Notes to Consolidated Financial Statements
3. STOCK-BASED COMPENSATION
In 2006, we adopted SFAS No. 123(R), “Share-Based Payment.” This statement requires us to expense the fair value of grants of various stock-based compensation programs over the vesting period of the awards. We used the “Modified Prospective Application” transition method whereby we do not restate prior year financial statements. Compensation expense is calculated and recorded beginning in 2006 as follows:
Awards Granted After November 30, 2005 – Awards are calculated at their fair value at date of grant. The resulting compensation expense is recorded in the income statement ratably over the shorter of the period until vesting or the employee’s retirement eligibility date. For employees eligible for retirement on the date of grant, compensation expense is recorded immediately.
Awards Granted Prior to November 30, 2005 – Awards were calculated at their fair value at the date of original grant. Compensation expense for the unvested portion of these options at December 1, 2005 is recorded in the income statement ratably over the remaining vesting period without regard to the employee’s retirement eligibility. Upon retirement, any unrecorded compensation expense will be recorded immediately.
For all grants, the amount of compensation expense to be recorded is adjusted for an estimated forfeiture rate which is based on historical data.
For the year ended November 30, 2006, we recorded $22.0 million of compensation expense in selling, general and administrative expense (SG&A). This amount included $5.1 million of expenses for 2006 grants to individuals who were eligible for retirement on or before the grant date. Additionally, we recorded $2.9 million of expense in restructuring charges for the acceleration of vesting in accordance with the provisions of the award for employees who are part of our severance charges (see note 4 of financial statements). Only nominal amounts of stock-based compensation expense were charged against income in prior years as we applied the provisions of APB No. 25 to those periods.
The following table presents the impact of stock-based compensation expense for 2006:
| (millions except per share data) | SG&A | Restructuring | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Reduction to income from consolidated operations before income taxes |
$ | 22.0 | $ | 2.9 | $ | 24.9 | |||
| Reduction to net income | 15.1 | 2.0 | 17.1 | ||||||
| Reduction to earnings per common share: Basic |
.11 | .02 | .13 | ||||||
| Diluted | .11 | .01 | .13 | ||||||
Total unrecorded stock-based compensation expense at November 30, 2006 was $19.5 million which is expected to be recognized over a weighted-average period of 1.3 years.
SFAS No. 123(R) also requires that the tax benefit from the exercise of options in excess of the tax benefit from the compensation expense recorded for those options be included in the cash flow statement as a cash inflow from financing activities. Prior to the adoption of SFAS No. 123(R), these tax benefits had been reflected as a cash inflow from operations. The prior years cash flow statements have not been restated. This excess tax benefit was $9.5 million, $13.8 million and $20.6 million for 2006, 2005 and 2004, respectively.
We have two types of stock-based compensation awards: restricted stock units (RSU’s) and stock options, including grants under an employee stock purchase plan (ESPP). Below, we have summarized the key terms and methods of valuation for our stock-based compensation awards:
RSU’s
RSU’s are valued at the market price of the underlying stock on the date of grant. Substantially all of the RSU’s vest over a two-year term and are expensed ratably over that period, subject to the retirement eligibility rules discussed above.
Stock Options
ESPP – We have an ESPP which enables employees to purchase McCormick common stock non-voting at the lower of the stock price at the grant date or purchase date. This plan has a two-year term and is expensed immediately on the date of grant since employees can purchase the full amount of stock upon grant. Historically, we have adopted a new ESPP upon the expiration of an existing plan. The last plan was offered in May 2005.
We value our ESPP using the Black-Scholes option pricing model which uses the assumptions shown in the table below. We use the Black-Scholes model as opposed to a lattice pricing model since employee exercise patterns, which are considered on a lattice model, are not relevant to this plan. The risk-free interest rate is based on the U.S. Treasury two-year rate in effect at the time of grant.
Other Option Plans – Stock options are granted with an exercise price equal to the market price of the stock at the date of grant. Substantially all of the options granted are exercisable ratably over a four-year vesting period.