Aesthetic laser manufacturer Candela
It did need more time -- because Candela had some material weaknesses in its internal controls for financial reporting. It failed to record "accruals and costs and appropriately account for demonstration equipment sales," which required their accountant to take more time sifting through the numbers. Accrual accounting, while giving management choices on how to record sales, also allows for numbers-fudging if management so chooses. There's no evidence that Candela was purposefully "inappropriately" recording sales, but the company prefaced its explanation for the delay with a lot of boilerplate about how no control procedure can catch every instance of fraud.
In any event, Candela did catch the error, changes were made, and the numbers released were not materially affected. More importantly, BDO Seidman agreed with the assessment. So why pick nits? There was little to surprise in the report.
"Little," of course, doesn't mean "nothing." The report revealed that Candela accelerated the vesting of unvested "out of the money" stock options at a cost of nearly $6.4 million.
Beginning this fiscal year, the company will have to comply with new reporting requirements. Under those standards, the stock option expense would have wiped out virtually all of the laser maker's earnings for the entire year. Net income for 2005 would have been reduced from $7.3 million to $714,000, and EPS would have shriveled from $0.32 to just $0.03 per share, a 91% decline.
Stock options are supposedly granted to employees to encourage them to help a company succeed and prosper. They give employees the right to purchase a company's stock for a certain price at some point in the future. Options usually vest over a period of years, meaning that new lots of stock regularly become available for purchase. This theoretically ensures that a steadily rising share price is in both management and stockholders' best interest.
After years of rancorous debate, companies will finally begin expensing stock options, a proposal the Fool has long maintained is essential to giving shareholders a truer picture of the costs options impose on a business. Companies, though, are taking advantage of the time period before the requirement kicks in to wipe the costs associated with these out-of-the-money options from future income statements.
Candela's not alone in this. According to a report by Bear Stearns
In the new fiscal year, Candela will have to amortize the fair value of all unvested options. "Vesting" is the length of time until employees can buy into the stock options they've been granted. Like most companies accelerating the vesting period, Candela is only cashing in options that are "underwater" -- those options whose purchase price is above current market prices. It will purchase approximately 535,000 shares, with exercise prices ranging between $9.50 to $12.33. While the company's stock closed yesterday at $9.82, when the plan was approved back in May, the shares were trading for about $1 less.
The costs associated with these shares won't appear on the income statement in future reporting periods. At least Candela was honest about it. In its filing, it said, "The primary purpose of the accelerated vesting is to . avoid recognizing future compensation expense associated with the accelerated stock options."
If Candela were eliminating its stock option program in favor of issuing restricted stock, or simply allowing management to buy shares at market prices like everyone else, the accelerated vesting plan might be a good idea. But the laser maker has no plans to eliminate options; it's merely trying to conceal from shareholders the cost of options already granted.
As the accelerated vesting plans have made apparent, stock options are a cost to companies. While underwater options, by definition, have zero intrinsic value, the new accounting rules show that they will have a Black-Scholes value that will have to be expensed, making companies afraid of what investors will think.
As I said, Candela is not alone in this practice, but the "everyone else is doing it" defense doesn't fly. The company is basing its decisions not on what's best for business, but on how to make the accounting look good. That should give investors a lot to think about.
Further Foolishness really adds up: