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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, 2007, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.

Spotlight: Stock Comp Do-Overs
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Posted by: Jack Ciesielski 11/4/2005 8:27 AM
Every once in a while, a particular accounting issue requiring restatement surfaces in a company or two, and you barely notice it. Then it seems like dozens of companies are restating financials for the same reason. The isolated issues become trends, the press picks up on it, and pretty soon fifth-graders are discussing lease restatements at the music store in the mall with Fitty Cent jamming in the background.

Well, it seems like the gab becomes that prevalent. And when one trend peters out, the gab turns to "what's next?" Here's a nomination: stock compensation do-overs.

Mercury Interactive turned a lot of heads this week (and turned over a lot of shares, too) with its disclosure of stock option malfeasance. In an interview with the Wall Street Journal, new CEO Anthony Zingale said "he believed 30 to 40 other Silicon Valley companies had received inquiries about their option-accounting practices from the SEC." That could kick off a trend, for sure.

No guessing games here about which companies have received inquiries; just noting things as they happen. While Mercury Interactive garnered the attention for the issue, there were a few other companies filing "non-reliance" 8-Ks this week - and their reasons related to stock compensation reporting. Let's look at them.


First up: internet media and market research firm NetRatings. The firm concluded that it needed to restate its financial statements for the period ended June 30, 2005, due to an error in accounting for the amortization of restricted stock grants. The restatement will increase NetRatings' net loss by $461,000, or $0.01 per share, in the quarter. The company's accounting policy for stock compensation is dictated by APB Opinion 25, calling for recognition of forfeitures of restricted stock as they actually occur; NetRatings used an estimated figure for forfeitures, which they'll have to do once Statement 123R goes effective for them in 2006. Apparently, NetRatings' estimate of forfeited restricted stock was greater than the actual forfeitures occurring, because there was an increase in the restricted stock compensation, meaning more shares were sticking around in the hands of employees.

Side note on NetRatings: this is another firm that backs restricted stock compensation out of earnings when calculating EBITDA. Take a look at the earnings release for the third quarter. As discussed last week, we're slouching down the road to EBITDASC - Earnings Before Interest, Taxes, Depreciation, Amortization, and Stock-based Comp.

Next up: Carmike Cinemas. Carmike is restating financials for the years 2003, 2004 and the first and second quarters of 2005. Reason: errors in tax treatment of stock compensation expense for stock issuable. Carmike treate the stock and certain bonus payments as fully tax deductible in the financials. It wasn't completely deductible; it was subject to Internal Revenue Code Section 162 (m) limits on deductions for non-performance based compensation. That's $1 million on an annual basis for covered employees. To make a long story short, Carmike had erroneously recognized more of a tax benefit in the financials than it was actually entitled to receive. The aggregate adjustment for the periods in question will increase tax expense and decrease net income by $2.0 to $2.4 million.

Last - and least, at least in terms of market cap - is Blue Dolphin Energy. Blue Dolphin is restating its first two quarters of 2005 because it had treated certain options exercised as being in a fixed award plan under APB Opinion 25. That would have avoided non-recognition of stock compensation. The glitch: being a "cashless" exercise of options, GAAP accounting (under Interpretation 44) requires them to be treated as "variable" plans - and that means compensation expense gets measured and recognized. The six months of additional compensation expense will cost Blue Dolphin approximately $686,000, or $0.09 per share.

What gives? It might be that the SEC really is looking at 30 or 40 firms' stock option compensation reporting. Maybe some of these firms were contacted, maybe not. It's irrelevant. What's more likely is that firms have not devoted a lot of accounting brainpower and resources to the accounting for stock options and other stock awards, perhaps figuring that if they were on APB 25 accounting with no expense recognized there was no need to spend a lot of time beating the subject to death. Better to put your best accounting minds on the nuances of an acquisition, perhaps, or on Section 404 compliance. Now that Statement 123R is becoming effective, the precision level is being ratcheted up on accounting that was previously glossed over - and accumulated errors are being discovered. We'll see if more of a trend emerges in the coming weeks.
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