GEO NECF 2015 - Best Practices and Trends in Financial Reporting

Joshua Hemmati, Assistant Corporate Controller, ON Semiconductor Corp.

Raenelle James, CPA, Sr. Manager Financial Reporting, Equity Methods, LLC

Joseph Purdy, CEP, Director, Product & Services Engineering, Solium

Best Practices and Trends in Financial Reporting

Disclaimer

This presentation contains general information only and the respective speakers and represented firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services.

Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speaker and firm shall not be responsible for any loss sustained by any person who relies on this presentation.

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Agenda

• Forecasting Trends

• Direct Tracing

• Award Design Trends

• Impact of ASC 718 Proposals on Trends

– Forfeiture rates

– APIC pool tracking

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STOCK COMPENSATION FORECASTING

Long-Run Strategy Plan

Annual SBC Budget

YTD Actuals

Rest of Year

Forecast

3 or 5 Year Strategy Plan Long-run waterfall forecast used an input in

long-run planning exercises

Granularity in out years is annual/ quarterly

Annual Budget Occurs as part of budgeting process for

following year (e.g., September/October)

Usually only one year in length, but monthly granularity to facilitate detailed budget-to-actual variance decomposition

2014 FY 2015 FY 2015 - 2018 When forecast is prepared

These forecast exercises are updated the budget developed in November 2013 for FY 2014

Stock Compensation ForecastingStandard Practices

Based on a calendar year end company

Stock Compensation ForecastingBest Practices to enhance granularity and transparency

Forecast Expense

Create hypothetical future awards

Granular (usually at employee level)

Allows for more accurate summarization by band level/department/cost center

Layer in retirement eligibility / related provisions that affect slope of expense recognition

Wherever there is potential variability (e.g., performance awards), introduce scenario analysis

Stock price and/or multiplier outcomes

3 scenarios are common: favorable, moderate, and unfavorable (work w/ FP&A for this)

Infer sensitivity of expense to scenario variables


Incorporate indicative data and implement in a granular (e.g., monthly) waterfall framework

Indicative data will facilitate what-if analysis

Waterfall framework further simplifies responding to ad hoc question and other requested research

Forecast Expense (cont’d)

Expense ForecastingItems for Consideration – Current & Future Equity

Outstanding Awards

- Constant forfeiture rate- Consider extraordinary events

- RIF’s- Modifications,- Repricings

Future Awards

- Work with HR/Internal Planning- Estimate price volatility - Constant forfeiture rate- Extraordinary events

- New director or officer- Acquisition - Shift in compensation

structure,

Expense ForecastingItems for Consideration

ESPP

- Estimate participation rates- Estimate employee contributions (factor in number of pay periods)- Consider significant events effecting participation (head count reductions,

acquisitions, change in stock price)- Derive fair value


Integrate with expense forecasting Separate processes are recipe for problems

How to forecast settlements Retirement eligible awards Stock option settlement assumptions

Importance of stock price assumptions High, low and moderate assumptions

Forecast Earnings Per Share

Stock Compensation Forecasting Forecast-to-Actual

Forecast to Actual “No surprise is a good surprise” Always be able to explain why numbers are above or below target

Flux Analysis

Comparisons between periods:

Current quarter to prior quarter

Current quarter to comparable quarter of prior fiscal year

Slice by division or other indicative data

Forecast-to-Actual & Flux Analysis

DIRECT TRACING

Basic Overview on Corporate Hierarchies

Legal entities A…n

Corporate Cost Center (“top of the house”)

Profit centers 1…n

Divisions 1…n

Cost centers 1…n

Specific nomenclature will vary from company to company

Size and complexity of entity structuring relates to industry, tax planning, revenue sourcing, and many other factors

Entity structures are highly dynamic and may even change monthly

Organizational Structure & Hierarchy ChangesProfit

Center

Legal Entity A

Division 1

Cost center A1.001

Cost center A1.002

Division 2

Cost center A2.001

Cost center A2.002

Legal Entity B

Division 1

Cost center B1.001

Cost center B1.002

Division 2

Cost center B2.001

Profit Center

Legal Entity A

Division 1

Cost center A1.001

Cost center A1.002

Cost center A1.003

Division 2

Cost center A2.001

Legal Entity B

Division 1

Cost center B1.001

Division 2

Cost center B2.001

Cost center B2.002

Cost center B2.003

Specific Questions and Considerations

1. How do you know if the hierarchy has changed? Where does that information live?

2. Cost center employee mobility can be very common and can occur simultaneously with overall hierarchy revisions. Ensure this form of mobility is managed.

3. When the hierarchy changes, should expense be restated as if the then-current hierarchy had always been in place?

4. Are overrides needed because executives are coded in the HRIS system as being in one hierarchy but, in fact, should have their expense allocated differently?

“Direct Tracing”

Why It’s Important

• Accurate performance measurement at the business unit level of interest – “direct tracing”

– Statutory reporting

• Prompt business units to directly pay for the cost of equity granted to their employees

• Comparative analysis to understand lumpiness of equity granting and expense across organization

• Facilitate better ad hoc / what-if analysis regarding potential termination/divestiture activity

– Budgeting and/or forecasting

Constraints

• Administration:– Employee mobility between divisions

and cost centers

– Changes to organizational hierarchy

– Retroactive pro-ration of adjustments to all affected cost centers

• Frequent requests from cost centers to explain sources of variance and justify allocated costs

• Data problems, especially for foreign employees

• Journal entry automation

• Corporate taxation

Employee Mobility Between Cost Centers

SERVICE PERIOD – 4 Year Cliff Vesting

Cost Center A1.001

Specific Questions and Considerations1. Do you have a way to track the movement of employees

between cost centers and the dates they were effective in each?

2. It is very possible the amount of expense recognized for a single employee grant can be pushed into two or more cost centers in the same reporting period.

3. You may need to generate expense with and with out the impact of mobility to show the expense of a grant as a whole and the breakout of the impact to each cost center impacted.

Cost Center B1.002Cost Center

B2.623Cost Center

A1.001Cost Center A1.042

YR 1 YR 2 YR 3 YR 4Grant

Employee Mobility Between Cost Centers

Cost Center A1.001

Specific Questions and Considerations

1. Impact of expense to a specific cost center can still arise long after the employee leaves that cost center (estimated forfeiture rate/ true-up for actual vesting would need to be accounted for in each cost center where shares were recognized).

2. Too complicated? Some companies will “move” all expense of an award to the new cost center so it follows them fully to the new cost center.

Cost Center B1.002Cost Center

B2.623Cost Center

A1.001Cost Center A1.042

YR 1 YR 2 YR 3 YR 4Grant

SERVICE PERIOD – VEST 2




AWARD DESIGN

Performance & Market Awards

Performance Based

• Performance Trigger based upon corporate or personal goals (e.g., EBITDA)

• Expense is based upon Intrinsic Value

• Typically an explicit or implied service period

Market Based

• Performance Trigger based upon stock price trigger (e.g., TSR).

• Expense is based upon a fair value derived from a Monte-Carlo model

• Can result in a derived service period

Performance Awards (Multiplier Style)

Non-Market Based

• You need to expense the number of probable units that will be earned until the final measurement is determined.

• If the employee earns 2.5x the target, the expense will reflect 2.5x as well.

Market Based

• The probability of units earned is built into the fair value. Expense is always based upon target units.

• If the employee earns 0x the target, the expense is still based upon target units with no credit.

Performance & Market Awards“We don’t like TSR… But we need some focus on TSR…”

• Gradual trend toward including multiple metrics in a single performance/market award:

– Independent metrics – the “simple” way

• Same performance period

• Same legal vesting date/requisite service period

– Complexity arises from an administrative versus financial reporting perspectives

• In essence four awards all having different targets moving independently

• Participants have only received one award agreement

Market & Performance AwardsHybrid design where market and performance conditions interact

Modifier Approach Matrix Approach

Performance Target

Payout1-Year EPS

3-Year TSR Modifier

Relative TSR Percentile

Stretch 150% $1.25 +50% 85th

Target 100% $1.15 +0% 50th

Threshold 50% $1.05 -25% 25th TSR

Ran

kin

g

Net Income as a % of Target< 70% 70% 100% 110%

> 80th 0.000 0.900 1.200 1.80060th -80th 0.000 0.825 1.100 1.65040th -59th 0.000 0.750 1.000 1.500<40th 0.000 0.675 0.900 1.350

EM 2015 SCB Survey Results – Describe Your Perf Awards

The Ascent of Performance Equity

Award with a relative TSR provision 40%

Award with absolute TSR provision 12%

Award with operational target such as EPS, EBITA, ROI 62%

Hybrid award containing both a performance and market condition

19%

Earnings Per Share

ASC 260-10-45-48 Shares whose issuance is contingent upon the satisfaction of certain conditions shall be

considered outstanding and included in the computation of diluted EPS as follows:(a)If all necessary conditions have been satisfied by the end of the period, those shares

shall be included as of the beginning of the period in which the conditions were satisfied

(b)If all necessary conditions have not been satisfied by the end of the period, the number of contingently issuable shares included in diluted EPS shall be based on the number of shares, if any, that would be issuable if the end of the reporting period were the end of the contingency period

Earnings Per Share

Performance Period Explicitly Stated using Averages…?

Options for Share Inclusion EPS Dilution Computation

Performance Period closes at the end of the 3 years

Look at historical 3 years

Use current performance period average

Assume 0 contingently issuable shares until period stipulated in plan document is complete Large dilution spike (assuming metrics hit) in final year

Use prior FY’s (outside performance period) to determine contingently issuable shares

In year 1, use current ROI

In year 2, use ROI average of year 1 & 2….

Performance & Market AwardsDisclose Incremental Shares Achieved Once Performance Contingency Resolved

Shares

Weighted-Average Grant

Date Fair Value

Aggregate Instrinsic Value

(in millions)

Non-vested December 31, 2010 800 $19.00

Incremental achieved 150 $16.00

Granted 230 $26.00

Vested - $0.00

Forfeited (250) $24.00



Granted 240 $32.00

Vested (300) $15.00




Granted 260 $25.00

Vested (280) $19.00


Non-vested December 31, 2013 730 $23.00 $65.00

Additional achievement once performance

achievement determined

Performance & Market AwardsSome companies update their disclosures every quarter based on new estimates

Estimated incremental shares that will be achieved. Can change even quarter over quarter depending on

the Expense multiplier.

Realized and Realizable Pay

• Summary Compensation Table (SCT)

• Equity compensation awards granted based on ASC 718 grant-date fair value

• A couple of problems:

• Not linked to compensation earned during the year,

• Failure to eventually earn all/some granted compensation will not show up in a future SCT

• One alternative: voluntary disclosure of Realized and/or Realizable Pay

• CAP Survey of Fortune 500 companies - 15% supplemented the SCT and GBPA with realized and/or realizable pay disclosure

Realized versus Realizable Pay

Realizable PayThe amount that the executive expects to realize in the near future, and typically includes the tracking value of total long-term incentive compensation awarded during the measurement period, even if such long-term awardshave not yet vested or been exercised

Realized pay The amount that the executive actually earned during the measurement period, and typically includes all gains realized upon exercise of options and vesting full-value equity grants that were exercised or vested during the measurement period irrespective of when the grants were made.

ASC 718 PROPOSALS

Proposed FASB Updates to ASC 718

Area Affected High-level Proposal Transition Method

APIC Pool(As a buffer to P&L)

Remove Prospective

Realization Requirement(Defer excess benefits in NOL cases)

Remove Modified retrospective

Forfeiture Rate(Requirement of)

Remove Modified retrospective

Minimum Statutory Withholding(Liability treatment trigger)

Changed Modified retrospective

Non-employee Awards(Treatment different than employee awards)

TBD TBD

Private Companies(Award Valuations)

Simplified Prospective

Cashflow Designations(Excess tax benefit and tax withholding)

Changed Retrospective

APIC Pool – Current vs. Proposed

• Tax windfalls and shortfalls recorded to additional paid-in capital (APIC)

• Track net windfalls in a memo account called an APIC pool.

• Shortfalls hit P&L only if the APIC pool is $0

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Push all tax windfalls and

shortfalls through the

income statement

Forfeiture Rates - Current vs Proposed

Companies must base their accruals of compensation cost on the estimated number of instruments for which the requisite service is expected to be rendered

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Companies may elect whether to include a forfeiture rate in their accruals of compensation cost or simply record forfeiture reversals as they occur

Thank You

Joshua HemmatiAssistant Corporate ControllerON Semiconductor [email protected]

Joseph Purdy, CEPDirector, Product & Services

[email protected]

Raenelle James, CPASenior Manager, Financial Reporting

Equity Methods [email protected]

mailto:[email protected]



Economy & Finance

GEO NECF 2015 - Best Practices and Trends in Financial Reporting