Options Would Have Sunk eBay Profit 43%

Including the expense would have cut third-quarter net income by more than $80 million.
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eBay's

(EBAY) - Get Report

reported third-quarter earnings would have been 43% lower if the company had included stock options expenses in its income statement.

The online auction giant bested analysts' estimates last week by posting earnings of $182.4 million, or 27 cents a share, on $805.9 million in sales. But that bottom-line tally didn't include options costs, which eBay chooses not to recognize. Had the company included such costs, it would have earned $103.3 million, or 15 cents a share.

In the year to date, options expenses would have reduced eBay's earnings by about 21%. Including such costs, the company would have reported earnings of $455.1 million, or 67 cents a share. Instead, eBay has reported that it earned $572.8 million, or 84 cents a share, on $2.34 billion in sales in the first nine months of this year.

The cost of stock options at eBay and other companies has drawn increased scrutiny among investors because of a prospective accounting rule that would require all public companies to include such expenses in their income statements. The rule, which accounting regulators expect to approve by the end of the year, would take effect in June 2005.

Under current accounting rules, companies can choose to ignore options costs in their income statements. Instead, they only have to include a footnote in their financial reports in which they estimate the cost of the options they've granted.

The prospective rule has proved controversial. Technology companies and other heavy options granters have urged Congress and the

Securities and Exchange Commission

to block the rule, arguing that no accurate model exists for estimating options costs. By requiring companies to expense options, regulators would force them to either abandon their options programs or recognize a misleading, noncash expense, options proponents say.

But advocates of expensing have argued that companies that don't recognize options costs are misleading investors by underreporting their payroll expenses. Because options reward short-term movements in stock prices, advocates of expensing have linked the options to the scandals at

Enron

and other companies. Critics charge that the use of options encourages corporate managers to take short-sighted or often illegal steps to boost share prices.

Most companies that grant options eventually buy back shares to prevent excessive dilution. That's a real use of cash -- caused by options grants -- that's obscured by talk of options costs being a noncash charge, some proponents of expensing say.

Unlike most options users, eBay has never systematically bought back optioned shares. In contrast, the company has quietly seen its cash balances balloon because of its employees' options exercises.

When employees exercise shares, they pay their company the strike price for each share. Additionally, companies recognize employee gains on options exercises as a payroll expense on their income taxes and are able to reduce their taxable income by that amount.

In the year to date, eBay has gained $429.2 million from employees exercising their options. The company also has seen a tax benefit of $184.5 million from such activity.

The latter figure implies that eBay employees have gained about $527.14 million in the first nine months of this year. On average, each of the company's 7,600 employees has gained about $69,360.