Adjusted deferred outstanding shares

What Is Adjusted Deferred Outstanding Shares?

Adjusted deferred outstanding shares refer to a nuanced concept within financial accounting and corporate finance, particularly relevant to understanding a company's true ownership structure and potential future dilution. This term falls under the broader financial category of equity analysis. It represents the number of common shares that would be outstanding if all deferred stock arrangements, such as restricted stock units (RSUs) or performance shares, that have not yet vested or been issued were fully accounted for. Unlike simply counting shares currently traded on an exchange, adjusted deferred outstanding shares consider future obligations a company has to issue stock, providing a more comprehensive view of its capital structure.

History and Origin

The concept of accounting for deferred share arrangements has evolved alongside the increasing prevalence of equity compensation in corporate structures. Prior to significant regulatory guidance, companies often had more flexibility in how they recognized the cost and impact of stock options and other share-based payments. However, concerns about transparency and the accurate reflection of executive compensation led to greater scrutiny.

A pivotal moment came with the issuance of Financial Accounting Standards Board (FASB) Statement No. 123R (later codified as ASC 718, Share-Based Payment) in 2004, which required companies to expense the fair value of employee stock options and other share-based compensation. This move aimed to provide a more accurate picture of a company's profitability. The U.S. Securities and Exchange Commission (SEC) further clarified the application of these rules with Staff Accounting Bulletin (SAB) 107 in March 2005, which provided interpretive guidance on the valuation methods and accounting for share-based payment arrangements for public companies¹¹, ¹², ¹³, ¹⁴. This guidance underscored the need for companies to consider all forms of potential share issuance, including deferred arrangements, when reporting their financial position. The SEC's EDGAR database is a primary resource for investors to access these company filings and disclosures⁷, ⁸, ⁹, ¹⁰.

Key Takeaways

• Adjusted deferred outstanding shares offer a forward-looking perspective on a company's share count by including unvested deferred equity awards.
• This metric is crucial for a complete analysis of a company's capitalization and potential future dilution.
• It differs from basic outstanding shares by incorporating future share issuances from compensation plans.
• Understanding adjusted deferred outstanding shares is vital for calculating a more conservative earnings per share (EPS) figure.
• This concept is particularly relevant for companies that heavily rely on equity compensation.

Formula and Calculation

The calculation of adjusted deferred outstanding shares typically involves adding the shares underlying unvested deferred equity awards to the current number of basic shares outstanding.

The general formula can be expressed as:

$\text{Adjusted Deferred Outstanding Shares} = \text{Basic Shares Outstanding} + \text{Unvested Restricted Stock Units (RSUs)} + \text{Unvested Performance Shares} + \text{Other Unvested Deferred Equity Awards}$

Where:

• Basic Shares Outstanding refers to the number of shares currently held by investors, excluding treasury stock. This figure is readily available in a company's financial statements.
• Unvested Restricted Stock Units (RSUs) are a form of equity compensation that gives an employee the right to receive shares of company stock once certain conditions (e.g., time-based vesting, performance targets) are met. Until vested, these shares are not considered outstanding in the basic share count.
• Unvested Performance Shares are similar to RSUs but their vesting is contingent on achieving specific performance metrics, such as revenue growth or profitability targets.
• Other Unvested Deferred Equity Awards encompass any other forms of compensation that involve the future issuance of company stock upon the fulfillment of certain conditions.

Companies often disclose these unvested awards in the footnotes to their financial statements, particularly in their 10-K (annual) and 10-Q (quarterly) filings with the SEC.

Interpreting the Adjusted Deferred Outstanding Shares

Interpreting adjusted deferred outstanding shares provides a more conservative and forward-looking view of a company's equity structure. A higher number of adjusted deferred outstanding shares compared to basic outstanding shares indicates a significant pool of unvested equity awards that will eventually convert into actual shares. This conversion leads to share dilution, which can impact per-share metrics such as earnings per share (EPS) or book value per share.

For investors, understanding this figure helps in assessing the potential impact on their ownership percentage and the future value of their investment. It is especially important for companies that frequently use equity compensation to incentivize employees, as a large number of unvested awards can dilute the value of existing shares over time. Analysts often use adjusted deferred outstanding shares when performing valuation models to account for all potential future share issuances.

Hypothetical Example

Consider "Tech Innovations Inc." with the following details:

• Basic Shares Outstanding: 100,000,000 shares
• Unvested Restricted Stock Units (RSUs): 10,000,000 shares (vesting over the next three years)
• Unvested Performance Shares: 5,000,000 shares (contingent on achieving specific revenue targets in the next two years)

To calculate Tech Innovations Inc.'s adjusted deferred outstanding shares:

$\text{Adjusted Deferred Outstanding Shares} = 100,000,000 + 10,000,000 + 5,000,000 = 115,000,000 \text{ shares}$

In this hypothetical example, while Tech Innovations Inc. currently has 100 million basic shares outstanding, considering its deferred equity compensation, the adjusted deferred outstanding shares reveal a potential future share count of 115 million. This difference of 15 million shares represents potential future dilution that investors should consider.

Practical Applications

Adjusted deferred outstanding shares have several practical applications in financial analysis and investment decision-making within the realm of corporate finance.

1. Valuation and Per-Share Metrics: When performing a company valuation, analysts often use adjusted deferred outstanding shares to calculate a more conservative fully diluted EPS. This provides a clearer picture of earnings available to each share once all potential equity awards are exercised or vested. This contrasts with basic EPS, which only considers currently outstanding shares.
2. Dilution Assessment: Investors and shareholders use this metric to gauge the extent of potential dilution from equity compensation plans. A high number of adjusted deferred outstanding shares relative to basic shares outstanding may signal significant future dilution, which can impact the stock's price appreciation.
3. Executive Compensation Analysis: The number of deferred outstanding shares provides insight into the company's long-term incentive plans for executives and employees. It helps in understanding how much future stock will be issued as part of compensation packages.
4. Mergers and Acquisitions (M&A): In M&A scenarios, accurately assessing the target company's total potential share count, including deferred outstanding shares, is critical for determining the true cost of acquisition and the acquiring company's resulting ownership stake.
5. Regulatory Compliance and Disclosure: Public companies are required by the SEC to disclose information about their share-based payment arrangements, including unvested awards, in their financial statements. This ensures transparency for investors and aligns with accounting standards⁶.

Limitations and Criticisms

While adjusted deferred outstanding shares provide a more comprehensive view of a company's potential share count, they come with certain limitations and criticisms. One primary limitation is that this metric represents a "potential" share count, not a guaranteed one. The actual number of shares issued from deferred arrangements can vary based on several factors, including:

• Vesting Conditions: Many deferred awards, especially performance shares, are contingent on specific performance metrics being met. If these metrics are not achieved, the awards may not vest, and the shares will not be issued.
• Employee Departures: Employees holding unvested RSUs or other deferred awards may leave the company before their awards vest, leading to forfeiture of those shares.
• Market Conditions: For some awards, such as stock options, the decision to exercise might depend on the stock price. If the stock price falls below the exercise price, the options may expire unexercised.

Critics argue that focusing solely on the "adjusted deferred outstanding shares" might overstate potential dilution if a significant portion of these awards is unlikely to vest. Furthermore, the inclusion of unvested awards may not fully capture the nuance of a company's capital structure, especially when considering different classes of equity or complex convertible securities. Additionally, while stock buybacks can reduce the outstanding share count and potentially increase earnings per share, they have also faced criticism for diverting capital that could otherwise be invested in growth or employee compensation², ³, ⁴, ⁵.

Adjusted Deferred Outstanding Shares vs. Fully Diluted Shares

Adjusted deferred outstanding shares and fully diluted shares are both forward-looking measures of a company's share count, but they differ in their scope.

While adjusted deferred outstanding shares specifically focus on the future issuance from unvested, deferred equity arrangements, fully diluted shares take a broader approach by assuming the conversion or exercise of all securities that could potentially become common shares. This includes convertible bonds and convertible preferred stock, in addition to employee stock options and deferred equity awards¹. Therefore, fully diluted shares will almost always be equal to or greater than adjusted deferred outstanding shares, as they encompass a wider range of potential dilutive instruments.

FAQs

What is the primary difference between basic outstanding shares and adjusted deferred outstanding shares?

Basic outstanding shares represent the shares currently held by investors. Adjusted deferred outstanding shares, on the other hand, include these basic shares plus any shares that are expected to be issued in the future from unvested deferred equity compensation plans, such as restricted stock units or performance shares.

Why is it important to consider adjusted deferred outstanding shares?

It's important because it provides a more complete picture of a company's potential future share count and the potential for dilution. This helps investors and analysts make more informed decisions by understanding the full scope of a company's equity obligations.

Are adjusted deferred outstanding shares always issued?

No, they are not always issued. The issuance of these shares is contingent on various factors, such as the fulfillment of vesting conditions (e.g., time-based or performance-based requirements) and employees remaining with the company. If these conditions are not met, the deferred shares may never be issued.

How do adjusted deferred outstanding shares impact earnings per share (EPS)?

While adjusted deferred outstanding shares are not directly used to calculate basic EPS, they are a component of the broader calculation of fully diluted EPS. By increasing the total number of shares in the denominator, a higher number of adjusted deferred outstanding shares (and thus fully diluted shares) would generally result in a lower diluted EPS.

Where can I find information about a company's deferred outstanding shares?

Information regarding a company's deferred equity awards and unvested shares can typically be found in the footnotes to its financial statements, specifically within its annual reports (Form 10-K) and quarterly reports (Form 10-Q) filed with the SEC.