American Home Shield 2007 Annual Report Download - page 77

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Notes to the Consolidated Financial Statements
provisions of SFAS 123(R) effective January 1, 2006 using the modified prospective method which requires application of the rule
after January 1, 2006.
Prior to adopting SFAS 123(R), and beginning in 2003, the Company adopted SFAS 123 using the "Prospective Method" as
permitted under SFAS 148, "Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB
Statement No. 123", which required the Company to expense the fair value of new employee option grants awarded subsequent to
2002. Related to the unvested option awards granted prior to 2003, the adoption of SFAS 123(R) in 2006 resulted in incremental
compensation expense for the twelve months ended December 31, 2006 of approximately $3.0 million pretax, $1.8 million after-
tax. Also, upon the adoption of SFAS 123(R) and effective January 1, 2006, the Company reclassified within Shareholders' Equity
the $14.4 million balance of "Restricted stock (unearned compensation)" to "Additional paid-in capital."
Prior to the adoption of SFAS 123(R), the Company adjusted option expense related to forfeited options as the forfeitures occurred.
With the adoption of SFAS 123(R), the Company is estimating the forfeitures that will occur and is recording periodic option
expense net of the estimated forfeitures. The cumulative impact of the change in accounting for forfeitures was not material to the
consolidated financial statements. As required by SFAS 123(R), the Company has included in Cash Used for Financing Activities
from Continuing Operations approximately $1 million of excess tax benefits associated with options exercised and restricted stock
that vested in 2006.
Beginning in 2005, the fair value of each option award was estimated on the date of the grant using a lattice-based option valuation
model. Prior to 2005, the Company used the Black-Scholes option pricing model. This change was made in order to provide a better
estimate of fair value, as the lattice-based model reflects the impact of stock price changes on exercise behavior, and changes in
volatility and interest rates.
Total pretax option expense and income tax benefits recognized was approximately $6.7 million and $2.7 million, respectively for
the twelve months ended December 31, 2006, $3.8 million and $1.5 million respectively, for the twelve months ended December
31, 2005, and $2.9 million and $1.2 million for the twelve months ended December 31, 2004.
Under a lattice-based model, expected volatilities are based on a term structure of implied volatilities from traded options on the
Company's stock and historical volatility of the Company's stock. The Company uses historical data to estimate option exercises
and employee terminations within the valuation model. The expected term of options granted is derived from the output of the
option valuation model and represents the period of time that options granted are expected to be outstanding. The range of risk-free
rates for periods within the contractual life of the options is based on the U.S. Treasury forward curve rate using a term structure.
The lattice-based model used the following assumptions for options awarded in 2006: range of expected volatility 17.90 percent to
42.10 percent; weighted-average volatility of 19 percent; expected life (in years) of 9; dividend yield of 3.0 percent; risk-free rate in
the range of 4.39 percent to 4.64 percent; and the weighted-average risk-free rate of 4.54 percent.
The lattice-based model used the following assumptions for options awarded in 2005: range of expected volatility 27.66 percent to
47.56 percent; weighted-average volatility of 28.24 percent; expected life (in years) of 6; dividend yield of 3.41 percent; risk-free
rate in the range of 2.98 percent to 4.65 percent; and the weighted-average risk-free rate of 4.06 percent.
For awards valued using the Black-Scholes option pricing model, the computation of fair value was based on the following
weighted-average assumptions in 2004: risk-free rate of 3.7 percent; dividend yield of 4.0 percent; share price volatility of 30.6
percent; and average expected life (in years) of six to seven years. The Company has estimated the value of these options assuming
a single weighted-average expected life for the entire award.
Options granted to employees during the twelve months ended December 31, 2006, 2005 and 2004 had a weighted average fair
value of $2.52, $2.80 and $2.35, respectively.
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