Quest Diagnostics 2008 Annual Report Download - page 60

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) the financial projections and future prospects of our
business, including its growth opportunities and likely operational improvements, and (ii) 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.
The process of estimating the fair value of stock-based compensation awards and recognizing stock-based
compensation cost over their requisite service periods 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 exercise behavior of employees. In addition, SFAS 123R requires us to estimate the
expected impact of forfeited awards and recognize stock-based compensation cost only for those awards expected
to vest. We use historical experience to estimate projected forfeitures. If actual forfeiture rates are materially
different from our estimates, stock-based compensation expense could be significantly different from what we
have recorded in the current period. We periodically review actual forfeiture experience and revise our estimates,
as considered necessary. 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.
Finally, the terms of our 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. For performance
share unit awards granted prior to 2008, the actual amount of any stock award earned is based on the Company’s
earnings per share growth as measured in accordance with its Amended and Restated Employee Long-Term
Incentive Plan for the performance period compared to that of a peer group of companies. Beginning with
performance share unit awards granted in 2008, the performance measure for these awards will be based on the
cumulative annual growth rate of the Company’s earnings per share from continuing operations over a three year
period. 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. If the actual number of performance share units earned is different
from our estimates, stock-based compensation could be significantly different from what we have recorded in the
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