An Acquired Expense

FIN 44 certainly has come into play in the acquisition of stock- option-heavy high-tech companies. But here the impact is also often light, largely because the assets of technology firms generally have shorter lives than those of other industries. Therefore, goodwill is often amortized over a much shorter span than the average--so short, in fact, that it would not have made much, if any, difference if unearned compensation had been part of goodwill.

For example, in February, fiber-optics giant JDS Uniphase Corp. completed its acquisition of SDL Inc., a fiber-optics networking company, for $41.5 billion. The deal generated about $39.5 billion of goodwill, which will be amortized over just five years. JDS also issued 42.2 million rollover options, valued at $4.1 billion; the expense of the unvested options comes to $203.7 million, to be amortized over four years.

On July 5, 2000, Vignette Corp., an Austin, Texas-based provider of Internet applications, completed its $1.5 billion acquisition of OnDisplay Inc., which designs software for E-commerce. About $52.9 million was recorded as deferred stock compensation, and will be amortized over the remaining life of the options. Most of that--$33 million--was expensed in 2000. Meanwhile, goodwill is being written off over only two to four years. Last year, the amortization charge for goodwill and other purchased intangibles was $328.7 million, accounting for most of the company's $532 million loss on its $367 million in revenues.

The unearned-compensation expense "was something we certainly were aware of and had to consider in the purchase," says Vignette CFO Joel Katz. "It did not make a significant difference going forward. We did make sure that in providing guidance to analysts, we included expected charges."

EVENTUALITIES AND DOUBLE TRIGGERS

In the context of M&A, one clear impact of FIN 44 is that when a stock option plan is designed, greater attention is being paid to the details of change-in-control vesting. "More companies are spending more time in planning options, designing the plan, and thinking up scenarios and options," says Ron Sonenthal, head of the human-capital practice at Andersen in Chicago. That's because under the rule, any change in the terms of a company's stock options could result in a charge to earnings.

"It used to be that we'd advise companies to draft plans as broadly as possible to give themselves discretion," says Susan Eichen, a senior compensation consultant at William M. Mercer Inc. "FIN 44 says the opposite: build in eventualities." So companies need to balance the desire for flexibility against the potential accounting costs.

For example, let's say that the question of whether vesting would accelerate in the case of a company's acquisition has been left open. Then the company makes a deal to be acquired, and the board's compensation committee decides to accelerate vesting, because it has learned that most companies have a provision that does this automatically. According to FIN 44, the cost of the options then becomes the spread between the price of the target company's stock on the day that the modification is made and the exercise price. The target company will have to expense the spread at the time the deal closes. Had the stock option plan originally provided for accelerated vesting, there would be no expense charge for the target company.

Actually, however, some companies that have automatic acceleration now wouldn't mind if they could do away with it. That's because automatic vesting leaves no incentive for employees of a target company to stay on. Even if the acquirer grants those employees new options with new vesting schedules, "you still have just put a lot of money in people's pockets," says Eichen, and they might then be inclined to leave.

"Companies don't want their employees to have windfalls," says Carol Silverman, another senior compensation consultant at Mercer. So more Mercer clients, especially high-tech companies, are designing plans that provide for "double trigger" vesting instead of automatic acceleration. A double trigger specifies that in a change of control, an employee's unvested options would vest only if he or she lost his or her job within a specified period, usually two years. Of course, the acquirer would have to book and amortize the unearned compensation, but the incentives would remain in place.

MORE VISIBLE

FIN 44 should become more significant in M&A situations after June 30, when purchase accounting will become the rule and pooling-of- interests accounting banned. Therefore, FIN 44 will be felt in more acquisitions. What's more, for fiscal years beginning after December 15, FASB will no longer require that goodwill be amortized at all, unless it is deemed to be impaired. So FIN 44's treatment of unvested options will stand out much more in terms of its impact on earnings, especially at technology companies.

Rolling over stock options "will now be a question of amortization versus no amortization," says Robert Willens, managing director at Lehman Brothers, "and it will come up in almost all acquisitions."

Hilary Rosenberg is a contributing editor of CFO.

THE EFFECT OF FIN 44 IN FIVE DEALS

Source: Company reports

• « previous
• 1
• 2