Effective Administration and Accounting for
        Option Exchange Programs
       Martin Percival, Group HR Director, St...
Agenda

• Who are StepStone and Norse Solutions

• What are option exchange programs

• Why and when to exchange

• Case S...
Who is StepStone
• Founded in Norway in 1996

• A European internet job board pioneer

• Listed on the Oslo stock exchange...
Who is Norse Solutions

• Founded in 2002 with background and experience in
  development of finance- and accounting softw...
What are option exchange programs

• Option holders surrender their outstanding options in exchange
  for new awards.
• Ne...
Why and when to exchange?
•   Options are underwater, i.e. strike price below current market price.
•   What are the reaso...
StepStone’s original stock option program

• The existing stock option program was re-issued in 2002.

• Allocated quarter...
Internal processes of StepStone - 1

• These evolved over the years as Company changed from a Western
  European/Nordics i...
Internal processes of StepStone - 2

• Board approved quarterly allocation of grants to individuals
  subject to proxy giv...
StepStone’s outstanding options
StepStone’s historical stock price

Tremendous growth in stock price from 2005 - hit hard by the 2008
                    ...
Considerations and impact of exchange

• Alternatives - offer other instruments, RS or cash settlement
    Options
       ...
Considerations and impact of exchange

• Strike price of new options
• Stock option pool
    • Cancelled options available...
Key features exchange program

• Type of program
    • Options-for-options exchange on a grant by grant basis
    • Allowe...
Accounting for share option exchange

• Case study background:
   • StepStone grants 160 options with an exercise price of...
Accounting for share option exchange

• Illustrative calculation of Q1 compensation expense
   • # of options per tranche:...
Accounting for share option exchange

• Illustrative calculation of deferred tax asset as of end of Q1
    • Assume NOK 26...
Accounting for share option exchange

• End of Year 2 (2008) - StepStone’s share price dropped to
  NOK 3.5, and the Board...
Accounting for share option exchange

• First step    compute the incremental fair value as of the
  modification date, be...
Accounting for share option exchange

• Under IFRS 2, the effects of modifications that increase the
  fair value are reco...
Accounting for share option exchange

• StepStone continues to recognize the grant date fair value of
  the original grant...
Accounting for share option exchange

• Alternative IFRS 2 accounting treatment         bifurcate
  modification into port...
Accounting for share option exchange

• Assume employee A exchanged all 160 “underwater”
  options for 80 re-priced option...
Accounting for share option exchange

• Illustrative calculation of annual compensation
  expense for tranche 16 of employ...
Accounting for share option exchange

• Illustrative calculation of year-end deferred tax asset
  for tranche 16 of employ...
Accounting for share option exchange

• For options that were modified during the period, the
  following incremental disc...
Working with your software provider

Administration advice
• Ensure that initial data input into the system is 100% clean ...
Working with your software provider

Accounting
• StepStone has reported under IFRS 2 since 2005.
   • Norse Solutions sof...
Working with your software provider

Audit trail
• All journals should be clearly identified within the system with a
  de...
Working with your software provider

Disclosures and notes to reports
• Activity report
    • How to clearly display the c...
Important considerations

• Consider an economic exchange, not a one-for-one swap

• Re-start vesting or impose a black-ou...
Q&A
           Martin Percival
  Group HR Director, StepStone ASA
 martin.percival@stepstonesolutions.com

          Renee...
Appendix: StepStone Timeline 2002 - 2010

  30
May 2002                  new stock option plan issued
Sept 2002           ...
About Deloitte
Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and
its network of member firms...
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Employee Stock Option Exchange Programmes - StepStone Case study

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Case study presentation on the 2009/09 StepStone Employee Stock Option Exchange Programme for the Global Equity Organisation conference

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Employee Stock Option Exchange Programmes - StepStone Case study

  1. 1. Effective Administration and Accounting for Option Exchange Programs Martin Percival, Group HR Director, StepStone ASA Renee Bomchill, Partner, Deloitte & Touche LLP Finn Dahl, Chief Operating Officer, Norse Solutions AS Chicago – April 2010
  2. 2. Agenda • Who are StepStone and Norse Solutions • What are option exchange programs • Why and when to exchange • Case Study – StepStone exchange program 2008/9 • Considerations and impact of exchange program • Internal processes - StepStone • Accounting for share option exchange program in accordance with IFRS • Working with your software provider for a smooth exchange • Lessons learned/Q&A *Tax and securities laws are not considered in this presentation
  3. 3. Who is StepStone • Founded in Norway in 1996 • A European internet job board pioneer • Listed on the Oslo stock exchange at IPO in 2000 • Co-founders of “The Network” in 2002 – an alliance of 36 job boards covering over 100 countries • StepStone Solutions founded in 2003 • Via acquisition of EasyCruit (Norway - 2004), i-GRasp (UK – 2005) and ExecuTrack (Germany - 2007) became the leading European HRIS/Talent Management software provider
  4. 4. Who is Norse Solutions • Founded in 2002 with background and experience in development of finance- and accounting software since 1986. • We are the largest supplier of software and services related to IFRS 2 in Northern Europe and ranked #183 on Deloitte’s EMEA Fast 500. • Our customers are located in 11 countries and have employees in 65+ countries. • We offer full or partly outsourcing of administration of equity based payment programs using Norse Options™ as platform for the service. • Norse Solutions cover all activities related to corporate finance, accrued payroll taxes, DTA calculations, accounting, reporting and disclosures, HR-functions as well as information to and interaction with employees and financial institutions.
  5. 5. What are option exchange programs • Option holders surrender their outstanding options in exchange for new awards. • New awards can be in the form of: • New option grant • Grant of restricted stock • Cash settlement or a combination of the above • An option exchange process may require the participation and dialogue between: • HR • Legal • Accounting • Tax in addition: the board, shareholders, auditors, proxy advisors etc.
  6. 6. Why and when to exchange? • Options are underwater, i.e. strike price below current market price. • What are the reasons for options being underwater • Are the options likely to go back in the money sometime soon? • Employee retention and motivation • Exchange underwater options to lessen risk of key employees moving to competitors and then grant options to new hires at today’s market price. • By allowing employees to exchange underwater stock options for new stock options with exercise price at current market value, the stock option plan would again provide the incentive and retention value that it was designed to provide. • Cash situation makes some companies rely heavily on equity incentives for motivation and retention enhancement • Lack of sufficient share reserves under the plan • Reduction of stock options outstanding to keep in line with market trends.
  7. 7. StepStone’s original stock option program • The existing stock option program was re-issued in 2002. • Allocated quarterly and vested 1/16th every quarter According to IFRS 2, each grant is valued separately resulting in a large amount of transaction for longstanding employees. • Strike price set equal to market value at grant, range from NOK 2 – NOK 155. • Over 1200 employees (and ex-employees) have passed through the stock option system and received one or more allocation of options.
  8. 8. Internal processes of StepStone - 1 • These evolved over the years as Company changed from a Western European/Nordics internet job board focused business to a global Talent Management focused software company • 450 employees at end of 2006, 967 at end 2008 • In final years the stock option process became more streamlined and Allocation bands were re- designed upon industry wide common job levels and bands used for compensation benchmarking purposes • Impact = simplified the process considerably as grants were no longer based on job-titles but level of contribution to the company, i.e. individual contributor, first line manager, senior manager, Director etc. • Grant process became simpler and more consistent
  9. 9. Internal processes of StepStone - 2 • Board approved quarterly allocation of grants to individuals subject to proxy given by Shareholders at AGM. • All grants were always at board discretion and this was always made very clear to employees. • Tended not to “sell” StepStone heavily to new employees on the basis of stock options • Board approval given for the re-price • Grant details entered into Norse Options & employees advised of their allocation and invited to view their account in Norse Options
  10. 10. StepStone’s outstanding options
  11. 11. StepStone’s historical stock price Tremendous growth in stock price from 2005 - hit hard by the 2008 financial crisis
  12. 12. Considerations and impact of exchange • Alternatives - offer other instruments, RS or cash settlement Options • Familiar with options • No cash outlay • Retains incentive and retentive value Restricted Stock • Protects against future drops in stock price Cash settlement • Easy to explain • No retentive value (unless subject to vesting conditions) • Cash outlay by the company • Balance the needs of employees and shareholders • Exchange ratio • New strike • Value for value • New vesting requirements • Block-out period
  13. 13. Considerations and impact of exchange • Strike price of new options • Stock option pool • Cancelled options available for new grants? • Include Executives? • Accounting consequences • Administrative issues • Employee communication and education • Does your software provider support such option exchange • Option exchange window • Exchanging fractional grants • Eligible employees / eligible options • Tax consequences • Regulatory requirements
  14. 14. Key features exchange program • Type of program • Options-for-options exchange on a grant by grant basis • Allowed for exchange of partially exercised grants • Participation • Executives included as stock price decline caused by external factors • Strike price • Set at market value • Exchange ratio • 2:1 • Vesting schedule • Vesting re-started and lock up during the first 12 months • 4/16ths vest after 12 months, thereafter 1/16th each quarter • Term • All new stock options have a new 10 year term
  15. 15. Accounting for share option exchange • Case study background: • StepStone grants 160 options with an exercise price of NOK 24 to each of its 1,000 employees • Options vest quarterly over 4 years (16 tranches) • Assume zero forfeitures • Under IFRS: • Grant date fair value is expensed over the vesting period (IFRS 2) • Deferred tax asset is recorded based on the expected tax deduction (intrinsic value) and “marked to market” each reporting date (IAS 12) Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  16. 16. Accounting for share option exchange • Illustrative calculation of Q1 compensation expense • # of options per tranche: 160 * 1,000 / 16 = 10,000 Tranche Calculation 1 10,000 * 5 (grant date FV) = 50,000 2 10,000 * 5.1 (grant date FV) * 1/2 = 25,500 3 10,000 * 5.2 (grant date FV) * 1/3 = 17,333 4 10,000 * 5.3 (grant date FV) * 1/4 = 13,250 … [calculations for tranches 5 – 15] 16 10,000 * 6.6 (grant date FV) * 1/16 = 4,125 Note: Calculations are performed for each of the 16 tranches, and the total is recognized in P&L (with the offset to APIC) in Q1. Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  17. 17. Accounting for share option exchange • Illustrative calculation of deferred tax asset as of end of Q1 • Assume NOK 26 stock price (hence NOK 2 intrinsic value) and 28% tax rate Tranche Calculation 1 10,000 * 2 (intrinsic value) * 28% = 5,600 2 10,000 * 2 (intrinsic value) * 28% * 1/2 = 2,800 3 10,000 * 2 (intrinsic value) * 28% * 1/3 = 1,867 4 10,000 * 2 (intrinsic value) * 28% * 1/4 = 1,400 … [calculations for tranches 5 – 15] 16 10,000 * 2 (intrinsic value) * 28% * 1/16 = 350 Note: Calculations are performed for each of the 16 tranches, and the total is recognized as a deferred tax asset (with the offset to P&L or equity, as appropriate) as of the end of Q1. Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  18. 18. Accounting for share option exchange • End of Year 2 (2008) - StepStone’s share price dropped to NOK 3.5, and the Board offered employees the opportunity to exchange their options as follows: • Outstanding options could be exchanged at a ratio of 2:1 for new options (i.e., # of options is reduced by half) • Exchange is not mandatory, and employees can choose to fully or partially participate • New exercise price is NOK 3.5 • Vesting is reset (i.e., re-priced options are divided into 16 equal tranches with new vesting schedule) Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  19. 19. Accounting for share option exchange • First step compute the incremental fair value as of the modification date, being the difference between the fair value of the original award immediately before it was modified and the fair value of the modified award • Fair value model must incorporate assumptions as of the modification date Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  20. 20. Accounting for share option exchange • Under IFRS 2, the effects of modifications that increase the fair value are recognized • If the modification occurs during the vesting period: • Incremental fair value is recognized from the modification date until the date the modified options vest • The amount based on the grant date fair value of the original options continues to be recognized over the remainder of the original vesting period • If the modification occurs after the vesting date: • Incremental fair value is recognized immediately • Under IFRS 2, the effects of modifications that decrease the fair value are not recognized Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  21. 21. Accounting for share option exchange • StepStone continues to recognize the grant date fair value of the original grant over the original 4 year vesting period • Once an employee completes the original 4 year service period, the related compensation cost is not reversed if employee leaves subsequent to original vesting • StepStone recognizes the incremental fair value of all re- priced options over the new vesting period • Assumes modification increases fair value • Vesting was reset so all re-priced options are unvested Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  22. 22. Accounting for share option exchange • Alternative IFRS 2 accounting treatment bifurcate modification into portion that is beneficial to employee, and portion that is not beneficial to employee • Account for reduction in number of options (i.e., portion that is not beneficial to the employee) as a cancellation of that portion of the grant, thereby immediately recognizing the expense • Account for the remainder of the re-priced grant (i.e., portion that is beneficial to employee) as noted on the prior slide • For purposes of the following illustrative example, we have not considered this alternative accounting treatment Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  23. 23. Accounting for share option exchange • Assume employee A exchanged all 160 “underwater” options for 80 re-priced options • Tranche 16 of employee A’s award • Original grant (before re-pricing): • 10 options in Tranche 16 • Grant date fair value: NOK 6.6 • Re-priced grant: • 5 options in Tranche 16 • Fair value immediately before modification: NOK 1 • Fair value immediately after modification: NOK 3 Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  24. 24. Accounting for share option exchange • Illustrative calculation of annual compensation expense for tranche 16 of employee A’s award Year Calculation 1 10 * 6.6 (grant date FV) * 4/16 = 16.5 2 10 * 6.6 (grant date FV) * 4/16 = 16.5 3 10 * 6.6 (grant date FV) * 4/16 = 16.5 (5 * 3) - (10 * 1) (incremental FV) * 4/16 = 1.25 4 10 * 6.6 (grant date FV) * 4/16 = 16.5 (5 * 3) - (10 * 1) (incremental FV) * 4/16 = 1.25 5 (5 * 3) - (10 * 1) (incremental FV) * 4/16 = 1.25 6 (5 * 3) - (10 * 1) (incremental FV) * 4/16 = 1.25 Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  25. 25. Accounting for share option exchange • Illustrative calculation of year-end deferred tax asset for tranche 16 of employee A’s award Year Calculation 1 10 * 2 (intrinsic value) * 28% * 4/16 = 1.4 2 10 * 0 (intrinsic value) * 28% * 8/16 = 0 3 5 * 0 (intrinsic value) * 28% * 4/16 = 0 4 5 * 2 (intrinsic value) * 28% * 8/16 = 1.4 5 5 * 5 (intrinsic value) * 28% * 12/16 = 5.25 6 5 * 4 (intrinsic value) * 28% * 16/16 = 5.6 Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  26. 26. Accounting for share option exchange • For options that were modified during the period, the following incremental disclosure is required under IFRS 2: • an explanation of those modifications; • the incremental fair value granted (as a result of those modifications); and • information on how the incremental fair value granted was measured Copyright ©2010 Deloitte Development LLC. All Rights Reserved.
  27. 27. Working with your software provider Administration advice • Ensure that initial data input into the system is 100% clean and that your software provider has a good base of information to work from. • Clearly communicate the basis of the exchange process in a timely fashion to employees to ensure that sufficient time is allowed for the exchange process to be initiated within the system • Consider impact on exercise and reporting periods (if relevant). • Provide Guidance and FAQ information to employees. • Translate these if possible • StepStone’s timeframe did not allow for website election • StepStone collected acceptances and provided elections to Norse Solutions in form of Excel spreadsheet. • If time permits, provide tender offer website for the employees.
  28. 28. Working with your software provider Accounting • StepStone has reported under IFRS 2 since 2005. • Norse Solutions software is transaction based, and grants are valued tranche-by-tranche according to IFRS 2. • Norse Solutions handles re-pricing of grants. Re-pricing of 16 outstanding tranches was thus straightforward using the modification date assumptions. • Special treatment required where part of the grant/tranches had been exercised. E.g. 7 tranches were exercised, and 9 remaining tranches to be modified into 16 new tranches. • Solution was to re-price 9 tranches, then adjust the quantity in those 9 tranches and allocate them the 7 ”new” tranches. • Led to a small and not significant timing issue of expensing, approved by auditor in advance. • Software provides modification accounting.
  29. 29. Working with your software provider Audit trail • All journals should be clearly identified within the system with a description of what is being performed within that journal and by whom. • All transactions should be tagged with Grant reference • Grant ref. enables user/auditor to pull all transactions connected to one award. • Facilitates the audit and recalculation of grant modification.
  30. 30. Working with your software provider Disclosures and notes to reports • Activity report • How to clearly display the changes due to option exchange? • “Weighted average fair value of options granted during the period” • How to accurately display the incremental expenses of option exchanges • Only incremental FV? • Full FV? • Don’t include but disclose incremental FV in separate section? • Outstanding options • Must show status at period end, adjusted quantities, new strikes, remaining life etc. • Option Plan overview • Cancelled options to revert to plan pool ? • Norwegian Stock Exchange rules required that all changes to stock option scheme had to be communicated
  31. 31. Important considerations • Consider an economic exchange, not a one-for-one swap • Re-start vesting or impose a black-out period • Consider the potential accounting impact • Confirm whether you require shareholder approval • Ensure compliance with local regulations for international employees • Involve HR, Accounting, Legal and software vendor at an early stage • With the benefit of hindsight, what could have been done differently?
  32. 32. Q&A Martin Percival Group HR Director, StepStone ASA martin.percival@stepstonesolutions.com Renee Bomchill Partner, Deloitte & Touche LLP rbomchill@deloitte.com Finn Dahl Chief Operating Officer, Norse Solutions AS finn.dahl@norse-solutions.com
  33. 33. Appendix: StepStone Timeline 2002 - 2010 30 May 2002 new stock option plan issued Sept 2002 acquires Careerportal (Netherlands) Feb 2003 StepStone & Hire.com partner for Europe April 2004 Board approve 20:1 share split 25 May 2004 split initiated Sept 2004 Axel Springer acquire minority interest in StepStone Deutschland AG Oct 2004 acquires Easycruit (Norway) Jan 2005 acquires Obvious Solutions (United Kingdom) July 2005 acquires i-GRasp (United Kingdom) 20 Oct 2005 StepStone & Norse Solutions sign contracts for provision of services Dec 2005 acquires Jobbsverige (Sweden) Dec 2005 first batch of new stock option grants entered into Norse July 2006 acquires IT-Jobbank (Denmark) Nov 2006 acquires Jobfinder (Austria) 15 Dec 2006 acquires ExecuTrack (Germany, UK and Switzerland) July 2007 acquires Recruiter Norge (Norway) Feb 2008 acquires Statsjobb (Norway) July 2008 acquires Les Villages Emploi (France) Nov 2008 resumes trading on the London Stock Exchange 10 Dec 2008 Axel Springer acquire 33.3 shareholding in StepStone ASA Dec 2008 Board approves re-pricing of employee stock options to NOK 3.51 due to market conditions and worldwide financial crisis Dec 2008 all communications regarding re-pricing sent to employees within 10 days Mar 2009 Norse Solutions complete project to re-price options to NOK 3.51 5 April 2009 new stock option grant ranges introduced Sept 2009 Axel Springer increases holding in StepStone ASA to 52% Dec 2009 Axel Springer completes acquisition of all outstanding shares in StepStone ASA Dec 2009 StepStone delists from Oslo Stock Exchange Dec 2009 Employees who have options under NOK 9 invited to participate in accelerated 0 stock programme as no market now exists for stock options Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Feb 2010 Norse Solutions complete system administration of accelerated stock options May-02 May-03 May-04 May-05 May-06 May-07 May-08 May-09
  34. 34. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms. Please see www.deloitte.com/us/about or a detailed description of the legal structure of Deloitte LLP and its subsidiaries. This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this presentation.

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