Quest Diagnostics 2007 Annual Report Download - page 78

The following securities were not included in the diluted earnings per share calculation due to their
antidilutive effect (in thousands):
2007 2006 2005
Stock options........................................................ 3,114 2,443 337
Restricted common shares and performance share units . . .............. 731 786 -
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”) encouraged, but did not require, companies to record compensation cost for stock-based
compensation plans at fair value. In addition, SFAS 148 provided alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee compensation, and
amended 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.
In December 2004, the FASB issued SFAS No. 123, revised 2004, “Share-Based Payment” (“SFAS 123R”).
SFAS 123R requires that companies recognize compensation cost relating to share-based payment transactions
based on the fair value of the equity or liability instruments issued. SFAS 123R is effective for annual periods
beginning after January 1, 2006. The Company adopted SFAS 123R effective January 1, 2006 using the modified
prospective approach and therefore has not restated results for prior periods. Under this approach, awards that are
granted, modified or settled after January 1, 2006 will be measured and accounted for in accordance with SFAS
123R. Unvested awards that were granted prior to January 1, 2006 will continue to be accounted for in
accordance with SFAS 123, as amended by SFAS 148, except that compensation cost will be recognized in the
Company’s results of operations.
Pursuant to the provisions of SFAS 123R, the Company records stock-based compensation as a charge to
earnings net of the estimated impact of forfeited awards. As such, the Company recognizes 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. The cumulative effect on current and
prior periods of a change in the estimated forfeiture rate is recognized as compensation cost in earnings in the
period of the revision. The terms of the Company’s performance share unit grants allow the recipients of such
awards to earn a variable number of shares based on the achievement of the performance goals specified in the
awards. The actual amount of any stock award is based on the Company’s earnings per share growth as measured
in accordance with its Amended and Restated Employee Long-Term Incentive Plan (“ELTIP”) for the
performance period compared to that of a peer group of companies. Stock-based compensation expense associated
with performance share units is recognized based on management’s best estimates of the achievement of the
performance goals specified in such awards and the resulting number of shares that will be earned. The
cumulative effect on current and prior periods of a change in the estimated number of performance share units
expected to be earned is recognized as compensation cost in earnings in the period of the revision. The Company
recognizes stock-based compensation expense related to the Company’s Amended Employee Stock Purchase Plan
(“ESPP”) based on the 15% discount at purchase. See Note 13 for a further discussion of stock-based
compensation.
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 ESPP
was 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 $2.0 million
in 2005.
The Company has several stock ownership and compensation plans, which are described more fully in Note
13. The following pro forma information is presented for comparative purposes and illustrates the pro forma
effect on net income and earnings per share for the period presented, as if the Company had elected to recognize
F-8
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(dollars in thousands unless otherwise indicated)