Waste Management 2006 Annual Report Download - page 59

operating margins and our cash flows. As we consider the continuing effects of this approach on our business, we
will continue to focus on our stated long-term strategy of seeking operational excellence and improving profit-
ability, divesting under-performing and non-strategic operations and seeking acquisition and investment candidates,
such as landfill gas-to-energy projects, that we believe will offer superior margins and returns on capital.
Basis of Presentation of Consolidated and Segment Financial Information
Accounting Change — On January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment
(“SFAS No. 123(R)”), which requires compensation expense to be recognized for all share-based payments made to
employees based on the fair value of the award at the date of grant. We adopted SFAS No. 123(R) using the modified
prospective method, which results in (i) the recognition of compensation expense using the provisions of
SFAS No. 123(R) for all share-based awards granted or modified after December 31, 2005 and (ii) the recognition
of compensation expense using the provisions of SFAS No. 123, Accounting for Stock-Based Compensation
(“SFAS No. 123”) for all unvested awards outstanding at the date of adoption.
Through December 31, 2005, as permitted by SFAS No. 123, we accounted for equity-based compensation in
accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees,
as amended (“APB No. 25”). Under APB No. 25, we recognized compensation expense based on an award’s
intrinsic value. For stock options, which were the primary form of awards we granted through December 31, 2004,
this meant that we recognized no compensation expense in connection with the grants, as the exercise price of the
options was equal to the fair market value of our common stock on the date of grant and all other provisions were
fixed. As discussed below, beginning in 2005, restricted stock units and performance share units became the
primary form of equity-based compensation awarded under our long-term incentive plans. For restricted stock units,
intrinsic value is equal to the market value of our common stock on the date of grant. For performance share units,
APB No. 25 required “variable accounting,” which resulted in the recognition of compensation expense based on
the intrinsic value of each award at the end of each reporting period until such time that the number of shares to be
issued and all other provisions are fixed.
In December 2005, the Management Development and Compensation Committee of our Board of Directors
approved the acceleration of the vesting of all unvested stock options awarded under our stock incentive plans,
effective December 28, 2005. The decision to accelerate the vesting of outstanding stock options was made
primarily to reduce the non-cash compensation expense that we would have otherwise recorded in future periods as
a result of adopting SFAS No. 123(R). We estimated that the acceleration eliminated approximately $55 million of
cumulative pre-tax compensation charges that would have been recognized during 2006, 2007 and 2008 as the stock
options would have continued to vest. We recognized a $2 million pre-tax charge to compensation expense during
the fourth quarter of 2005 as a result of the acceleration, but do not expect to recognize future compensation expense
for the accelerated options under SFAS No. 123(R).
Additionally, as a result of changes in accounting required by SFAS No. 123(R) and a desire to design our long-
term incentive plans in a manner that creates a stronger link to operating and market performance, the Management
Development and Compensation Committee approved a substantial change in the form of awards that we grant.
Beginning in 2005, annual stock option grants were replaced with either (i) grants of restricted stock units and
performance share units or (ii) an enhanced cash compensation award. Stock option grants in connection with new
hires and promotions were replaced with grants of restricted stock units. The terms of restricted stock units and
performance share units granted during 2006 are summarized in Note 15 to the Consolidated Financial Statements.
As a result of the acceleration of the vesting of stock options and the replacement of future awards of stock
options with other forms of equity awards, the adoption of SFAS No. 123(R) on January 1, 2006 did not significantly
affect our accounting for equity-based compensation or net income for the year ended December 31, 2006. We do
not currently expect this change in accounting to significantly impact our future results of operations. However, we
do expect equity-based compensation expense to increase over the next three years because of the incremental
expense that will be recognized each year as additional awards are granted.
Reconsideration of a Variable Interest — During 2006, the debt of a previously consolidated variable interest
entity was refinanced. As a result of the refinancing, our guarantee arrangement was also renegotiated, significantly
reducing the value of our guarantee. We determined that the refinancing of the entity’s debt obligations and
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