10. 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.
In November 2005, the FASB issued FASB Staff Position (FSP) No. FAS 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” to provide an alternate transition method (“short-cut” or “simplified” method) for the implementation of SFAS No. 123R. This FSP provides that companies may elect to use a specified short-cut method to calculate the historical pool of windfall tax benefits upon adoption of SFAS No. 123R. This method comprises (a) a computational component that establishes a beginning balance of the additional paid-in-capital pool (“APIC pool”) related to employee stock-based compensation and (b) a simplified method to determine the subsequent impact on the APIC pool of employee awards that are fully vested and outstanding upon the adoption of SFAS No. 123R. The Company elected the short-cut method as set forth in this FSP to determine its APIC pool. For the fiscal year ended August 31, 2007, the Company determined that it does have a pool of windfall tax benefits.
The adoption of SFAS No. 123R also resulted in certain changes to the Company’s accounting for its restricted stock awards, which is discussed below in more detail.
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. The compensation expense related to all of the Company’s stock-based compensation arrangements is recorded as a component of selling, general and administrative expenses, consistent with the classification of the cash compensation paid to the related option holder. Prior to the Company’s adoption of SFAS No. 123R, the Company presented tax benefits resulting from the exercise of stock options as cash flows from operating activities on the Company’s consolidated statements of cash flows. SFAS No. 123R requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities.
The Company issues new shares upon the exercise of stock options and the issuance of restricted stock.
Stock Options
At August 31, 2007, the Company had one stock option plan. Under the Company’s current stock option plan, the Board of Directors may grant options to purchase up to 4,480,000 shares of the Company’s common stock to officers, key employees and non-employee directors of the Company. At August 31, 2007, options for 1,022,667 shares remained available for future grant under the plan. Options cancelled due to forfeiture or expiration return to the pool available for grant. The plan is administered by the Board of Directors or its designees and provides that options granted under the plan will be exercisable at such times and under such conditions as may be determined by the Board of Directors at the time of grant of such option, however options may not be granted for terms in excess of ten years. Options outstanding under the plan have been granted with immediate vesting, vesting after one year and vesting over a period of three years. Compensation expense related to stock options granted is recognized ratably over the service vesting period for the entire option award. The total number of stock option awards expected to vest is adjusted by estimated forfeiture rates. The terms of the plan provide for the granting of options at an exercise price not less than 100 percent of the fair market value of the stock at the date of grant, as determined by the closing market value stock price on the grant date. The exercise price of all options granted during the fiscal years ended August 31, 2007, 2006 and 2005 was greater than or equal to the market value on the date of grant and, accordingly, no stock-based compensation expense for such options is reflected in net income for fiscal year 2005.
The estimated fair value of each option award granted was determined on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for option grants during the fiscal years ended August 31, 2007, 2006 and 2005:
| Year Ended August 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2005 | |||||||||
| Risk-free interest rate | 4.70 | % | 4.34 | % | 2.90 | % | |||||
| Expected volatility of common stock | 23.89 | % | 25.11 | % | 41.35 | % | |||||
| Expected dividend yield | 2.81 | % | 3.22 | % | 2.88 | % | |||||
| Expected option term | 4.91 years | 4.85 years | 3.18 years | ||||||||
The computation of the expected term is based on a weighted average calculation combining the average life of options that have already been exercised or cancelled with the estimated life of all unexercised options. The increase in the expected term in fiscal years 2007 and 2006 compared to fiscal year 2005 is due to anticipated lower volatility in the future and to a change in the mix of employees receiving stock option awards. The expected volatility is based on the historical volatility of the Company’s stock. For option grants during the fiscal years ended August 31, 2007 and 2006, the expected volatility computation is based on the average of the volatility over the most recent one-year period, the most recent period commensurate with the expected option term and WD-40 Company’s long-term mean reversion volatility. For option grants during the fiscal year ended August 31, 2005, the expected volatility computation is based on the volatility over the five-year period prior to the date of grant of such prior year options. Beginning in fiscal year 2006, the Company revised its volatility calculation method to include consideration of both long-term and short-term volatility measures in addition to volatility over the period commensurate with the expected option term. The Company expects this revised methodology to be a better predictor of future volatility. The risk-free interest rate is based on the implied yield on a U.S. Treasury constant maturity with a remaining term equal to the expected term of the option. The expected dividend yield is based on the projected annual dividend payment per share, divided by the stock price at the grant date.
A summary of the status of the Company’s stock option plan as of August 31, 2007, 2006 and 2005 and of changes in options outstanding under the plan during the three years ended August 31, 2007 is as follows:
| Number of Shares | Weighted-Average Exercise Price per Share |
Weighted-Average Remaining Contractual Term (in years) |
Aggregate Intrinsic Value |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Options outstanding at August 31, 2004 | 1,269,920 | $ | 25.57 | |||||||||||||
| Options granted | 276,650 | $ | 27.80 | |||||||||||||
| Options exercised | (128,567 | ) | $ | 22.08 | ||||||||||||
| Options forfeited or expired | (36,107 | ) | $ | 28.20 | ||||||||||||
| Options outstanding at August 31, 2005 | 1,381,896 | $ | 26.27 | |||||||||||||
| Options vested and exercisable at August 31, 2005 | 881,871 | $ | 25.17 | |||||||||||||
| Options granted | 247,000 | $ | 27.35 | |||||||||||||
| Options exercised | (282,159 | ) | $ | 24.87 | ||||||||||||
| Options forfeited or expired | (28,815 | ) | $ | 29.04 | ||||||||||||
| Options outstanding at August 31, 2006 | 1,317,922 | $ | 26.71 | |||||||||||||
| Options vested and exercisable at August 31, 2006 | 870,270 | $ | 26.16 | |||||||||||||
| Options granted | 301,700 | $ | 35.63 | |||||||||||||
| Options exercised | (368,735 | ) | $ | 26.45 | ||||||||||||
| Options forfeited or expired | (12,313 | ) | $ | 32.29 | ||||||||||||
| Options outstanding at August 31, 2007 | 1,238,574 | $ | 28.91 | 6.79 | $ | 7,260,000 | ||||||||||
| Options vested and exercisable at August 31, 2007 | 767,516 | $ | 26.92 | 5.72 | $ | 6,029,000 | ||||||||||
The Company’s determination of fair value is affected by the Company’s stock price as well as a number of assumptions that require judgment. The weighted-average fair value of all options granted during the fiscal years ended August 31, 2007, 2006 and 2005, estimated as of the grant date using the Black-Scholes option valuation model, was $7.65, $5.61 and $7.28 per option, respectively. The total intrinsic value of options exercised was $3.4 million, $2.0 million, and $1.2 million during the fiscal years ended August 31, 2007, 2006 and 2005, respectively.
As of August 31, 2007, there was $1.8 million of unamortized compensation cost related to non-vested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 1.8 years.
Cash received from stock option exercises for the fiscal years ended August 31, 2007, 2006 and 2005 was $9.8 million, $7.0 million and $2.8 million, respectively. The income tax benefits from stock option exercises totaled $1.0 million, $0.6 million and $0.4 million for the fiscal years ended August 31, 2007, 2006 and 2005, respectively.
For stock options granted prior to the adoption of SFAS No. 123R, the following table illustrates the pro forma effect on net income and earnings per common share as if the Company had applied the fair value recognition provisions of SFAS No. 123 in determining stock-based compensation for awards under the plan:
| Year Ended August 31, 2005 |
|||
|---|---|---|---|
| Net income, as reported | $ | 27,798,000 | |
| Deduct: Total stock-based compensation expense determined under fair value-based method for all awards, net of related tax | |||
| effects | (1,229,000 | ) | |
| Pro forma net income | $ | 26,569,000 | |
| Earnings per common share: Basic - as reported |
$ | 1.67 | |
| Basic - pro forma | $ | 1.60 | |
| Diluted - as reported | $ | 1.65 | |
| Diluted - pro forma | $ | 1.59 | |
Restricted Stock
Pursuant to the Company’s current Amended and Restated WD-40 Company 1999 Non-Employee Director Restricted Stock Plan (the Plan) and the director compensation policy in effect for 2007, restricted shares are issued to non-employee directors of the Company WD-40 Company in lieu of cash compensation of up to $32,000 according to an election made by each director by November of the prior year. A director who held shares of the Company having a value of at least $50,000 may have elected to receive his or her annual director’s fee entirely in cash. Otherwise, directors would have elected to receive restricted stock in lieu of cash in the amount of $5,500, $11,000, $16,500, $22,000, $27,500 or $32,000. The restricted shares were issued in accordance with the director’s election as soon as practicable after the first day of March. The number of shares issued was equal to the amount of compensation paid in shares divided by 90% of the closing price of the Company’s shares as of the first business day of March or other date of issuance of such shares. Compensation expense related to restricted stock issued is recognized ratably over the service vesting period. Restricted shares issued to a director do not become vested for resale for a period of five years or until the director’s retirement from the Board following the director’s 65th birthday. Unless a director has reached age 65, the shares are subject to forfeiture if, during the five-year vesting period, the director resigns from service as a director. During the years ended August 31, 2007, 2006 and 2005, the Company issued 3,896, 6,099 and 4,828 shares of restricted stock, respectively.
In accordance with SFAS No. 123R, the fair value of restricted stock awards is estimated based on the closing market value stock price on the date of share issuance. The total number of restricted stock awards expected to vest is adjusted by estimated forfeiture rates. As of August 31, 2007, there was $286,000 of unamortized compensation cost related to non-vested restricted stock awards, which is expected to be recognized over a remaining weighted-average vesting period of 3.0 years. The unamortized compensation cost related to non-vested restricted stock awards was recorded as unearned stock-based compensation in shareholders’ equity at August 31, 2005. As part of the adoption of SFAS No. 123R, such unamortized compensation cost was reclassified as a component of paid-in-capital in fiscal year 2006.
A summary of the status of the Company’s restricted stock awards as of August 31, 2007 and of changes in restricted stock outstanding under the plan during the three years ended August 31, 2007 is as follows:
| Number of Shares |
Weighted-Average Grant Date Fair Value per Share |
||||||
|---|---|---|---|---|---|---|---|
| Restricted stock awards outstanding at August 31, 2004 | 11,091 | $ | 24.84 | ||||
| Shares issued | 4,828 | $ | 32.62 | ||||
| Shares vested | (3,958 | ) | $ | 26.16 | |||
| Shares forfeited | — | $ | — | ||||
| Restricted stock awards outstanding at August 31, 2005 | 11,961 | $ | 28.87 | ||||
| Shares issued | 6,099 | $ | 30.32 | ||||
| Shares vested | (201 | ) | $ | 30.32 | |||
| Shares forfeited | — | $ | — | ||||
| Restricted stock awards outstanding at August 31, 2006 | 17,859 | $ | 29.35 | ||||
| Shares issued | 3,896 | $ | 32.08 | ||||
| Shares vested | (2,718 | ) | $ | 24.40 | |||
| Shares forfeited | — | $ | — | ||||
| Restricted stock awards outstanding at August 31, 2007 | 19,037 | $ | 30.61 | ||||