Great question actually. This can cause debate. For me personally this is a key expense and should be ‘above the line’. What that means is it’s part of operating profit and not an adjustment. The key reason is that if I’m the CEO and I’m on $300k per year in cash salary we’d consider that an expense right? If I instead get the equivalent in stock or options that vest in a future year the cash impact is positive but it’s still compensation. If it’s not an expense then this method artificially distorts the P&L. MWR distorts their P&L in two ways. I’ve given you one, anyone want to guess the other way? I’ll explain when I do a deep dive on the financials. Understanding how companies can window dress their financials is very very important in investing and they do it all the time!
MWR account for options using the fair value method. This uses the black scholes method of estimating the expense in a given financial year. Very simply, the expense will increase as a share price increases and decrease or not exist when the SP falls. Even if options are out of the money or don’t get converted they can still be an expense. This occurs when the conversion date falls in more than one year so an expense estimate is required. If they lapse it means there is no impact on equity or shares outstanding. Not the easiest subject to understand so hopefully that makes a bit of sense. I’m sure there is someone that can explain it better than me though.
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