The following summarizes other commercial commitments as of August 31, 2007:
- The Company has relationships with various suppliers (contract manufacturers) who manufacture the Company’s products. Although the Company does not have any definitive minimum purchase obligations included in the contract terms with contract manufacturers, supply needs are communicated and the Company is committed to purchase the products produced based on sales forecasts provided to the contract manufacturers, ranging from two to five months.
- In addition to the commitments to purchase products from contract manufacturers described above, the Company has also entered into commitments with other manufacturers to purchase finished goods and components of $1.1 million in fiscal year 2008.
- The Company provides fixed retirement benefits to certain of its key executives under a supplemental employee retirement plan. Under the plan, the Company is committed to pay benefits to current retirees of $141,000 in fiscal year 2008 and $84,000 in each of fiscal years 2009 through 2012. Benefits payable to current employees vest upon retirement. As a result, the timing of payments and the total annual benefit payment amounts beyond fiscal year 2012 are uncertain. However, the Company has actuarially determined the present value of all future benefit payments to be $2.0 million as of August 31, 2007.
STOCK-BASED COMPENSATION
Effective September 1, 2005, the Company began recording compensation expense associated with stock options in accordance with SFAS No. 123R, “Share-Based Payment.” Prior to September 1, 2005, the Company accounted for stock-based compensation related to stock options under the recognition and measurement principles of Accounting Principles Board Opinion No. 25; therefore, the Company measured compensation expense for its stock option plan using the intrinsic value method, that is, as the excess, if any, of the fair market value of the Company’s stock at the grant date over the amount required to be paid to acquire the stock, and provided the disclosures required by SFAS Nos. 123 and 148. The Company adopted the modified prospective transition method provided under SFAS No. 123R, and as a result, did not retroactively adjust results from prior periods. Under this transition method, compensation expense associated with stock options recognized in fiscal years 2007 and 2006 includes: 1) expense related to the remaining unvested portion of all stock option awards granted prior to September 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and 2) expense related to all stock option awards granted subsequent to September 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.
The adoption of SFAS No. 123R also resulted in certain changes to the Company’s accounting for its restricted stock awards, which is discussed in more detail in Note 10—Stock-based Compensation, included in the Notes to Consolidated Financial Statements under Part IV—Item 15.
As a result of the adoption of SFAS No. 123R, the Company’s net income included $1.8 million of compensation expense for each of the fiscal years ended August 31, 2007 and 2006; and $0.6 million and $0.5 million of income tax benefits in fiscal years ended August 31, 2007 and 2006, respectively, related to the Company’s stock options. For the fiscal year ended August 31, 2005, there was no compensation expense or corresponding income tax benefits related to stock options included in net income.
As of August 31, 2007, there was $1.8 million and $0.3 million of unamortized compensation costs related to non-vested stock option awards and non-vested restricted stock awards, respectively. These costs are expected to be recognized over weighted-average periods of 1.8 years and 3.0 years, respectively.
The Company estimates the fair value of each option award on the date of grant using the Black-Scholes option valuation model with the assumptions described in Note 10 to the Consolidated Financial Statements.
For fiscal year 2008, the Company will continue to grant stock options to employees. The Company has also evaluated the use of other forms of long-term stock-based compensation arrangements. The Board of Directors has approved a policy for compensation of non-employee directors effective in calendar year 2008 that, subject to stockholder approval, includes the award of restricted stock units. As with all compensation arrangements, the award of stock-based compensation is subject to periodic review.
Readers are also directed to refer to Note 10 — Stock-based Compensation, included in the Notes to Consolidated Financial Statements under Part IV — Item 15.
CRITICAL ACCOUNTING POLICIES
The Company’s results of operations and financial condition, as reflected in the Company’s consolidated financial statements, have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of financial statements requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Management uses historical experience and other relevant factors when developing estimates and assumptions. These estimates and assumptions are continually evaluated. Note 1 to the Company’s consolidated financial statements includes a discussion of significant accounting policies. The accounting policies discussed below are the ones management considers critical to an understanding of the Company’s consolidated financial statements because their application places the most significant demands on our judgment. The Company’s financial results may have been different if different assumptions had been used or other conditions had prevailed. The Company’s critical accounting policies have been reviewed with the Audit Committee of the Board of Directors.
Revenue Recognition
Sales are recognized as revenue at the time of delivery to the customer when risk of loss and title pass. Management must make judgments and certain assumptions in the determination of when delivery occurs. Through an analysis of end-of-period shipments, the Company determines an average time of transit that is used to estimate the time of delivery. Differences in judgments or estimates, such as the lengthening or shortening of the estimated delivery time used, could result in material differences in the timing of revenue recognition. Sales are recorded net of allowances for damaged goods and other sales returns, sales incentives, trade promotions and cash discounts.
Accounting for Sales Incentives
The Company records sales incentives as a reduction of sales in its consolidated statements of operations. The Company offers on-going trade promotion programs with customers, and consumer coupon programs that require the Company to estimate and accrue the expected costs of such programs. Programs include cooperative marketing programs, shelf price reductions, coupons, rebates, consideration and allowances given to retailers for space in their stores, consideration and allowances given to obtain favorable display positions in the retailers’ stores and other promotional activity. Costs related to rebates, co-operative advertising and other promotional activity are recorded upon delivery of products to customers. Costs related to coupon offers are based upon historical redemption rates and are recorded as incurred, when coupons are circulated.
Estimated sales incentives are calculated and recorded at the time related sales are made and are based primarily on historical rates and consideration of recent promotional activities. The determination of sales incentive liabilities requires the Company to use judgment for estimates that include current and past trade-promotion spending patterns, status of trade-promotional activities and the interpretation of historical spending trends by customer and category. We review our assumptions and adjust our reserves quarterly. Our financial statements could be materially impacted if the actual promotion rates fluctuate from the estimated rate. If the Company’s accrual estimates for sales incentives at August 31, 2007 were to differ by 10%, the impact on net sales would be approximately $0.5 million.