Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : Employee Stock Options - NQSOs & ISOs -- Ignore unavailable to you. Want to Upgrade?

To: Clarksterh who wrote (135)	7/28/2002 12:33:26 PM
From: Exacctnt	Respond to of 786

<<<<I have tried to find out whether total dilution includes only vested options or not, and although I am not sure I believe it is only for vested options. >>>> Fully diluted EPS includes in-the-money options both vested and non-vested. Fluctuations in the number of diluted shares will occur quarter to quarter based upon the market price of the stock. The full affect from market price changes won't be felt because basic and diluted shares are a weighted average number of shares over the current year.

To: Clarksterh who wrote (135)	7/28/2002 3:35:49 PM
From: rkral	Read Replies (1) \| Respond to of 786

There does not seem to be a settled method of accounting for options. For instance Coke (and The Washington Post?) are using some obscure method for which I have not yet seen a good description. And then the pro forma reporting done in all of the 10Ks according to the FASB rules uses Black Scholes. I assume you are referring to: "Coca-Cola said it would expense all future stock option grants based on the fair value at the date options are granted. That value will be determined from stock prices received from financial institutions that trade Coke shares under terms identical to the options." I suspect that KO is just trying to appear at "arms-length" from the Black-Scholes valuation of the option. In practice, this probably means institutions will determine the volatility and risk-free interest rate .. but KO will still need to guide the institutions in determined the "option life". Regardless of which method is used for accounting for options, there will be a permanent disconnect between the cash flow and earnings. Cash flow always matters to a company, earnings do not except in so far as they effect taxes and public relations. As a hypothetical, let's assume a company can choose between claiming an expense of zero, or the intrinsic value of the option. Let's further assume that Levin-McCain S.1940 passes and expenses on the tax books and financial books must be the same. Do you believe that companies will claim the expense in order to obtain the cash flow (due to the tax benefit) even though doing so will reduce the reported earnings? ... up to speed on all of the FASB stuff. Did you order a copy of some of the letters? Kudo appreciated. I have purchased FAS 123 "Stock Based Compensation" and FAS 128 "Earnings". Have read a lot of 123, very little of 128. Ron P.S. Gotta run. Will add to reply later.

To: Clarksterh who wrote (135)	7/28/2002 6:00:28 PM
From: hueyone	Read Replies (1) \| Respond to of 786

Regardless of which method is used for accounting for options, there will be a permanent disconnect between the cash flow and earnings. I don't know what you mean by this. Net income can always be adjusted to cash flow from operations with adjustments for non cash items in the adjustments section of the cash flow statement. In fact, many folks on the Gorilla thread try to diminish the impact from expensing stock options on the income statement by stating that there will be zero change in free cash flow even if options are expensed. My answer to that contention is that it depends on how one calculates free cash flow and where the adjustment to reconcile cash and non-cash occurs. Nevertheless, the quality of the free cash flow number you generate and understanding what comprises that number is the important point here. It can be argued that free cash flow will not change, but that does not change the fact that free cash flow inflated by substituting stock options for cash compensation is a lot less valuable than free cash flow which is comprised of an all cash payroll. Companies that rely heavily on stock options to compensate employees have to keep giving away parts of the company every year just to maintain the same level of yearly free cash flow, whereas companies that are compensating employees in cash do not. To put things more succinctly, if you were looking to purchase a company in its entirety to take it private, you would likely avoid any company whose positive free cash flow was largely explained by substituting stock options grants for cash compensation, because if you planned to own the entire company as a private venture, you could not count on slicing up the ownership every year in to more and more pieces to keep your compensation costs low and cash flow high. As an investor considering taking a company private, you would want to calculate where free cash flow would lie when you had to substitute cash compensation for stock options compensation after you purchased the company. In theory, the investment analysis should be no different for us small investors when we consider buying a small piece of a company as opposed to the entire company. Denis Guenette published a very interesting article a few posts back, post #131, which discussed possible changes in the options culture of Silicon Valley precipitated by the fall in market prices as opposed to government action. Apparently some employees are beginning to opt for cash compensation right now over stock options. In these instances, stock options will in essence be "expensed", without any changes in the law, and investors will understand very quickly what the true cost is to operate some of these companies. Hence, in my view, any company that relies heavily on stock options grants for a large portion of its payroll, is a very risky investment right now. Irrespective of government action, and irrespective of whether these companies expense stock options on the income statement, the market itself may soon call these companies bluff and their true costs of operating will be exposed if market forces move them towards cash compensation. We are only in the beginning stages of the dirty laundry coming out in the wash and eventually it will all come out. Finally, there is another possible dynamic that could be at work here. Many of the greater fools that have been mindlessly supporting these companies as they transfer their hard earned money to Silicon Valley (and I have been one of these fools myself to some extent), are either tapped out or they are beginning to understand many of the ruses that companies use to overstate performance in their quarterly earnings reports. Skepticism and a dearth of cash flow from foolish investors may rule the day. So in essence, we may end up with the stock options pyramid scheme beginning to work in reverse---investor skepticism about companies who heavily rely on stock options for compensation forestalls recoveries in stock prices for these companies; the longer stock prices are low, the more employees try to opt for cash over stock options; the more employees opt for cash, the worst earnings and cash flow look and the more investors eschew these companies---starting another potential round of devaluation for these companies' stock prices and so on. Certainly there is no foregone conclusion that such a scenario will occur and it is only one of many potential scenarios. Hype could well rule the day again and investors could overlook this issue as well as all the other questionable pro forma numbers in many company’s earnings releases---as they have done in the past, but with the likes of Warren Buffet, Alan Greenspan, Standard & Poors and the popular financial press giving the issue of expensing stock options plenty of airtime, the cat may already be out of the bag. Serious attendant consequences resulting from the public airing of this issue are not out of the question, and in response, this particular investor will be proceeding very cautiously. Best, Huey