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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (5627)	2/18/2002 2:53:31 AM
From: Raymond Duray	Read Replies (1) \| Respond to of 33421

Enough about Options already! <gg> How about some derivatives chatter to add to the smorgasbord of corporate excess exorcisms? riskcenter.com [[Free registration required]] February 18: Enron - Congress Revisits Derivatives Trading Location: Washington, D.C. Author: RiskCenter Staff Date: Monday, February 18, 2002 Congress has started to zero in on derivatives trading as it continued to investigate the issues raised by the Enron collapse. After initially digging into Enron's off-balance-sheet partnerships and the company's questionable financing and accounting schemes, lawmakers in both houses began focusing on federal oversight of the energy trading business. Some legislators pointed the finger at Enron's huge role, through its EnronOnline trading platform, in the over-the-counter market for power forwards, saying the bankruptcy points to the need for more federal oversight. Such increased regulation is the focus of legislation introduced Thursday by a group of senators from Western states, who want to further regulate wholesale energy trading by subjecting derivatives deals, including over-the-counter forward power deals and online trading of those contracts, to more federal scrutiny. The proposal would "make sure all energy transactions are transparent and subject to some regulatory oversight," Dianne Feinstein (D-Calif.), one of the bill's sponsors, said. Feinstein said she, along with co-sponsors Maria Cantwell (D-Wash.) and Ron Wyden (D-Ore.), are seeking to "reinstate regulatory oversight to the marketplace and help ensure there is not a repeat of the energy crisis that had such a devastating impact on "California and the West." The derivatives legislation may be added as an amendment to a comprehensive energy bill that was set to be introduced on the Senate floor late last week, Feinstein said. But, she added, she did not want derivatives legislation to be torpedoed if the comprehensive bill failed. Last year's huge run-up in Western wholesale prices figured prominently in the senators' statements on the need for such legislation. They said Enron, because of the opacity of derivatives and over-the-counter markets in which it traded, may have been able to drive up wholesale prices in the West, and the Federal Energy Regulatory Commission said it would begin a formal probe into those allegations. ......................................................... Hi John, Thanks so much for all the good work you are doing on putting the stock options debate together. You're doing such a splendid job, I'm leaving it in your able hands. I have been so impressed this past couple of weeks with Sen. Peter Fitzgerald (R. - IL). He's a securities attorney and has been ripping the guts out of the Enron illusions. I expect his imprimatur on McCain's options bill will go a long way to helping steamroll the reforms that are starting to fly out of Congress. I fully expect the Administration to be as obstructionist as possible on meaningful reform. Something that hopefully the electorate will wake up to eventually. The rot in the American corporate system has gotten to intolerable levels and I'm delighted to see the pendulum start to swing back to rational policy instead of piracy as the corporate ideal. -Ray

To: John Pitera who wrote (5627)	2/18/2002 8:49:30 AM
From: Jorj X Mckie	Read Replies (3) \| Respond to of 33421

An argument for why the stock options controversy may eventually be swept under the rug. I have always been a believer in not taxing businesses. Many conservatives/libertarians think along the same lines. But now with the everyone seeing an "enron" in every balance sheet, the tax benefits from the exercising of stock options is being viewed with the ugly eye. So what happens if we take this little tax benefit away from the Cisco's of the world? Same thing as if Cisco has its taxes raised. Simple, they will raise their prices commensurate to their margin targets. The taxes will be passed along to the consumer no matter what. This would pretty much act as a damper on an already hurting economy. And I think that it is simple enough to explain that even our most dense congresscritters will understand the ramifications of making too much of an issue. While there have been many implications that businesses who have benefitted from the stock options tax benefit are somehow ripping off the system, I see this as more of a "return to zero" from the revenues that are stolen by the gov't in the form of taxes. Sorry, my inner libertarian sneaked out again.

To: John Pitera who wrote (5627)	2/18/2002 2:54:15 PM
From: Logain Ablar	Respond to of 33421

John: One must also remember an qualified options are worthless on the date of the grant since by defination they are issued @ the closing price of the stock on the grant date. Its only if they appreciate that its an issue or if they don't appreciate the company issues new options. You know the GAAP rules will come back and haunt some companies like BRCD if the stock ever recovers. The employees have the old options now not in the money and then new ones recently issued.

To: John Pitera who wrote (5627)	3/1/2002 2:36:17 PM
From: John Pitera	Read Replies (2) \| Respond to of 33421

When Cash Flow Lies--When it's coming from Corp. deducting Employee stock options gains from their taxable income!!! By Pat Dorsey Friday March 1, 6:00 am Eastern Time Morningstar.com It's natural to think of a company's financial performance as being independent of its share-price performance. Companies make money by selling gizmos or providing services, right? If demand for widgets goes up, and WidgetWorks manages to fend off archrival Widget-o-Rama, then WidgetWorks makes more money. Easy. Maybe WidgetWorks' stock goes up, maybe it goes down, but as long as more widgets are going out the door and customers are paying their bills, WidgetWorks keeps on increasing earnings and cash flow. Well, maybe. The fact is, if WidgetWorks compensates its hard-working employees with stock options, then a stock-price decline could cause both earnings and cash flow to decline quite a bit, regardless of how many widgets are sold. Why? The reason is the wonderful little tax benefit that option-granting companies reap when happy employees exercise their stock options, which can quickly vaporize when the stock heads south and fewer employees cash in their options. This little accounting quirk is worth your attention because, unlike a lot of accounting conventions, it affects cash flows. As I've often pointed out, there are a lot of ways that a company can fiddle with its reported earnings to make it look like it's growing faster than it really is. However, the statement of cash flows usually reveals these kinds of shenanigans, which is why we at Morningstar tend to use it as our touchstone when assessing the quality of companies' financial results. (For more on how cash flow and earnings can diverge, check out this article.) Tax Breaks Clouding the Picture Unfortunately, stock options provide cash tax benefits to companies that issue them, which means that cash flows can be inflated--and that, in turn, means that a declining stock price can lead to dramatically lower cash flows. Here's how this works: Your employer gives you 100 options with an exercise price of $10. A few years later, the stock is trading for $30, and you decide to cash in. You pay taxes on the $2,000 difference (the $30 market price less the $10 exercise price), and your employer gets to take a tax deduction of $2,000 against its corporate income. (In general, taxable employee compensation is tax-deductible for companies.) In other words, your employer reduced its tax bill by $700--assuming a 35% tax rate--just because you exercised your 100 options. As long as your company's stock keeps going up, and it keeps giving out options, this process continues. More options are exercised, tax deductions are taken, and your company saves cash by lowering its tax bill. But what happens if the stock takes a tumble? Well, a lot of people's options will be worthless--since their exercise prices will be higher than the market price--and consequently fewer options will be exercised. Since fewer options are exercised, the company's tax deduction gets a lot smaller, which means it has to pay more taxes than before--and that means lower cash flow. Pretty neat, huh? When the stock price declines, the company makes less money than it was before. And lest you think the amounts involved are trivial, let's run through a few examples. No Small Distortion Luckily for us, many companies break out the effect of the stock-option tax benefit on their cash flow statements. (Look for a line labeled ``tax benefits from employee stock plans,'' or ``tax benefit of stock options exercised.'') Sun Microsystems SUNW reported about $2.1 billion in cash flow from operations in fiscal 2001, $816 million of which resulted from this lovely tax benefit. In other words, Sun would have generated 40% less cash in 2001 if its employees hadn't exercised tons of options. Or how about red-hot graphics-chip designer NVIDIA NVDA? This firm generated about $16 million in cash from operations in fiscal 2000, but had a $10.6 million tax benefit. In fiscal 2001, NVIDIA generated about $68 million in cash from operations, with $63.2 million coming from the option-related tax benefit. In other words, if NVIDIA's stock hadn't been on fire and employees hadn't exercised boatloads of options, the company would have generated very little cash that year. And of you're wondering just how quickly the stock option tax benefit disappears once a company's stock starts tanking, look no further than Sun. If we look at the 10-Q filing that Sun submitted a couple of weeks ago for the quarter ended December 31, 2001, we find Sun's tax benefit from employee stock plans declined to $41 million in the latter half of 2001 from $621 million in the second half of 2000. You can see what's happening pretty clearly: In 2000, Sun's stock was still pretty high, so employees exercised options and generated $621 million in tax benefits for Sun. (Since Sun's cash flow from operations was about $1.2 billion in the second half of 2000, you can see that the $621 million tax benefit helped the company out quite a bit.) In 2001, with Sun's stock in the dumps, very few options were being exercised, which means that cash flow doesn't get the options-related boost. Take a Closer Look The lesson? If you're analyzing a company with great cash flow that also has a high-flying stock, check to see how much of that cash flow growth is coming from stock-options tax benefits. Unless you think you can predict the stock market, that's not cash you want to count on in years to come. biz.yahoo.com ------------- Be sure to read the 6 posts on ESOP and options accounting that this post is responding too!!!