TO ALL: I sent the following message to Dick Kraber (CFO) over a week
ago but have not received any response to date. These seem like fair
questions for shareholders to ask management and I hope that we can
expect a reply soon.
Subject: Shareholder Questions
Date: Sun, 05 Jul 1998 20:16:27 -0400
From: Michael Greene <mfgreene@mediaone.net>
To: Richard Kraber <dickk@wrs.com>
CC: Ronald Abelmann <rona@wrs.com>
Mr. Kraber, I am a shareholder with a few questions.
You may or may not be aware that there has been a discussion on the
Wind River thread at the Silicon Investor web site about the impact
of employee stock options upon shareholder value. I would like to
present a devil's advocate perspective on this issue and ask you to
comment upon it. We understand that the granting of stock options to
executives and other employees is common practice in the software
industry. The objective here is not so much to question this practice
but rather to evaluate its impact upon Wind River shareholders. It is
my intention to share this request and your response with the other
shareholders on the thread.
As you know, on page 38 of the 1998 Annual Report there is a section
entitled "Pro Forma Disclosures" introduced per FAS 123 requirements
which reveals the cost of employee stock options not recognized as an
expense under standard APB Opinion No. 25 reporting. These options,
typically 10 year calls on the common stock, have considerable value
which is estimated by application of the Black-Scholes model in
order to place a value on these unrecognized compensation expenses.
The table below contains selected financial data for the past three
fiscal years which are pertinent to our discussion. In order to be
consistent I have adjusted the reported 1998 numbers by ignoring the
"Acquired in-process R and D" write-off and applying a 38% tax rate
to get net income of 17,684,000 which is 0.63 per share fully
diluted. This should be close enough for purposes of this discussion.
1998 1997 1996
Net Income:
as reported 17,684 11,280 5,383
Pro Forma 7,032 7,296 4,248
Diluted EPS:
as reported 0.63 0.43 0.23
Pro Forma 0.25 0.28 0.18
Pro Forma expense
after tax effect 10,652 3,984 1,135
Pro Forma expense
as percent of "as
reported" net income 60% 35% 21%
Diluted shares
outstanding 28,153 26,129 23,435
Expenditures to
repurchase shares 12,364 7,050 3,265
OBSERVATIONS AND CONCLUSONS
There is a real and sizable cost associated with employee stock
options which the "as reported" earnings fail to recognize.
Therefore, Pro Forma earnings should be considered to be a better
reflection of actual performance.
Pro Forma compensation expense is rapidly escalating as a percentage
of reported earnings. This quote from the Annual Report, "In future
years, the annual compensation expense factor is expected to increase
relative to the fair value of stock options granted in those years",
suggests that this trend will continue.
Earnings, after taking into account the unrecognized expense of
employee options, have stopped growing.
While we recognize that Pro Forma earnings are an accounting construct
there are real costs associated with the employee stock options and
for Wind River today this cost seems to be substantial. Pro Forma
recognized costs may even be conservative in light of the eventual
dilution and/or share repurchase premiums over exercise prices
incurred to honor future redemption of currently granted options.
Spending 60 to 70 percent of "as reported" earnings over each of the
past three years on stock repurchases has not been sufficient to
supply all of the shares required for the exercise of options. There
has been significant share dilution and, in fact, spending all of "as
reported" earnings would not be sufficient to avoid dilution. It
appears that between spending cash to repurchase shares for option
exercises and share dilution there is little prospect in the next few
years of increasing intrinsic shareholder value.
Do you agree with the above observations? If not, please share your
thoughts with myself and the other concerned shareholders.
Thank you in advance,
Michael Greene |
