth. We intend to focus on
commercializing diagnostic applications of discoveries in the areas of
functional genomics (the analysis

9

of genes and their functions) and proteomics (the discovery of new
proteins made possible by the human genome project).

o ANATOMIC PATHOLOGY: While we are one of the leading providers of anatomic
pathology services in the United States, we have traditionally been
strongest in cytology, and specifically in the analysis of Pap tests to
detect cervical cancer. During the last several years, we have led the
industry in converting over 80% of our Pap smear business to the use of
liquid-based technology for cervical cancer screening, a higher quality
and more profitable product offering. We intend to continue to expand our
anatomic pathology business into higher growth segments, including
histology (tissue pathology), and actively participate in the emerging
use of molecular testing as a screening tool in conjunction with Pap
tests. We estimate that the current United States market for anatomic
pathology services is approximately $6 billion per year. We estimate
that cytology represents about $1 billion per year of this market, and
that tissue pathology represents about $5 billion per year of this
market. We generated approximately $500 million in net revenues from
such services during 2003.

o INFORMATION TECHNOLOGY: We continue to invest in the development and
improvement of information technology products for customers and
providers by developing differentiated products that will provide
friendlier, easier access to ordering and resulting of laboratory tests
and patient-centric information. In February 2003, we launched our
proprietary eMaxx'r' Internet portal to physicians nationwide. The
eMaxx'r' Internet portal enables doctors to order diagnostic tests and
review laboratory results online, as well as check patients' insurance
eligibility in real time and view clinical information from many sources.
In pilot markets, physicians are also able to use eMaxx'r' to prescribe
pharmaceuticals. This service allows us to replace older technology
desktop products that we currently provide to many physicians and
thereby streamline our support structure. Demand has been growing for
our information technology solutions as physician offices have expanded
their usage of the Internet. By the end of 2003, we were receiving
approximately 25% of all test orders and delivering about 35% of all
test results via the Internet.

The eMaxx'r' Internet portal was developed by MedPlus Inc., or MedPlus,
which we acquired in November 2001. MedPlus' ChartMaxx'r' and eMaxx'r'
patient record systems are designed to support the creation and
management of electronic patient records, by bringing together in one
patient-centric view information from various sources, including the
physician's records and laboratory and hospital data. We intend to
expand the services offered through our portal over time as other
strategic arrangements are realized, which will enhance our ability to
introduce a broad range of electronic services to healthcare providers.

o SELECTIVE REGIONAL ACQUISITIONS: The clinical laboratory industry remains
highly fragmented. We expect to continue to acquire other regional
clinical laboratories that can be integrated with our existing
laboratories, thereby enabling us to reduce costs and improve
efficiencies through the elimination of redundant facilities and
equipment, and reductions in personnel (see "Recent Acquisitions" for a
discussion of our recent acquisitions). We may also consider
acquisitions of ancillary businesses as part of our overall growth
strategy, such as our November 2001 acquisition of MedPlus, which
develops clinical connectivity products designed to enhance patient
care (see "Information Technology").

INFORMATION SYSTEMS

Information systems are used extensively in virtually all aspects of our
business, including laboratory testing, billing, customer service, logistics,
and management of medical data. Our success depends, in part, on the continued
and uninterrupted performance of our information technology, or IT systems.
Computer systems are vulnerable to damage from a variety of sources, including
telecommunications or network failures, malicious human acts and natural
disasters. Moreover, despite network security measures, some of our servers are
potentially vulnerable to physical or electronic break-ins, computer viruses and
similar disruptive problems. Despite the precautionary measures that we have
taken to prevent unanticipated problems that could affect our IT systems,
sustained or repeated system failures that interrupt our ability to process test
orders, deliver test results or perform tests in a timely manner could adversely
affect our reputation and result in a loss of customers and net revenues.

During the 1980s and early 1990s when we acquired many of our laboratory
facilities, our regional laboratories were operated as local, decentralized
units, and we did not standardize their billing, laboratory and some of their
other information systems. As a result, by the end of 1995 we had many different
information

10

systems for billing, test results reporting, and other transactions. Over
time, the growth in the size and network of our customers and the increasing
complexity of billing demonstrated a greater need for standardized systems.

During 2002, we began implementation of a standard laboratory information
system and a standard billing system. We expect that deployment of the
standardized systems will take several more years to complete and will result in
significantly more centralized systems than we have today. We expect the
integration of these systems will improve operating efficiency and provide
management with more timely and comprehensive information with which to make
management decisions. However, failure to properly implement this
standardization process could materially adversely impact us. During system
conversions of this type, workflow may be re-engineered to take advantage of
enhanced system capabilities, which may cause temporary disruptions in service.
In addition, the implementation process, including the transfer of databases and
master files to new data centers, presents significant conversion risks that
need to be managed carefully.

BILLING

Billing for laboratory services is complicated. Depending on the billing
arrangement and applicable law, we must bill various payers, such as patients,
insurance companies, Medicare, Medicaid, doctors and employer groups, all of
which have different requirements. Additionally, auditing for compliance with
applicable laws and regulations as well as internal compliance policies and
procedures adds further complexity to the billing process. Among many other
factors complicating billing are:

o pricing differences between our fee schedules and the reimbursement rates
of the payers;

o disputes with payers as to which party is responsible for payment; and

o disparity in coverage and information requirements among various payers.

We incur significant additional costs as a result of our participation in
Medicare and Medicaid programs, as billing and reimbursement for clinical
laboratory testing is subject to considerable and complex federal and state
regulations. These additional costs include those related to: (1) complexity
added to our billing processes; (2) training and education of our employees and
customers; (3) compliance and legal costs; and (4) costs related to, among other
factors, medical necessity denials and advance beneficiary notices. Compliance
with applicable laws and regulations, as well as internal compliance policies
and procedures, adds further complexity and costs to the billing process.
Changes in laws and regulations could negatively impact our ability to bill our
clients. The Centers for Medicare & Medicaid Services, or CMS (formerly the
Health Care Financing Administration), establishes procedures and continuously
evaluates and implements changes in the reimbursement process.

We believe that most of our bad debt expense, which was 4.8% of our net
revenues in 2003, is primarily the result of missing or incorrect billing
information on requisitions received from healthcare providers rather than
credit related issues. In general, we perform the requested tests and report
test results regardless of whether the billing information is incorrect or
missing. We subsequently attempt to contact the provider to obtain any missing
information and rectify incorrect billing information. Missing or incorrect
information on requisitions adds complexity to and slows the billing process,
creates backlogs of unbilled requisitions, and generally increases the aging of
accounts receivable. When all issues relating to the missing or incorrect
information are not resolved in a timely manner, the related receivables are
written off to the allowance for doubtful accounts.

We have implemented "best practices" for billing that have significantly
reduced the percentage of requisitions with missing billing information from
approximately 16% at the beginning of 1996 to approximately 4% in 2003. These
initiatives, together with our Six Sigma and standardization initiatives and
progress in dealing with Medicare medical necessity documentation requirements,
have significantly reduced bad debt expense as a percentage of net revenues from
about 7% during 1996 to 4.8% during 2003. We believe that in the longer term,
with a continuing focus on process discipline and the increased use of
electronic ordering by our customers, bad debt as a percentage of net revenues
can be reduced to 4% or less (see "Regulation of Reimbursement for Clinical
Laboratory Services").

COMPETITION

While there has been significant consolidation in the clinical laboratory
testing business in recent years, our industry remains fragmented and highly
competitive. We compete with three types of laboratory providers:
hospital-affiliated laboratories, other commercial clinical laboratories and
physician-office laboratories. We are the leading clinical laboratory provider
in the United States, with net revenues of $4.7 billion during 2003, and
facilities in substantially all of the country's major metropolitan areas. Our
largest competitor is LabCorp. In

11

addition, we compete with, and service, many smaller regional and local
commercial clinical laboratories, as well as laboratories owned by physicians
and hospitals (see "Payers and Customers -- Customers").

We believe that healthcare providers consider a number of factors when
selecting a laboratory, including:

o service capability and quality;

o accuracy, timeliness and consistency in reporting test results;

o number and type of tests performed by the laboratory;

o number, convenience and geographic coverage of patient service centers;

o reputation in the medical community; and

o pricing.

We believe that we compete favorably in each of these areas.

We believe that large commercial clinical laboratories may be able to
increase their share of the overall clinical laboratory testing market due to
their large service networks and lower cost structures. These advantages should
enable larger clinical laboratories to more effectively serve large customers,
including managed care organizations. In addition, we believe that consolidation
in the clinical laboratory testing business will continue. However, a majority
of the clinical laboratory testing is likely to continue to be performed by
hospitals, which generally have affiliations with community physicians that
refer testing to us (see "Payers and Customers -- Customers -- Hospitals"). As
a result of these affiliations, we compete against hospital-affiliated
laboratories primarily on the basis of service capability and quality as well
as other non-pricing factors. Our failure to provide service superior to
hospital-affiliated laboratories and other laboratories could negatively
impact our net revenues.

The diagnostic testing industry is faced with changing technology and new
product introductions. Advances in technology may lead to the development of
more cost-effective tests that can be performed outside of a commercial clinical
laboratory such as (1) point-of-care tests that can be performed by physicians
in their offices and (2) home testing that can be performed by patients or by
physicians in their offices. Development of such technology and its use by our
customers would reduce the demand for our laboratory testing services and
negatively impact our net revenues (see "Regulation of Clinical Laboratory
Operations").

QUALITY ASSURANCE

Our goal is to continually improve the processes for collection, storage and
transportation of patient specimens, as well as the precision and accuracy of
analysis and result reporting. Our quality assurance efforts focus on
proficiency testing, process audits, statistical process control and personnel
training for all of our laboratories and patient service centers. We continue to
implement our Six Sigma and standardization initiatives to help achieve our goal
of becoming recognized as the undisputed quality leader in the healthcare
services industry. Our Nichols Institute facility in San Juan Capistrano was the
first clinical laboratory in North America to achieve ISO-9001 certification.
Two of our clinical trials laboratories, our diagnostic kits facility and one of
our routine laboratories have also achieved ISO-9001 certification. These
certifications are international standards for quality management systems.

INTERNAL PROFICIENCY TESTING, QUALITY CONTROL AND AUDITS. Quality control
samples are processed in parallel with the analysis of patient specimens. The
results of tests on quality control samples are monitored to identify trends,
biases or imprecision in the analytical processes. We also perform internal
process audits as part of our comprehensive Quality Assurance program.

EXTERNAL PROFICIENCY TESTING AND ACCREDITATION. All of our laboratories
participate in various external quality surveillance programs. They include
proficiency testing programs administered by the College of American
Pathologists, or CAP, as well as some state agencies.

CAP is an independent, non-governmental organization of board certified
pathologists. CAP is approved by CMS to inspect clinical laboratories to
determine compliance with the standards required by the Clinical Laboratory
Improvement Amendments of 1988, or CLIA. CAP offers an accreditation program to
which laboratories may voluntarily subscribe. All of our major regional
laboratories are accredited by CAP. Accreditation includes on-site inspections
and participation in the CAP (or equivalent) proficiency testing program.

12

REGULATION OF CLINICAL LABORATORY OPERATIONS

The clinical laboratory industry is subject to significant federal and state
regulation, including inspections and audits by governmental agencies.
Governmental authorities may impose fines or criminal penalties or take other
actions to enforce laws and regulations, including revoking a clinical
laboratory's federal certification to operate a clinical laboratory operation.
Changes in regulation may increase the costs of performing clinical laboratory
tests, increase the administrative requirements of claims or decrease the amount
of reimbursement.

CLIA AND STATE REGULATION. All of our laboratories and (where applicable)
patient service centers are licensed and accredited by the appropriate federal
and state agencies. CLIA regulates virtually all clinical laboratories by
requiring they be certified by the federal government and comply with various
operational, personnel and quality requirements intended to ensure that their
clinical laboratory testing services are accurate, reliable and timely. CLIA
does not preempt state laws that are more stringent than federal law. For
example, state laws may require additional personnel qualifications, quality
control, record maintenance and/or proficiency testing. The cost of compliance
with CLIA makes it cost prohibitive for many physicians to operate clinical
laboratories in their offices. However, manufacturers of laboratory equipment
and test kits could seek to increase their sales by marketing point-of-care
laboratory equipment to physicians and by selling test kits approved for home
use to both physicians and patients. Diagnostic tests approved or cleared by the
FDA for home use are automatically deemed to be "waived" tests under CLIA and
may be performed in physician office laboratories with minimal regulatory
oversight as well as by patients in their homes.

DRUG TESTING. The Substance Abuse and Mental Health Services Administration,
or SAMHSA, regulates drug testing for public sector employees and employees of
certain federally regulated businesses. SAMHSA has established detailed
performance and quality standards that laboratories must meet to perform drug
testing on these employees. All laboratories that perform such testing must be
certified as meeting SAMHSA standards.

CONTROLLED SUBSTANCES. The federal Drug Enforcement Administration, or DEA,
regulates access to controlled substances used to perform drugs of abuse
testing. Laboratories that use controlled substances are licensed by the DEA.

MEDICAL WASTE, HAZARDOUS WASTE AND RADIOACTIVE MATERIALS. Clinical
laboratories are also subject to federal, state and local regulations relating
to the handling and disposal of regulated medical waste, hazardous waste and
radioactive materials. We generally use outside vendors to dispose of such
waste.

FDA. The FDA has regulatory responsibility over instruments, test kits,
reagents and other devices used to perform diagnostic testing by clinical
laboratories. In the past, the FDA has claimed regulatory authority over
laboratory-developed tests, but has exercised enforcement discretion in not
regulating most laboratory-developed tests performed by high complexity
CLIA-certified laboratories. In December 2000, the Department of Health and
Human Services, or HHS, Secretary's Advisory Committee on Genetic Testing
recommended that the FDA be the lead federal agency to regulate genetic testing.
In late 2002, a new HHS Secretary's Advisory Committee on Genetics, Health and
Society was appointed to replace the prior Advisory Committee, but it has not
yet made any final recommendations. In the meantime, the FDA is considering
revising its regulations on analyte specific reagents, which are used in
laboratory-developed tests, including laboratory developed genetic testing.
Representatives of clinical laboratories (including Quest Diagnostics) and the
American Clinical Laboratory Association (our industry trade association) have
met with representatives of the FDA to address industry issues pertaining to
potential FDA regulation of genetic testing in general and issues with regard to
the impact of potential increased oversight over analyte specific reagents. We
expect those discussions to continue. Increased FDA regulation of the reagents
used in laboratory-developed testing could lead to increased costs and delays in
introducing new tests, including genetic tests.

OCCUPATIONAL SAFETY. The federal Occupational Safety and Health
Administration, or OSHA, has established extensive requirements relating
specifically to workplace safety for healthcare employers. This includes
developing and implementing multi-faceted programs to protect workers from
exposure to blood-borne pathogens, such as HIV and hepatitis B and C, including
preventing or minimizing any exposure through sharps or needle stick injuries.

SPECIMEN TRANSPORTATION. Transportation of most clinical laboratory
specimens and hazardous materials is subject to regulation by the Department of
Transportation, the Public Health Service, the United States Postal Service and
the International Civil Aviation Organization.

CORPORATE PRACTICE OF MEDICINE. Many states, including some in which our
principal laboratories are located, prohibit corporations from engaging in the
practice of medicine. The corporate practice of medicine doctrine has been
interpreted in certain states to prohibit corporations from employing licensed
healthcare professionals to provide services on the corporation's behalf. The
scope of the doctrine, and how it applies,

13

varies from state to state. In certain states these restrictions affect our
ability to directly provide anatomic pathology services and/or to provide
clinical laboratory services directly to consumers.

PRIVACY AND SECURITY OF HEALTH INFORMATION; STANDARD TRANSACTIONS

Pursuant to the Health Insurance Portability and Accountability Act of 1996,
or HIPAA, the Secretary of HHS has issued final regulations designed to improve
the efficiency and effectiveness of the health care system by facilitating the
electronic exchange of information in certain financial and administrative
transactions while protecting the privacy and security of the information
exchanged. Three principal regulations have been issued in final form: privacy
regulations, security regulations, and standards for electronic transactions.

The HIPAA privacy regulations, which fully came into effect in April 2003,
establish comprehensive federal standards with respect to the uses and
disclosures of protected health information by health plans, healthcare
providers and healthcare clearinghouses. The regulations establish a complex
regulatory framework on a variety of subjects, including:

o the circumstances under which uses and disclosures of protected health
information are permitted or required without a specific authorization by
the patient, including but not limited to treatment purposes, activities
to obtain payment for our services, and our health care operations
activities;

o a patient's rights to access, amend and receive an accounting of certain
disclosures of protected health information;

o the content of notices of privacy practices for protected health
information; and

o administrative, technical and physical safeguards required of entities
that use or receive protected health information.

We have implemented the HIPAA privacy regulations, as required by law. The
HIPAA privacy regulations establish a "floor" and do not supersede state laws
that are more stringent. Therefore, we are required to comply with both federal
privacy standards and varying state privacy laws. In addition, for healthcare
data transfers relating to citizens of other countries, we need to comply with
the laws of other countries. The federal privacy regulations restrict our
ability to use or disclose patient-identifiable laboratory data, without patient
authorization, for purposes other than payment, treatment or healthcare
operations (as defined by HIPAA) except for disclosures for various public
policy purposes and other permitted purposes outlined in the final privacy
regulations. The privacy regulations provide for significant fines and other
penalties for wrongful use or disclosure of protected health information,
including potential loss of licensure and civil and criminal fines and
penalties. Although the HIPAA statute and regulations do not expressly provide
for a private right of damages, we also could incur damages under state laws to
private parties for the wrongful use or disclosure of confidential health
information or other private personal information.

The final HIPAA security regulations, which establish requirements for
safeguarding electronic patient information, were published on February 20, 2003
and became effective on April 21, 2003, although healthcare providers have until
April 20, 2005 to comply. We are conducting an analysis to determine the proper
security measures to reasonably and appropriately comply with the standards and
implementation specifications by the compliance deadline of April 20, 2005.

The final HIPAA regulations for electronic transactions, which we refer to
as the transaction standards, establish uniform standards for electronic
transactions and code sets, including the electronic transactions and code sets
used for claims, remittance advices, enrollment and eligibility. The transaction
standards became effective in October 2002, although covered entities were
eligible to obtain a one-year extension if approved through an application to
the Secretary of HHS. We received this one-year extension through October 16,
2003 from HHS.

HHS issued guidance on July 24, 2003 stating that it would not penalize a
covered entity for post-implementation date transactions that are not fully
compliant with the transactions standards, if the covered entity could
demonstrate its good faith efforts to comply with the standards. HHS' stated
purpose for this flexible enforcement position was to "permit health plans to
mitigate unintended adverse effects on covered entities' cash flow and business
operations during the transition to the standards, as well as on the
availability and quality of patient care." We continue to work in good faith to
complete the implementation of these standards with those payers who either were
not ready to exchange files in the standard formats as of the compliance date,
or who have varying interpretations of the requirements. Working with these
payers requires that we continue to trade electronic claims files and payments
in legacy formats, even after the compliance deadline of October 16, 2003.

14

On September 23, 2003, CMS announced that it would implement a contingency
plan for the Medicare program to accept electronic transactions that are not
fully compliant with the transaction standards after the October 16, 2003
compliance deadline. The CMS contingency plan, as announced, allows Medicare
carriers to continue to accept and process Medicare claims in the pre-October 16
electronic formats to give healthcare providers additional time to complete the
testing process, provided that they continue to make a good faith effort to
comply with the new standards. Almost all other payers have followed the lead of
CMS, accepting legacy formats until both parties to the transactions are ready
to implement the new electronic transaction standards.

As part of its plan, CMS is expected to regularly reassess the readiness of
its healthcare providers to determine how long the contingency plan will remain
in effect. Many of our payers were not ready to implement the transaction
standards by the October 2003 compliance deadline or were not ready to test or
trouble-shoot claims submissions. We are working in good faith with payers that
have not converted to the new standards to reach agreement on each payer's data
requirements and to test claims submissions.

The HIPAA transaction standards are complex, and subject to differences in
interpretation by payers. For instance, some payers may interpret the standards
to require us to provide certain types of information, including demographic
information not usually provided to us by physicians. As a result of
inconsistent interpretations of transaction standards by payers or our inability
to obtain certain billing information not usually provided to us by physicians,
we could face increased costs and complexity, a temporary disruption in
receipts and ongoing reductions in reimbursements and net revenues. We are
working closely with our payers to establish acceptable protocols for claims
submissions and with our trade association and an industry coalition to
present issues and problems as they arise to the appropriate regulators and
standards setting organizations.

Compliance with all of the HIPAA requirements requires significant capital
and personnel resources from all healthcare organizations, not just Quest
Diagnostics. While we believe that our total costs to comply with HIPAA will not
be material to our results of operations or cash flows, the potential need for
additional customer contact to obtain data for billing as a result of different
interpretations of the current regulations could impose significant additional
costs on us.

REGULATION OF REIMBURSEMENT FOR CLINICAL LABORATORY SERVICES

OVERVIEW. The healthcare industry has experienced significant changes in
reimbursement practices during the past several years. Government payers, such
as Medicare (which principally serves patients 65 years and older) and Medicaid
(which principally serves indigent patients), as well as private payers and
large employers, have taken steps and may continue to take steps to control the
cost, utilization and delivery of healthcare services, including clinical
laboratory services. If we cannot offset additional reductions in the payments
we receive for our services by reducing costs, increasing test volume and/or
introducing new procedures, it could have a material adverse impact on our net
revenues and profitability. On the other hand, we believe that laboratory tests
are an effective means to detect certain medical conditions at an earlier point
in time, leading to potential reduction in other healthcare costs such as the
cost of hospitalization.

Principally as a result of government reimbursement reductions and measures
adopted by CMS to reduce utilization described below, the percentage of our net
revenues derived from Medicare and Medicaid programs declined from approximately
20% in 1995 to approximately 15% in 2002. This percentage increased to
approximately 17% in 2003 principally as a result of our acquisition of Unilab,
which had a higher percentage of its net revenues derived from Medicare and
Medicaid programs. While the cost to comply with Medicare administrative
requirements is disproportionately higher than our cost to bill other payers,
average Medicare reimbursement rates approximate the Company's overall average
reimbursement rate from all sources, making the Medicare business generally less
profitable. However, we believe that our other business may significantly depend
on continued participation in the Medicare and Medicaid programs, because many
customers want a single laboratory to perform all of their clinical laboratory
testing services, regardless of whether reimbursements are ultimately made by
themselves, Medicare, Medicaid or other payers.

Billing and reimbursement for clinical laboratory testing is subject to
significant and complex federal and state regulation. Penalties for violations
of laws relating to billing federal healthcare programs and for violations of
federal fraud and abuse laws include: (1) exclusion from participation in
Medicare/Medicaid programs; (2) asset forfeitures; (3) civil and criminal fines
and penalties; and (4) the loss of various licenses, certificates and
authorizations necessary to operate some or all of a clinical laboratory's
business. Civil monetary penalties for a wide range of violations are not more
than $10,000 per violation plus three times the amount claimed and, in the case
of kickback violations, not more than $50,000 per violation plus up to three
times the amount

15

of remuneration involved. A parallel civil remedy under the federal False
Claims Act provides for damages not more than $11,000 per violation plus up to
three times the amount claimed.

REDUCED REIMBURSEMENTS. In 1984, Congress established a Medicare fee
schedule payment methodology for clinical laboratory services performed for
patients covered under Part B of the Medicare program. Congress then imposed a
national ceiling on the amount that carriers could pay under their local
Medicare fee schedules. Since then, Congress has periodically reduced the
national ceilings. The Medicare national fee schedule limitations were reduced
in 1996 to 76% of the 1984 national median of the local fee schedules and in
1998 to 74% of the 1984 national median. The national ceiling applies to tests
for which limitation amounts were established before January 1, 2001. For more
recent tests (tests for which a limitation amount is first established on or
after January 1, 2001), the limitation amount is set at 100% of the median of
all the local fee schedules established for that test in accordance with the
Social Security Act. The Balanced Budget Act of 1997 eliminated the provision
for annual increases to the Medicare national fee schedule based on the consumer
price index from 1998 through 2002. A 1.1% increase based on the consumer price
index became effective on January 1, 2003. The Prescription Drug, Improvement,
and Modernization Act of 2003 eliminated for five years (beginning January 1,
2004) the provision for annual increases to the Medicare national fee schedule
based on the consumer price index, including the adjustment (which would have
been 2.6%) that had been scheduled for January 1, 2004. Thus, by law an
adjustment to the national fee schedule for clinical laboratory services based
on the consumer price index cannot occur before January 1, 2009.

Pathology services are reimbursed by Medicare based on a resource-based
relative value scale, or RBRVS, that is periodically updated by CMS. Less than
1% of our net revenues are derived from pathology services reimbursed by
Medicare based on RBRVS.

With regard to the rest of our laboratory services performed on behalf of
Medicare beneficiaries, we must bill the Medicare program directly and must
accept the carrier's fee schedule amount as payment in full. In addition, state
Medicaid programs are prohibited from paying more (and in most instances, pay
significantly less) than Medicare. Major clinical laboratories, including Quest
Diagnostics, typically use two fee schedules for tests billed on a
fee-for-service basis:

o "Client" fees charged to physicians, hospitals, and institutions for
which a clinical laboratory performs testing services on a wholesale
basis and which are billed on a monthly basis. These fees are generally
subject to negotiation or discount.

o "Patient" fees charged to individual patients and third-party payers,
like Medicare and Medicaid. These fees generally require separate bills
for each requisition.

The fee schedule amounts established by Medicare are typically substantially
lower than patient fees otherwise charged by us, but are sometimes higher than
our fees actually charged to certain other clients. During 1992, the Office of
the Inspector General, or OIG, of the HHS issued final regulations that
prohibited charging Medicare fees substantially in excess of a provider's usual
charges. The OIG, however, declined to provide any guidance concerning
interpretation of these rules, including whether or not discounts to non-
governmental clients and payers or the dual-fee structure might be inconsistent
with these rules.

A proposed rule released in September 1997 would have authorized the OIG to
exclude providers from participation in the Medicare program, including clinical
laboratories, that charge Medicare and other programs fees that are
"substantially in excess of . . . usual charges . . . to any of [their]
customers, clients or patients." This proposal was withdrawn by the OIG in 1998.
In November 1999, the OIG issued an advisory opinion which indicated that a
clinical laboratory offering discounts on client bills may violate the "usual
charges" regulation if the "charge to Medicare substantially exceeds the amount
the laboratory most frequently charges or has contractually agreed to accept
from non-Federal payers." The OIG subsequently issued a letter clarifying that
the usual charges regulation is not a blanket prohibition on discounts to
private pay customers.

In September 2003, the OIG published a Notice of Proposed Rulemaking that
would amend the OIG's exclusion regulations addressing excessive claims. Under
the proposed exclusion rule, the OIG would have the authority to exclude a
provider for submitting claims to Medicare that contain charges that are
substantially in excess of the provider's usual charges. The proposal would
define "usual charges" as the average payment from non-government entities, on a
test by test basis, excluding capitated payments; and would define
"substantially in excess" to be an amount that is more than 20% greater than the
usual charge. We believe that the rule is unnecessary because Congress has
already established fee schedules for the services that the rule proposes to
regulate. We also believe that the rule is unworkable and overly burdensome.
Through our industry trade association, we filed comments opposing the proposed
rule and we are working with our trade association and a coalition of other
healthcare providers who also oppose this proposed regulation as drafted. If
this regulation is

16

adopted as proposed, it could potentially reduce the amounts reimbursed to us
by Medicare and other federal payers or affect the fees we charge to other
payers and could also be costly for us to administer.

The 1997 Balanced Budget Act permits CMS to adjust statutorily prescribed
fees for some medical services, including clinical laboratory services, if the
fees are "grossly excessive." In December 2002, CMS issued an interim final rule
setting forth a process and factors for establishing a "realistic and equitable"
payment amount for all Medicare Part B services (except physician services and
services paid under a prospective payment system) when the existing payment
amounts are determined to be inherently unreasonable. Payment amounts may be
considered unreasonable because they are either grossly excessive or deficient.
We cannot provide any assurances to investors that fees payable by Medicare
could not be reduced as a result of the application of this rule or that the
government might not assert claims for reimbursement by purporting to
retroactively apply this rule or the OIG interpretation concerning "usual
charges."

Currently, Medicare does not require the beneficiary to pay a co-payment for
clinical laboratory testing. When co-payments were last in effect before
adoption of the clinical laboratory services fee schedules in 1984, clinical
laboratories received from Medicare carriers only 80% of the Medicare allowed
amount and were required to bill Medicare beneficiaries for the unpaid balance
of the Medicare allowed amount. If re-enacted, a co-payment requirement could
adversely affect the revenues of the clinical laboratory industry, including us,
by exposing the testing laboratory to the credit of individuals and by
increasing the number of bills. In addition, a laboratory could be subject to
potential fraud and abuse violations if adequate procedures to bill and collect
the co-payments are not established and followed. The Medicare reform bill
approved by the United State Senate in June 2003 included a co-payment
provision, under which clinical laboratories would receive from Medicare
carriers only 80% of the Medicare allowed amount for clinical laboratory tests
and would be required to bill Medicare beneficiaries for the 20% balance of
the Medicare allowed amount. The co-payment provision was dropped from the
bill as passed (known as Prescription Drug, Improvement, and Modernization Act
of 2003), although the final legislation did include (as discussed above) a
five year freeze on adjustments to the Medicare national fee schedule based on
the consumer price index. Certain Medicaid programs do provide co-payments for
clinical laboratory testing.

REDUCED UTILIZATION OF CLINICAL LABORATORY TESTING. In recent years, CMS has
taken several steps to reduce utilization of clinical laboratory testing. Since
1995, Medicare carriers have adopted policies under which they do not pay for
many commonly ordered clinical tests unless the ordering physician has provided
an appropriate diagnosis code supporting the medical necessity of the test.
Physicians are required by law to provide diagnostic information when they order
clinical tests for Medicare and Medicaid patients. However, CMS has not
prescribed any penalty for physicians who fail to provide diagnostic information
to laboratories. Moreover, regulations adopted in accordance with HIPAA require
submission of diagnosis codes as part of the standard claims transaction.

We are generally permitted to bill patients directly for some statutorily
excluded clinical laboratory services. If a patient signs an advance beneficiary
notice, or ABN, we are also generally permitted to bill patients for clinical
laboratory tests that Medicare does not cover due to "medical necessity"
limitations (these tests include limited coverage tests for which the ordering
physician did not provide an appropriate diagnosis code and certain tests
ordered on a patient at a frequency greater than covered by Medicare). An ABN is
a notice signed by the beneficiary which documents the patient's informed
decision to personally assume financial liability for laboratory tests which are
likely to be not covered by Medicare because they are deemed to be not medically
necessary. We do not have any direct contact with most of these patients and, in
such cases, cannot control the proper use of the ABN by the physician or the
physician's office staff. If the ABN is not timely provided to the beneficiary
or is not completed properly, we end up performing tests that we cannot
subsequently bill to the patient if they are not reimbursable by Medicare due to
coverage limitations.

INCONSISTENT PRACTICES. Currently, many different local carriers administer
Medicare. They have inconsistent policies on matters such as: (1) test coverage;
(2) automated chemistry panels; (3) diagnosis coding; (4) claims documentation;
and (5) fee schedules (subject to the national fee schedule limitations).
Inconsistent carrier rules and policies have increased the complexity of the
billing process for clinical laboratories. As part of the 1997 Balanced Budget
Act, HHS was required to adopt uniform policies on the above matters by January
1, 1999, and replace the current local carriers with no more than five regional
carriers. Although HHS has finalized a number of uniform test coverage/diagnosis
coding policies, it has not taken any final action to replace the local carriers
with five regional carriers. However, in November 2000, CMS published a
solicitation in the Commerce Business Daily seeking two contractors to process
Part B clinical laboratory claims. In the solicitation, CMS stated that the
Secretary has decided to limit the number of carriers processing clinical
diagnostic laboratory test claims to two contractors. The solicitation indicated
that the request for proposals, or RFP, would be released

17

on or before December 31, 2000 but as of February 2004, the RFP had not been
issued; the solicitation did not indicate the effective date for a final
transition to the regional carrier model. CMS plans to achieve standardization
in part through implementing a single claims processing system for all
carriers. This initiative, however, was suspended due to CMS's Year 2000
compliance priorities.

CARRIER JURISDICTION CHANGES FOR LAB-TO-LAB REFERRALS. On October 31, 2003,
CMS announced its intention to change the manner in which Medicare contractors
currently process claims for lab-to-lab referrals. While laboratories are, under
certain criteria, permitted to directly bill Medicare for tests they refer to
other laboratories, they must be reimbursed at the correct fee schedule amount
based on the Medicare fee schedule in effect in the Medicare carrier region in
which the test was actually performed. Historically, laboratories needed to
enroll with and file claims to multiple carriers in order to bill for such
out-of-area test referrals, to ensure receipt of the appropriate payment amount.
This has proven to be an administratively difficult process, with many obstacles
to obtaining accurate claims payment, including applying the correct fee
schedule. The announced change will enable the laboratory's "home" carrier to
maintain and apply the clinical laboratory fee schedule applicable to the
carrier region where the test was performed. This will streamline the claims
filing process by allowing a laboratory to file all of its claims to its "home"
carrier. As of January 2004, CMS has indicated a July 1, 2004 effective date for
this change.

COMPETITIVE BIDDING. The Prescription Drug, Improvement and Modernization
Act of 2003 requires CMS to conduct and complete by December 31, 2005, a
demonstration project on the application of competitive acquisition to clinical
laboratory tests. The details of how this federal demonstration project will be
implemented are unknown at this time. Florida has issued a proposal for
competitive bidding for its Medicaid program. If competitive bidding were
implemented on a regional or national basis for clinical laboratory testing,
it could materially adversely affect the clinical laboratory industry and us.

FUTURE LEGISLATION. Future changes in federal, state and local regulations
(or in the interpretation of current regulations) affecting governmental
reimbursement for clinical laboratory testing could adversely affect us. We
cannot predict, however, whether and what type of legislative proposals will be
enacted into law or what regulations will be adopted by regulatory authorities.

FRAUD AND ABUSE REGULATIONS. Medicare and Medicaid anti-kickback laws
prohibit clinical laboratories from making payments or furnishing other benefits
to influence the referral of tests billed to Medicare, Medicaid or other federal
programs. As noted above, the penalties for violation of these laws may include
criminal and civil fines and penalties and/or suspension or exclusion from
participation in federal programs. Many of the anti-fraud statutes and
regulations, including those relating to joint ventures and alliances, are vague
or indefinite and have not been interpreted by the courts. We cannot predict if
some of the fraud and abuse rules will be interpreted contrary to our practices.

In November 1999, the OIG issued an advisory opinion concluding that the
industry practice of discounting client bills may constitute a kickback if the
discounted price is below a laboratory's overall cost (including overhead) and
below the amounts reimbursed by Medicare. Advisory opinions are not binding but
may be indicative of the position that prosecutors may take in enforcement
actions. The OIG's opinion, if enforced, could result in fines and possible
exclusion and could require us to eliminate offering discounts to clients below
the rates reimbursed by Medicare. The OIG subsequently issued a letter
clarifying that it did not intend to imply that discounts are a per se violation
of the federal anti-kickback statute, but may merit further investigation
depending on the facts and circumstances presented.

In addition, since 1992, a federal anti-"self-referral" law, commonly known
as the "Stark" law, prohibits, with certain exceptions, Medicare payments for
laboratory tests referred by physicians who have, personally or through a family
member, an investment interest in, or a compensation arrangement with, the
testing laboratory. Since January 1995, these restrictions have also applied to
Medicaid-covered services. Many states have similar anti-"self-referral" and
other laws that are not limited to Medicare and Medicaid referrals and could
also affect investment and compensation arrangements with physicians. We cannot
predict if some of the state laws will be interpreted contrary to our practices.
In April 2003, the OIG issued a Special Advisory Bulletin addressing what it
described as "questionable contractual arrangements" in contractual joint
ventures. The OIG Bulletin focused on arrangements where a health care provider,
or Owner, expands into a related health care business by contracting with a
health care provider, or Manager, that already is engaged in that line of
business for the Manager to provide related health care items or services to the
patients of the Owner in return for a share of the profits of the new line of
business. While we believe that the Bulletin is directed at "sham" arrangements
intended to induce referrals, we cannot predict whether the OIG might choose to
investigate all contractual joint ventures, including our joint ventures with
various hospitals or hospital systems.

18

GOVERNMENT INVESTIGATIONS AND RELATED CLAIMS

We are subject to extensive and frequently changing federal, state and local
laws and regulations. We believe that, based on our experience with government
settlements and public announcements by various government officials, the
federal government continues to strengthen its position on healthcare fraud. In
addition, legislative provisions relating to healthcare fraud and abuse give
federal enforcement personnel substantially increased funding, powers and
remedies to pursue suspected cases of fraud and abuse. Many of the regulations
applicable to us, including those relating to billing and reimbursement of tests
and those relating to relationships with physicians and hospitals, are vague or
indefinite and have not been interpreted by the courts. They may be interpreted
or applied by a prosecutorial, regulatory or judicial authority in a manner that
could require us to make changes in our operations, including our billing
practices. If we fail to comply with applicable laws and regulations, we could
suffer civil and criminal penalties, including the loss of licenses or our
ability to participate in Medicare, Medicaid and other federal and state
healthcare programs.

During the mid-1990s, Quest Diagnostics and SBCL settled government claims
that primarily involved industry-wide billing and marketing practices that both
companies believed to be lawful. The aggregate amount of the settlements for
these claims exceeded $500 million. The federal or state governments may bring
additional claims based on new theories as to our practices that we believe to
be in compliance with law. The federal government has substantial leverage in
negotiating settlements since the amount of potential fines far exceeds the
rates at which we are reimbursed, and the government has the remedy of
excluding a non-compliant provider from participation in the Medicare and
Medicaid programs, which represented approximately 17% of our net revenues
during 2003.

Although management believes that established reserves for claims are
sufficient, including qui tam cases, of which management is aware, it is
possible that additional information may become available that may cause the
final resolution of these matters to exceed established reserves by an amount
which could be material to our results of operations and cash flows in the
period in which such claims are settled. We do not believe that these issues
will have a material adverse effect on our overall financial condition. However,
we understand that there may be pending qui tam claims brought by former
employees or other "whistle blowers" as to which we have not been provided with
a copy of the complaint and accordingly cannot determine the extent of any
potential liability.

As an integral part of our compliance program discussed below, we
investigate all reported or suspected failures to comply with federal healthcare
reimbursement requirements. Any non-compliance that results in Medicare or
Medicaid overpayments is reported to the government and reimbursed by us. As a
result of these efforts, we have periodically identified and reported
overpayments. While we have reimbursed these overpayments and have taken
corrective action where appropriate, we cannot assure investors that in each
instance the government will necessarily accept these actions as sufficient.

COMPLIANCE PROGRAM

Compliance with all government rules and regulations has become a
significant concern throughout the clinical laboratory industry because of
evolving interpretations of regulations and the national debate over healthcare.
We established a compliance program early in 1993.

We emphasize the development of training programs intended to ensure the
strict implementation and observance of all applicable laws, regulations and
Company policies. Further, we conduct in-depth reviews of procedures, personnel
and facilities to assure regulatory compliance throughout our operations. The
Quality, Safety and Compliance Committee of the Board of Directors requires
periodic reporting of compliance operations from management.

We seek to conduct our business in compliance with all statutes and
regulations applicable to our operations. Many of these statutes and regulations
have not been interpreted by the courts. We cannot assure investors that
applicable statutes or regulations will not be interpreted or applied by a
prosecutorial, regulatory or judicial authority in a manner that would adversely
affect us. Potential sanctions for violation of these statutes include
significant damages, penalties, and fines, exclusion from participation in
governmental healthcare programs and the loss of various licenses, certificates
and authorization necessary to operate some or all of our business, which
could have a material adverse effect on our business.

19

INTELLECTUAL PROPERTY RIGHTS

Other companies or individuals, including our competitors, may obtain
patents or other property rights that would prevent, limit or interfere with our
ability to develop, perform or sell our tests or operate our business. As a
result, we may be involved in intellectual property litigation and we may be
found to infringe on the proprietary rights of others, which could force us to
do one or more of the following:

o cease developing, performing or selling products or services that
incorporate the challenged intellectual property;

o obtain and pay for licenses from the holder of the infringed intellectual
property right;

o redesign or reengineer our tests;

o change our business processes; or

o pay substantial damages, court costs and attorneys' fees, including
potentially increased damages for any infringement held to be willful.

Patents generally are not issued until several years after an application is
filed. The possibility that, before a patent is issued to a third party, we may
be performing a test or other activity covered by the patent is not a defense
to an infringement claim. Thus, even tests that we develop could become the
subject of infringement claims if a third party obtains a patent covering those
tests.

Infringement and other intellectual property claims, regardless of their
merit, can be expensive and time-consuming to litigate. In addition, any
requirement to reengineer our tests or change our business processes could
substantially increase our costs, force us to interrupt product sales or delay
new test releases. In the past, we have settled several disputes regarding our
alleged infringement of intellectual property rights of third parties. We are
currently involved in settling several additional disputes. We do not believe
that resolution of these disputes will have a material adverse effect on our
results of operations, cash flows or financial condition. However, infringement
claims could arise in the future as patents could be issued on tests or
processes that we may be performing, particularly in such emerging areas as
gene-based testing and other specialty testing.

INSURANCE

As a general matter, providers of clinical laboratory 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 our client base and reputation.
We maintain various liability insurance programs for claims that could result
from providing or failing to provide clinical laboratory testing services,
including inaccurate testing results and other exposures. Our insurance coverage
limits our maximum exposure on individual claims; however, we are essentially
self-insured for a significant portion of these claims. The basis for claims
reserves incorporates actuarially determined losses based upon our historical
and projected loss experience. Management believes that present insurance
coverage and reserves are sufficient to cover currently estimated exposures.
Although management cannot predict the outcome of any claims made against the
Company, management does not anticipate that the ultimate outcome of any such
proceedings or claims will have a material adverse effect on our financial
position but may be material to our results of operations and cash flows in the
period in which such claims are resolved. Similarly, although we believe that we
will be able to obtain adequate insurance coverage in the future at acceptable
costs, we cannot assure you that we will be able to do so.

EMPLOYEES

At December 31, 2003 and 2002, we employed approximately 37,200 and 33,400
people, respectively. These totals exclude employees of the joint ventures where
we do not have a majority interest. We have no collective bargaining agreements
with any unions covering any employees in the United States, and we believe that
our overall relations with our employees are good.

20

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Some statements and disclosures in this document are forward-looking
statements. Forward-looking statements include all statements that do not relate
solely to historical or current facts and can be identified by the use of words
such as "may", "believe", "will", "expect", "project", "estimate", "anticipate",
"plan" or "continue". These forward-looking statements are based on our current
plans and expectations and are subject to a number of risks and uncertainties
that could significantly cause our plans and expectations, including actual
results, to differ materially from the forward-looking statements. The Private
Securities Litigation Reform Act of 1995, or the Litigation Reform Act, provides
a "safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies without fear of litigation.

We would like to take advantage of the "safe harbor" provisions of the
Litigation Reform Act in connection with the forward-looking statements included
in this document. Investors are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
document. The following important factors could cause our actual financial
results to differ materially from those projected, forecasted or estimated by us
in forward-looking statements:

(a) Heightened competition, including increased pricing pressure,
competition from hospitals for testing for non-patients and competition
from physicians. See "Business -- Competition".

(b) Impact of changes in payer mix, including any shift from fee-for-service
to capitated fee arrangements. See "Business -- Payers and
Customers -- Customers -- Managed Care Organizations and Other Insurance
Providers".

(c) Adverse actions by government or other third-party payers, including
unilateral reduction of fee schedules payable to us, competitive
bidding, or an increase in the practice of negotiating for exclusive
contracts that involve aggressively priced capitated payments by managed
care organizations. See "Business -- Regulation of Reimbursement for
Clinical Laboratory Services" and "Business -- Payers and
Customers -- Customers -- Managed Care Organizations and Other Insurance
Providers".

(d) The impact upon our testing volume and collected revenue or general or
administrative expenses resulting from our compliance with Medicare and
Medicaid administrative policies and requirements of third party payers.
These include:

(1) the requirements of Medicare carriers to provide diagnosis codes for
many commonly ordered tests and the possibility that third party
payers will increasingly adopt similar requirements;

(2) the policy of CMS to limit Medicare reimbursement for tests
contained in automated chemistry panels to the amount that would
have been paid if only the covered tests, determined on the basis of
demonstrable "medical necessity", had been ordered;

(3) continued inconsistent practices among the different local carriers
administering Medicare;

(4) inability to obtain from patients an advance beneficiary notice form
for tests that cannot be billed without prior receipt of the form;
and

(5) the potential need to monitor charges and lower certain fees to
Medicare to comply with the OIG's proposed rule pertaining to
exclusion of providers for submitting claims to Medicare containing
charges that are substantially in excess of the provider's usual
charges.

See "Business -- Regulation of Reimbursement for Clinical Laboratory
Services" and "Business -- Billing".

(e) Adverse results from pending or future government investigations,
lawsuits or private actions. These include, in particular significant
monetary damages, loss or suspension of licenses, and/or suspension or
exclusion from the Medicare and Medicaid programs and/or other
significant litigation matters. See "Business -- Government
Investigations and Related Claims".

(f) Failure to obtain new customers at profitable pricing or failure to
retain existing customers, and a reduction in tests ordered or specimens
submitted by existing customers.

(g) Failure to efficiently integrate acquired clinical laboratory
businesses, including Unilab, or to efficiently integrate clinical
laboratory businesses from joint ventures and alliances with hospitals,
and to manage the costs related to any such integration, or to retain
key technical and management personnel. See "Business -- Recent
Acquisitions".

21

(h) Inability to obtain professional liability or other insurance coverage
or a material increase in premiums for such coverage or reserves for
self-insurance. See "Business -- Insurance".

(i) Denial of CLIA certification or other licenses for any of our clinical
laboratories under the CLIA standards, revocation or suspension of the
right to bill the Medicare and Medicaid programs or other adverse
regulatory actions by federal, state and local agencies. See
"Business -- Regulation of Clinical Laboratory Operations".

(j) Changes in federal, state or local laws or regulations, including
changes that result in new or increased federal or state regulation of
commercial clinical laboratories, including regulation by the FDA.

(k) Inability to achieve expected synergies from our acquisitions of other
business, including Unilab. See "Business -- Recent Acquisitions".

(l) Inability to achieve additional benefits from our Six Sigma and
standardization initiatives.

(m) Adverse publicity and news coverage about the clinical laboratory
industry or us.

(n) Computer or other system failures that affect our ability to perform
tests, report test results or properly bill customers, including
potential failures resulting from the standardization of our IT systems
and other system conversions, telecommunications failures, malicious
human acts (such as electronic break-ins or computer viruses) or natural
disasters. See "Business -- Information Systems" and "Business --
Billing".

(o) Development of technologies that substantially alter the practice of
laboratory medicine, including technology changes that lead to the
development of more cost-effective tests such as (1) point-of-care tests
that can be performed by physicians in their offices and (2) home
testing that can be carried out without requiring the services of
clinical laboratories. See "Business -- Competition" and "Business --
Regulation of Clinical Laboratory Operations".

(p) Issuance of patents or other property rights to our competitors or
others that could prevent, limit or interfere with our ability to
develop, perform or sell our tests or operate our business.

(q) Development of tests by our competitors or others which we may not be
able to license, or usage of our technology or similar technologies or
our trade secrets by competitors, any of which could negatively affect
our competitive position.

(r) Inability to commercialize newly licensed tests or technologies or to
obtain appropriate reimbursements for such tests.

(s) Inability to obtain or maintain adequate patent and other proprietary
rights protections of our products and services or to successfully
enforce our proprietary rights.

(t) Development of an Internet-based electronic commerce business model
that does not require an extensive logistics and laboratory network.

(u) The impact of the privacy regulations, security regulations and
standards for electronic transactions regulations issued under HIPAA on
our operations as well as the cost to comply with the regulations,
including the failure of third party payers to complete testing with us,
failure to agree on data content for claims, failure to accept default
diagnosis codes in the absence of physician-supplied codes, or inability
of payers to accept or remit transactions in HIPAA-required standard
transaction and code set format. See "Business -- Privacy and Security
of Health Information; Standard Transactions".

(v) Inability to promptly or properly bill for our services or to obtain
appropriate payments for services that we do bill. See "Business --
Billing".

(w) Changes in interest rates and changes in our credit ratings from
Standard & Poor's and Moody's Investor Services causing an unfavorable
impact on our cost of and access to capital.

(x) Inability to hire and retain qualified personnel or the loss of the
services of one or more of our key senior management personnel.

(y) Terrorist and other criminal activities, which could affect our
customers, transportation or power systems, or our facilities, and for
which insurance may not adequately reimburse us for.

22

ITEM 2. PROPERTIES

Our principal laboratories (listed alphabetically by state) are located in
or near the following metropolitan areas. In certain areas (indicated by the
number (2)), we have two principal laboratories as a result of recent
acquisitions.

Our executive offices are located at an owned facility in Teterboro, New
Jersey and at leased facilities in Lyndhurst, New Jersey. We also lease a site
in Norristown, Pennsylvania, that serves as a billing center; a site in San
Clemente, California, that serves as the main facility for Nichols Institute
Diagnostics; a site in Cincinnati that serves as the main office for MedPlus;
and an additional site in West Hills, California, that will serve as our
regional laboratory in the Los Angeles metropolitan area after we complete the
integration of Unilab. We also own an administrative office in Collegeville,
Pennsylvania, and a site in Norriton, Pennsylvania, that serves as our national
data center. We own our laboratory facility in Mexico City and lease laboratory
facilities in San Juan, Puerto Rico and near London, England. We believe that,
in general, our laboratory facilities are suitable and adequate for our current
and anticipated future levels of operation. We believe that if we were unable to
renew a lease on any of our testing facilities, we could find alternative space
at competitive market rates and relocate our operations to such new location.

23

ITEM 3. LEGAL PROCEEDINGS

In addition to the investigations described in "Business -- Government
Investigations and Related Claims", we are involved in various legal proceedings
arising in the ordinary course of business. Some of the proceedings against us
involve claims that are substantial in amount. Although we cannot predict the
outcome of such proceedings or any claims made against us, we do not anticipate
that the ultimate outcome of the various proceedings or claims will have a
material adverse effect on our financial position, but may be material to our
results of operations and cash flows in the period in which such proceedings or
claims are resolved.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

24

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed and traded on the New York Stock Exchange under
the symbol "DGX." The following table sets forth, for the periods indicated, the
high and low sales price per share as reported on the New York Stock Exchange
Consolidated Tape:

As of February 23, 2004, we had approximately 5,900 record holders of our
common stock.

On October 21, 2003, we declared a quarterly cash dividend of $.15 per
common share, payable on January 23, 2004 to holders of record on January 8,
2004. On February 19, 2004, we declared a quarterly cash dividend of $.15 per
common share, payable on April 21, 2004 to holders of record on April 7, 2004.
Prior to October 2003, we had not previously declared or paid cash dividends on
our common stock. We expect to fund future dividend payments with cash flows
from operations, and do not expect the dividend to have a material impact on our
ability to finance future growth.

In May 2003, our Board of Directors authorized a share repurchase program,
which permits us to purchase up to $300 million of our common stock. In October
2003, our Board of Directors increased the share repurchase authorization by an
additional $300 million. Through December 31, 2003, we repurchased approximately
4 million shares of our common stock at an average price of $64.54 per share for
a total of $258 million.

ITEM 6. SELECTED FINANCIAL DATA

See page 34.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

See page 37.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See Management's Discussion and Analysis of Financial Condition and Results
of Operations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 15 (a) 1 and 2.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

25

ITEM 9A. CONTROLS AND PROCEDURES

(a) Our Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the design and operation of
our disclosure controls and procedures (as defined under
Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act
of 1934, as amended) as of the end of the period covered by
this report. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures are adequate and
effective.

(b) During the quarter ended December 31, 2003, there were no
changes in our internal control over financial reporting
that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.

26

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning the directors of the Company is incorporated by
reference to the information in the Company's Proxy Statement to be filed on or
before April 29, 2004, or the Proxy Statement, appearing under the caption
"Election of Directors."

EXECUTIVE OFFICERS OF THE REGISTRANT

Officers of the Company are elected annually by the Board of Directors and
hold office at the discretion of the Board of Directors. The following persons
serve as executive officers of the Company:

Kenneth W. Freeman (53) is Chairman of the Board and Chief Executive Officer
of the Company. Mr. Freeman joined the Company in May 1995 as President and
Chief Executive Officer, was elected a Director in July 1995 and was elected
Chairman of the Board in December 1996. Prior to 1995, he served in a variety of
financial and managerial positions at Corning, which he joined in 1972. He was
elected Controller and a Vice President of Corning in 1985, Senior Vice
President in 1987, General Manager of the Science Products Division in 1989 and
Executive Vice President in 1993. He was appointed President and Chief Executive
Officer of Corning Asahi Video Products Company in 1990.

Surya N. Mohapatra, Ph.D. (54) is President and Chief Operating Officer and
a Director of the Company. Prior to joining the Company in February 1999 as
Senior Vice President and Chief Operating Officer, he was Senior Vice President
of Picker International, a worldwide leader in advanced medical imaging
technologies, where he served in various executive positions during his 18-year
tenure. Dr. Mohapatra was appointed President and Chief Operating Officer in
June 1999.

The Company is implementing an orderly succession plan under which Dr.
Mohapatra will succeed Mr. Freeman as Chief Executive Officer by the date of the
2004 annual meeting of stockholders, scheduled to be held on May 4, 2004. At
that time Mr. Freeman will continue as Chairman of the Board.

Robert A. Hagemann (47) is Senior Vice President and Chief Financial
Officer. He joined Corning Life Sciences, Inc., in 1992, where he held a variety
of senior financial positions before being named Vice President and Corporate
Controller of the Company in 1996. Prior to joining the Company, Mr. Hagemann
was employed by Prime Hospitality, Inc. and Crompton & Knowles, Inc. in senior
financial positions. He was also previously associated with Ernst & Young. Mr.
Hagemann assumed his present responsibilities in August 1998.

Gerald C. Marrone (61) is Senior Vice President, Administration. Mr. Marrone
joined the Company in November 1997 as Chief Information Officer, after 12 years
with Citibank, N.A. He assumed his current position in October 2002. While at
Citibank, he served as Vice President, Division Executive for Citibank's Global
Production Support Division, and was also the Chief Information Officer of
Citibank's Global Cash Management business. Prior to joining Citibank, he served
for five years as the Chief Information Officer for Memorial Sloan-Kettering
Cancer Center in New York.

Michael E. Prevoznik (42) is Senior Vice President and General Counsel.
Prior to joining SBCL in 1994 as its Chief Legal Compliance Officer, Mr.
Prevoznik was with Dechert Price & Rhodes. In 1996, he became Vice President and
Chief Legal Compliance Officer for SmithKline Beecham Healthcare Services. In
1998, he was appointed Vice President, Compliance for SmithKline Beecham,
assuming additional responsibilities for coordinating all compliance activities
within SmithKline Beecham worldwide. Mr. Prevoznik joined the Company as Vice
President and General Counsel in August 1999. In 2003, he assumed additional
responsibilities for coporate communication and governmental affairs.

David M. Zewe (52) is Senior Vice President, Diagnostics Testing Services.
Mr. Zewe oversees diagnostic testing operations company-wide, including
physician, clinical trials, international and drugs of abuse testing, as well
as the diagnostic instruments business. Mr. Zewe joined the Company in 1994 as
General Manager of the Philadelphia regional laboratory, became Regional Vice
President Sales and Marketing for the mid-Atlantic region in August 1996, became
Vice President, Revenue Services in August 1999, leading the billing function
company-wide, and became Senior Vice President, U.S. Operations in January 2001,
responsible for all core business operations and revenue services. Mr. Zewe
assumed his current position in May 2002. Prior to joining the Company, Mr. Zewe
was with the Squibb Diagnostics Division of Bristol Myers Squibb, most recently
serving as Vice President of Sales.

27

ITEM 11. EXECUTIVE COMPENSATION

The information called for by this Item is incorporated by reference to the
information under the caption "Executive Compensation" appearing in the Proxy
Statement. The information contained in the Proxy Statement under the captions
"Compensation Committee Report on Executive Compensation" and "Performance
Graph" is not incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Except for the Equity Compensation Plan information set forth below, the
information called for by this Item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" appearing in the Proxy Statement.

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of December 31, 2003 about our
common stock that may be issued upon the exercise of options, warrants and
rights under our existing equity compensation plans:

The only equity compensation plan that has not been approved by the
Company's stockholders is the Company's Employee Stock Purchase Plan, or ESPP.
The ESPP permits employees to purchase the Company's common stock each calendar
quarter through payroll deductions. The purchase price is 85% of the closing
market price on the last business day of the calendar quarter (or, if lower, the
closing market price on the first business day of the calendar quarter). The
ESPP authorizes the issuance of 4 million shares of the Company's common stock.
The number of securities reflected in the table above for the ESPP includes the
share allocation for the fourth quarter of 2003, which were issued in January
2004. The ESPP was adopted prior to the spinoff of the Company in 1996 and, as a
result of action taken by the Board in 2001, has a term ending on December 31,
2006.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information called for by this Item is incorporated by reference to the
information under the caption "Certain Relationships and Related Transactions"
appearing in the Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information called for by this Item is incorporated by reference to the
information under the caption "Ratification of Appointment of
PricewaterhouseCoopers LLP" appearing in the Proxy Statement.

28

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Documents filed as part of this report:

1. Index to financial statements and supplementary data filed as part of
this report:

2. Financial Statement Schedule:

3. Exhibits filed as part of this report:

See (c) below.

(b) Report on Form 8-K filed during the fourth quarter of 2003:

On October 21, 2003, the Company furnished a current report on Form 8-K
reporting under Item 7 its press release of October 31, 2003 announcing,
among other things, its results for the quarter and nine months ended
September 30, 2003 and its press release announcing a quarterly cash
dividend and the expansion of the Company's share repurchase program.

On October 31, 2003, the Company filed a current report on Form 8-K
reporting under Item 5 operating income for the quarters ended March 31,
2003, June 30, 2003 and September 30, 2003 and the nine months ended
September 30, 2003 and for the quarters ended March 31, 2002, June 30,
2002, September 30, 2002 and December 31, 2002 and the year ended
December 31, 2002 on a basis consistent with the preparation of the
Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.

On November 20, 2003, the Company filed an amended current report on
Form 8-K (Date of Report: February 26, 2003) reporting under Item 2 on the
acquisition of the outstanding capital stock of Unilab Corporation.

(c) Exhibits filed as part of this report:

29

10.1 Form of 6 3/4% Senior Notes due 2006, including the form of
guarantee endorsed thereon (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report:
June 27, 2001) and incorporated herein by reference)
10.2 Form of 7 1/2% Senior Notes due 2011, including the form of
guarantee endorsed thereon (filed as an Exhibit to the
Company's current report on Form 8-K (Date of Report:
June 27, 2001) and incorporated herein by reference)
10.3 Form of 1.75% Contingent Convertible Debentures due 2021,
including the form of guarantee endorsed thereon (filed as
an Exhibit to the Company's current report on Form 8-K (Date
of Report: November 26, 2001) and incorporated herein by
reference)
10.4 Indenture dated as of June 27, 2001, among the Company, the
Subsidiary Guarantors, and the Trustee (filed as an Exhibit
to the Company's current report on Form 8-K (Date of Report:
June 27, 2001) and incorporated herein by reference)
10.5 First Supplemental Indenture, dated as of June 27, 2001,
among the Company, the Subsidiary Guarantors, and the
Trustee to the Indenture referred to in Exhibit 10.4 (filed
as an Exhibit to the Company's current report on Form 8-K
(Date of Report: June 27, 2001) and incorporated herein by
reference)
10.6 Second Supplemental Indenture, dated as of November 26,
2001, among the Company, the Subsidiary Guarantors, and the
Trustee to the Indenture referred to in Exhibit 10.4 (filed
as an Exhibit to the Company's current report on Form 8-K
(Date of Report: November 26, 2001) and incorporated herein
by reference)
10.7 Third Supplemental Indenture, dated as of April 4, 2002,
among Quest Diagnostics, the Additional Subsidiary
Guarantors, and the Trustee to the Indenture referred to in
Exhibit 10.4 (filed as an Exhibit to the Company's current
report on Form 8-K (Date of Report: April 1, 2002) and
incorporated herein by reference)
10.8 Fourth Supplemental Indenture dated as of March 19, 2003,
among Unilab Corporation (f/k/a Quest Diagnostics Newco
Incorporated), Quest Diagnostics Incorporated, The Bank Of
New York, and the Subsidiary Guarantors (filed as an Exhibit
to the Company's quarterly report on Form 10-Q for the
quarter ended March 31, 2003 and incorporated herein by
reference)
10.9 Credit Agreement, dated as of June 27, 2001, among the
Company, the Subsidiary Guarantors and the Banks (filed as
an Exhibit to the Company's current report on Form 8-K (Date
of Report: June 27, 2001) and incorporated herein by
reference)
10.10 Second Amended and Restated Credit and Security Agreement
dated as of September 30, 2003 among Quest Diagnostics
Receivables Inc., as Borrower, Quest Diagnostics
Incorporated, as Servicer, each of the lenders party thereto
and Wachovia Bank, National Association, as Administrative
Agent (filed as an Exhibit to the Company's quarterly report
on Form 10-Q for the quarter ended September 30, 2003 and
incorporated herein by reference)
10.11 Amended and Restated Receivables Sale Agreement dated as of
September 30, 2003 among Quest Diagnostics Incorporated and
each of its direct or indirect wholly owned subsidiaries who
is or hereafter becomes a seller hereunder, as the Sellers,
and Quest Diagnostics Receivables Inc., as the Buyer (filed
as an Exhibit to the Company's quarterly report on
Form 10-Q for the quarter ended September 30, 2003 and
incorporated herein by reference)
10.12 Term Loan Credit Agreement dated as of June 21, 2002 among
Quest Diagnostics Incorporated, certain subsidiary
guarantors of the Company, the lenders party thereto, and
Bank of America, N.A., as Administrative Agent (filed as an
Exhibit to the Company's Registration Statement on Form S-4
(No. 333-88330) and incorporated herein by reference)
10.13 First Amendment to Credit Agreement dated as of
September 20, 2002 among Quest Diagnostics Incorporated,
certain subsidiary guarantors of the Company, the lenders
party thereto, and Bank of America, N.A., as Administrative
Agent (filed as an Exhibit to the Company's quarterly report
on Form 10-Q for the quarter ended September 30, 2002 and
incorporated herein by reference)
10.14 Second Amendment to Credit Agreement dated as of
December 19, 2002 among Quest Diagnostics Incorporated,
certain subsidiary guarantors of the Company, the lenders
party thereto, and Bank of America, N.A., as Administrative
Agent (filed as an Exhibit to post effective Amendment No. 1
to the Company's Registration Statement on Form S-4
(No. 333-88330) and incorporated herein by reference)

30

10.15 Term Loan Credit Agreement dated as of December 19, 2003
among Quest Diagnostics Incorporated, certain subsidiary
guarantors of the Company, the lenders party thereto, and
Sumitomo Mitsui Banking Corporation
10.16 Stock and Asset Purchase Agreement dated as of February 9,
1999 among SmithKline Beecham plc, SmithKline Beecham
Corporation and the Company (the "Stock and Asset Purchase
Agreement") (filed as Appendix A of the Company's Definitive
Proxy Statement dated May 11, 1999 and incorporated herein
by reference)
10.17 Amendment No. 1 dated August 6, 1999 to the Stock and Asset
Purchase Agreement (filed as an Exhibit to the Company's
current report on Form 8-K (Date of Report: August 16, 1999)
and incorporated herein by reference)
10.18 Non-Competition Agreement dated as of August 16, 1999
between SmithKline Beecham plc and the Company (filed as an
Exhibit to the Company's current report on Form 8-K (Date of
Report: August 16, 1999) and incorporated herein by
reference)
10.19 Stockholders Agreement dated as of August 16, 1999 between
SmithKline Beecham plc and the Company (filed as an Exhibit
to the Company's current report on Form 8-K (Date of Report:
August 16, 1999) and incorporated herein by reference)
10.20 Amended and Restated Global Clinical Trials Agreement, dated
as of December 19, 2002 between SmithKline Beecham plc dba
GlaxoSmithKline and the Company (filed as an Exhibit to post
effective amendment No. 1 to the Company's Registration
Statement on Form S-4 (No. 333-88330) and incorporated
herein by reference)
10.21 Agreement and Plan of Merger, dated as of April 2, 2002, as
amended, among the Company, Quest Diagnostics Newco
Incorporated and Unilab Corporation (filed as an annex to
the Company's final prospectus, dated August 6, 2002, and
incorporated herein by reference)
10.22 Amendment to the Agreement and Plan of Merger, dated as of
May 13, 2002, among the Company, Quest Diagnostics Newco
Incorporated and Unilab Corporation (filed as an annex to
the Company's final prospectus, dated August 6, 2002, and
incorporated herein by reference)
10.23 Amendment No. 2 to the Agreement and Plan of Merger, dated
as of June 20, 2002, among the Company, Quest Diagnostics
Newco Incorporated and Unilab Corporation (filed as an annex
to the Company's final prospectus, dated August 6, 2002, and
incorporated herein by reference)
10.24 Amendment No. 3 to the Agreement and Plan of Merger, dated
as of September 25, 2002, among the Company, Quest
Diagnostics Newco Incorporated and Unilab Corporation
(incorporated herein by reference to Exhibit (a)(11) of the
Company's Schedule TO Amendment No. 12 filed with the
Commission on September 26, 2002, file No. 001-12215)
10.25 Amendment No. 4 to the Agreement and Plan of Merger, dated
as of January 4, 2003, among the Company, Quest Diagnostics
Newco Incorporated and Unilab Corporation (incorporated
herein by reference to Exhibit (a)(20) of Quest Diagnostics'
Schedule TO Amendment No. 20 filed with the Commission on
January 6, 2003, file No. 001-12215)
10.26 Form of Employees Stock Purchase Plan, as amended (filed as an
Exhibit to the Company's annual report on Form 10-K for the year
ended December 31, 2002 and incorporated herein by reference)
10.27 Form of 1996 Employee Equity Participation Program, as
amended (filed as an Exhibit to the Company's quarterly
report on Form 10-Q for the quarter ended September 30, 2002
and incorporated herein by reference)
10.28 Form of 1999 Employee Equity Participation Program, as amended
as of July 31, 2003 (filed as an Exhibit to the Company's
quarterly report on Form 10-Q for the quarter ended June 30, 2003
and incorporated herein by reference)
10.29 Procedures for the Exercise of Designated Options by Covered
Employees (filed as an Exhibit to the Company's quarterly report
on Form 10-Q for the quarter ended June 30, 2003 and incorporated
herein by reference)
10.30 Form of Stock Option Plan for Non-Employee Directors (filed
as an Exhibit to post effective amendment No. 1 to the
Company's Registration Statement on Form S-4
(No. 333-88330) and incorporated herein by reference)
10.31 Form of Amended and Restated Deferred Compensation Plan For
Directors (filed as an Exhibit to the Company's quarterly report
on Form 10-Q for the quarter ended June 30, 2003 and incorporated
herein by reference)

31

10.32 Employment Agreement between the Company and Kenneth W.
Freeman dated as of January 1, 2003 (filed as an Exhibit to
the Company's annual report on Form 10-K for the year ended
December 31, 2002 and incorporated herein by reference)
10.33 Employment Agreement between the Company and Surya N.
Mohapatra dated as of November 9, 2003
10.34 Form of Supplemental Deferred Compensation Plan (filed as an
Exhibit to the Company's annual report on Form 10-K for the
year ended December 31, 1998 and incorporated herein by
reference)
10.35 Amendment No. 1 to the Supplemental Deferred Compensation
Plan (filed as an Exhibit to post effective amendment No. 1
to the Company's Registration Statement on Form S-4
(No. 333-88330) and incorporated herein by reference)
10.36 Amendment No. 2 to the Supplemental Deferred Compensation
Plan (filed as an Exhibit to post effective amendment No. 1
to the Company's Registration Statement on Form S-4
(No. 333-88330) and incorporated herein by reference)
10.37 Form of Executive Retirement Supplemental Plan (filed as an
Exhibit to the Company's Registration Statement on Form 10
(File No. 1-12215) and incorporated herein by reference)
10.38 Form of Senior Management Incentive Plan (filed as Appendix A
to the Company's proxy statement dated March 28, 2003 and
incorporated herein by reference)
14 Code of Business Ethics
21 Subsidiaries of Quest Diagnostics Incorporated
23.1 Consent of PricewaterhouseCoopers LLP
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. 'SS' 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

32

SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Quest Diagnostics Incorporated

By /s/ Kenneth W. Freeman Chairman of the Board and Chief February 26, 2004
---------------------------- Executive Officer
Kenneth W. Freeman

By /s/ Robert A. Hagemann Senior Vice President and Chief February 26, 2004
----------------------------- Financial Officer
Robert A. Hagemann

By /s/ Thomas F. Bongiorno Vice President, Controller and February 26, 2004
----------------------------- Chief Accounting Officer
Thomas F. Bongiorno

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and on the dates indicated.

33

SELECTED HISTORICAL FINANCIAL DATA OF OUR COMPANY

The following table summarizes selected historical financial data of our
Company and our subsidiaries at the dates and for each of the periods presented.
We derived the selected historical financial data for the years 1999 through
2003 from the audited consolidated financial statements of our Company. As
discussed in Note 2 to the Consolidated Financial Statements, all per share data
has been restated to reflect our two-for-one stock split effected on May 31,
2001. In April 2002, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 145, "Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections", or SFAS 145. Pursuant to SFAS 145, extraordinary losses
associated with the extinguishment of debt in 1999, 2000 and 2001, previously
presented net of applicable taxes, were reclassified to other non-operating
expenses. The selected historical financial data is only a summary and should
be read together with the audited consolidated financial statements and related
notes of our Company and management's discussion and analysis of financial
condition and results of operations included elsewhere in this Annual Report
on Form 10-K.

- --------------------------------------------------------------------------------

(a) On February 28, 2003, we completed the acquisition of Unilab Corporation,
or Unilab. Consolidated operating results for 2003 include the results of
operations of Unilab subsequent to the closing of the acquisition. See
Note 3 to the Consolidated Financial Statements.

(b) On April 1, 2002, we completed the acquisition of American Medical
Laboratories, Incorporated, or AML. Consolidated operating results for 2002
include the results of operations of AML subsequent to the closing of the
acquisition. See Note 3 to the Consolidated Financial Statements.

34

(c) On August 16, 1999, we completed the acquisition of SmithKline Beecham
Clinical Laboratories, Inc., or SBCL. Consolidated operating results for
1999 include the results of operations of SBCL subsequent to the closing of
the acquisition.

(d) In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangibles", or SFAS 142, which the Company adopted on January 1, 2002.
The following table presents net income and basic and diluted earnings per
common share data adjusted to exclude the amortization of goodwill,
assuming that SFAS 142 had been in effect for the periods presented:

(e) During the second quarter of 2000, we recorded a net special charge of $2.1
million. This net charge resulted from a $13.4 million charge related to
the costs to cancel certain contracts that we believed were not
economically viable as a result of the SBCL acquisition, and which were
principally associated with the cancellation of a co-marketing agreement
for clinical trials testing services, which charges were in large part
offset by a reduction in reserves attributable to a favorable resolution of
outstanding claims for reimbursements associated with billings of certain
tests.

(f) During 1999, we recorded provisions for restructuring and other special
charges of $73 million in conjunction with the acquisition and planned
integration of SBCL. Of the $73 million charge, $19.8 million represented
stock-based employee compensation related to special one-time grants to
certain employees of the combined company and accelerated vesting,
$12.7 million represented professional and consulting fees related
to planned integration activities and $3.5 million represented special
recognition awards granted to certain employees involved in the transaction
and integration planning processes of the SBCL acquisition. The remaining
$36 million represented a charge to earnings in the fourth quarter of 1999
representing the costs associated with planned integration activities
affecting Quest Diagnostics' operations and employees. See Note 4 to the
Consolidated Financial Statements for further details.

(g) In conjunction with our debt refinancing in 2001, we recorded a loss on
debt extinguishment of $42 million. The loss represented the write-off of
deferred financing costs of $23 million, associated with the debt which was
refinanced, and $13 million of payments related primarily to the tender
premium incurred in connection with our cash tender offer of our 10 3/4%
senior subordinated notes due 2006. The remaining $6 million of losses
represented amounts incurred in conjunction with the cancellation of
certain interest rate swap agreements which were terminated in connection
with the debt that was refinanced. See Note 7 to the Consolidated Financial
Statements for further details.

(h) During the fourth quarter of 2000, we recorded a $4.8 million loss on the
extinguishment of debt representing the write-off of deferred financing
costs resulting from the prepayment of $155 million of term loans under our
then existing senior secured credit facility.

(i) In conjunction with the acquisition of SBCL, we repaid the entire amount
outstanding under our then existing credit agreement. The loss on the
extinguishment of debt recorded in the third quarter of 1999

35

represented $3.6 million of deferred financing costs, which were
written-off in connection with the extinguishment of the then existing
credit agreement.

(j) Potentially dilutive common shares primarily include stock options and
restricted common shares granted under our Employee Equity Participation
Program. During the period in which net income available for common
stockholders is a loss, diluted weighted average common shares outstanding
equals basic weighted average common shares outstanding, since under this
circumstance, the incremental shares would have an anti-dilutive effect.

(k) On December 31, 2001, the Company repurchased all of its then outstanding
preferred stock for its par value of $1 million plus accrued dividends.

36

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

OVERVIEW

The underlying fundamentals of the diagnostic testing industry have improved
since the early to mid-1990s, which was a period of declining reimbursement and
reduced test utilization. During the early 1990s, the industry was negatively
impacted by significant government regulation and investigations into various
billing practices. In addition, the rapid growth of managed care, as a result of
the need to reduce overall healthcare costs, and excess laboratory testing
capacity, led to revenue and profit declines across the diagnostic testing
industry, which in turn led to industry consolidation, particularly among
commercial laboratories. As a result of these dynamics, fewer but larger
commercial laboratories have emerged, which have greater economies of scale,
rigorous programs designed to assure compliance with government billing
regulations and other laws, and a more disciplined approach to pricing services.
These changes have resulted in improved profitability and a reduced risk of
non-compliance with complex government regulations. At the same time, a slowdown
in the growth of managed care and decreasing influence by managed care
organizations on the ordering of clinical laboratory testing by physicians has
contributed to renewed growth in testing and further improvements in
profitability since 1999. Partially offsetting these favorable trends have been
changes in the United States economy during the last several years, which has
resulted in an increase in the number of unemployed and uninsured. In addition,
in an attempt to slow the rapidly rising costs of healthcare, employers and
healthcare insurers have made design changes to healthcare plans, which shift a
larger portion of healthcare costs to consumers. We believe that these factors
have reduced the utilization of healthcare services in general. Orders for
laboratory testing are generated from physician offices, hospitals and
employers. As such, factors such as the number of unemployed and uninsured and
design changes in healthcare plans, which impact the level of employment or the
number of physicians office and hospital visits, will impact the utilization of
laboratory testing.

We believe the diagnostic testing industry has continued to grow during the
last several years despite the slowdown in the United States economy and the
changes in healthcare plan design, and that growth will accelerate as the
economy improves. In addition, over the longer term, growth is expected to
accelerate as a result of the following factors:

o general expansion and aging of the United States population;

o continuing research and development in the area of genomics and
proteomics, which is expected to yield new, more sophisticated and
specialized diagnostics tests;

o increasing recognition by consumers and payers of the value of early
detection and prevention which can be provided through laboratory testing
as a means to improve health and reduce the overall cost of healthcare;
and

o increasing affordability of tests due to advances in technology and cost
efficiencies.

Quest Diagnostics, as the largest clinical laboratory testing company with a
leading position in most of its geographic markets and service offerings, is
well positioned to benefit from the growth expected in the industry.

Payments for clinical laboratory testing services are made by the
government, health insurers, physicians, hospitals, employers and patients.
Physicians, hospitals and employers are typically billed on a fee-for-service
basis based on fee schedules, which are typically negotiated. Fees billed to
patients and health insurers are based on the laboratory's patient fee schedule,
subject to any limitations on fees negotiated with the health insurers or with
physicians on behalf of their patients. Medicare and Medicaid reimbursements are
based on fee schedules set by governmental authorities.

We incur significant additional costs as a result of our participation in
Medicare and Medicaid programs, as billing and reimbursement for clinical
laboratory testing is subject to considerable and complex federal and state
regulations. These additional costs include those related to: (1) complexity
added to our billing processes; (2) training and education of our employees and
customers; (3) compliance and legal costs; and (4) costs related to, among other
factors, medical necessity denials and advance beneficiary notices. Compliance
with applicable laws and regulations, as well as internal compliance policies
and procedures, adds further complexity and costs to the billing process. We
have implemented "best practices" that have significantly improved our billing
and collection processes. These efforts, together with our Six Sigma and
standardization initiatives, have significantly reduced bad debt expense as a
percentage of net revenues over the last several years. While the

37

total cost to comply with Medicare administrative requirements is
disproportionate to our cost to bill other payers, average Medicare
reimbursement rates approximate the Company's overall average reimbursement rate
from all payers, making this business generally less profitable. Government
payers, such as Medicare and Medicaid, as well as insurers and larger employers
have taken steps and may continue to take steps to control the cost, utilization
and delivery of healthcare services, including clinical laboratory services.
Principally as a result of reimbursement reductions and measures adopted by the
Centers for Medicare & Medicaid Services, or CMS (formerly the Health Care
Financing Administration) which establishes procedures and continuously
evaluates and implements changes in the reimbursement process to control
utilization, the percentage of our aggregate net revenues derived from Medicare
and Medicaid programs declined from approximately 20% in 1995 to approximately
17% in 2003. Despite the added cost and complexity of participating in the
Medicare and Medicaid programs, we continue to participate in such programs
because we believe that our other business may significantly depend on continued
participation in the Medicare and Medicaid programs, because many customers want
a single laboratory to perform all of their clinical laboratory testing
services, regardless of who pays for such services.

Health insurers, which typically contract with a limited number of clinical
laboratories for their members, represent approximately one-half of our total
testing volumes and one-half of our net revenues. Larger health insurers
typically prefer to use large commercial clinical laboratories because they can
provide services on a national or regional basis and can manage networks of
local or regional laboratories to provide even broader access to their members
and physicians. In certain markets, such as California, health insurers delegate
their covered members to independent physician associations, or IPA, which in
turn contract with laboratories for clinical laboratory services.

Over the last decade, health insurers have been consolidating, resulting in
fewer but larger insurers with significant bargaining power to negotiate fee
arrangements with healthcare providers, including clinical laboratories. These
health insurers demand that clinical laboratory service providers accept
discounted fee structures or assume all or a portion of the financial risk
associated with providing testing services to their members through capitated
payment contracts. Under these capitated payment contracts, the Company and
health insurers agree to a predetermined monthly contractual rate for each
member of the health insurer's plan regardless of the number or cost of services
provided by the Company. Capitated agreements have historically been priced
aggressively, particularly for exclusive or semi-exclusive arrangements. In
2003, we derived approximately 14% of our testing volume and 8% of our net
revenues from capitated payment contracts. In recent years, there has been a
shift in the way major insurers contract with clinical laboratories. Health
insurers have begun to offer more freedom of choice to their affiliated
physicians, including greater freedom to determine which laboratory to use and
which tests to order. Accordingly, most of our agreements with major health
insurers are non-exclusive arrangements. As a result, under these non-exclusive
arrangements, physicians have more freedom of choice in selecting laboratories,
and laboratories are likely to compete more on the basis of service and quality
rather than price alone. Also, health insurers have been giving patients greater
freedom of choice and patients have increasingly been selecting plans (such as
preferred provider organizations and consumer driven plans) that offer a greater
choice of providers. Pricing for these preferred provider organizations is
typically negotiated on a fee-for-service basis, which generally results in
higher revenue per requisition than under a capitated fee arrangement. Despite
these trends, health insurers continue to aggressively seek cost reductions in
order to keep their premiums to their customers competitive.

We expect that the overall reimbursement dynamics for all payers on a
combined basis are neutral for the diagnostic testing industry. Today, many
federal and state governments face serious budget deficits and healthcare
spending is a prime target for reductions. For example, the Prescription Drug,
Improvement, and Modernization Act of 2003 eliminated for five years (beginning
January 1, 2004) the provision for annual increases to the Medicare national fee
schedule based on the consumer price index. Efforts to impose reduced
reimbursements and more stringent cost controls by government and other payers
for existing tests may continue. However, we believe that as new tests are
developed which either improve on the effectiveness of existing tests or provide
new diagnostic capabilities, government and other payers will add these tests as
covered services, because of the importance of laboratory testing in assessing
and managing the health of patients. We continue to emphasize the importance and
the high value of laboratory testing with insurers and government payers at the
federal and state level.

The diagnostic testing industry is subject to seasonal fluctuations in
operating results and cash flows. Typically, testing volume declines during the
summer months, year-end holiday periods and other major holidays, reducing net
revenues and operating cash flows below annual averages. Testing volume is also
subject to declines in winter months due to inclement weather, which varies in
severity from year to year.

38

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 force, billing operations
(including bad debt expense), and general management and administrative support.

Information systems are used extensively in virtually all aspects of our
business, including laboratory testing, billing, customer service, logistics,
and management of medical data. Our success depends, in part, on the continued
and uninterrupted performance of our information technology systems. In 2002, we
began implementation of a standard laboratory information system and a standard
billing system, which we expect will take several more years to complete.
Through proper planning and execution, we expect to reduce the risks associated
with systems conversions of this type, and minimize any disruptions in our
operations.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions and select accounting policies that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities and the reported amounts of revenues and expenses in our
financial statements. 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 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:

o revenues and accounts receivable;

o reserves for general and professional liability claims;

o billing-related settlement reserves; and

o accounting for and recoverability of goodwill.

Revenues and accounts receivable

The process for estimating the ultimate collection of receivables involves
significant assumptions and judgments. Billings for services under third-party
payer programs, including Medicare and Medicaid, are recorded as revenues net of
allowances for differences between amounts billed and the estimated receipts
under such programs. Adjustments to the estimated receipts, based on final
settlement with the third-party payers, are recorded upon settlement as an
adjustment to net revenues.

We have implemented a monthly standardized approach to estimate and review
the collectibility of our receivables based on the period they have been
outstanding. Historical collection and payer reimbursement experience is an
integral part of the estimation process related to reserves for doubtful
accounts. In addition, we assess the current state of our billing functions in
order to identify any known collection or reimbursement issues in order to
assess the impact, if any, on our reserve estimates, which involves judgment. We
believe that the collectibility of our receivables is directly linked to the
quality of our billing processes, most notably those related to obtaining the
correct information in order to bill effectively for the services we provide. As
such, we have implemented "best practices" to reduce the number of requisitions
that we receive from healthcare providers with missing or incorrect billing
information. Revisions in reserve for doubtful accounts estimates are recorded
as an adjustment to bad debt expense within selling, general and administrative
expenses. We believe that our collection and reserves processes, along with our
close monitoring of our billing processes, helps to reduce the risk associated
with material revisions to reserve estimates resulting from adverse changes in
collection and reimbursement experience and billing operations.

Reserves for general and professional liability claims

As a general matter, providers of clinical laboratory 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 our client base and reputation.
We maintain

39

various liability insurance programs for claims that could result from providing
or failing to provide clinical laboratory testing services, including inaccurate
testing results and other exposures. Our insurance coverage limits our maximum
exposure on individual claims; however, we are essentially self-insured for a
significant portion of these claims. While the basis for claims reserves
incorporates actuarially determined losses based upon our historical and
projected loss experience, the process of analyzing, assessing and establishing
reserve estimates relative to these types of claims involves a high degree of
judgment. Changes in the facts and circumstances associated with a claim could
have a material impact on our results of operations, principally costs of
services, and cash flows in the period that reserve estimates are revised. We
believe that present insurance coverage and reserves are sufficient to cover
currently estimated exposures, but we cannot assure investors that we will not
incur liabilities in excess of recorded reserves. Similarly, although we
believe that we will be able to obtain adequate insurance coverage in the
future at acceptable costs, we cannot assure investors that we will be able
to do so.

Billing-related settlement reserves

Our business is subject to extensive and frequently changing federal, state
and local laws and regulations. We have entered into several settlement
agreements with various government and private payers during recent years
relating to industry-wide billing and marketing practices that had been
substantially discontinued by early 1993. In addition, we are aware of several
pending lawsuits filed under the qui tam provisions of the civil False Claims
Act and have received notices of private claims relating to billing issues
similar to those that were the subject of prior settlements with various
government payers. We have a comprehensive compliance program that is intended
to ensure the strict implementation and observance of all applicable laws,
regulations and Company policies. The Quality, Safety and Compliance Committee
of the Board of Directors requires periodic reporting of compliance operations
from management. As an integral part of our compliance program, we investigate
all reported or suspected failures to comply with federal healthcare
reimbursement requirements. Any non-compliance that results in Medicare or
Medicaid overpayments is reported to the government and reimbursed by us. As a
result of these efforts, we have periodically identified and reported
overpayments. While we have reimbursed these overpayments and have taken
corrective action where appropriate, we cannot assure investors that in each
instance the government will necessarily accept these actions as sufficient.

While we believe that we are in material compliance with all applicable
laws, many of the regulations applicable to us, including those relating to
billing and reimbursement of tests and those relating to relationships with
physicians and hospitals, are vague or indefinite and have not been interpreted
by the courts. They may be interpreted or applied by a prosecutorial, regulatory
or judicial authority in a manner that could require us to make changes in our
operations, including our billing practices. If we fail to comply with
applicable laws and regulations, we could suffer civil and criminal penalties,
including the loss of licenses or our ability to participate in Medicare,
Medicaid and other federal and state healthcare programs.

Although management believes that established reserves for billing-related
claims are sufficient, it is possible that additional information (such as the
indication by the government of criminal activity, additional tests being
questioned or other changes in the government's or private claimants' theories
of wrongdoing) may become available which may cause the final resolution of
these matters to exceed established reserves by an amount which could be
material to our results of operations and cash flows in the period in which such
claims are settled. We do not believe that these issues will have a material
adverse effect on our overall financial condition.

Accounting for and recoverability of goodwill

In July 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 142, "Goodwill and
Other Intangible Assets", or SFAS 142. The impact of adopting SFAS 142 is
summarized in Note 2 to the Consolidated Financial Statements.

Effective January 1, 2002, we evaluate the recoverability and measure the
potential impairment of our goodwill under SFAS 142. The annual impairment test
is a two-step process that begins with the estimation of the fair value of the
reporting unit. The first step screens for potential impairment and the second
step measures the amount of the impairment, if any. Our estimate of fair value
considers publicly available information regarding the market capitalization of
our Company, as well as (i) publicly available information regarding comparable
publicly-traded companies in the clinical laboratory testing industry, (ii) the
financial projections and future prospects of our business, including its growth
opportunities and likely operational improvements, and (iii) comparable sales
prices, if available. As part of the first step to assess potential impairment,
we compare

40

our estimate of fair value for the Company to the book value of our consolidated
net assets. If the book value of our consolidated net assets is greater than our
estimate of fair value, we would then proceed to the second step to measure the
impairment, if any. The second step compares the implied fair value of goodwill
with its carrying value. The implied fair value is determined by allocating the
fair value of the reporting unit to all of the assets and liabilities of that
unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the purchase price paid to acquire the
reporting unit. The excess of the fair value of the reporting unit over the
amounts assigned to its assets and liabilities is the implied fair value of
goodwill. If the carrying amount of the reporting unit's goodwill is greater
than its implied fair value, an impairment loss will be recognized in the amount
of the excess. We believe our estimation methods are reasonable and reflective
of common valuation practices.

On a quarterly basis, we perform a review of our business to determine if
events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the Company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would perform an
impairment test of goodwill as of the end of the quarter, consistent with the
annual impairment test, and record any noted impairment loss.

ACQUISITION OF UNILAB CORPORATION

On February 28, 2003, we completed the acquisition of Unilab Corporation, or
Unilab, the leading commercial clinical laboratory in California. In connection
with the acquisition, we paid $297 million in cash and issued 7.1 million shares
of Quest Diagnostics common stock to acquire all of the outstanding capital
stock of Unilab. In addition, we reserved approximately 0.3 million shares of
Quest Diagnostics common stock for outstanding stock options of Unilab which
were converted upon the completion of the acquisition into options to acquire
shares of Quest Diagnostics common stock. In connection with the acquisition of
Unilab, as part of a settlement agreement with the United States Federal Trade
Commission, we entered into an agreement to sell to Laboratory Corporation of
America Holdings, Inc., or LabCorp, certain assets in northern California for
$4.5 million, including the assignment of agreements with four IPA's and leases
for 46 patient service centers (five of which also serve as rapid response
laboratories), or the Divestiture. We completed the transfer of assets and
assignment of the IPA agreements to LabCorp and recorded a $1.5 million gain in
the third quarter of 2003 in connection with the Divestiture, which is included
in "other operating (income) expense, net" in the consolidated statements of
operations. See Note 3 to the Consolidated Financial Statements for a full
discussion of the Unilab acquisition and the Divestiture.

INTEGRATION OF ACQUIRED BUSINESSES

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", or SFAS 146. SFAS 146, which we adopted
effective January 1, 2003, requires that a liability for a cost associated with
an exit activity, including those related to employee termination benefits and
contractual obligations, be recognized when the liability is incurred, and not
necessarily the date of an entity's commitment to an exit plan, as under
previous accounting guidance. The provisions of SFAS 146 apply to integration
costs associated with actions that impact the employees and operations of Quest
Diagnostics. Costs associated with actions that impact the employees and
operations of an acquired company, such as Unilab, are accounted for as a cost
of the acquisition and included in goodwill in accordance with Emerging Issues
Task Force No. 95-3, "Recognition of Liabilities in Connection with a Purchase
Business Combination".

Unilab Corporation

As part of the Unilab acquisition, we acquired all of Unilab's operations,
including its primary testing facilities in Los Angeles, San Jose and
Sacramento, California, and approximately 365 patient service centers and 35
rapid response laboratories and approximately 4,100 employees. During the fourth
quarter of 2003, we finalized our plan related to the integration of Unilab into
our laboratory network. As part of the plan, following the sale of certain
assets to LabCorp as part of the Divestiture, we closed our previously owned
clinical laboratory in the San Francisco Bay area and completed the integration
of remaining customers in the northern California area to Unilab's laboratories
in San Jose and Sacramento. We continue to have two laboratories in the Los
Angeles metropolitan area (our facilities in Van Nuys and Tarzana). We plan to
open a new regional laboratory in the Los Angeles metropolitan area and then
integrate our business in the Los Angeles metropolitan area into the new
facility.

41

We expect to incur up to $20 million of costs through 2005 to integrate
Unilab and our existing California operations. During 2003, we recorded $9
million of such costs associated with executing the plan. The majority of these
integration costs related to employee severance and contractual obligations
associated with leased facilities and equipment. Employee groups affected as a
result of this plan include those involved in the collection and testing of
specimens, as well as administrative and other support functions. Of the $9
million in costs, $7.9 million was recorded in the fourth quarter and related to
actions that impact the employees and operations of Unilab, was accounted for as
a cost of the Unilab acquisition and included in goodwill. Of the $7.9 million,
$6.8 million related to employee severance benefits for approximately 150
employees, with the remainder primarily related to contractual obligations. In
addition, $1.1 million of integration costs, related to actions that impact
Quest Diagnostics' employees and operations and comprised principally of
employee severance benefits for approximately 30 employees, were accounted for
as a charge to earnings in the third quarter of 2003 and included in "other
operating (income) expense, net" within the consolidated statements of
operations. As of December 31, 2003, accruals related to the Unilab integration
plan totaled approximately $7 million. While the majority of the accrued costs
at December 31, 2003 are expected to be paid in 2004, there are certain
severance costs that have payment terms extending into 2005. The remaining
estimated costs associated with executing the Unilab integration plan relate to
actions which are expected to take place through 2005. Such costs will be
accounted for as a charge to earnings in the periods that the related actions
are taken.

Upon completion of the Unilab integration, we expect to realize
approximately $25 million to $30 million of annual synergies and we expect to
achieve this annual rate of synergies by the end of 2005.

American Medical Laboratories, Incorporated and Clinical Diagnostics
Services, Incorporated

On April 1, 2002, we completed our acquisition of all of the outstanding
voting stock of American Medical Laboratories, Incorporated, or AML. In
addition, during the fourth quarter of 2001, we acquired all of the voting stock
of Clinical Diagnostic Services, Inc.

See Notes 3 and 4 to the Consolidated Financial Statements for a full
discussion of these transactions.

SIX SIGMA AND STANDARDIZATION INITIATIVES

We intend to become recognized as the quality leader in the healthcare
services industry. We continue to implement our Six Sigma and standardization
initiatives throughout all aspects of our organization. Six Sigma is a
management approach that requires a thorough understanding of customer needs and
requirements, root cause analysis, process improvements and rigorous tracking
and measuring of services. We have integrated our Six Sigma initiative with our
initiative to standardize operations and processes across all of our Company by
adopting identified Company best practices. We plan to continue these
initiatives during the next several years and expect that their successful
implementation will result in measurable improvements in customer satisfaction
and operating results.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2003 COMPARED WITH YEAR ENDED DECEMBER 31, 2002

Net income for the year ended December 31, 2003 increased to $437 million
from $322 million for the prior year period. This increase in earnings was
primarily attributable to revenue growth and improved efficiencies generated
from our Six Sigma and standardization initiatives.

Net Revenues

Net revenues for the year ended December 31, 2003 grew by 15.3% over the
prior year level and include the results of Unilab, which was acquired on
February 28, 2003, for ten months. Net revenues for 2003 also included twelve
months of results for AML, which was acquired on April 1, 2002. Pro forma
revenue growth, assuming that the Unilab and AML acquisitions and the related
Divestiture had been completed on January 1, 2002, was 4.3% for the year ended
December 31, 2003.

For the year ended December 31, 2003, clinical testing volume, measured by
the number of requisitions, increased 11.3% compared to 2002. On a pro forma
basis, assuming that the Unilab and AML acquisitions and the Divestiture had
been completed on January 1, 2002, testing volume declined 1.2%. The combined
effect of the severe winter storms and the New Jersey physicians' strike during
the first quarter of 2003 and Hurricane

42

Isabel and the blackout in the third quarter of 2003 reduced testing volume by
approximately 0.5% for the year ended December 31, 2003. In addition, our
drugs-of-abuse testing business, which is most directly impacted by economic
conditions and accounts for approximately 3% of our net revenues and 6% of our
testing volume, declined during 2003, reducing Company-wide testing volume
growth by approximately 0.5%. Both reported and pro forma testing volume have
been impacted by general economic conditions, which have increased the number of
uninsured and unemployed and, we believe, have reduced utilization of healthcare
services in 2003.

For the year ended December 31, 2003, average revenue per requisition
improved 3.6%, or 5.1% on a pro forma basis, assuming that the Unilab and AML
acquisitions and the Divestiture had been completed on January 1, 2002. These
improvements in average revenue per requisition were primarily attributable to a
continuing shift in test mix to higher value testing, including gene-based and
esoteric testing. Gene-based testing net revenues exceeded $500 million for
2003, and grew over 20% compared to the prior year. In addition, a shift in
payer mix to higher priced fee-for-service reimbursement contributed a portion
of the increase in average revenue per requisition. The inclusion of Unilab's
results subsequent to February 28, 2003 served to reduce average revenue per
requisition, reflecting Unilab's lower revenue per requisition.

Our businesses, other than clinical laboratory testing, which represent
approximately 4% of our consolidated net revenues, grew approximately 16% during
the year and contributed about 0.5% to the reported growth in net revenues.

Operating Costs and Expenses

Total operating costs and expenses for 2003 increased $426 million from 2002
primarily due to increases in our clinical testing volume (largely as a result
of the Unilab acquisition), employee compensation and benefits, testing supply
costs and depreciation expense. While our cost structure has been favorably
impacted by the improved efficiencies generated from our Six Sigma and
standardization initiatives, we continue to make investments to enhance our
infrastructure to pursue our overall business strategy. These investments
include:

o Skills training for all employees, which together with our competitive
pay and benefits, helps to increase employee satisfaction and
performance, which we believe will result in better service to our
customers;

o Our information technology strategy, which is designed to improve our
efficiency and provide better service to our customers; and

o Our strategic growth opportunities.

Cost of services, which includes the costs of obtaining, transporting and
testing specimens, was 58.4% of net revenues for 2003, compared to 59.2% in the
prior year. This improvement was primarily the result of efficiency gains
resulting from our Six Sigma and standardization initiatives and the increase in
average revenue per requisition. This improvement was partially offset by
initial installation costs of deploying our Internet-based orders and results
systems in physicians' offices and our patient service centers. The increase in
the number of orders and test results reported via our Internet-based systems is
improving the initial collection of billing information which is reducing the
cost of billing and bad debt expense, both of which are components of selling,
general and administrative expenses. At December 31, 2003, approximately 25% of
our orders and approximately 35% of our test results were being transmitted via
the Internet. Additionally, we are seeing an increase in the number of
physicians who no longer draw blood in their office, which is resulting in an
increase in the number of blood draws in our patient service centers or by our
phlebotomists placed in physicians' offices. This shift has increased our
operating costs associated with our blood draws, but is reducing costs in
accessioning and other parts of our operations due to improved billing
information and a reduction in the number of inadequate patient samples obtained
by our trained phlebotomists compared to samples collected by physician employed
phlebotomists.

Selling, general and administrative expenses, which include the costs of the
sales force, billing operations, bad debt expense and general management and
administrative support, decreased during 2003, as a percentage of net revenues,
to 24.6% from 26.2% in the prior year. This improvement was primarily due to
efficiencies from our Six Sigma and standardization initiatives and the
improvement in average revenue per requisition. During 2003, bad debt expense
improved to 4.8% of net revenues, compared to 5.3% in 2002. The reduction in bad
debt expense as a percentage of net revenues occurred despite the addition of
Unilab, which has higher levels of bad debt than the rest of Quest Diagnostics.
This improvement primarily relates to the collection of diagnosis, patient and
insurance information necessary to more effectively bill for services performed.
We believe that our Six Sigma and standardization initiatives and the increased
use of electronic ordering by our customers will provide additional
opportunities to further improve our overall collection experience and cost
structure.

43

Other operating (income) expense, net represents miscellaneous income and
expense items related to operating activities, and includes gains and losses
associated with the disposal of operating assets.

Operating Income

Operating income for the year ended December 31, 2003 improved to $796
million, or 16.8% of net revenues, from $592 million, or 14.4% of net revenues,
in 2002. The increase in operating income was primarily due to revenue growth
and improved efficiencies generated from our Six Sigma and standardization
initiatives.

Other Income (Expense)

Net interest expense for the year ended December 31, 2003 increased from
2002 by $6 million and was primarily attributable to the amounts borrowed to
finance the acquisition of Unilab and to repay substantially all of Unilab's
outstanding debt, partially offset by decreased amounts borrowed under our
secured receivables credit facility.

Other income (expense), 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.

YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001

Net income for the year ended December 31, 2002 increased to $322 million
from $162 million for the year ended December 31, 2001. Assuming that the
provisions of SFAS 142 related to accounting for goodwill amortization had been
in effect in 2001, net income for the year ended December 31, 2001 would have
been $198 million. The increase in earnings was primarily attributable to
revenue growth, improved efficiencies generated from our Six Sigma and
standardization initiatives, and a reduction in net interest expense, partially
offset by increases in employee compensation and supply costs, depreciation
expense and investments in our information technology strategy and strategic
growth opportunities. In addition, results for the year ended December 31, 2001
included a loss on debt extinguishment of $42 million, which was incurred in
conjunction with our debt refinancing in the second quarter of 2001.

Net Revenues

Net revenues for the year ended December 31, 2002 grew by 13.2% compared
with the prior year. The acquisition of AML, which was completed on April 1,
2002, contributed approximately one-half of the increase in net revenues. For
the year ended December 31, 2002, clinical testing volume, measured by the
number of requisitions, increased 9.7% compared with the prior year.
Assuming AML had been part of Quest Diagnostics in 2001, clinical testing volume
would have increased above the prior year level by 3.4% on a pro forma basis.
Other smaller acquisitions completed in 2001 contributed approximately 1.5% to
testing volume growth in 2002. Partially offsetting these increases was a
decline in testing volumes associated with our drugs of abuse testing business,
which reduced total Company testing volume for the year ended December 31, 2002
by about one-half of a percent. Drugs of abuse testing, which accounted for
approximately 7% of our testing volume and 4% of our net revenues, was impacted
by a general slowing of the economy and a corresponding slowdown in hiring.
Average revenue per requisition increased 3.2% for the year ended December 31,
2002, compared with the prior year. The improvement in average revenue
per requisition was primarily attributable to a continuing shift in test mix to
higher value testing, including gene-based testing, which contributed over
one-half of the improvement, and a shift in payer mix to higher priced
fee-for-service reimbursement. We continued to see strong growth in our
gene-based and esoteric testing with gene-based testing net revenues, which
approached $400 million for the year, growing at more than 20% compared with
the prior year. Our businesses, other than clinical laboratory testing, which
accounted for approximately 4% of our total net revenues in 2002, grew about
15% over the prior year and accounted for 0.6% of the 13.2% increase in net
revenues, or approximately $20 million. Most of this increase was from our
MedPlus subsidiary, which we acquired in November 2001, which develops clinical
connectivity products designed to enhance patient care.

Operating Costs and Expenses

Total operating costs for the year ended December 31, 2002 increased $300
million from the prior year primarily due to increases in our clinical testing
volume, largely as a result of the AML acquisition, employee compensation and
supply costs and depreciation expense; partially offset by reductions in
amortization of

44

goodwill and bad debt expense. While our cost structure has been favorably
impacted by the synergies realized as a result of the integration of SBCL and
the improved efficiencies generated from our Six Sigma and standardization
initiatives, we continue to make investments to enhance our infrastructure to
pursue our overall business strategy. These investments include those related
to:

o Skills training for all employees, which together with our competitive
pay and benefits, helps to increase employee satisfaction and
performance, which we believe will result in better service to our
customers;

o Our information technology strategy, which is designed to improve our
efficiency and provide better service to our customers; and

o Our strategic growth opportunities.

Cost of services, which includes the costs of obtaining, transporting and
testing specimens, was 59.2% of net revenues for the year ended December 31,
2002, decreasing slightly from 59.3% in the prior year. The positive impact of
our Six Sigma and standardization initiatives and the increase in average
revenue per requisition, which reduced cost of services as a percentage of net
revenues, was partially offset by the addition of AML's higher cost of services
as of April 1, 2002. Cost of services has also increased due to a greater
percentage of patients having their blood drawn in our patient service centers
or by our phlebotomists placed in physicians' offices. During 2002, in an effort
to reduce their costs, many physicians took action to simplify activities in
their offices by ceasing blood draws by physician staff. Additionally, reflected
in the cost of services are the one-time installation costs of deploying our
Internet-based orders and results systems in physicians' offices. As of December
31, 2002, approximately 10% of all orders and 15% of all test results were being
transmitted via the Internet. Both the reduction of blood draws in the
physicians' offices and the increased use of the Internet for ordering and
resulting are improving the initial collection of billing information and
generating savings in the cost of billing and bad debt expense, both of which
are components of selling, general and administrative expense. Increased blood
draws by Company-trained employee phlebotomists also improve the overall
preparation of the blood sample, which can improve efficiency of the testing
process.

Selling, general and administrative expenses, which include the costs of the
sales force, billing operations, bad debt expense and general management and
administrative support, decreased during the year ended December 31, 2002 as a
percentage of net revenues to 26.2% from 28.1% in the prior year. This decrease
was primarily due to efficiencies from our Six Sigma and standardization
initiatives, in particular bad debt expense, the improvement in average revenue
per requisition and the impact of AML's cost structure as of April 1, 2002.
During 2002, bad debt expense improved to 5.3% of net revenues, compared to 6.0%
of net revenues in 2001. The improvements in bad debt expense were principally
attributable to the continued progress that we have made in our overall
collection experience through process improvements, driven by our Six Sigma and
standardization initiatives. These improvements primarily relate to the
collection of diagnosis, patient and insurance information necessary to
effectively bill for services performed. We believe that our Six Sigma and
standardization initiatives will provide additional opportunities to further
improve our overall collection experience.

Amortization of goodwill for the year ended December 31, 2002 decreased from
the prior year by $38 million as the result of adopting SFAS 142, effective
January 1, 2002. See Note 2 to the Consolidated Financial Statements for further
details regarding the impact of SFAS 142.

Other operating (income) expense, net represents miscellaneous income and
expense items related to operating activities, such as gains and losses
associated with the disposal of operating assets.

Operating Income

Operating income for the year ended December 31, 2002 improved to $592
million, or 14.4% of net revenues, from $412 million, or 11.3% of net revenues,
in 2001. The increase in operating income was primarily due to revenue growth,
improved efficiencies generated from our Six Sigma and standardization
initiatives and a reduction in amortization of goodwill, partially offset by
increases in employee compensation and supply costs, depreciation expense and
investments in our information technology strategy and strategic growth
opportunities.

Other Income (Expense)

Net interest expense for the year ended December 31, 2002 decreased from the
prior year by $17 million. The reduction was primarily due to the favorable
impact of our debt refinancings in 2001 and a favorable interest rate
environment.

45

In 2001, we refinanced a majority of our long-term debt on a senior
unsecured basis. Specifically, we completed a $550 million senior notes
offering, or the Senior Notes, and entered into a new $500 million senior
unsecured credit facility, or the Credit Agreement, which included a five-year
$325 million revolving credit agreement and a $175 million term loan. We used
the net proceeds from the senior notes offering and the term loan, together with
cash on hand, to repay all of the $584 million which was outstanding under our
then existing senior secured credit agreement, including the costs to settle
existing interest rate swap agreements, and to consummate a cash tender offer of
our 10 3/4% senior subordinated notes due 2006, or the Subordinated Notes. In
conjunction with our debt refinancing, we recorded a loss on debt extinguishment
of $42 million, $36 million of which represented the write-off of $23 million of
deferred financing costs, associated with the debt which was refinanced, and $13
million of payments related primarily to the tender premium incurred in
connection with our cash tender offer for our Subordinated Notes. The remaining
$6 million of losses represented amounts incurred in conjunction with the
cancellation of certain interest rate swap agreements, which were terminated in
connection with the debt that was refinanced. Prior to our debt refinancing, our
secured credit agreement required us to maintain interest rate swap agreements
to mitigate the risk of changes in interest rates associated with a portion of
our variable interest rate indebtedness.

Other income (expense), 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 year ended December 31,
2002, other income (expense), net includes a $4.9 million pretax gain on the
sale of certain assets, partially offset by losses on miscellaneous
non-operating assets. For the year ended December 31, 2001, other income
(expense), net includes the net impact of writing-off $9.6 million of certain
impaired assets, partially offset by a $6.3 million gain on the sale of an
investment.

Income Taxes

During 2001, our effective tax rate was significantly impacted by goodwill
amortization, the majority of which was not deductible for tax purposes, and had
the effect of increasing the overall tax rate. The reduction in the effective
tax rate for the year ended December 31, 2002 was primarily due to the
elimination of amortization of goodwill (as a result of adopting SFAS 142,
effective January 1, 2002) the majority of which was not deductible for tax
purposes.

IMPACT OF CONTINGENT CONVERTIBLE DEBENTURES ON DILUTED EARNINGS PER COMMON SHARE

On November 26, 2001, we completed our $250 million offering of 1 3/4%
contingent convertible debentures due 2021, or the Debentures. Each one thousand
dollar principal amount of Debentures is convertible into 11.429 shares of our
common stock, which represents an initial conversion price of $87.50 per share.
Holders may surrender the Debentures for conversion into shares of our common
stock under any of the following circumstances: (i) if the sales price of our
common stock is above 120% of the conversion price (or $105 per share) for
specified periods; (ii) if we call the Debentures; or (iii) if specified
corporate transactions have occurred. See Note 11 to the Consolidated Financial
Statements for a further discussion of the Debentures.

The if-converted method is used in determining the dilutive effect of the
Debentures in periods when the holders of such securities are permitted to
exercise their conversion rights. As of and for each of the years ended December
31, 2003 and 2002, the holders of our Debentures did not have the ability to
exercise their conversion rights. Had the requirements to allow the holders to
exercise their conversion rights been met and the Debentures remained
outstanding for the entire period, diluted earnings per common share would have
been reduced by approximately 2% during each of the years ended December 31,
2003 and 2002.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We address our exposure to market risks, principally the market risk of
changes in interest rates, through a controlled program of risk management that
may include the use of derivative financial instruments. We do not hold or issue
derivative financial instruments for trading purposes. We do not believe that
our foreign exchange exposure is material to our financial position or results
of operations. See Note 2 to the Consolidated Financial Statements for
additional discussion of our financial instruments and hedging activities.

At December 31, 2003 and 2002, the fair value of our debt was estimated at
$1.2 billion and $899 million, respectively, using quoted market prices and
yields for the same or similar types of borrowings, taking into account the
underlying terms of the debt instruments. At December 31, 2003 and 2002, the
estimated fair value exceeded the carrying value of the debt by approximately
$86 million and $77 million, respectively. An

46

assumed 10% increase in interest rates (representing approximately 50 and 60
basis points at December 31, 2003 and 2002, respectively) would potentially
reduce the estimated fair value of our debt by approximately $17 million and $21
million, respectively, at December 31, 2003 and 2002.

The Debentures have a contingent interest component that will require us to
pay contingent interest based on certain thresholds, as outlined in the
indenture governing the Debentures. The contingent interest component, which is
more fully described in Note 11 to the Consolidated Financial Statements, is
considered to be a derivative instrument subject to SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", as amended. As such, the
derivative was recorded at its fair value in the consolidated balance sheets and
was not material at December 31, 2003 and 2002.

Borrowings under our unsecured revolving credit facility under our Credit
Agreement, our term loan facilities and our secured receivables credit facility
are subject to variable interest rates, unless fixed through interest rate swaps
or other agreements. Interest rates on our unsecured revolving credit facility
and term loans are subject to a pricing schedule that can fluctuate based on
changes in our credit rating. As such, our borrowing cost under these credit
arrangements will be subject to both fluctuations in interest rates and changes
in our credit rating. As of December 31, 2003, our borrowing rate for
LIBOR-based loans was principally LIBOR plus 1.1875%. At December 31, 2003,
there was $305 million outstanding under our term loan due June 2007 and there
were no borrowings outstanding under our unsecured revolving credit facility or
secured receivables credit facility.

Based on our net exposure to interest rate changes, an assumed 10% change in
interest rates on our variable rate indebtedness (representing approximately 12
basis points) would impact annual net interest expense by approximately $0.4
million, assuming no changes to the debt outstanding at December 31, 2003.

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

Cash and cash equivalents at December 31, 2003 totaled $155 million,
compared to $97 million at December 31, 2002. Cash flows from operating
activities in 2003 provided cash of $663 million, which together with cash
on-hand were used to fund investing and financing activities, which required
cash of $417 million and $188 million, respectively. Cash and cash equivalents
at December 31, 2002 totaled $97 million, a decrease of $26 million from
December 31, 2001. Cash flows from operating activities in 2002 provided cash of
$596 million, which together with cash on-hand were used to fund investing and
financing activities, which required cash of $477 million and $145 million,
respectively.

Cash Flows from Operating Activities

Net cash provided by operating activities for 2003 was $663 million compared
to $596 million in the prior year period. This increase was primarily due to
improved operating performance, partially offset by an increase in accounts
receivable associated with growth in net revenues. Days sales outstanding, a
measure of billing and collection efficiency, improved to 48 days at December
31, 2003 from 49 days at December 31, 2002. Net cash provided by operating
activities for 2002 benefited from our ability to accelerate the tax deduction
for certain operating expenses resulting from Internal Revenue Service rule
changes.

Net cash from operating activities for 2002 was $131 million higher than the
2001 level. This increase was primarily due to improved operating performance,
our ability to accelerate the tax deductions resulting from Internal Revenue
Service rule changes, efficiencies in our billing and collection processes and a
reduction in SBCL integration costs paid. The increase was partially offset by
settlement payments, primarily related to contractual disputes previously
reserved for, and a decrease in the tax benefits realized associated with the
exercise of employee stock options. The year-over-year comparisons were also
impacted by the payment of indemnifiable tax matters to GlaxoSmithKline in 2002
and cash received from Corning Incorporated in 2001 related to an indemnified
billing-related claim. Days sales outstanding decreased to 49 days at December
31, 2002 from 54 days at December 31, 2001.

Cash Flows from Investing Activities

Net cash used in investing activities in 2003 was $417 million, consisting
primarily of acquisition and related transaction costs of $238 million to
acquire the outstanding capital stock of Unilab and capital expenditures of $175
million. The acquisition and related transaction costs included the cash portion
of the

47

Unilab purchase price of $297 million and approximately $12 million of
transaction costs paid in 2003, partially offset by $72 million of cash acquired
from Unilab.

Net cash used in investing activities in 2002 was $477 million, consisting
primarily of acquisition and related costs of $334 million, primarily to acquire
the outstanding voting stock of AML, and capital expenditures of $155 million.

Cash Flows from Financing Activities

Net cash used in financing activities in 2003 was $188 million, consisting
primarily of debt repayments totaling $392 million and purchases of treasury
stock totaling $258 million, partially offset by $450 million of borrowings
under our term loan due June 2007. Borrowings under our term loan due
June 2007 were used to finance the cash portion of the purchase price and
related transaction costs associated with the acquisition of Unilab, and to
repay $220 million of debt, representing substantially all of Unilab's then
existing outstanding debt, and related accrued interest. Of the $220 million,
$124 million represented payments related to our cash tender offer, which was
completed on March 7, 2003, for all of the outstanding $101 million principal
amount of Unilab's 12 3/4% Senior Subordinated Notes due 2009 and $23 million
of related tender premium and associated tender offer costs. The remaining
debt repayments in 2003 consisted primarily of $145 million of repayments
under our term loan due June 2007 and $24 million of capital lease repayments.
The $258 million in treasury stock purchases represents 4.0 million shares of
our common stock repurchased at an average price of $64.54 per share.

Net cash used in financing activities in 2002 was $145 million, consisting
primarily of the net cash activity associated with the financing of the AML
acquisition. We financed AML's all-cash purchase price of approximately $335
million and related transaction costs, together with the repayment of
approximately $150 million of acquired AML debt and accrued interest with cash
on-hand, $300 million of borrowings under our secured receivables credit
facility and $175 million of borrowings under our unsecured revolving credit
facility. During the last three quarters of 2002, we repaid all of the $475
million in borrowings related to the acquisition of AML.

Dividend Policy

Through October 20, 2003, we had never declared or paid cash dividends on
our common stock. On October 21, 2003, our Board of Directors declared the
payment of a quarterly cash dividend of $0.15 per common share. The initial
quarterly dividend was paid on January 23, 2004 to shareholders of record on
January 8, 2004 and totaled $15.4 million. We expect to fund future dividend
payments with cash flows from operations, and do not expect the dividend to have
a material impact on our ability to finance future growth.

Share Repurchase Plan

In May 2003, our Board of Directors authorized a share repurchase program,
which permits us to purchase up to $300 million of our common stock. In October
2003, our Board of Directors increased our share repurchase authorization by an
additional $300 million. Through December 31, 2003, we have repurchased 4.0
million shares of our common stock at an average price of $64.54 per share for a
total of $258 million under the program. We expect to fund the share repurchase
program with cash flows from operations and do not expect the share repurchase
program to have a material impact on our ability to finance future growth.

Contingent Convertible Debentures

On November 30, 2004, 2005, 2008, 2012 and 2016 each holder of the
Debentures may require us to repurchase the holder's Debentures for the
principal amount of the Debentures plus any accrued and unpaid interest. We may
repurchase the $250 million Debentures for cash, common stock, or a combination
of both. We expect to settle any repurchases from any put on the Debentures with
a cash payment, funding such payment with a combination of cash on-hand and
borrowings under our credit facilities.

48

Contractual Obligations and Commitments

The following table summarizes certain of our contractual obligations as of
December 31, 2003. See Notes 11 and 15 to the Consolidated Financial Statements
for further details.

See Note 11 to the Consolidated Financial Statements for a full description
of the terms of our indebtedness and related debt service requirements. A full
discussion and analysis regarding our minimum rental commitments under
noncancelable operating leases, noncancelable commitments to purchase products
or services, and reserves with respect to insurance and billing-related claims
is contained in Note 15 to the Consolidated Financial Statements.

In December 2003, we entered into two lines of credit with two financial
institutions totaling $68 million for the issuance of letters of credit, which
mature in December 2004. Standby letters of credit are obtained, principally in
support of our risk management program, to ensure our performance or payment to
third parties and amounted to $57 million at December 31, 2003, of which $44
million was issued against the $68 million letter of credit lines with the
remaining $13 million issued against our $325 million unsecured revolving credit
facility. The letters of credit, which are renewed annually, primarily represent
collateral for automobile liability and workers' compensation loss payments.

Our credit agreements relating to our unsecured revolving credit facility
and our term loan facilities contain various covenants and conditions, including
the maintenance of certain financial ratios, that could impact our ability to,
among other things, incur additional indebtedness, repurchase shares of our
outstanding common stock, make additional investments and consummate
acquisitions. We do not expect these covenants to adversely impact our ability
to execute our growth strategy or conduct normal business operations.

Unconsolidated Joint Ventures

We have investments in unconsolidated joint ventures in Phoenix, Arizona;
Indianapolis, Indiana; and Dayton, Ohio, which are accounted for under the
equity method of accounting. We believe that our transactions with our joint
ventures are conducted at arm's length, reflecting current market conditions and
pricing. Total net revenues of our unconsolidated joint ventures, on a combined
basis, are less than 6% of our consolidated net revenues. Total assets
associated with our unconsolidated joint ventures are less than 3% of our
consolidated total assets. We have no material unconditional obligations or
guarantees to, or in support of, our unconsolidated joint ventures and their
operations.

Requirements and Capital Resources

We estimate that we will invest approximately $180 million to $190 million
during 2004 for capital expenditures to support and expand our existing
operations, principally related to investments in information technology,
equipment, and facility upgrades. During January 2004, $13 million in letters of
credit issued against our $325 million unsecured revolving credit facility were
cancelled and $17 million of letters of credit were issued under the letter
of credit lines. As of February 26, 2004, all of the $325 million unsecured
revolving credit facility and all of the $250 million secured receivables
credit facility remained available to us for future borrowing. Our secured
receivables credit facility is set to expire on April 21, 2004. We are
currently in discussions with our lenders regarding a replacement for the
facility and expect to have a replacement in place during the second quarter of
2004. If in the unexpected instance the facility is not renewed, we expect that
other sources of liquidity could be readily obtained.

We believe that cash from operations and our borrowing capacity under our
credit facilities and any replacement facilities will provide sufficient
financial flexibility to meet seasonal working capital requirements and to fund
capital expenditures, debt service requirements, cash dividends on common
shares, share repurchases

49

and additional growth opportunities for the foreseeable future, exclusive of any
potential temporary impact of the Health Insurance Portability and
Accountability Act of 1996, as discussed below. Our investment grade credit
ratings have had a favorable impact on our cost of and access to capital, and we
believe that our improved financial performance should provide us with access to
additional financing, if necessary, to fund growth opportunities that cannot be
funded from existing sources.

HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996

The Secretary of the Department of Human Health and Services, or HHS, has
issued final regulations under the Health Insurance Portability and
Accountability Act of 1996, or HIPAA, designed to improve the efficiency and
effectiveness of the healthcare system by facilitating the electronic exchange
of information in certain financial and administrative transactions while
protecting the privacy and security of the information exchanged. Three
principal regulations have been issued: privacy regulations, security
regulations, and standards for electronic transactions.

We implemented the HIPAA privacy regulations by April 2003, as required, and
are conducting an analysis to determine the proper security measures to
reasonably and appropriately comply with the standards and implementation
specifications by the compliance deadline of April 20, 2005.

The HIPAA regulations on electronic transactions, which we refer to as the
transaction standards, establish uniform standards for electronic transactions
and code sets, including the electronic transactions and code sets used for
claims, remittance advices, enrollment and eligibility.

On September 23, 2003, CMS announced that it would implement a
contingency plan for the Medicare program to accept electronic transactions that
are not fully compliant with the transaction standards after the October 16,
2003 compliance deadline. The CMS contingency plan, as announced, allows
Medicare carriers to continue to accept and process Medicare claims in the
pre-October 16 electronic formats to give healthcare providers additional time
to complete the testing process, provided that they continue to make a good
faith effort to comply with the new standards. Almost all other payers have
followed the lead of CMS, accepting legacy formats until both parties to the
transactions are ready to implement the new electronic transaction standards.

As part of its plan, CMS is expected to regularly reassess the readiness of
its healthcare providers to determine how long the contingency plan will remain
in effect. Many of our payers were not ready to implement the transaction
standards by the October 2003 compliance deadline or were not ready to test or
trouble-shoot claims submissions. We are working in good faith with payers that
have not converted to the new standards to reach agreement on each payer's data
requirements and to test claims submissions.

The HIPAA transaction standards are complex, and subject to differences in
interpretation by payers. For instance, some payers may interpret the standards
to require us to provide certain types of information, including demographic
information not usually provided to us by physicians. As a result of
inconsistent interpretation of transaction standards by payers or our inability
to obtain certain billing information not usually provided to us by physicians,
we could face increased costs and complexity, a temporary disruption in receipts
and ongoing reductions in reimbursements and net revenues. We are working
closely with our payers to establish acceptable protocols for claims submissions
and with our trade association and an industry coalition to present issues and
problems as they arise to the appropriate regulators and standards setting
organizations. Compliance with the HIPAA requirements requires significant
capital and personnel resources from all healthcare organizations. While we
believe that our total costs to comply with HIPAA will not be material to our
results of operations or cash flows, additional customer contact to obtain
data for billing as a result of different interpretations of the current
regulations could impose significant additional costs on us.

OUTLOOK

As discussed in the Overview, we believe that the underlying fundamentals of
the diagnostic testing industry will continue to improve and that the growth in
the market for laboratory testing will accelerate over the long term. We believe
that in the short term, the market will continue to expand, despite the negative
impact which the current levels of unemployed and uninsured, and healthcare plan
design changes are having on our business. As the leading national provider of
diagnostic testing, information and related services with the most extensive
network of laboratories and patient service centers throughout the United
States, we expect to further enhance patient access and customer service. We
provide a broad range of benefits for customers

50

including: continued improvements in quality; convenience and accessibility; a
broad test menu; and a broad range of information technology products to help
providers and insurers better manage their patients' health.

We continue to invest in areas that are differentiating us from our
competitors, including: Six Sigma quality, which is benefiting margins by
improving efficiencies and is beginning to attract new business by improving
service quality; state-of-the-art electronic client connectivity options that
enhance customer loyalty; and new tests and testing techniques including
gene-based testing. We also pursue selective acquisitions when they make
strategic and economic sense. While there are fewer large acquisition
opportunities available as a result of industry consolidation, there remain
numerous regional and local acquisition opportunities. Additionally, we see an
opportunity to use our strong customer service capabilities to expand our
current position in many markets around the country.

Our credit profile continues to improve. Our strong cash generation and
balance sheet position us well to take advantage of growth opportunities.

INFLATION

We believe that inflation generally does not have a material adverse effect
on our results of operations or financial condition because the majority of our
contracts are short term.

IMPACT OF NEW ACCOUNTING STANDARDS

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised in December 2003. The impact of this
accounting standard is discussed in Note 2 to the Consolidated Financial
Statements.

51

STATEMENT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS

The management of Quest Diagnostics Incorporated is responsible for the
preparation, presentation and integrity of the consolidated financial statements
and other information included in this annual report. The financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America and include certain amounts based on
management's best estimates and judgments.

Quest Diagnostics maintains a comprehensive system of internal controls
designed to provide reasonable assurance as to the reliability of the financial
statements as well as to safeguard assets from unauthorized use or disposition.
The system is reinforced by written policies, selection and training of highly
competent financial personnel, appropriate division of responsibilities and a
program of internal audits.

The Audit and Finance Committee of the Board of Directors is responsible for
reviewing and monitoring Quest Diagnostics' financial reporting and accounting
practices and the annual appointment of the independent auditors. The Audit and
Finance Committee meets periodically with management, the internal auditors and
the independent auditors to review and assess the activities of each. Both the
independent auditors and the internal auditors meet with the Audit and Finance
Committee, without management present, to review the results of their audits.

The consolidated financial statements have been audited by our independent
auditors, PricewaterhouseCoopers LLP. Their responsibility is to express an
opinion with respect to the consolidated financial statements on the basis of an
audit conducted in accordance with auditing standards generally accepted in the
United States of America.

By /s/ Kenneth W. Freeman Chairman of the Board and February 26, 2004
---------------------------- Chief Executive Officer
Kenneth W. Freeman

By /s/ Surya N. Mohapatra President and February 26, 2004
---------------------------- Chief Operating Officer
Surya N. Mohapatra

By /s/ Robert A. Hagemann Senior Vice President and February 26, 2004
---------------------------- Chief Financial Officer
Robert A. Hagemann

52

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders
of Quest Diagnostics Incorporated

In our opinion, the accompanying consolidated financial statements
listed in the index appearing under Item 15(a)(1) present fairly, in all
material respects, the financial position of Quest Diagnostics Incorporated and
its subsidiaries (the "Company") at December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the index appearing under Item
15(a)(2) presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

As discussed in Note 2 to the financial statements, the Company adopted SFAS
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which changed the
method of accounting for goodwill and other intangible assets effective January
1, 2002.

/s/ PricewaterhouseCoopers LLP
_______________________________
PricewaterhouseCoopers LLP
Stamford, Connecticut
January 23, 2004

F-1

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these statements.

F-2

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these statements.

F-3

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)

The accompanying notes are an integral part of these statements.

F-4

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)

RETAINED ACCUMULATED
ADDITIONAL EARNINGS UNEARNED OTHER COMPRE-
COMMON PAID-IN (ACCUMULATED COMPEN- COMPREHENSIVE TREASURY HENSIVE
STOCK CAPITAL DEFICIT) SATION INCOME (LOSS) STOCK INCOME

BALANCE, DECEMBER 31, 2000.......... $ 465 $1,591,976 $(525,111) $(31,077) $(5,458) $ -
Net income.......................... 162,303 $162,303
Other comprehensive income.......... 1,988 1,988
--------
Comprehensive income................ $164,291
--------
--------
Two-for-one stock split
(47,149 common shares)............. 472 (472)
Preferred dividends declared........ (118)
Issuance of common stock under
benefit plans (233 common shares).. 2 25,040 (3,540)
Exercise of stock options
(2,101 common shares).............. 21 25,610
Tax benefits associated with
stock-based compensation plans..... 71,917
Adjustment to Corning receivable.... 605
Amortization of unearned
compensation....................... 21,364
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001.......... 960 1,714,676 (362,926) (13,253) (3,470) -
Net income.......................... 322,154 $322,154
Other comprehensive loss............ (2,054) (2,054)
--------
Comprehensive income................ $320,100
--------
--------
Issuance of common stock under
benefit plans (418 common shares).. 4 31,310
Exercise of stock options
(1,521 common shares).............. 16 27,018
Tax benefits associated with
stock-ased compensation plans..... 44,507
Amortization of unearned
compensation....................... 9,921
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002.......... 980 1,817,511 (40,772) (3,332) (5,524) -
Net income.......................... 436,717 $436,717
Other comprehensive income.......... 11,471 11,471
--------
Comprehensive income................ $448,188
--------
--------
Dividend declared................... (15,386)
Shares issued to acquire Unilab
(7,055 common shares).............. 71 372,393
Fair value of Unilab converted
options............................ 8,452
Issuance of common stock under
benefit plans (400 common shares).. 4 18,081 (4,313)
Exercise of stock options
(1,567 common shares).............. 15 29,872
Shares to cover employee payroll tax
withholdings on stock issued under
benefit plans (181 common shares).. (2) (9,791)
Tax benefits associated with
stock-based compensation plans..... 30,496
Amortization of unearned
compensation....................... 5,299
Purchases of treasury stock
(3,990 common shares).............. (257,548)
- ----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2003.......... $1,068 $2,267,014 $ 380,559 $(2,346) $ 5,947 $(257,548)
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.

F-5

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

1. DESCRIPTION OF BUSINESS

Quest Diagnostics Incorporated and its subsidiaries ("Quest Diagnostics" or
the "Company") is the largest clinical laboratory testing business in the United
States. Prior to January 1, 1997, Quest Diagnostics was a wholly owned
subsidiary of Corning Incorporated ("Corning"). On December 31, 1996, Corning
distributed all of the outstanding shares of common stock of the Company to the
stockholders of Corning as part of the "Spin-Off Distribution".

As the nation's leading provider of diagnostic testing and related services
for the healthcare industry, Quest Diagnostics offers a broad range of clinical
laboratory testing services to physicians, hospitals, managed care
organizations, employers, governmental institutions and other commercial
clinical laboratories. Quest Diagnostics is the leading provider of esoteric
testing, including gene-based testing, and testing for drugs of abuse. The
Company is also a leading provider of anatomic pathology services and testing to
support clinical trials of new pharmaceuticals worldwide. Through the Company's
national network of laboratories and patient service centers, and its esoteric
testing laboratory and development facilities, Quest Diagnostics offers
comprehensive and innovative diagnostic testing, information and related
services used by physicians and other healthcare customers to diagnose, treat
and monitor diseases and other medical conditions.

During 2003, Quest Diagnostics processed over 130 million requisitions
through its extensive network of laboratories and patient service centers in
virtually every major metropolitan area throughout the United States.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of all entities
controlled by the Company. The equity method of accounting is used for
investments in affiliates which are not Company controlled, in which the
Company's ownership interest is between 20 and 49 percent and in which the
Company has significant influence. The Company's share of equity earnings from
investments in affiliates, accounted for under the equity method, totaled $17.4
million, $16.7 million and $10.8 million, respectively, for 2003, 2002 and 2001.
All significant intercompany accounts and transactions are eliminated in
consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.

Reclassifications

Certain amounts reported in the Company's consolidated statements of
operations for the years ended December 31, 2002 and 2001 have been reclassified
to conform to the December 31, 2003 presentation, which reports operating income
on the face of the consolidated statements of operations. In April 2002, the
Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). Pursuant to SFAS 145, the extraordinary loss associated with the
extinguishment of debt in 2001, previously presented net of applicable taxes,
was reclassified to other non-operating expenses. Certain amounts reported in
the Company's consolidated statements of cash flows for the years ended
December 31, 2002 and 2001 have been reclassified to conform to the December 31,
2003 presentation.

Revenue Recognition

The Company primarily recognizes revenue for services rendered upon
completion of the testing process. Billings for services under third-party payer
programs, including Medicare and Medicaid, are recorded as revenues net of
allowances for differences between amounts billed and the estimated receipts
under such

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

programs. Adjustments to the estimated receipts, based on final settlement
with the third-party payers, are recorded upon settlement. In 2003, 2002 and
2001, approximately 17%, 15% and 14%, respectively, of net revenues were
generated by Medicare and Medicaid programs. Under capitated agreements with
health insurers, the Company recognizes revenue based on a predetermined
monthly contractual rate for each member of the insurers' health plan
regardless of the number or cost of services provided by the Company.

Taxes on Income

The Company uses the asset and liability approach to account for income
taxes. Under this method, deferred tax assets and liabilities are recognized for
the expected future tax consequences of differences between the carrying amounts
of assets and liabilities and their respective tax bases using tax rates in
effect for the year in which the differences are expected to reverse. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period when the change is enacted.

Earnings Per Share

On May 8, 2001, the stockholders approved an amendment to the Company's
restated certificate of incorporation to increase the number of common shares
authorized from 100 million shares to 300 million shares. On May 31, 2001, the
Company effected a two-for-one stock split through the issuance of a stock
dividend of one new share of common stock for each share of common stock held by
stockholders of record on May 16, 2001. References to the number of common
shares and per common share amounts in the accompanying consolidated statements
of operations, including earnings per common share calculations and related
disclosures, have been restated to give retroactive effect to the stock split
for all periods presented.

Basic earnings per common share is calculated by dividing net income, less
preferred stock dividends ($30 per quarter in 2001), by the weighted average
common shares outstanding. Diluted earnings per common share is calculated by
dividing net income, less preferred stock dividends, by the weighted average
common shares outstanding after giving effect to all potentially dilutive common
shares outstanding during the period. The if-converted method is used in
determining the dilutive effect of the Company's 1 3/4% contingent convertible
debentures in periods when the holders of such securities are permitted to
exercise their conversion rights (see Note 11). Potentially dilutive common
shares include outstanding stock options and restricted common shares granted
under the Company's Employee Equity Participation Program. During the fourth
quarter of 2001, the Company redeemed all of its then issued and outstanding
shares of preferred stock.

The computation of basic and diluted earnings per common share was as
follows (in thousands, except per share data):

F-7

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The following securities were not included in the diluted earnings per share
calculation due to their antidilutive effect (in thousands):

Stock-Based Compensation

SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition
and Disclosure -- an amendment of FASB Statement No. 123" ("SFAS 148")
encourages, but does not require, companies to record compensation cost for
stock-based compensation plans at fair value. In addition, SFAS 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation, and amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.

The Company has chosen to adopt the disclosure only provisions of SFAS 148
and continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations. Under this approach, the cost of restricted stock awards is
expensed over their vesting period, while the imputed cost of stock option
grants and discounts offered under the Company's Employee Stock Purchase Plan
("ESPP") is disclosed, based on the vesting provisions of the individual grants,
but not charged to expense. Stock-based compensation expense recorded in
accordance with APB 25, relating to restricted stock awards, was $5 million, $9
million and $21 million in 2003, 2002 and 2001, respectively.

The Company has several stock ownership and compensation plans, which are
described more fully in Note 13. The following table presents net income and
basic and diluted earnings per common share, had the Company elected to
recognize compensation cost based on the fair value at the grant dates for stock
option awards and discounts granted for stock purchases under the Company's
ESPP, consistent with the method prescribed by SFAS 123, as amended by
SFAS 148:

F-8

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:

The majority of options granted in 2003 were issued prior to the declaration
of the Company's quarterly cash dividend in the fourth quarter of 2003 and as
such carry a dividend yield of 0%, thereby reducing the weighted average
dividend yield for 2003 to 0.0%.

Foreign Currency

Assets and liabilities of foreign subsidiaries are translated into U.S.
dollars at year-end exchange rates. Income and expense items are translated at
average exchange rates prevailing during the year. The translation adjustments
are recorded as a component of accumulated other comprehensive income (loss)
within stockholders' equity. Gains and losses from foreign currency transactions
are included within "other operating (income) expense, net" in the consolidated
statements of operations. Transaction gains and losses have not been material.

Cash and Cash Equivalents

Cash and cash equivalents include all highly-liquid investments with
maturities, at the time acquired by the Company, of three months or less.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations
of credit risk are principally cash, cash equivalents, short-term investments
and accounts receivable. The Company's policy is to place its cash, cash
equivalents and short-term investments in highly rated financial instruments and
institutions. Concentration of credit risk with respect to accounts receivable
is mitigated by the diversity of the Company's clients and their dispersion
across many different geographic regions, and is limited to certain customers
who are large buyers of the Company's services. To reduce risk, the Company
routinely assesses the financial strength of these customers and, consequently,
believes that its accounts receivable credit risk exposure, with respect to
these customers, is limited. While the Company has receivables due from federal
and state governmental agencies, the Company does not believe that such
receivables represent a credit risk since the related healthcare programs are
funded by federal and state governments, and payment is primarily dependent on
submitting appropriate documentation.

Inventories

Inventories, which consist principally of supplies, are valued at the lower
of cost (first in, first out method) or market.

Property, Plant and Equipment

Property, plant and equipment is recorded at cost. Major renewals and
improvements are capitalized, while maintenance and repairs are expensed as
incurred. Costs incurred for computer software developed or obtained for
internal use are capitalized for application development activities and expensed
as incurred for preliminary project activities and post-implementation
activities. Capitalized costs include external direct costs of materials and
services consumed in developing or obtaining internal-use software, payroll and
payroll-related costs for employees who are directly associated with and who
devote time to the internal-use software project and interest costs incurred,
when material, while developing internal-use software. Capitalization of such
costs ceases when the project is substantially complete and ready for its
intended purpose. Certain costs, such as

F-9

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

maintenance and training, are expensed as incurred. The Company capitalizes
interest on borrowings during the active construction period of major capital
projects. Capitalized interest is added to the cost of the underlying assets and
is amortized over the useful lives of the assets. Depreciation and amortization
are provided on the straight-line method over expected useful asset lives as
follows: buildings and improvements, ranging from ten to thirty years;
laboratory equipment and furniture and fixtures, ranging from three to seven
years; leasehold improvements, the lesser of the useful life of the improvement
or the remaining life of the building or lease, as applicable; and computer
software developed or obtained for internal use, ranging from three to five
years.

Goodwill

Goodwill represents the cost of acquired businesses in excess of the fair
value of assets acquired, including separately recognized intangible assets,
less the fair value of liabilities assumed in a business combination. In June
2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), which broadens the criteria for recording intangible assets
separate from goodwill and requires the use of a nonamortization approach to
account for purchased goodwill and certain intangibles. Under a nonamortization
approach, goodwill and certain intangibles are not amortized into results of
operations, but instead are reviewed for impairment. Prior to July 1, 2001,
goodwill was amortized on the straight-line method over periods not exceeding
forty years. Pursuant to SFAS 142, goodwill recorded in connection with
acquisitions consummated prior to July 1, 2001 continued to be amortized through
December 31, 2001 and has not been amortized thereafter. In addition, goodwill
recognized in connection with acquisitions consummated after June 30, 2001 has
not been amortized.

The following table presents net income and basic and diluted earnings per
common share, adjusted to reflect results as if the nonamortization provisions
of SFAS 142 had been in effect for the periods presented:

Intangible Assets

Intangible assets are recognized as an asset apart from goodwill if the
asset arises from contractual or other legal rights, or if it is separable.
Intangible assets, principally representing the cost of customer lists and
non-competition agreements acquired, are capitalized and amortized on the
straight-line method over their expected useful life, which generally ranges
from five to fifteen years. The Company does not have any intangible assets that
have an indefinite useful life.

Recoverability and Impairment of Goodwill

The new criteria for recording intangible assets separate from goodwill did
not require the Company to reclassify any of its intangible assets. Under the
nonamortization provisions of SFAS 142, goodwill and certain intangibles are not
amortized into results of operations, but instead are reviewed for impairment
and an impairment charge is recorded in the periods in which the recorded
carrying value of goodwill and certain

F-10

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

intangibles is more than its estimated fair value. The provisions of SFAS 142
require that a transitional impairment test be performed as of the beginning
of the year the statement is adopted. The provisions of SFAS 142 also require
that a goodwill impairment test be performed annually or in the case of other
events that indicate a potential impairment. The Company's transitional
impairment test indicated that there was no impairment of goodwill upon
adoption of SFAS 142 effective January 1, 2002. The annual impairment test of
goodwill was performed at the end of the Company's fiscal year on December
31st and indicated that there was no impairment of goodwill as of December 31,
2003.

Effective January 1, 2002, the Company evaluates the recoverability and
measures the potential impairment of its goodwill under SFAS 142. The annual
impairment test is a two-step process that begins with the estimation of the
fair value of the reporting unit. The first step screens for potential
impairment and the second step measures the amount of the impairment, if any.
Management's estimate of fair value considers publicly available information
regarding the market capitalization of the Company as well as (i) publicly
available information regarding comparable publicly-traded companies in the
clinical laboratory testing industry, (ii) the financial projections and future
prospects of the Company's business, including its growth opportunities and
likely operational improvements, and (iii) comparable sales prices, if
available. As part of the first step to assess potential impairment, management
compares the estimate of fair value for the Company to the book value of the
Company's consolidated net assets. If the book value of the consolidated net
assets is greater than the estimate of fair value, the Company would then
proceed to the second step to measure the impairment, if any. The second step
compares the implied fair value of goodwill with its carrying value. The implied
fair value is determined by allocating the fair value of the reporting unit to
all of the assets and liabilities of that unit as if the reporting unit had been
acquired in a business combination and the fair value of the reporting unit was
the purchase price paid to acquire the reporting unit. The excess of the fair
value of the reporting unit over the amounts assigned to its assets and
liabilities is the implied fair value of goodwill. If the carrying amount of the
reporting unit's goodwill is greater than its implied fair value, an impairment
loss will be recognized in the amount of the excess. Management believes its
estimation methods are reasonable and reflective of common valuation practices.

On a quarterly basis, management performs a review of the Company's business
to determine if events or changes in circumstances have occurred which could
have a material adverse effect on the fair value of the Company and its
goodwill. If such events or changes in circumstances were deemed to have
occurred, the Company would perform an impairment test of goodwill as of the end
of the quarter, consistent with the annual impairment test, and record any noted
impairment loss.

Prior to 2002, the Company evaluated the recoverability and measured the
possible impairment of goodwill under APB Opinion No. 17, "Intangible Assets"
based on a fair value methodology. The fair value method was applied to each of
the regional laboratories. Management's estimate of fair value was primarily
based on multiples of forecasted revenue or multiples of forecasted earnings
before interest, taxes, depreciation and amortization. The multiples were
primarily determined based upon publicly available information regarding
comparable publicly-traded companies in the industry, but also considered
(i) the financial projections of each regional laboratory, (ii) the future
prospects of each regional laboratory, including its growth opportunities,
managed care concentration and likely operational improvements, and
(iii) comparable sales prices, if available. During 2001, no impairments of
goodwill were recorded.

Recoverability and Impairment of Intangible Assets and Other Long-Lived
Assets

Effective January 1, 2002, the Company evaluates the possible impairment of
its long-lived assets, including intangible assets which are amortized pursuant
to the provisions of SFAS 142, under SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). The Company reviews the
recoverability of its long-lived assets when events or changes in circumstances
occur that indicate that the carrying value of the asset may not be recoverable.
Evaluation of possible impairment is based on the Company's ability to recover
the asset from the expected future pretax cash flows (undiscounted and without
interest charges) of the related operations. If the expected undiscounted pretax
cash flows are less than the carrying amount of such asset, an impairment loss
is recognized for the difference between the estimated fair value and carrying
amount of the asset. The Company's adoption of SFAS 144 did not result in any
impairment loss being recorded.

F-11

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Investments

The Company accounts for investments in equity securities, which are
included in "other assets" in conformity with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", which requires the use of
fair value accounting for trading or available-for-sale securities. Both
realized and unrealized gains and losses for trading securities are recorded
currently in earnings as a component of non-operating expenses within "other
income (expense), net" in the consolidated statements of operations. Unrealized
gains and losses for available-for-sale securities are recorded as a component
of accumulated other comprehensive income (loss) within stockholders' equity.
Gains and losses on securities sold are based on the average cost method.

Investments at December 31, 2003 and 2002 consisted of the following:

Investments in available-for-sale equity securities consist primarily of
equity securities in public corporations. Investments in trading equity
securities represent participant directed investments of deferred employee
compensation and related Company matching contributions held in a trust pursuant
to the Company's supplemental deferred compensation plan (see Note 13). Other
investments do not have readily determinable fair values and consist primarily
of investments in preferred and common shares of privately held companies.

As of December 31, 2003 and 2002, the Company had gross unrealized gains
(losses) from available-for-sale equity securities of $15.5 million and $(6.6)
million, respectively. "Other income (expense), net" for the year ended December
31, 2001 included a gain of $6.3 million associated with the sale of certain
available-for-sale equity securities. For the years ended December 31, 2003,
2002 and 2001, gains (losses) from trading equity securities totaled $1.9
million, $(1.0) million and $(0.1) million, respectively, and are included in
"other income (expense), net" within the consolidated statements of operations.

Financial Instruments

The Company's policy for managing exposure to market risks may include the
use of financial instruments, including derivatives. The Company has established
a control environment that includes 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 trading purposes.

SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"), as amended, requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Effective January 1,
2001, the Company adopted SFAS 133, as amended. The cumulative effect of the
change in accounting for derivative financial instruments upon adoption on
January 1, 2001 of SFAS 133, as amended, reduced comprehensive income by
approximately $1 million.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable and accrued expenses approximate fair value based on the short
maturity of these instruments. At December 31, 2003 and 2002, the fair value of
the Company's debt was estimated at $1.2 billion and $899 million, respectively,
using quoted market prices and yields for the same or similar types of
borrowings, taking into account the underlying terms of the debt instruments. At
December 31, 2003 and 2002, the estimated fair value exceeded the carrying value
of the debt by $86 million and $77 million, respectively.

F-12

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The Company's 1 3/4% contingent convertible notes due 2021 have a contingent
interest component that will require the Company to pay contingent interest
based on certain thresholds, as outlined in the indenture governing such notes.
The contingent interest component, which is more fully described in Note 11, is
considered to be a derivative instrument subject to SFAS 133, as amended. As
such, the derivative was recorded at its fair value in the consolidated balance
sheets and was not material at both December 31, 2003 and 2002.

Comprehensive Income

Comprehensive income encompasses all changes in stockholders' equity (except
those arising from transactions with stockholders) and includes net income, net
unrealized capital gains or losses on available-for-sale securities and foreign
currency translation adjustments.

Segment Reporting

The Company currently operates in one reportable business segment.
Substantially all of the Company's services are provided within the United
States, and substantially all of the Company's assets are located within the
United States. No one customer accounted for ten percent or more of net
revenues in 2003, 2002, or 2001.

New Accounting Standards

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised in December 2003 ("FIN 46"). FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. Historically, entities generally were not consolidated unless
the entity was controlled through voting interests. FIN 46 also requires
disclosures about variable interest entities that a company is not required to
consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 will apply to variable interest entities as
of March 31, 2004 for the Company. Also, certain disclosure requirements apply
to all financial statements issued after December 31, 2003, regardless of when
the variable interest entity was established. The adoption of this standard is
not expected to have a material impact on the Company's consolidated financial
statements.

3. BUSINESS ACQUISITIONS

Acquisition of Unilab Corporation

On February 28, 2003, the Company completed the acquisition of Unilab
Corporation ("Unilab"), the leading commercial clinical laboratory in
California. In connection with the acquisition, the Company paid $297 million in
cash and issued 7.1 million shares of Quest Diagnostics common stock to acquire
all of the outstanding capital stock of Unilab. In addition, the Company
reserved approximately 0.3 million shares of Quest Diagnostics common stock for
outstanding stock options of Unilab which were converted upon the completion of
the acquisition into options to acquire shares of Quest Diagnostics common stock
(the "converted options").

The aggregate purchase price of $698 million included the cash portion of
the purchase price of $297 million and transaction costs of approximately $20
million, with the remaining portion of the purchase price paid through the
issuance of 7.1 million shares of Quest Diagnostics common stock (valued at $372
million or $52.80 per share, based on the average closing stock price of Quest
Diagnostics common stock for the five trading days ended March 4, 2003) and the
issuance of approximately 0.3 million converted options (valued at approximately
$9 million, based on the Black Scholes option-pricing model). Of the total
transaction costs incurred, approximately $8 million was paid during fiscal
2002.

In conjunction with the acquisition of Unilab, the Company repaid $220
million of debt, representing substantially all of Unilab's then existing
outstanding debt, and related accrued interest. Of the $220 million, $124
million represents payments related to the Company's cash tender offer, which
was completed on March 7, 2003, for all of the outstanding $101 million
principal amount and related accrued interest of Unilab's 12 3/4%

F-13

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Senior Subordinated Notes due 2009 and $23 million of related tender premium and
associated tender offer costs.

The Company financed the cash portion of the purchase price and related
transaction costs, and the repayment of substantially all of Unilab's
outstanding debt and related accrued interest, with the proceeds from a new $450
million amortizing term loan due 2007 (see Note 11) and cash on-hand.

As part of the Unilab acquisition, Quest Diagnostics acquired all of
Unilab's operations, including its primary testing facilities in Los Angeles,
San Jose and Sacramento, California, and approximately 365 patient service
centers and 35 rapid response laboratories and approximately 4,100 employees.
The Company expects to realize significant benefits from the acquisition of
Unilab. As the leading commercial clinical laboratory in California, the
acquisition of Unilab positions the Company to capitalize on its leading
position within the laboratory testing industry, further enhancing its national
network and access to its comprehensive range of services. Customers and
patients are expected to benefit from the acquisition by having greater access
to diagnostic testing services through the Company's expanded network of patient
service centers. In addition, customers will be provided with state-of-the-art
electronic connectivity services, innovative technologies and an expanded
esoteric testing menu from the Company's Nichols Institute based in San Juan
Capistrano, California.

In connection with the acquisition of Unilab, as part of a settlement
agreement with the United States Federal Trade Commission, the Company entered
into an agreement to sell to Laboratory Corporation of America Holdings, Inc.,
("LabCorp"), certain assets in northern California for $4.5 million, including
the assignment of agreements with four independent physician associations
("IPA") and leases for 46 patient service centers (five of which also serve as
rapid response laboratories) (the "Divestiture"). Approximately $27 million in
annual net revenues were generated by capitated fees under the IPA contracts and
associated fee-for-service testing for physicians whose patients use these
patient service centers, as well as from specimens received directly from the
IPA physicians. The Company completed the transfer of assets and assignment of
the IPA agreements to LabCorp and recorded a $1.5 million gain in the third
quarter of 2003 in connection with the Divestiture, which is included in "other
operating (income) expense, net" within the consolidated statements of
operations.

The acquisition of Unilab was accounted for under the purchase method of
accounting. As such, the cost to acquire Unilab has been allocated to the assets
and liabilities acquired based on estimated fair values as of the closing date.
The consolidated financial statements include the results of operations of
Unilab subsequent to the closing of the acquisition.

The following table summarizes the Company's purchase price allocation
related to the acquisition of Unilab based on the estimated fair value of the
assets acquired and liabilities assumed on the acquisition date.

Based on management's review of the net assets acquired and consultations
with third-party valuation specialists, no intangible assets meeting the
criteria under SFAS No. 141, "Business Combinations", were

F-14

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

identified. Of the $736 million allocated to goodwill, approximately $85 million
is expected to be deductible for tax purposes.

Acquisition of American Medical Laboratories, Incorporated

On April 1, 2002, the Company completed its acquisition of all of the
outstanding voting stock of American Medical Laboratories, Incorporated, ("AML")
and an affiliated company of AML, LabPortal, Inc. ("LabPortal"), a provider of
electronic connectivity products, in an all-cash transaction with a combined
value of approximately $500 million, which included the assumption of
approximately $160 million in debt.

Through the acquisition of AML, Quest Diagnostics acquired all of AML's
operations, including two full-service laboratories, 51 patient service centers,
and hospital sales, service and logistics capabilities. The all-cash purchase
price of approximately $335 million and related transaction costs, together with
the repayment of approximately $150 million of principal and related accrued
interest, representing substantially all of AML's debt, was financed by Quest
Diagnostics with cash on-hand, $300 million of borrowings under its secured
receivables credit facility and $175 million of borrowings under its unsecured
revolving credit facility. During 2002, Quest Diagnostics repaid all of the $475
million in borrowings related to the acquisition of AML.

The acquisition of AML was accounted for under the purchase method of
accounting. As such, the cost to acquire AML has been allocated to the assets
and liabilities acquired based on estimated fair values as of the closing date.
The consolidated financial statements include the results of operations of AML
subsequent to the closing of the acquisition.

The following table summarizes the Company's purchase price allocation
related to the acquisition of AML based on the estimated fair value of the
assets acquired and liabilities assumed on the acquisition date.

Based on management's review of the net assets acquired and consultations
with valuation specialists, no intangible assets meeting the criteria under SFAS
No. 141, "Business Combinations", were identified. Of the $426 million allocated
to goodwill, approximately $17 million is expected to be deductible for tax
purposes.

Acquisition of LabPortal

The all-cash purchase price for LabPortal of approximately $4 million and
related transaction costs, together with the repayment of all of LabPortal's
outstanding debt of approximately $7 million and related accrued interest, was
financed by Quest Diagnostics with cash on-hand. The acquisition of LabPortal
was accounted for under the purchase method of accounting. As such, the cost to
acquire LabPortal has been allocated to the assets and liabilities acquired
based on estimated fair values as of the closing date, including approximately
$8 million of goodwill. The consolidated financial statements include the
results of operations of LabPortal subsequent to the closing of the acquisition.

F-15

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Pro Forma Combined Financial Information

The following unaudited pro forma combined financial information for the
years ended December 31, 2003 and 2002 assumes that the Unilab and AML
acquisitions and the Divestiture were completed on January 1, 2002. The
unaudited pro forma combined financial information for the year ended December
31, 2001 assumes that the AML acquisition was completed on January 1, 2001 (in
thousands, except per share data):

The pro forma combined financial information presented above reflects
certain reclassifications to the historical financial statements of Unilab and
AML to conform the acquired companies' accounting policies and classification of
certain costs and expenses to that of Quest Diagnostics. These adjustments had
no impact on pro forma net income. Pro forma results for the year ended December
31, 2003 exclude $14.5 million of direct transaction costs, which were incurred
and expensed by Unilab in conjunction with its acquisition by Quest Diagnostics.
Pro forma results for the year ended December 31, 2002 exclude $14.5 million and
$6.3 million, respectively, of direct transaction costs, which were incurred and
expensed by AML and Unilab, respectively, in conjunction with their acquisitions
by Quest Diagnostics.

2001 Acquisitions

During 2001, the Company acquired the assets of Clinical Laboratories of
Colorado, LLC and the assets of Las Marias Reference Lab Corp. and Laboratorio
Clinico Las Marias, Inc., a clinical laboratory based in San Juan, Puerto Rico.
During 2001, the Company also acquired the outstanding voting shares that it did
not already own of MedPlus, Inc., a leading developer and integrator of clinical
connectivity and data management solutions for healthcare organizations and
clinicians, and all of the voting stock of Clinical Diagnostic Services, Inc.
("CDS"), which operated a diagnostic testing laboratory and more than 50 patient
service centers in New York and New Jersey. Additionally, during 2001, the
Company acquired the minority ownership interest of a consolidated joint venture
from its joint venture partner. The combined purchase price for these
acquisitions was $155 million, which was paid primarily in cash.

The Company accounted for the above acquisitions under the purchase method
of accounting. In connection with the above transactions, the Company recorded
$153 million of goodwill during 2001, representing acquisition costs in excess
of the fair value of net assets acquired, and approximately $8 million
associated with non-compete agreements. The amounts paid under the non-compete
agreements are being amortized on the straight-line basis over their five-year
terms. During 2002, the Company recorded approximately $4 million of adjustments
to finalize the purchase price allocations associated with the businesses
acquired in 2001, primarily related to accruals for integration costs for
actions impacting the employees and operations of the acquired businesses,
partially offset by adjustments to finalize the deferred tax position of the
acquired entities.

The historical financial statements of Quest Diagnostics include the results
of operations of each acquired company subsequent to the closing of the
respective acquisition.

4. INTEGRATION OF ACQUIRED BUSINESSES

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146, which the Company
adopted effective January 1, 2003, requires that a liability for a cost
associated with an exit activity, including those related to employee
termination benefits and contractual obligations, be recognized when the
liability is incurred, and not necessarily the date of an entity's

F-16

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

commitment to an exit plan, as under previous accounting guidance. The
provisions of SFAS 146 apply to integration costs associated with actions that
impact the employees and operations of Quest Diagnostics. Costs associated with
actions that impact the employees and operations of an acquired company, such as
Unilab, are accounted for as a cost of the acquisition and included in goodwill
in accordance with Emerging Issues Task Force No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination".

Integration of Unilab Corporation

During the fourth quarter of 2003, the Company finalized its plan related to
the integration of Unilab into Quest Diagnostics' laboratory network. As part of
the plan, following the sale of certain assets to LabCorp as part of the
Divestiture, the Company closed its previously owned clinical laboratory in the
San Francisco Bay area and completed the integration of remaining customers in
the northern California area to Unilab's laboratories in San Jose and
Sacramento. The Company currently operates two laboratories in the Los Angeles
metropolitan area. As part of the integration plan, the Company plans to open a
new regional laboratory in the Los Angeles metropolitan area into which it will
integrate all of its business in the area.

During 2003, the Company recorded $9 million of costs associated with
executing the Unilab integration plan. The majority of these integration costs
related to employee severance and contractual obligations associated with leased
facilities and equipment. Employee groups affected as a result of this plan
include those involved in the collection and testing of specimens, as well as
administrative and other support functions. Of the $9 million in costs, $7.9
million was recorded in the fourth quarter of 2003 and related to actions that
impact the employees and operations of Unilab, was accounted for as a cost of
the Unilab acquisition and included in goodwill. Of the $7.9 million, $6.8
million related to employee severance benefits for approximately 150 employees,
with the remainder primarily related to contractual obligations. In addition,
$1.1 million of integration costs, related to actions that impact Quest
Diagnostics' employees and operations and comprised principally of employee
severance benefits for approximately 30 employees, were accounted for as a
charge to earnings in the third quarter of 2003 and included in "other operating
(income) expense, net" within the consolidated statements of operations. As of
December 31, 2003, accruals related to the Unilab integration plan totaled
$6.6 million. While the majority of the accrued costs at December 31, 2003
are expected to be paid in 2004, there are certain severance costs that
have payment terms extending into 2005.

Integration of American Medical Laboratories, Incorporated

During the third quarter of 2002, the Company finalized its plan related to
the integration of AML into Quest Diagnostics' laboratory network. The plan
focused principally on improving customer service by enabling the Company to
perform esoteric testing on the east and west coasts of the United States, and
redirecting certain physician testing volumes within its national network to
provide more local testing. As part of the plan, the Company's Chantilly,
Virginia laboratory, acquired as part of the AML acquisition, has become the
primary esoteric testing laboratory and hospital service center for the eastern
United States, complementing the Company's Nichols Institute esoteric testing
facility in San Juan Capistrano, California. Esoteric testing volumes have been
redirected within the Company's national network to provide customers with
improved turnaround time and customer service. The Company has completed the
transition of certain routine clinical laboratory testing previously performed
in the Chantilly, Virginia laboratory to other testing facilities within the
Company's regional laboratory network. A reduction in staffing occurred as the
Company executed the integration plan and consolidated duplicate or overlapping
functions and facilities. Employee groups affected as a result of this plan
included those involved in the collection and testing of specimens, as well as
administrative and other support functions.

In connection with the AML integration plan, the Company recorded $11
million of costs associated with executing the plan. The majority of these
integration costs related to employee severance and contractual obligations
associated with leased facilities and equipment. Of the total costs indicated
above, $9.5 million, related to actions that impact the employees and operations
of AML, was accounted for as a cost of the AML acquisition and included in
goodwill. Of the $9.5 million, $5.9 million related to employee severance
benefits for approximately 200 employees, with the remainder primarily related
to contractual obligations associated with leased facilities and equipment. In
addition, $1.5 million of integration costs, related to actions that impact

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Quest Diagnostics' employees and operations and comprised principally of
employee severance benefits for approximately 100 employees, were accounted for
as a charge to earnings in the third quarter of 2002 and included in "other
operating (income) expense, net" within the consolidated statements of
operations. As of December 31, 2003 and 2002, accruals related to the AML
integration plan totaled $4.1 million and $8.3 million, respectively. The
actions associated with the AML integration plan, including those related to
severed employees, were completed in 2003. The remaining accruals at
December 31, 2003, substantially all of which represented severance and facility
exit costs, are expected to be paid in 2004.

Integration of Clinical Diagnostic Services, Inc.

During the fourth quarter of 2002, the Company finalized its plan related to
the integration of CDS into Quest Diagnostics' laboratory network in the New
York metropolitan area. Of the $13.3 million of costs recorded in the fourth
quarter of 2002 in connection with the execution of the CDS integration plan,
all of which were associated with actions impacting the employees and operations
of CDS, $3 million related to employee severance benefits for approximately 150
employees with the remainder primarily associated with remaining contractual
obligations under facility and equipment leases. The costs outlined above were
recorded as a cost of the acquisition and included in goodwill. As of
December 31, 2003 and 2002, accruals related to the CDS integration plan totaled
$5.3 million and $10.3 million, respectively. The actions associated with the
CDS integration plan, including those related to severed employees, were
completed in 2003. The remaining accruals at December 31, 2003, substantially
all of which represented remaining contractual obligations under facility
leases, have terms extending beyond 2004.

Integration of SmithKline Beecham Clinical Laboratory Testing Business

On August 16, 1999, the Company completed the acquisition of SmithKline
Beecham Clinical Laboratories, Inc. ("SBCL"), which operated the clinical
laboratory business of SmithKline Beecham plc ("SmithKline Beecham"). During the
fourth quarter of 1999, Quest Diagnostics finalized its plan to integrate SBCL
into Quest Diagnostics' laboratory network and recorded the estimated costs
associated with executing the integration plan. The majority of these
integration costs related to employee severance, contractual obligations
associated with leased facilities and equipment, and the write-off of fixed
assets which management believed would have no future economic benefit upon
combining the operations. The plan focused principally on laboratory
consolidations in geographic markets served by more than one of the Company's
laboratories, and the redirection of testing volume within the Company's
national network to provide more local testing and improve customer service. The
actions associated with the SBCL integration plan, including those related to
severed employees, were completed as of June 30, 2001. During 2001, the Company
utilized $27 million of the remaining accruals established in connection with
the SBCL integration, principally related to the payment of severance benefits
to terminated employees. The remaining accruals associated with the SBCL
integration plan, principally comprised of remaining contractual obligations
under facility leases, were not material at December 31, 2002.

5. TAXES ON INCOME

In conjunction with the Spin-Off Distribution, the Company entered into a
tax sharing agreement with its former parent and a former subsidiary, that
provide the parties with certain rights of indemnification against each other.
As part of the SBCL acquisition agreements, the Company entered into a tax
indemnification arrangement with SmithKline Beecham that provides the parties
with certain rights of indemnification against each other.

The Company's pretax income (loss) consisted of $736 million, $547 million
and $290 million from U.S. operations and approximately $1.4 million, $(4.5)
million and $6.6 million from foreign operations for the years ended
December 31, 2003, 2002 and 2001, respectively.

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The components of income tax expense for 2003, 2002 and 2001 were as
follows:

A reconciliation of the federal statutory rate to the Company's effective
tax rate for 2003, 2002 and 2001 was as follows:

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 2003 and 2002 were as
follows:

As of December 31, 2003, the Company had estimated net operating loss
carryforwards for federal and state income tax purposes of $45 million and
$430 million, respectively, which expire at various dates through 2023. As of
December 31, 2003 and 2002, deferred tax assets associated with net operating
loss carryforwards for federal and state income tax purposes of $51 million and
$29 million, respectively, have each been reduced by a valuation reserve of $33
million and $27 million respectively.

Income taxes payable at December 31, 2003 and 2002 were $29 million and $20
million, respectively, and consisted primarily of federal income taxes payable
of $22 million and $23 million, respectively.

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

6. SUPPLEMENTAL CASH FLOW AND OTHER DATA

7. LOSS ON DEBT EXTINGUISHMENT

On June 27, 2001, the Company refinanced a majority of its long-term debt on
a senior unsecured basis to reduce overall interest costs and obtain less
restrictive covenants. Specifically, the Company completed a $550 million senior
notes offering (the "Senior Notes") and entered into a new $500 million senior
unsecured credit facility (the "Credit Agreement") which included a five-year
$325 million revolving credit agreement and a $175 million term loan. The
Company used the net proceeds from the senior notes offering and the term loan,
together with cash on hand, to repay all of the $584 million which was
outstanding under its then existing senior secured credit agreement, including
the costs to settle existing interest rate swap agreements, and to consummate a
cash tender offer and consent solicitation for its 10 3/4% senior subordinated
notes due 2006 (the "Subordinated Notes"). During the remainder of 2001, the
Company repaid the $175 million term loan under the Credit Agreement.

In conjunction with its debt refinancing, the Company recorded a loss on
debt extinguishment of $42 million, $36 million of which represented the
write-off of $23 million of deferred financing costs, associated with the
Company's debt which was refinanced, and $13 million of payments related
primarily to the tender premium incurred in connection with the Company's cash
tender offer of the Subordinated Notes. The remaining $6 million of losses
represented amounts incurred in conjunction with the cancellation of certain
interest rate swap agreements, which were terminated in connection with the debt
that was refinanced. Prior to the Company's debt refinancing in June 2001, the
Company's senior secured credit agreement required the Company to maintain
interest rate swap agreements to mitigate the risk of changes in interest rates
associated with a portion of its variable interest rate indebtedness. These
interest rate swap agreements were considered a hedge against changes in the
amount of future cash flows associated with the interest payments of the
Company's variable rate debt obligations. Accordingly, the interest rate swap
agreements were recorded at their estimated fair value in the Company's
consolidated balance sheet and the related losses on these contracts were
deferred in stockholders' equity as a component of comprehensive income. In
conjunction with the debt refinancing, the interest rate swap agreements were
terminated and the losses reflected in stockholders' equity as a component of
comprehensive income were reclassified to earnings and reflected as a charge
within the loss on debt extinguishment in the consolidated statements of
operations for the year ended December 31, 2001.

F-20

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

8. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment at December 31, 2003 and 2002 consisted of the
following:

9. GOODWILL AND INTANGIBLE ASSETS

Goodwill at December 31, 2003 and 2002 consisted of the following:

The changes in the gross carrying amount of goodwill for the years ended
December 31, 2003 and 2002 are as follows:

Intangible assets at December 31, 2003 and 2002 consisted of the following:

Amortization expense related to intangible assets was $8,201, $8,373 and
$7,715 for the years ended December 31, 2003, 2002 and 2001, respectively.

F-21

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The estimated amortization expense related to other intangible assets for
each of the five succeeding fiscal years and thereafter as of December 31, 2003
is as follows:

10. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses at December 31, 2003 and 2002
consisted of the following:

11. DEBT

Long-term debt at December 31, 2003 and 2002 consisted of the following:

Secured Receivables Credit Facility

On July 21, 2000, the Company completed a receivables-backed financing
transaction (the "secured receivables credit facility"), the proceeds of which
were used to pay down loans outstanding under the Company's then existing senior
secured credit facility that was used to finance the acquisition of SBCL. The
secured receivables credit facility is currently being provided by Blue Ridge
Asset Funding Corporation, a commercial paper funding vehicle administered by
Wachovia Bank, N.A., La Fayette Asset Securitization LLC, a commercial funding
vehicle administered by Credit Lyonnais and Jupiter Securitization Corporation,
a commercial funding vehicle administered by Bank One, N.A.

Interest on the $250 million secured receivables credit facility is based on
rates that are intended to approximate commercial paper rates for highly rated
issuers. Borrowings outstanding under the secured receivables credit facility,
if any, are classified as a current liability on our consolidated balance sheet
since the

F-22

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

lenders fund the borrowings through the issuance of commercial paper which
matures at various dates within one year from the date of issuance and the term
of the one-year back-up facilities described below. There were no borrowings
outstanding as of December 31, 2003 and 2002.

The secured receivables credit facility has the benefit of one-year back-up
facilities provided by three banks on a committed basis. On June 27, 2003, the
Company extended the expiration date of the back-up facilities of its secured
receivables credit facility from July 21, 2003 to April 21, 2004. The Company is
currently in discussions with its lenders regarding a replacement for the
facility and expects to have a replacement in place during the second quarter of
2004.

Credit Agreement

The Credit Agreement currently includes a $325 million unsecured revolving
credit facility which expires in June 2006. Interest on the unsecured revolving
credit facility is based on certain published rates plus an applicable margin
that will vary over an approximate range of 50 basis points based on changes in
the Company's credit ratings. At the option of the Company, it may elect to
enter into LIBOR-based interest rate contracts for periods up to 180 days.
Interest on any outstanding amounts not covered under the LIBOR-based interest
rate contracts is based on an alternate base rate, which is calculated by
reference to the prime rate or federal funds rate (as defined in the Credit
Agreement). Additionally, the Company has the ability to borrow up to $200
million under the $325 million unsecured revolving credit facility at rates
determined by a competitive bidding process among the lenders. As of
December 31, 2003, the Company's borrowing rate for LIBOR-based loans was LIBOR
plus 1.1875%. As of December 31, 2003 and 2002, there were no borrowings
outstanding under the unsecured revolving credit facility.

Borrowings under the Credit Agreement are guaranteed by our wholly owned
subsidiaries that operate clinical laboratories in the United States (the
"Subsidiary Guarantors"). The Credit Agreement contains various covenants,
including the maintenance of certain financial ratios, which could impact the
Company's ability to, among other things, incur additional indebtedness,
repurchase shares of its outstanding common stock, make additional investments
and consummate acquisitions.

Term Loan due June 2007

As discussed in Note 3, the Company financed the cash portion of the
purchase price and related transaction costs associated with the Unilab
acquisition, and the repayment of substantially all of Unilab's outstanding debt
and related accrued interest, with the proceeds from a $450 million amortizing
term loan facility (the "term loan due June 2007") and cash on-hand. The term
loan due June 2007 carries interest at LIBOR plus an applicable margin that
can fluctuate over a range of up to 80 basis points, based on changes in the
Company's credit rating. At the option of the Company, it may elect to enter
into LIBOR-based interest rate contracts for periods up to 180 days. Interest
on any outstanding amounts not covered under the LIBOR-based interest rate
contracts is based on an alternate base rate, which is calculated by reference
to the prime rate or federal funds rate. As of December 31, 2003, the Company's
borrowing rate for LIBOR-based loans was LIBOR plus 1.1875%. As of December 31,
2003, the term loan due June 2007 required remaining principal repayments of
the initial amount borrowed equal to 16.18%, 16.18%, 17.19% and 18.2% in 2004
through 2007, respectively. The term loan due June 2007 is guaranteed by the
Subsidiary Guarantors and contains various covenants similar to those under
the Credit Agreement. Through December 31, 2003, the Company has repaid $145
million of principal under the term loan due June 2007. On January 12, 2004,
the Company repaid an additional $75 million of principal under the term loan
due June 2007 with the proceeds from a lower cost term loan due Decemeber
2008. The repayment in 2004 reduces the remaining principal payments of the
initial amount borrowed equal to 9.7%, 13.0%, 13.8% and 14.6% in 2004 through
2007, respectively.

Term Loan due December 2008

On December 19, 2003, the Company entered into a new $75 million amortizing
term loan facility (the "term loan due December 2008"), which was funded on
January 12, 2004 and the proceeds of which were used to repay $75 million under
the term loan due June 2007. The term loan due December 2008 carries a lower
interest rate than the

F-23

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

term loan due June 2007 and is based on LIBOR plus an applicable margin that
can fluctuate over a range of up to 119 basis points, based on changes in the
Company's public debt rating. At the option of the Company, it may elect to
enter into LIBOR-based interest rate contracts for periods up to 180 days.
Interest on any outstanding amounts not covered under the LIBOR-based interest
rate contracts is based on an alternate base rate, which is calculated by
reference to the prime rate or federal funds rate. As of December 31, 2003, the
Company's borrowing rate for LIBOR-based loans was LIBOR plus 0.55%. The term
loan due December 2008 requires principal repayments of the initial amount
borrowed equal to 20% on each of the third and fourth anniversary dates of the
funding and the remainder of the outstanding balance on December 31, 2008. The
term loan due December 2008 is guaranteed by the Subsidiary Guarantors and
contains various covenants similar to those under the Credit Agreement.

Senior Notes

In conjunction with its 2001 debt refinancing (see Note 7), the Company
completed a $550 million senior notes offering in June 2001. The Senior Notes
were issued in two tranches: (a) $275 million aggregate principal amount of
6 3/4% senior notes due 2006 ("Senior Notes due 2006"), issued at a discount of
approximately $1.6 million and (b) $275 million aggregate principal amount of
7 1/2% senior notes due 2011 ("Senior Notes due 2011"), issued at a discount of
approximately $1.1 million. After considering the discounts, the effective
interest rate on the Senior Notes due 2006 and Senior Notes due 2011 is 6.9% and
7.6%, respectively. The Senior Notes require semiannual interest payments which
commenced January 12, 2002. The Senior Notes are unsecured obligations of the
Company and rank equally with the Company's other unsecured senior obligations.
The Senior Notes are guaranteed by the Subsidiary Guarantors and do not have
a sinking fund requirement.

1 3/4% Contingent Convertible Debentures

On November 26, 2001, the Company completed its $250 million offering of
1 3/4% contingent convertible debentures due 2021 (the "Debentures"). The net
proceeds of the offering, together with cash on hand, were used to repay all of
the $256 million principal that was then outstanding under the Company's secured
receivables credit facility. The Debentures, which pay a fixed rate of interest
semi-annually commencing on May 31, 2002, have a contingent interest component,
which is considered to be a derivative instrument subject to SFAS 133, as
amended, that will require the Company to pay contingent interest based on
certain thresholds, as outlined in the indenture governing the Debentures. For
income tax purposes, the Debentures are considered to be a contingent payment
security. As such, interest expense for tax purposes is based on an assumed
interest rate related to a comparable fixed interest rate debt security issued
by the Company without a conversion feature. The assumed interest rate for tax
purposes was 7% for both 2003 and 2002.

The Debentures are guaranteed by the Subsidiary Guarantors and do not have a
sinking fund requirement.

Each one thousand dollar principal amount of Debentures is convertible
initially into 11.429 shares of the Company's common stock, which represents an
initial conversion price of $87.50 per share. Holders may surrender the
Debentures for conversion into shares of the Company's common stock under any of
the following circumstances: (1) if the sales price of the Company's common
stock is above 120% of the conversion price (or $105 per share) for specified
periods; (2) if the Company calls the Debentures or (3) if specified corporate
transactions have occurred.

The Company may call the Debentures at any time on or after November 30,
2004 for the principal amount of the Debentures plus any accrued and unpaid
interest. On November 30, 2004, 2005, 2008, 2012 and 2016 each holder of the
Debentures may require the Company to repurchase the holder's Debentures for the
principal amount of the Debentures plus any accrued and unpaid interest. The
Company may repurchase the Debentures for cash, common stock, or a combination
of both. The Company intends to settle any repurchases with a cash payment,
funding such payment with a combination of cash on-hand and borrowings under its
unsecured revolving credit facility. The Debentures are classified as long-term
debt on the consolidated balance sheet at December 31, 2003 due to the Company's
existing ability and intent to refinance the Debentures on a long-term basis in
the event the Debentures are put to the Company in November 2004.

F-24

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Letter of Credit Lines

In December 2003, the Company entered into two lines of credit with two
financial institutions totaling $68 million for the issuance of letters of
credit (the "letter of credit lines"). The letter of credit lines mature in
December 2004 and are guaranteed by the Subsidiary Guarantors. As of December
31, 2003, there $44 million of outstanding letters of credit under the letter
of credit lines.

As of December 31, 2003, long-term debt, including capital leases, maturing
in each of the years subsequent to December 31, 2004, is as follows:

The table above assumes that the Debentures are repaid at their stated
maturity in 2021.

12. PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY

Series Preferred Stock

Quest Diagnostics is authorized to issue up to 10 million shares of Series
Preferred Stock, par value $1.00 per share. The Company's Board of Directors has
the authority to issue such shares without stockholder approval and to determine
the designations, preferences, rights and restrictions of such shares. Of the
authorized shares, 1,300,000 shares have been designated Series A Preferred
Stock and 1,000 shares have been designated Voting Cumulative Preferred Stock.
No shares have been issued, other than the Voting Cumulative Preferred Stock.

Voting Cumulative Preferred Stock

During the fourth quarter of 2001, the Company redeemed all of the then
issued and outstanding shares of preferred stock for $1 million plus accrued
dividends. The Voting Cumulative Preferred Stock is generally entitled to one
vote per share, voting together as one class with the Company's common stock.
Whenever dividends on the Voting Cumulative Preferred Stock are in arrears, no
dividends or redemptions or purchases of shares may be made with respect to any
stock ranking junior as to dividends or liquidation to the Voting Cumulative
Preferred Stock until all such amounts have been paid. The Voting Cumulative
Preferred Stock is not convertible into shares of any other class or series of
stock of the Company. The Voting Cumulative Preferred Stock ranks senior to the
Quest Diagnostics common stock and the Series A Preferred Stock.

Preferred Share Purchase Rights

Each share of Quest Diagnostics common stock trades with a preferred share
purchase right, which entitles stockholders to purchase one-hundredth of a share
of Series A Preferred Stock upon the occurrence of certain events. In
conjunction with the SBCL acquisition, the Board of Directors of the Company
approved an amendment to the preferred share purchase rights. The amended rights
entitle stockholders to purchase shares of Series A Preferred Stock at a
predefined price in the event a person or group (other than SmithKline Beecham)
acquires 20% or more of the Company's outstanding common stock. The preferred
share purchase rights expire December 31, 2006.

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QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) for 2003,
2002 and 2001 were as follows:

The market value adjustments for 2003, 2002 and 2001 represented unrealized
holding gains (losses), net of taxes.

For the year ended December 31, 2001, other comprehensive income included
the cumulative effect of the change in accounting for derivative financial
instruments upon adoption of SFAS 133, as amended, which reduced comprehensive
income by approximately $1 million. In addition, in conjunction with the
Company's debt refinancing, the interest rate swap agreements were terminated
and the losses reflected in stockholders' equity as a component of comprehensive
income were reclassified to earnings and reflected within the loss on debt
extinguishment in the consolidated statements of operations for the year ended
December 31, 2001 (see Note 7).

Dividend Policy

Through October 20, 2003, the Company never declared or paid cash dividends
on its common stock. On October 21, 2003, the Company's Board of Directors
declared a quarterly cash dividend of $0.15 per common share. The initial $15.4
million quarterly dividend was paid on January 23, 2004 to shareholders of
record on January 8, 2004.

Share Repurchase Plan

In May 2003, the Company's Board of Directors authorized a share repurchase
program, which permits the Company to purchase up to $300 million of its common
stock. In October 2003, the Board of Directors increased the share repurchase
authorization by an additional $300 million. Through December 31, 2003, the
Company has repurchased 4.0 million shares of its common stock at an average
price of $64.54 per share for a total of $258 million under the program.

13. STOCK OWNERSHIP AND COMPENSATION PLANS

Employee and Non-employee Directors Stock Ownership Programs

In 1999, the Company established the 1999 Employee Equity Participation
Program (the "1999 EEPP") to replace the Company's prior plan established in
1996 (the "1996 EEPP"). The 1999 EEPP provides for three types of awards: (a)
stock options, (b) stock appreciation rights and (c) incentive stock awards. The
1999 EEPP provides for the grant to eligible employees of either non-qualified
or incentive stock options, or both, to purchase shares of Quest Diagnostics
common stock at no less than the fair market value on the date of grant. The
stock options are subject to forfeiture if employment terminates prior to the
end of the prescribed vesting

F-26

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

period, as determined by the Board of Directors. The stock options expire on the
date designated by the Board of Directors but in no event more than eleven years
from date of grant. Grants of stock appreciation rights allow eligible employees
to receive a payment based on the appreciation of Quest Diagnostics common
stock in cash, shares of Quest Diagnostics common stock or a combination
thereof. The stock appreciation rights are granted at an exercise price at no
less than the fair market value of Quest Diagnostics common stock on the date
of grant. Stock appreciation rights expire on the date designated by the Board
of Directors but in no event more than eleven years from date of grant. No stock
appreciation rights have been granted under the 1999 EEPP. Under the incentive
stock provisions of the plan, the 1999 EEPP allows eligible employees to receive
awards of shares, or the right to receive shares, of Quest Diagnostics common
stock, the equivalent value in cash or a combination thereof. These shares are
generally earned on achievement of financial performance goals and are subject
to forfeiture if employment terminates prior to the end of the prescribed
vesting period, which ranges primarily from three to four years. The market
value of the shares awarded is recorded as unearned compensation. The amount of
unearned compensation is subject to adjustment based upon changes in earnings
estimates, if any, during the initial year of grant and is amortized to
compensation expense over the prescribed vesting period. Key executive,
managerial and technical employees are eligible to participate in the 1999 EEPP.
The provisions of the 1996 EEPP were similar to those outlined above for the
1999 EEPP.

The 1999 EEPP increased the maximum number of shares of Quest Diagnostics
common stock that may be optioned or granted to 18 million shares. In addition,
any remaining shares under the 1996 EEPP are available for issuance under the
1999 EEPP.

In 1998, the Company established the Quest Diagnostics Incorporated Stock
Option Plan for Non-employee Directors (the "Director Option Plan"). The
Director Option Plan provides for the grant to non-employee directors of
non-qualified stock options to purchase shares of Quest Diagnostics common
stock at no less than fair market value on the date of grant. The maximum number
of shares that may be issued under the Director Option Plan is 1 million shares.
The stock options expire ten years from date of grant and generally vest over
three years. During 2003, 2002 and 2001, grants under the Director Option Plan
totaled 94, 94 and 81 thousand shares, respectively.

Transactions under the stock option plans were as follows (options in
thousands, except per share amounts):

F-27

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

The following relates to options outstanding at December 31, 2003:

The following summarizes the activity relative to incentive stock awards
granted in 2003, 2002 and 2001 (shares in thousands):

The balance of the incentive stock awards at December 31, 2003 are subject
to forfeiture if employment terminates prior to the end of the prescribed
vesting period.

Employee Stock Purchase Plan

Under the Company's Employee Stock Purchase Plan ("ESPP"), substantially all
employees can elect to have up to 10% of their annual wages withheld to purchase
Quest Diagnostics common stock. The purchase price of the stock is 85% of the
lower of its beginning-of-quarter or end-of-quarter market price. Under the
ESPP, the maximum number of shares of Quest Diagnostics common stock which may
be purchased by eligible employees is 4 million. Approximately 272, 236 and 203
thousand shares of common stock were purchased by eligible employees in 2003,
2002 and 2001, respectively.

Employee Stock Ownership Plan

Prior to 1999, the Company maintained its Employee Stock Ownership Plan
("ESOP") to account for certain shares of Quest Diagnostics common stock which
had been issued for the account of all active regular employees of the Company
as of December 31, 1996. Effective with the closing of the SBCL acquisition, the
Company modified certain provisions of the ESOP to provide an additional benefit
to employees through ownership of the Company's common stock. During the year
ended December 31, 2002, the ESOP was merged into the Company's defined
contribution plan. Prior to the merger of the ESOP into the Company's defined
contribution plan, substantially all of the Company's employees were eligible to
participate in the ESOP. The Company's contributions to the ESOP trust were
based on 2% of eligible employee compensation for those employees who were
actively employed or on a leave of absence on the last day of the Plan year.
Company contributions to the trust were made in the form of shares of Quest
Diagnostics common stock. The Company's contributions to this plan aggregated
$10.4 million and $19.7 million for 2002 and 2001, respectively.

F-28

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Defined Contribution Plan

The Company maintains a qualified defined contribution plan covering
substantially all of its employees. During the year ended December 31, 2002, the
ESOP, to which the Company made annual contributions equal to 2% of eligible
compensation, was merged into the Company's defined contribution plan and the
Company increased its maximum matching contribution for its defined contribution
plan from 4% to 6% of an employee's eligible wages. The Company's expense for
contributions to its defined contribution plan aggregated $54 million, $42
million and $30 million for 2003, 2002 and 2001, respectively.

Supplemental Deferred Compensation Plan

The Company's supplemental deferred compensation plan is an unfunded,
non-qualified plan that provides for certain management and highly compensated
employees to defer up to 50% of their eligible compensation. The compensation
deferred under this plan, together with Company matching amounts, are credited
with earnings or losses measured by the mirrored rate of return on investments
elected by plan participants. Each plan participant is fully vested in all
deferred compensation, Company match and earnings credited to their account.
Although the Company is currently contributing all participant deferrals and
matching amounts to a trust, the funds in the trust, totaling $19.2 million and
$14.8 million at December 31, 2003 and 2002, respectively, are general assets of
the Company and are subject to any claims of the Company's creditors. The
Company's expense for matching contributions to this plan were $0.4 million,
$0.4 million and $0.6 million for 2003, 2002 and 2001, respectively.

14. RELATED PARTY TRANSACTIONS

As a result of the merger of Glaxo Wellcome and SmithKline Beecham in
December 2000, GlaxoSmithKline plc ("GSK") currently beneficially owns
approximately 22% of the outstanding shares of Quest Diagnostics common stock.

As part of the SBCL acquisition agreements, SmithKline Beecham and Quest
Diagnostics entered into data access agreements under which Quest Diagnostics
granted SmithKline Beecham and certain affiliated companies certain
non-exclusive rights and access to use Quest Diagnostics' proprietary clinical
laboratory information database, which were terminated as of December 31, 2002.

In addition to the contracts outlined above, GSK has a long-term contractual
relationship with Quest Diagnostics under which Quest Diagnostics is the primary
provider of testing to support GSK's and SmithKline Beecham's clinical trials
testing requirements worldwide (the "Clinical Trials Agreements").

Significant transactions with GSK and SmithKline Beecham during 2003, 2002
and 2001 included:

In addition, under the SBCL acquisition agreements, SmithKline Beecham has
agreed to indemnify Quest Diagnostics, on an after tax basis, against certain
matters primarily related to taxes and billing and professional liability
claims.

At December 31, 2003 and 2002, accounts payable and accrued expenses
included $21 million and $26 million, respectively, due to SmithKline Beecham,
primarily related to tax benefits associated with indemnifiable matters.

During 2001, the Company received $8.7 million from Corning related to
certain indemnified billing-related claims settled in 2001 and 2000.

F-29

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

15. COMMITMENTS AND CONTINGENCIES

Minimum rental commitments under noncancelable operating leases, primarily
real estate, in effect at December 31, 2003 are as follows:

Operating lease rental expense for 2003, 2002 and 2001 aggregated $121
million, $97 million and $83 million, respectively.

The Company has certain noncancelable commitments to purchase products or
services from various suppliers, mainly for telecommunications and standing
orders to purchase reagents and other laboratory supplies. At December 31, 2003,
the approximate total future purchase commitments are $75 million, of which $39
million are expected to be incurred in 2004.

In support of its risk management program, the Company has standby letters
of credit issued under its letter of credit lines and unsecured revolving credit
facility to ensure its performance or payment to third parties, which amounted
to $57 million at December 31, 2003, of which $44 million was issued against the
letter of credit lines with the remaining $13 million issued against our $325
million unsecured revolving credit facility. The letters of credit, which are
renewed annually, primarily represent collateral for current and future
automobile liability and workers' compensation loss payments. During January
2004, $13 million in letters of credit issued against the $325 million unsecured
revolving credit facility were cancelled and $17 million of letters of credit
were issued under the letter of credit lines.

The Company has entered into several settlement agreements with various
government and private payers during recent years relating to industry-wide
billing and marketing practices that had been substantially discontinued by
the mid-1990s. In addition, the Company is aware of several pending lawsuits
filed under the qui tam provisions of the civil False Claims Act and has
received notices of private claims relating to billing issues similar to those
that were the subject of prior settlements with various government payers. Some
of the proceedings against the Company involve claims that are substantial in
amount. Some of the cases involve the operations of Unilab prior to the closing
of the Unilab acquisition.

Although management believes that established reserves for both indemnified
and non-indemnified claims are sufficient, it is possible that additional
information (such as the indication by the government of criminal activity,
additional tests being questioned or other changes in the government's or
private claimants' theories of wrongdoing) may become available which may cause
the final resolution of these matters to exceed established reserves by an
amount which could be material to the Company's results of operations and cash
flows in the period in which such claims are settled. The Company does not
believe that these issues will have a material adverse effect on its overall
financial condition.

In addition to the billing-related settlement reserves discussed above, the
Company is involved in various legal proceedings arising in the ordinary course
of business. Some of the proceedings against the Company involve claims that are
substantial in amount. Although management cannot predict the outcome of such
proceedings or any claims made against the Company, management does not
anticipate that the ultimate outcome of the various proceedings or claims will
have a material adverse effect on our financial position but may be material to
the Company's results of operations and cash flows in the period in which such
proceedings or claims are resolved.

F-30

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

As a general matter, providers of clinical laboratory 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 programs for
claims that could result from providing or failing to provide clinical
laboratory 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. The basis for claims reserves incorporates
actuarially determined losses based upon the Company's historical and projected
loss experience. Management believes that present insurance coverage and
reserves are sufficient to cover currently estimated exposures. Although
management cannot predict the outcome of any claims made against the Company,
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
position but may be material to the Company's results of operations and cash
flows in the period in which such claims are resolved.

16. SUMMARIZED FINANCIAL INFORMATION

As described in Note 11, the Senior Notes and the Debentures are guaranteed
by the Subsidiary Guarantors. With the exception of Quest Diagnostics
Receivables Incorporated (see paragraph below), the non-guarantor subsidiaries
are primarily foreign and less than wholly owned subsidiaries.

In conjunction with the Company's secured receivables credit facility
described in Note 11, the Company formed a new wholly owned non-guarantor
subsidiary, Quest Diagnostics Receivables Incorporated ("QDRI"). The Company and
the Subsidiary Guarantors, with the exception of AML and Unilab, transfer all
private domestic receivables (principally excluding receivables due from
Medicare, Medicaid and other federal programs, and receivables due from
customers of its joint ventures) to QDRI. QDRI utilizes the transferred
receivables to collateralize the Company's secured receivables credit facility.
The Company and the Subsidiary Guarantors provide collection services to QDRI.
QDRI uses cash collections principally to purchase new receivables from the
Company and the Subsidiary Guarantors.

The following condensed consolidating financial data illustrates the
composition of the combined guarantors. Investments in subsidiaries are
accounted for by the parent using the equity method for purposes of the
supplemental consolidating presentation. Earnings (losses) of subsidiaries are
therefore reflected in the parent's investment accounts and earnings. The
principal elimination entries relate to investments in subsidiaries and
intercompany balances and transactions. On April 1, 2002, Quest Diagnostics
acquired AML (see Note 3), which has been included in the accompanying condensed
consolidating financial data, subsequent to the closing of the acquisition, as a
Subsidiary Guarantor. On February 28, 2003, Quest Diagnostics acquired Unilab
(see Note 3), which has been included in the accompanying condensed
consolidating financial data, subsequent to the closing of the acquisition, as a
Subsidiary Guarantor.

F-31

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Condensed Consolidating Balance Sheet
December 31, 2003

Condensed Consolidating Balance Sheet
December 31, 2002

F-32

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Condensed Consolidating Statement of Operations
For the Year Ended December 31, 2003

Condensed Consolidating Statement of Operations
For the Year Ended December 31, 2002

F-33

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Condensed Consolidating Statement of Operations
For the Year Ended December 31, 2001

Condensed Consolidating Statement of Cash Flows
For the Year Ended December 31, 2003

F-34

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)

Condensed Consolidating Statement of Cash Flows
For the Year Ended December 31, 2002

Condensed Consolidating Statement of Cash Flows
For the Year Ended December 31, 2001

F-35

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTERLY OPERATING RESULTS (UNAUDITED)

(a) On February 28, 2003, Quest Diagnostics completed the acquisition of
Unilab. The quarterly operating results include the results of operations
of Unilab subsequent to the closing of the acquisition (see Note 3).

(b) On April 1, 2002, Quest Diagnostics completed its acquisition of AML. The
quarterly operating results include the results of operations of AML
subsequent to the closing of the acquisition (see Note 3).

F-36

QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
SCHEDULE II -- VALUATION ACCOUNTS AND RESERVES
(IN THOUSANDS)

F-37

STATEMENT OF DIFFERENCES
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