To All: Good exegesis on options from Yahoo Board:
Net income in 2002 was lower than operating income because of those investment impairments. Remember, this is non-cash. I think this is some of the goofiest acctg rules out there (aside from not expensing stock options...). The rules say when a stock you hold has a decline in market value that is "not temporary", you have to record the expense for the write-down, even if you have not sold the stock. I know I have some stocks trading below what I paid - I don't deduct them from my income this year. And, when (and if) the value rises, they don't get to record the gains into income, until they sell it. It's inconsistent. So, I look through the impairments, it's (hopefully) non-recurring and doesn't reflect the operating income being generated by the company.
A noticable part of the cash flow is from employee stock option exercise. What is a good way to account for the ongoing stockdilution from these transactions?
Well, it's actually not true that stock options generate a large portion of cash flows. Microsoft uses the more commonly used "indirect" method of preparing a cash flow statement. This means they start with net income and then make the non-cash adjustments to arrive at cash. (the direct method would just build up to the cash flows from scratch).
SO, the math works like this. MSFT does not include stock option expense in their GAAP financial statements today. But, they record a 32% tax expense against their GAAP income. In reality, tax code says they get to deduct option expense from their taxable income, so the real tax bill is less than 32% of their GAAP income. The stock options acctg don't really generate any cash, they just took too big of an expense on the GAAP books. The math works like this, simplified.
GAAP books:
Pre-tax income = 1000
Taxes = 320
Net income = 680
Tax books:
Pretax GAAP income = 1000
Stock opt expense = 300
Taxable income = 700
Taxes = 224
Cash Flow statement:
Net income (GAAP) = 680
+non-cash tax exp = (320-224) = 96
Net operating cash (680+96) = 776
So, in the above cash, MSFT had to report taxes for GAAP income of 320. Actual taxes paid is only 224. So, their cash flow statement adds the difference back to the GAAP income. There really is no cash benefit, unless of course tax laws are changed to no longer permit that deduction.
If rules are changed to require MSFT to deduct stock opt expense from GAAP income, you will see no change to cash flow. Instead, there will be no adjustment between tax & GAAP books.
GAAP income:
Pre-tax income: 1000
Stock opt exp: 300
Pretax inc = 700
Taxes (32%) = 224
Net income = (700-224) 476
Tax income: (same as before)
Pretax GAAP income = 1000
Stock opt expense = 300
Taxable income = 700
Taxes = 224
Cash flow statement:
GAAP net income: 476
Tax adjustment: 0
+stock option exp: 300
Net cash: 776
Same cash position. (Remember, stock option expense does not affect cash flows, so you have to add it back to net income to adjust for the non-cash stuff).
As far as ongoing dilution goes - you should absolutely avoid companies that excessively dilute shareholder value through options. Companies like SEBL gives away 20% of the company's value as options. I think MSFT gives away about 1-2% each year, but they buy back shares to offset it. So, if you look at the diulated outstanding share count, it's stayed flat for years. There is no incremental dilution from options at MSFT, and they have the cash position to continue to manage that dilution effectively.
And stock options are included in the share count used to calculate EPS already, as you probably know.
JFD |
