I own some tech stocks, and if not expensing options is as big a lie as it sounds, it does need to change. It's proper for Apple to refuse this now, but if they are being honest they should help convince the entire industry to change at the same time.

Cronyism at Apple's board makes Apple one of the worst offenders for handing out massive stock options to the privileged few insiders, while the company is barely profitable. A few quotes from this article that TMO chose not to highlight:

"If the cost of stock options and interest earnings are subtracted, then Apple would have earned just 5 cents per share in the past four quarters."

"if stock options were to be treated as a line-item cost on the balance sheet, Apple's price-earnings ratio for fiscal 2005 would soar to 187."

"Meyer thinks Apple is properly valued as an $18 stock."

Actually with a PE ratio of 187 Apple's stock isn't worth much more than $5.00 a share. Once options are expensed by law, Apple's financial shenanigans will be exposed.

Apple shareholders at the last two annual meeting voted to expense options to stop the insanity, but Apple's board led by puppeteer Steve Jobs blew off their wishes.

Enjoy your high flying Apple stock while it lasts, just like Ken Lay did at Enron before the truth hit the fan.

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RealityCheck wrote:
Cronyism at Apple's board makes Apple one of the worst offenders for handing out massive stock options to the privileged few insiders, while the company is barely profitable.

Really? According to who (besides you)?

Most technology firms (especially Intel who is aggressively fighting the expensing of options) have used stock options as employee incentives.

The chief reason is because it allows the company to potentially reward an employee for hard work without increasing salary expenses.

Secondly, at the moment the options are granted there is no "cost" to the company. The only cost is imputed. From an accounting standpoint options are an equity and asset account transaction, not an income and expense transaction.

What the FASB is attempting to due is impute an expense value to the transaction.

The company receives cash when options are executed adding to the asset value of the company.

What the author of this article fails to take into account is the increase in the company's asset base from the windfall of cash received when options are realized nor does the author take into account the value of interest received on that cash or the return to the company on the value of the cash invested in operations.

Barely profitable? Really? Not according to GAAP which dictates the manner in which Apple's earnings are calculated.

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RealityCheck wrote:

"If the cost of stock options and interest earnings are subtracted, then Apple would have earned just 5 cents per share in the past four quarters."

Again, the author fails to take into account the value of the cash received. There is no "expense" to record other than the difference in the paid in capital account.

If these kinds of equity account transactions are to be accounted as an expense, I submit Dell's use of several billion dollars of cash to repurchase shares in order to artificially increase earnings per share should also be accounted for as an expense. After all, using cash to repurchase shares also impacts the equity balances.

Dell essentially blew through much of its cash in order to increase the earnings per share performance it couldn't achieve through operations.

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RealityCheck wrote:

Actually with a PE ratio of 187 Apple's stock isn't worth much more than $5.00 a share. Once options are expensed by law, Apple's financial shenanigans will be exposed.

Really? $5.00 per share?

Apple has no debt, over $4.5 billion in cash, prime Silicon Valley real estate and a patent library. Just taking the cash into account gives Apple more than $12 in cash per share with no debt and net tangible assets of about $5 billion, far more than the market cap at $5.00 per share you suggest.

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RealityCheck wrote:

Apple shareholders at the last two annual meeting voted to expense options to stop the insanity, but Apple's board led by puppeteer Steve Jobs blew off their wishes.

Management has stated the expensing of options will be seriously considered and even adopted once uniform rules are announced. Apple's board and management oppose the expensing of options until uniform guidelines are established. Why? Becuase it leads to investor confusion if different firms use different methods to account for earnings and earnings per share. Blame Intel and others for fighting the expensing of options, not Apple.

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RealityCheck wrote:

Enjoy your high flying Apple stock while it lasts, just like Ken Lay did at Enron before the truth hit the fan.

Enron? Really?

IMHO a poor analogy. What caused Enron its biggest problems is management broke with industry practice and began to book the full dollar amount of energy contract transactions rather than just the margin made. This artificially increased the company's reported asset base and led to heavy borrowing against the artificially inflated asset values. Enron's bubble burst because of heavy debt that could no longer be serviced. The auditors chose to ignore the practice out of fear of losing Enron's consulting business which was 8 to 10 times the fees generated from the audit work. A clear conflict of interest.

Apple was one of the first Silicon Valley firms to announce their auditors would not do consulting business for the company to avoid Enron-style conflicts of interest.

Again, Apple has no debt.

Go ahead...make my day. Find another major PC maker that has no debt.

This is a result of the Bush economic stimulus package. In the long run, it will work out great for investors, even though some companies (such as Apple) will have a bumpy start.

BusinessWeek agrees with me that Apple's governance is the worst, check out these gems:

http://www.businessweek.com/magazine/content/02_40/b3802004.htm

http://www.businessweek.com/technology/content/mar2003/tc20030327_1562_tc056.htm

http://www.businessweek.com/technology/content/jan2004/tc2004015_0436_tc056.htm

http://www.businessweek.com/magazine/content/02_40/b3802001.htm

My favorite quote from these is "This is the old boys' network at its worst"

When options are expensed Apple's profits are paper thin. With the fat margins on iPods and high sales volume, profits should be much higher. Only one possible explanation, which Mac idolators refuse to see, the Mac business is a huge money loser. The new Mac division was created by Jobs to make shutting down the Mac business that much easier.

Apple's spin that they really want to expense options and are just waiting until standards are developed is the RDF spin machine in high gear. Amazon, BankOne, and Coca-Cola are already expensing options. Apple's delay is that they don't want their excessive stock options to be exposed. This new BW article showed that Apple profits would be drastically slashed, much worse by far than Dell or HP, if options were expensed.

Apple's financial shell game will be exposed, and it'll be another giant I told you so.

As is typical, RC picks his "facts" out of thin air, instead of basing them on published, reliable information. Apple's latest financial report shows income both before and after options, and they are still profitable.

Likewise, the statements about "fat margins on iPod" and "Mac business is a hugh money lower" are based on nothing more than RC's obsessive fantasies.

Check out the facts at:

http://media.corporate-ir.net/media_files/irol/10/107357/aaplQ204-10QFinal.pdf

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RealityCheck wrote:
BusinessWeek agrees with me that Apple's governance is the worst, check out these gems:

Two of the articles are from 2002, one from 2003 and one from January 2004. Can't you find something more credible or current?

The editorial comments of the author are not a concern. The performance of the board is the matter in question.

Let's look at the facts:

Since the return of Steve Jobs 7 years ago the company has quadrupled the cash on hand, eliminated all debt and added billions in retained earnings (cumulative profits) to the company's balance sheet.

On the issue of governance, IMHO the number of board members should be expanded. However, that's an issue for the board and shareholders to determine, not an issue of impropriety or an issue for a BusinessWeek columnist who wishes to sell copy at accuracy's expense.

The outside board members who have served Apple since the return of Steve Jobs have added tremendously to Apple's success. Mr. Drexler, for example, was the chief architect of Apple's retail store strategy.

But the governance issue is a red herring with regard to the FASB proposed rules. Again, Apple's board is seeking uniform guidelines for the expensing of options.

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RealityCheck wrote:


When options are expensed Apple's profits are paper thin. With the fat margins on iPods, profits should be much higher. Only one possible explanation, which Mac idolators refuse to see, the Mac business is a huge money loser. The new Mac division was created by Jobs to make shutting down the Mac business that much easier.

Again, the author fails to take into account the benefit of the cash received when the options are executed. One of the things that has negatively impacted Apple's earnings over the past four years has been the sharp fall off in interest rates. Interest on the company's cash used to contribute hundreds of millions of dollars to the company's net earnings. In response to the 40-year lows in interest rates Apple has chosen to use their cash assets in order to eliminate all debt.

IMHO Apple should have followed Dell's lead in using a portion of cash on hand to reduce the number of shares outstanding. The board has authorized up to $500 million in share buybacks but only a portion of that authorization has been used.

Further, I'd like to see Apple reinstitute a quarterly dividend. There are many conservative mutual funds that restrict investment to only dividend paying firms.

However, as interest rates rise Apple's net earning will only increase and increase again as options are executed adding to the company's cash and asset base.

In terms of Apple having "meager" earnings if all options were executed, there's another side to this story. Apple invests heavily in R&D. Apple also aggressively writes-down R&D expenses. As a growth company (growth defined as the company's sales in its target market growing faster than that market itself), I'd prefer high cash flow to higher earnings. Apple's target market is PCs (laptops and desktops) abouve $1,000.00. Apple continues to grow its share in this high-margin market.

As Forbes magazine points out in this article, Apple invests 6.6% of sales in R&D. This penalizes current earnings but provides for future growth. In fact, Apple is one of the nation's leading R&D investors as measured by percent of sales.

Apple aggressively writes-down R&D in part to reduce tax expense. Again, I'd prefer to see Apple invest in the future while reducing tax expense in the present. Every dollar in R&D expensed reduces Apple's tax expense by $.30 to $.40. Apple's expensing strategy has helped the company build its cash while reducing heavy corporate tax expense.

If one were to add R&D expense back into earnings (as Forbes suggests as a more accurate measure of corporate performance,) one sees an even brighter future for the Mac maker,.

As this table indicates, Apple's cash flow in the most recent fiscal year far exceeded earnings and totaled over $1 billion. That's an extraordinary success by any measure.

On the remaining point, Apple isn't about to stop manufacturing the Mac any more than HP will stop making printers.

The Macintosh is certainly not a money loser and information concerning Apple's revenue and expenses and revenue by product line is available on the Apple Web site.

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RealityCheck wrote:

Apple's spin that they really want to expense options and are just waiting until standards are developed is the RDF spin machine in high gear. Amazon, BankOne, and Coca-Cola are already expensing options. Apple's delay is that they don't want their excessive stock options to be exposed. This new BW article showed that Apple profits would be drastically slashed, much worse by far than Dell or HP, if options were expensed.

Apple's financial shell game will be exposed, and it'll be another giant I told you so.

To claim that Apple doesn't want its options overhang to be "exposed" is an absurd statement. Those options are already represented in part in the fully diluted share calculation as it relates to earnings per share.

Again, every option exercised brings in cash equal to the strike price. Amazon, BankOne and Coca-Cola are in different industries than Apple. To avoid investor confusion Apple will expense options when the rules are formally adopted, uniform guidelines established and HP, Dell, Gateway and other major PC makers are obliged to account for options by regulation the same way.

One final point on the issue of board governance: Measured in terms of performance, the board that has served under the chairmanship of Steve Jobs has been far more productive that the boards who served under John Sculley, Michael Spindler and Gil Amelio.

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RealityCheck wrote:
BusinessWeek agrees with me that Apple's governance is the worst, check out these gems:

Shouldn't that be that YOU agree with BusinessWeek?

It's not like they interviewed you for the story then said, "Hey yeah! RC is right! Let's charge ahead with RC's views and we will be loved!"