Most people wouldn’t know a 10K report from a 10K run, but financial voyeurs like me sift them for nuggets of information. And Microsoft’s 10K for its fiscal year ended June 30 has got a nifty nugget. To wit, for the first time, Microsoft has placed a value on the stock options that it gives employees. And it’s a big, fat number: $570 million. Had Microsoft been required to charge that as an expense, which it doesn’t have to do, the company’s profits would have shrunk by more than 15 percent. And Microsoft’s stock price, assuming the market acted perfectly rationally, would be around $115 rather than $137, its Friday close. That would have sliced $3 billion off Bill Gates’s $19 billion fortune (poor baby ) and reduced Microsoft’s stock-market value by $12 billion or so.
Before we jump to any hasty conclusions about what this might or might not mean, let’s boot up some background. Microsoft offers stock options to most employees rather than to a select few. That’s a tradition among high-tech companies. Not only does this transform employees into owners, which I think is marvelous, but it also means a company can pay lower salaries and bonuses than it otherwise would. ““Our options program is of great value to employees and all our shareholders,’’ said Microsoft spokesman Greg Shaw. ““It enhances the employees’ motivation, which helps our stock price rise and is good for all our stockholders.''
There’s another way in which options are useful. Companies don’t have to reduce reported income by one penny in order to issue them, as they would to pay wages, even though options are a big chunk of their employees’ compensation. It’s like getting a free lunch, along with a free ride. Counting options as an expense wouldn’t make any difference to a company’s cash flow. But doing so would take a big bite out of reported profits for companies like Microsoft that issue them by the bushel. That might in turn hurt their stock price, too. It would also remove a big advantage these companies have over companies like my employer, The Washington Post Company, which issue few options and pay us wage-slaves in hard, cold cash that counts against the bottom line. Ouch.
Accounting watchdogs have been wrangling for ages over how to properly treat options. It’s their version of the Hundred Years’ War–and it still hasn’t come to a satisfactory denouement. Recently, however, the green-eyeshade boys came out with a ruling. Companies still don’t have to charge the costs against earnings. But for years starting after Dec. 15, 1995, they do have to reveal those little nuggets to their shareholders.
Which brings us back to Microsoft, and its recent filing. Because Microsoft’s fiscal year began on July 1, 1995, it wasn’t obliged to disclose its option costs until next year. So what if it jumped the gun a bit? Think of it as geeks bearing gifts to financial analysts. Microsoft says that the options that became vested in fiscal 1996 were worth $570 million when they were issued. That doesn’t sound like much for a company whose stock is valued at $82 billion. But that added pretax expense would have cut Microsoft’s reported profits to $1.83 billion from $2.20 billion, about 17 percent.
No big deal? Well, consider this. Options costs aren’t entirely an accounting exercise. Last year Microsoft shelled out big bucks to keep options from diluting existing shareholders’ stakes. The company spent $1.26 billion to buy back 13 million shares. It sold 22 million shares to options exercisers for $502 million. Even if you count the $352 million of tax savings the options exercisers generated for Microsoft, the company was still $405 million out of pocket. Also remember that the company issued 9 million new shares, which at the current price would fetch $1.2 billion. But the company didn’t have to charge a single cent to reported expenses.
Microsoft isn’t breaking any rules or shortchanging shareholders in any way, mind you. Shareholders approved the options plan. And Bill Gates, Microsoft’s 23 percent owner who has no options him- self, is perfectly happy to bear 23 percent of the cost. My point is that Microsoft, perfectly legally, massages its earnings and stock price as deftly as it peddles software. Whether you use the company’s $570 million or the buyback cost of $405 million or the value of $1.1 billion that some experts place on the options issued last year, this all amounts to much moola. Almost magically, Microsoft transmutes this money into a nonexpense item that makes its already solid earnings perform- ance look even better. If Microsoft’s techies could come up with software to let the rest of us run our lives half so ele- gantly, Windows 95 would look like small beer.
