Quest Diagnostics 2007 Annual Report Download - page 59

The process of analyzing, assessing and establishing reserve estimates relative to legal proceedings involves
a high degree of judgment. Management has established reserves for legal proceedings in accordance with
generally accepted accounting principles. Changes in facts and circumstances related to such proceedings could
lead to significant revisions to reserve estimates for such matters and could have a material impact on our results
of operations, cash flows and financial condition in the period that reserve estimates are revised or paid.
Accounting for and recoverability of goodwill
Goodwill is our single largest asset. We evaluate the recoverability and measure the potential impairment of
our goodwill under Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other
Intangible Assets”. 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 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 our estimate of fair value
for the reporting unit to the book value of the reporting unit. If the book value 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 reflect 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 performed at
the end of our fiscal year on December 31st, and record any noted impairment loss.
Accounting for stock-based compensation expense
Effective January 1, 2006, we adopted SFAS No. 123, revised 2004, “Share-Based Payment” (“SFAS
123R”), using the modified prospective approach and therefore have not restated results for prior periods.
Pursuant to the provisions of SFAS 123R, we record stock-based compensation as a charge to earnings net of the
estimated impact of forfeited awards. As such, we recognize stock-based compensation cost only for those stock-
based awards that are estimated to ultimately vest over their requisite service period, based on the vesting
provisions of the individual grants.
Prior to the adoption of SFAS 123R, the Company accounted for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued
to Employees” (“APB 25”), and related interpretations and chose to adopt the disclosure-only provisions of SFAS
123, as amended by SFAS 148. Under this approach, the cost of restricted stock awards was expensed over their
vesting period, while the imputed cost of stock option grants and discounts offered under the Company’s
Employee Stock Purchase Plan was disclosed, based on the vesting provisions of the individual grants, but not
charged to expense.
The process of estimating the fair value of stock-based compensation awards and recognizing stock-based
compensation cost over their requisite service period involves significant assumptions and judgments. We estimate
the fair value of stock option awards on the date of grant using a lattice-based option-valuation model which
requires management to make certain assumptions regarding: (i) the expected volatility in the market price of the
Company’s common stock; (ii) dividend yield; (iii) risk-free interest rates; and (iv) the period of time employees
are expected to hold the award prior to exercise (referred to as the expected holding period). The expected
volatility under the lattice-based option-valuation model is based on the current and historical implied volatilities
from traded options of our common stock. The dividend yield is based on the approved annual dividend rate in
effect and current market price of the underlying common stock at the time of grant. The risk-free interest rate is
based on the U.S. Treasury yield curve in effect at the time of grant for bonds with maturities ranging from one
month to seven years. The expected holding period of the awards granted is estimated using the historical
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