13. Stock-based compensation

Stock option and restricted stock activity

Options

The following table summarizes stock option activity for the six months ended December 31, 2018 and 2017:


				Weighted
			Weighted	average		Weighted
			average	remaining	Aggregate	average
			exercise	contractu	intrinsic	grant date
	Number of		price	al term	value	fair value
	shares		($)	(in years)	($'000)	($)

Outstanding – June 30, 2018	809,274		13.99	2.67	370	4.20
Granted – September 2018	600,000		6.20	10.00	1,212	2.02
Forfeitures	(200,000	)	24.46			7.17
Outstanding – December 31, 2018	1,209,274		8.41	6.15	72	2.62

Outstanding – June 30, 2017	846,607		13.87	3.80	486	4.21
Forfeitures	(37,333	)	11.23			4.55
Outstanding – December 31, 2017	809,274		13.99	3.40	468	4.20

During the six months ended December 31, 2018, 600,000 stock options were awarded to executive officers and employees. No stock options were awarded during the three months ended December 31, 2018, or during the three and six months ended December 31, 2017, respectively. During the six months ended December 31, 2018, executive officers forfeited 200,000 stock options granted in August 2008, with a strike price of $24.46 per share, as these stock options expired unexercised. During the six months ended December 31, 2017, employees forfeited 37,333 stock options.

The fair value of each option is estimated on the date of grant using the Cox Ross Rubinstein binomial model that uses the assumptions noted in the following table. The estimated expected volatility is calculated based on the Company's 750 day volatility. The estimated expected life of the option was determined based on historical behavior of employees who were granted options with similar terms.

The table below presents the range of assumptions used to value options granted during the six months ended December 31, 2018:


	Six months
	ended
	December 31,
	2018
Expected volatility	44	%
Expected dividends	0	%
Expected life (in years)	3
Risk-free rate	2.75	%

The following table presents stock options vested and expected to vest as of December 31, 2018:


			Weighted
		Weighted	average
		average	remaining	Aggregate
		exercise	contractual	intrinsic
	Number of	price	term	value
	shares	($)	(in years)	($'000)
Vested and expected to vest – December 31, 2018 .	1,209,274	8.41	6.15	72

These options have an exercise price range of $6.20 to $13.16.

The following table presents stock options that are exercisable as of December 31, 2018:


			Weighted
		Weighted	average
		average	remaining	Aggregate
		exercise	contractual	intrinsic
	Number of	price	term	value
	shares	($)	(in years)	($'000)

Exercisable – December 31, 2018	609,274	10.56	2.84	72

No stock options became exercisable during the three and six months ended December 31, 2018, or during the three months ended December 31, 2017, respectively. However, during the six months ended December 31, 2017, 105,982 stock options became exercisable. The Company issues new shares to satisfy stock option exercises.

Restricted stock

The following table summarizes restricted stock activity for the six months ended December 31, 2018 and 2017:


	Number of		Weighted
	shares of		average grant
	restricted		date fair value
	stock		($'000)
Non-vested – June 30, 2018	765,411		6,162
Granted – September 2018	148,000		114
Vested – August 2018	(52,594	)	459
Non-vested – December 31, 2018	860,817		5,785

Non-vested – June 30, 2017	505,473		11,173
Granted – August 2017	588,594		4,288
Vested – August 2017	(56,250	)	527
Forfeitures	(30,635	)	358
Forfeitures – August and November 2014 awards with market conditions	(95,326	)	1,133
Non-vested – December 31, 2017	911,856		9,365

The September 2018 grants comprise 148,000 shares of restricted stock awarded to executive officers that are subject to market and time-based vesting. The August 2017 grants comprise (i) 326,000 shares of restricted stock awarded to executive officers and employees that are subject to time-based vesting, (ii) 210,000 shares of restricted stock awarded to executive officers that are subject to market and time-based vesting, and (iii) 52,594 shares of restricted stock awarded to non-employee directors.

The 326,000 shares of restricted stock will only vest if the recipient is employed by the Company on a full-time basis on August 23, 2020. The 52,594 shares of restricted stock awarded to non-employee directors in August 2017 vested on August 23, 2018. During the three months ended December 31, 2017, 56,250 shares of restricted stock granted to non-employee directors vested and employees forfeited 30,635 shares of restricted stock with either market or performance conditions upon their termination from the Company.

Market Conditions - Restricted Stock Granted in September 2018

The 148,000 shares of restricted stock awarded to executive officers in September 2018 are subject to time-based and performance-based (a market condition) vesting conditions and vest in full only on the date, if any, that the following conditions are satisfied: (1) the price of the Company's common stock must equal or exceed certain agreed VWAP levels (as described below) during a measurement period commencing on the date that it files its Annual Report on Form 10-K for the fiscal year ended 2021 and ending on December 31, 2021 and (2) the recipient is employed by the Company on a full-time basis when the condition in (1) is met. If either of these conditions is not satisfied, then none of the shares of restricted stock will vest and they will be forfeited. The $23.00 price target represents an approximate 55% increase, compounded annually, in the price of the Company's common stock on Nasdaq over the $6.20 closing price on September 7, 2018.

The VWAP levels and vesting percentages related to such levels are as follows:

Below $15.00 (threshold)—0%
At or above $15.00 and below $19.00—33%
At or above $19.00 and below $23.00—66%
At or above $23.00—100%

The fair value of these shares of restricted stock was calculated using a Monte Carlo simulation of a stochastic volatility process. The choice of a stochastic volatility process as an extension to the standard Black Scholes process was driven by both observations of larger than expected moves in the daily time series for the Company's VWAP price, but also the observation of the strike structure of volatility (i.e. skew and smile) for out-of-the money calls and out-of-the money puts versus at-the-money options for both the Company's stock and NASDAQ futures.

In scenarios where the shares do not vest, the final vested value at maturity is zero. In scenarios where vesting occurs, the final vested value on maturity is the share price on vesting date. In its calculation of the fair value of the restricted stock, the Company used an average volatility of 37.4% for the VWAP price, a discounting based on USD overnight indexed swap rates for the grant date, and no future dividends. The average volatility was extracted from the time series for VWAP prices as the standard deviation of log prices for the three years preceding the grant date. The mean reversion of volatility and the volatility of volatility parameters of the stochastic volatility process were extracted by regressing log differences against log levels of volatility from the time series for at-the-money options 30 day volatility quotes, which were available from January 2, 2018 onwards.

Market Conditions - Restricted Stock Granted in August 2017

The 210,000 shares of restricted stock awarded to executive officers in August 2017 are subject to time-based and performance-based (a market condition) vesting conditions and vest in full only on the date, if any, that the following conditions are satisfied: (1) the price of the Company's common stock must equal or exceed certain agreed VWAP levels (as described below) during a measurement period commencing on the date that it files its Annual Report on Form 10-K for the fiscal year ended 2020 and ending on December 31, 2020 and (2) the recipient is employed by the Company on a full-time basis when the condition in (1) is met. If either of these conditions is not satisfied, then none of the shares of restricted stock will vest and they will be forfeited. The $23.00 price target represents an approximate 35% increase, compounded annually, in the price of the Company's common stock on Nasdaq over the $9.38 closing price on August 23, 2017. The VWAP levels and vesting percentages related to such levels are as follows:

Below $15.00 (threshold)—0%
At or above $15.00 and below $19.00—33%
At or above $19.00 and below $23.00—66%
At or above $23.00—100%

These 210,000 shares of restricted stock are effectively forward starting knock-in barrier options with multi-strike prices of zero. The fair value of these shares of restricted stock was calculated utilizing a Monte Carlo simulation model which was developed for the purpose of the valuation of these shares. For each simulated share price path, the market share price condition was evaluated to determine whether or not the shares would vest under that simulation. A standard Geometric Brownian motion process was used in the forecasting of the share price instead of a "jump diffusion" model, as the share price volatility was more stable compared to the highly volatile regime of previous years. Therefore, the simulated share price paths capture the idiosyncrasies of the observed Company share price movements.

In scenarios where the shares do not vest, the final vested value at maturity is zero. In scenarios where vesting occurs, the final vested value on maturity is the share price on vesting date. The value of the grant is the average of the discounted vested values. The Company used an expected volatility of 44.0%, an expected life of approximately three years, a risk-free rate ranging between 1.275% to 1.657% and no future dividends in its calculation of the fair value of the restricted stock. The estimated expected volatility was calculated based on the Company's 30 day VWAP share price using the exponentially weighted moving average of returns.

Performance Conditions - Restricted Stock Granted in August 2016

In August 2016 the Company awarded 350,000 shares of restricted stock to executive officers. In May 2017, the Company agreed to accelerate the vesting of 200,000 of these shares of restricted stock granted to the Company's former Chief Executive Officer. The remaining 150,000 shares continue to be subject to time-based and performance-based vesting conditions. In order for any of the shares to vest, the recipient must remain employed by the Company on a full-time basis on the date that it files its Annual Report on Form 10-K for the fiscal year ended June 30, 2019. If that condition is satisfied, then the shares will vest based on the level of Fundamental EPS the Company achieves for the fiscal year ended June 30, 2019 ("2019 Fundamental EPS"), as follows:

One-third of the shares will vest if the Company achieves 2019 Fundamental EPS of $2.60;
Two-thirds of the shares will vest if the Company achieves 2019 Fundamental EPS of $2.80; and
All of the shares will vest if the Company achieves 2019 Fundamental EPS of $3.00.

At levels of 2019 Fundamental EPS greater than $2.60 and less than $3.00, the number of shares that will vest will be determined by linear interpolation relative to 2019 Fundamental EPS of $2.80. Any shares that do not vest in accordance with the above-described conditions will be forfeited. All shares of restricted stock have been valued utilizing the closing price of shares of the Company's common stock quoted on The Nasdaq Global Select Market on the date of grant.

Forfeiture of restricted stock awarded in August and November 2014 that did not achieve targeted market conditions

During the three and six months ended December 31, 2017, restricted stock with market conditions awarded in August and November 2014, were forfeited, because the target market conditions were not achieved. The stock-based compensation charge related to these awards was not reversed upon forfeiture because these awards contained market conditions.

The fair value of restricted stock vesting during each of the six months ended December 31, 2018 and 2017, respectively, was $0.5 million.

Stock-based compensation charge and unrecognized compensation cost

The Company recorded a stock-based compensation charge during each of the three months ended December 31, 2018 and 2017 of $0.6 million respectively, which comprised:


				Allocated to cost
				of goods sold, IT		Allocated to
				processing,		selling, general
		Total		servicing and		and
		charge		support		administration
Three months ended December 31, 2018
Stock-based compensation charge	$	598	$	-	$	598
Total – three months ended December 31, 2018 .	$	598	$	-	$	598
Three months ended December 31, 2017
Stock-based compensation charge	$	608	$	-	$	608
Total – three months ended December 31, 2017 .	$	608	$	-	$	608

The Company recorded a stock-based compensation charge during the six months ended December 31, 2018 and 2017 of $1.2 million and $1.4 million respectively, which comprised:


					Allocated to cost
					of goods sold, IT		Allocated to
					processing,		selling, general
		Total			servicing and		and
		charge			support		administration
Six months ended December 31, 2018
Stock-based compensation charge	$	1,185		$	-	$	1,185
Total – six months ended December 31, 2018	$	1,185		$	-	$	1,185
Six months ended December 31, 2017
Stock-based compensation charge	$	1,477		$	-	$	1,477
Reversal of stock compensation charge related to
stock options forfeited		(42	)		-		(42	)
Total – six months ended December 31, 2017	$	1,435		$	-	$	1,435

The stock-based compensation charges have been allocated to selling, general and administration based on the allocation of the cash compensation paid to the relevant employees.

As of December 31, 2018, the total unrecognized compensation cost related to stock options was approximately $1.1 million, which the Company expects to recognize over approximately three years. As of December 31, 2018, the total unrecognized compensation cost related to restricted stock awards was approximately $2.6 million, which the Company expects to recognize over approximately two years.

As of December 31, 2018 and June 30, 2018, respectively, the Company recorded a deferred tax asset of approximately $0.8 million and $0.7 million, related to the stock-based compensation charge recognized related to employees of Net1. As of December 31, 2018, and June 30, 2018, respectively, the Company recorded a valuation allowance of approximately $0.8 million and $0.7 million, related to the deferred tax asset because it does not believe that the stock-based compensation deduction would be utilized as it does not anticipate generating sufficient taxable income in the United States. The Company deducts the difference between the market value on date of exercise by the option recipient and the exercise price from income subject to taxation in the United States.