How eBay Cashes In on Employee Options

First, while the money made on the sale of an exercised option is counted as income for the employee, it also counts as a compensation expense for the company and is tax deductible for the company.

eBay and many other companies don't include options expenses on their income statements they file with the Securities and Exchange Commission, so they don't include the corresponding tax benefit from them on those statements. But they do include the tax benefit in their statements of cash flows, because the benefit does have a real effect on the amount of cash going into and out of the company.

The other way a company benefits from an option exercise is that it receives all of the money for the option up to the exercise price. Thus, if an employee sells an option that has a strike price of $50 for $75, the employee gains $25 of income and the company raises $50 from the stock sale.

Turning Options Into Cash

At eBay, these two benefits have turned into huge cash generators.

In 2002, for instance, the company had operating cash flow of $479.9 million. Operating cash flow is supposed to represent the money a company generates from its operations and is essentially calculated by removing noncash gains and charges from the company's net income.

But more than $91 million of eBay's operating cash flow came from the tax benefit related to options.

Meanwhile, eBay last year generated an impressive $341.2 million in free cash flow, which is operating cash flow minus capital expenditures. But if the tax benefit the company saw from options is combined with the cash it received from options sales -- $255.6 million -- the company saw more money from options-related benefits than it posted in free cash flow.

Those trends continued in the first quarter of this year. Of the $190 million eBay generated in operating cash flow in the quarter, nearly 22% came from the tax benefit related to options. With the company seeing $208.4 million from the exercise of stock options, eBay's total options benefit in the quarter was 171% of the $146.1 million it posted in free cash flow.