>The company might not have had any operating profits at all last
>quarter if they had expensed costs as incurred like INTS! We can't really tell...
Mark, I'm going to respond to this even though the consensus on the thread is that we need to focus more on important developments, like the NC and I2O, and I agree. The reason I'm going to respond is that we have never discussed some important accounting conventions, and you keep implying wrongly that WIND is cheating through accounting chicanery, which grates.
You are correct that WIND's policy statement concerning capitalized software development costs MIGHT appear to provide a vehicle for deferring expenses thereby inflating earnings. But despite the statement, WIND is extremely conservative in capitalizing development costs. For the quarter in question they capitalized a mere $179,000. Even this paltry sum was offset by $150,000 amortized software costs from previous period capitalized software costs, for a net deferred amount of $29,000. These numbers are not even enough to talk about, so to suggest that WIND might not have had any operating profits had they expensed costs is nonsense. A consistent policy of expensing all development costs would not have made any material difference in earnings. Watch what they do, not what they say.
Now here is the real point. The truth is that you are absolutely mistaken in suggesting that any company that capitalizes software development costs is somehow bending the rules so as to inflate earnings. The theory behind accrual accounting is to synchronize revenues and expenses, and I can't think of anything that is more out of synch with revenues than expensed development costs. I believe strongly that companies like WIND should capitalize virtually all of their development costs, and slowly amortize them against a realistic product lifetime, much greater than 18 months, for example.
Aggressive capitalizing of development costs would allow WIND to make massive software development expenditures, by dipping into their giant war chest of $100 million, without taking an earnings hit and crashing the stock. I like that, since I want management to be positioned to spend as freely as necessary to bring products to market. I also like it because, I repeat, it is theoretically correct.
There are many reasons why WIND doesn't follow this "appropriate" practice, and in fact is extremely conservative about capitalizing development costs - despite what you say. Since these reasons are important for everyone to understand, I will enumerate a few in order of importance:
1. In general, as long as current operating profits are acceptable, then most managers prefer to expense everything they can, so future earnings will be seen to grow substantially. In other words, if a company is making an adequate operating margin, then management has no incentive to delay costs, because delaying costs makes comparative performance improvement more difficult to achieve in the future than otherwise. (Anyone noticing this is the exact opposite of what Mark complains about?)
2. The market is conditioned only to accept limited capitalizing, and would punish any company that capitalized development costs aggressively beyond traditional amounts - especially if the company changed its behavior in midstream. Of course the reason is that investors like Mark would conclude that the company is trying to defer expenses to make its earnings.
3. If development expenses are aggressively capitalized, then the current tax bill is higher than it would be otherwise. This policy actually drains cash from the treasury, which is never to management's nor my liking. Consequently, this tempers my enthusiasm for theoretical perfection.
The irony is that WIND is not doing the thing you accuse it of, but the thing you are accusing it of, it should be doing. If you are getting the feeling that you absolutely do not understand of what you are accusing, then you are absolutely correct.
Allen
PS -- You are correct about our bad habit of including "other income" in WIND EPS, but the number is not nearly as big as you represent (just use the reported amount), and WIND is comfortably in the black without including interest. (Incidentally, my projections do not confuse or otherwise mistreat other income.)
PPS -- I will not address your comments about growth in equity, because that subject is far more complicated than capitalizing costs. It turns on the critical importance of establishing incentives through stock options and stock buybacks - the essence of Silicon Valley. Suffice it to say that WIND's management is following proven policies of MSFT, INTC and other successful high-tech firms in their management of equity. So far, management's policies in this regard have achieved precisely what is needed, and they need full stockholder support for staying the course. |
