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Making Timely & Informed Equity Compensation Diversification Decisions An Employee Workshop from: Net Worth Strategies, Inc. Copyright Net Worth Strategies, Inc. 2016 Workshop Objectives Provide you with unique insights regarding your company stock and option holdings Enable you to make timely diversification decisions to maximize the value of your grants Copyright Net Worth Strategies, Inc. 2016 Background PRESENTER / FIRM NAME INFO INFO Net Worth Strategies, Inc.: Developer of the industry’s best equity compensation diversification tools Website: www.StockOpter.com Copyright Net Worth Strategies, Inc. 2016 Agenda Myths and Truths about Equity Comp. StockOpter Personal Equity Compensation Analysis Equity Compensation Concepts & Taxation StockOpter Analysis Output Resources and Tools Copyright Net Worth Strategies, Inc. 2016 Equity Compensation Misconceptions & Truths Copyright Net Worth Strategies, Inc. 2016 Common Misconceptions Getting assistance or creating an equity comp. strategy is unnecessary One should exercise / sell when: Options expire or employment is terminated Money is needed Stock price target is met Taxation can be avoided I’m now getting Restricted Stock Grants so managing my Stock Options is unnecessary Copyright Net Worth Strategies, Inc. 2016 Equity Comp. Truths Careful planning and professional assistance facilitates informed decisions & reduces costly mistakes Exercise / sell decisions should be based on: Remaining time value / leverage not stock price alone Financial goals not just cash flow requirements Level of concentration in company stock and options Taxes are unavoidable but they can be managed Outstanding Stock Option Grants still require timely action ® StockOpter The Personal Equity Compensation Analysis Copyright Net Worth Strategies, Inc. 2016 Equity Comp. Analysis Portfolio Summary & Key Findings Stock Option Valuation Restricted / Owned Share Valuation Forfeit Value Investment Risk / Reward Financial Attainment Analysis Concentrated Position Analysis Value at Risk (VaR) Insight Ratios Table (Stock Options) Copyright Net Worth Strategies, Inc. 2016 Equity Compensation Concepts Copyright Net Worth Strategies, Inc. 2016 What are Stock Options? Definition: Grant Price: (aka – exercise, strike or option price) A grant of the right to purchase company stock in the future at a fixed (grant) price It is the price at which an employee can exercise the stock option, once vested Vesting Date: The date when a traunch of options can be exercised Copyright Net Worth Strategies, Inc. 2016 Stock Option Definitions Bargain Element: (aka: Spread) Exercise: The difference between the option exercise price & the market price of the stock at exercise The process of purchasing the option shares at the grant price Selling: Selling the purchased shares stock of an exercised option (the option itself is not sold) Copyright Net Worth Strategies, Inc. 2016 Restricted Stock Definitions Restricted Stock Award = RSA A Grant of employer stock at no cost or substantial discount that is subject to restrictions AKA: Restricted Stock Unit = RSU Types of Restrictions Time Vesting (i.e. Future Date) Performance Vesting (i.e. Revenue Target) Copyright Net Worth Strategies, Inc. 2016 Stock Option Valuation In-the-Money Value (ITMV): Fair Market Value (FMV) – Grant Price x Shares Option Value (aka: Full or Black-Scholes Value [BSV]): Made up of two components: In-the-Money Value + Time Value (TV) Time Value is estimated using methodologies including the Black-Scholes formula BSV = TV + ITMV Copyright Net Worth Strategies, Inc. 2016 Time Value Illustration Strike Price In the Money $65.00 $70.50 Under Water $75.00 Option Price Expiry Dec 16, 2016 Expiry March 17, 2017 $7.01 $8.40 Last Trade As of 8/8/16 $1.25 $2.50 NDAQ Market Traded Options as of August 8, 2016 Copyright Net Worth Strategies, Inc. 2016 Option Valuation Methods Practical Applications: Valuing Market Traded Options Expensing Stock Options on Financial Statements Valuing Employee Stock Options for diversification Black-Scholes is the most broadly used and practical model for valuing employee stock options for decision support because the assumptions used are less complicated than alternatives The Binomial model is an alternative to BlackScholes that financial experts believe can produce lower values for expensing purposes because it uses changes in volatility and option-forfeiture rates Copyright Net Worth Strategies, Inc. 2016 Estimating Time Value The Black Scholes formula calculates the Time Value of a stock option using the following factors: 1. Time until expiration 2. Volatility of the stock price 3. The In-the-money value / Leverage 4. Risk free rate of return (RFR) 5. Per share dividend Copyright Net Worth Strategies, Inc. 2016 Time Until Expiration Time Value Element Total Option Value Spread 0 2 4 6 8 Years Time Value decreases as the expiration date approaches. Copyright Net Worth Strategies, Inc. 2016 10 Stock Price Volatility The annualized standard deviation of the stock's changes in price Expressed as a percentage (i.e. std dev of 0.3 is volatility of 30%) Statistical method to provide range of possible stock prices over option life Types of Volatility: Historical: the actual volatility that occurred to the underlying stock during some look back time period Implied: the market's estimate of future volatility derived from the option's bid/ask mid price Copyright Net Worth Strategies, Inc. 2016 NDAQ Volatility 12 Month Price Volatility of NDAQ Stock as of 8/9/16 A volatile stock has a higher upside potential over time. The greater the volatility, the higher the Time Value. Copyright Net Worth Strategies, Inc. 2016 Volatility Selection Depends on application: Valuing Employee Stock Options for diversification Expensing Stock Options on Financial Statements Analyzing Market Traded Options Consequently, selection is an “art” not “science” Compare a variety of sources to validate: Company Annual Report (SEC Filings) Market Traded Options: www.ivolatility.com Peer Comparisons (use for private companies) Copyright Net Worth Strategies, Inc. 2016 In-the-Money Value As the ITM value increases, TV decreases because upside leverage is less. Copyright Net Worth Strategies, Inc. 2016 Stock Option Leverage High Leverage/TV: stock price is close to the option price... Stock $ 11.00 10% Increase $ 12.10 Option $10.00 $10.00 ITMV $1.00 $2.10 110% Low Leverage/TV: option has significant ITM value... Stock $ 100.00 10% Increase $ 110.00 Option $10.00 $10.00 ITMV $90.00 $100.00 11% The higher the current stock price is relative to the strike price, the less time value or upside leverage remains in the option. Copyright Net Worth Strategies, Inc. 2016 Risk Free Rate of Return An option provides the holder with the right to own stock at a certain price without having to purchase the stock… Consequently, an option’s value is enhanced by the ability to use the capital that would otherwise be invested in the stock for some other investment… The Risk Free Rate represents the return on this other investment which enhances the value of the stock option The higher the risk-free rate of return, the higher the BSV and TV of the option. Copyright Net Worth Strategies, Inc. 2016 The Risk Free Rate Affect For option valuation purposes: The higher the Risk Free Rate of Return, the higher the Time Value of the option. The Risk Free Rate can be derived from the yield of intermediate term bodns or from similar investments This value can also be found in the company’s annual report for the purpose of option expensing Copyright Net Worth Strategies, Inc. 2016 Per Share Dividend Decrease an option’s Time Value because the holder is forgoing the dividend until the time of exercise A dividend can produce negative Time Value depending on the other BSV factors The inclusion of a dividend is not relevant if you intend to exercise and sell immediately for diversification purposes The Time Value of an option is lower when the dividend is factored in. Copyright Net Worth Strategies, Inc. 2016 Time Value Factor Summary TV decreases as the expiration date approaches. TV decreases as the in-the-money amount increases. TV is higher for stocks with higher volatility. TV is higher when the risk free rate of return is higher. Copyright Net Worth Strategies, Inc. 2016 Equity Compensation Taxation Copyright Net Worth Strategies, Inc. 2016 Taxation Unavoidable! Occurs when the client takes ownership by exercising stock options or when RSAs vest Incentive Stock Options (ISOs): ISO’s trigger Alternative Minimum Tax (AMT) AMT planning is critical to optimize & avoid problems Non Qualified Stock Options (NQSOs), Stock Appreciation Rights (SARs), & RSAs: Taxed at ordinary income rates (compensation) Cashless Exercise: sale proceeds used to pay exercise price and withheld for taxes Copyright Net Worth Strategies, Inc. 2016 ISOs: Tax Consequences $100 FMV at sale FMV at exercise AMT C.G. AMT adjustment $0 Strike price Copyright Net Worth Strategies, Inc. 2016 NQSOs: Tax Consequences $100 FMV at sale FMV at exercise Capital Gains Compensation Income $0 Strike price Copyright Net Worth Strategies, Inc. 2016 RSAs: Tax Consequences $100 FMV at sale Vest Regular C.G. Capital Gains Compensation Income $0 Grant Copyright Net Worth Strategies, Inc. 2016 RSA 83(b) Election Accelerates taxation from date of vest to date of grant Starts capital gains holding period Eliminates taxation at vesting Must be made within 30 days of the grant (or early exercise) Election made by filing document with IRS Election is irrevocable Copyright Net Worth Strategies, Inc. 2016 RSAs: 83b Consequences $100 FMV at sale 83b Election Vest Original Cap. Gains Additional Cap. Gains Grant $0 Compensation Income Copyright Net Worth Strategies, Inc. 2016 Taxation Summary Unavoidable (gifting retains tax liability)! Employee Stock Options: NQSOs & SARs – compensation income when “Exercised” ISOs – AMT planning is crucial Restricted Stock Awards: Compensation income when restrictions lapse (vest) Copyright Net Worth Strategies, Inc. 2016 ® StockOpter Analysis Output Copyright Net Worth Strategies, Inc. 2016 Sally Sample Example Financial Goal: $3,000,000 Diversified Portfolio Value: $500,000 Company: NDAQ (Nasdaq, Inc.) Current Stock Price: $70.00 Stock Volatility: 50% Risk Free Rate: 2% Income Tax Rate: 40% Cap Gains: 20% (Fed+State) Stock Options: 4: 25,500 vested & 11,500 unvested Shares: 10,000 shares held (cost basis: $200,000) 6,500 RSAs (cost basis: $0) Copyright Net Worth Strategies, Inc. 2016 StockOpter Tables/Charts Summary Values In-the-Money Values After Tax Values Black Scholes, Time and Forfeit Values Restricted Shares / Units Values Owned Share Values Leverage & Share Analysis Financial Goal Attainment Concentration Key Ratios Copyright Net Worth Strategies, Inc. 2016 Portfolio Summary Asset Vested Stock Options Unvested Stock Options Restricted/Performance Shares Company Owned Shares Other Investments Total Pre Tax After Tax After Tax Value Pre Tax Percent Value Percent 1,097,550 36.03 % 658,530 31.24 % 293,550 9.64 % 176,130 8.36 % 455,000 14.94 % 273,000 12.95 % 700,000 22.98 % 600,000 28.47 % 500,000 16.41 % 400,000 18.98 % 3,046,100 100 % 2,107,660 100 % Copyright Net Worth Strategies, Inc. 2016 In-the-Money Valuation ITM Value = Current Value ($60) – Exercise Price x Shares Copyright Net Worth Strategies, Inc. 2016 After Tax Valuation Grant ID SAR2009 NQ2011 NQ2013 ISO2015 Total Grant Expire Exercise Vested Type Date Price Options SAR 10/1/2019 $18.0600 5,000 NQSO 9/1/2021 $24.0000 10,000 NQSO 2/1/2023 $28.0000 7,500 ISO 5/1/2025 $49.0500 3,000 25,500 Vested Potential After Tax ITMV $ Tax $ Value $ 259,700 103,880 155,820 460,000 184,000 276,000 315,000 126,000 189,000 62,850 25,140 37,710 1,097,550 439,020 658,530 Cash Out Value = ITM Value – Potential Tax (calculated by applying a 40% income tax rate) Copyright Net Worth Strategies, Inc. 2016 Black Scholes Valuation Black Scholes Value = Time Value + ITM Value Compare to ITM Value of $1,391,100 Copyright Net Worth Strategies, Inc. 2016 Option Forfeit Valuation Forfeit Value = Time Value of Vested + BSV of Unvested Forfeit Value® $744,636 Copyright Net Worth Strategies, Inc. 2016 Vs. ITM Value of Unvested: $293,550 Restricted Share Values Grant ID PG1 RU2 Total Grant Type PSG RSU Gross Value Potential After Tax Shares $ Tax $ Value $ 3,000 210,000 84,000 126,000 3,500 245,000 98,000 147,000 6,500 455,000 182,000 273,000 Gross RSA Value = Shares * FMV Year 2017 2019 Tax Tax Tax Tax Tax Shares Liability at: Liability at: Liability at: Liability at: Liability at: Shares Vesting 44.80 56.00 70.00 84.00 100.80 Required Net Shares 3,000 53,760 67,200 84,000 100,800 120,960 1,200 1,800 3,500 62,720 78,400 98,000 117,600 141,120 1,400 2,100 Shows estimated tax liabilities & net shares at vesting Copyright Net Worth Strategies, Inc. 2016 Total Forfeit Value Total Forfeit Value = Option Forfeit Value + RSA Value Copyright Net Worth Strategies, Inc. 2016 Owned Share Valuation NDAQ Stock Price: $70 Description Number of Shares Gross Value Cost Basis Taxable Gain Potential Tax After Tax Value Amount 10,000 700,000 200,000 500,000 100,000 600,000 After Tax Value of Owned Shares = Share * Price – Basis * Cap Gains Rate (20%) Copyright Net Worth Strategies, Inc. 2016 Leverage (All Grants) Potential Stock Increment Option Value Price Change $ $28.67 -20.00 % 106,450 $35.84 -20.00 % 285,700 $44.80 -20.00 % 509,700 $56.00 -20.00 % 873,100 $70.00 0.00 % 1,391,100 $84.00 20.00 % 1,909,100 $100.80 20.00 % 2,530,700 $120.96 20.00 % 3,276,620 $145.15 20.00 % 4,171,650 $174.18 20.00 % 5,245,760 Option Value Change -62.74 % -43.95 % -41.62 % -37.24 % 0.00 % 37.24 % 32.56 % 29.47 % 27.32 % 25.75 % Leverage: a 20% increase or decrease in price yields a greater change in Option value RSA & Owned Shares $ 473,055 591,360 739,200 924,000 1,155,000 1,386,000 1,663,200 1,995,840 2,394,975 2,873,970 RSA & Owned Option, RSA Change & Owned $ -20.00 % 579,505 -20.00 % 877,060 -20.00 % 1,248,900 -20.00 % 1,797,100 0.00 % 2,546,100 20.00 % 3,295,100 20.00 % 4,193,900 20.00 % 5,272,460 20.00 % 6,566,625 20.00 % 8,119,730 Option, RSA & Owned -33.93 % -29.77 % -30.50 % -29.42 % 0.00 % 29.42 % 27.28 % 25.72 % 24.55 % 23.65 % NO Leverage: a 20% price change yields the same change in Share value Copyright Net Worth Strategies, Inc. 2016 Leverage (Individual Options) Grant Grant ID Type SAR2009 SAR NQ2011 NQSO NQ2013 NQSO ISO2015 ISO Current Stock Current Price Value $70.00 259,700 $70.00 460,000 $70.00 420,000 $70.00 251,400 Price +20% $84.00 $84.00 $84.00 $84.00 Value +% Price Value +20% Change 20% 20% 329,700 26.95 % $56.00 189,700 600,000 30.43 % $56.00 320,000 560,000 33.33 % $56.00 280,000 419,400 66.83 % $56.00 83,400 The % change for individual options will vary based on the differences in the exercise prices (options with lower exercise prices will have less leverage) Copyright Net Worth Strategies, Inc. 2016 -% Change -26.95 % -30.43 % -33.33 % -66.83 % Share Valuation Analysis Owned Owned Potential Increment RSA Gross RSA After Share Gross Share After Total Gross Total After Stock Price Change Value $ Tax Value $ Value $ Tax Value $ Value $ Tax Value $ $28.67 -20.00 % 186,355 111,813 286,700 269,360 473,055 381,173 $35.84 -20.00 % 232,960 139,776 358,400 326,720 591,360 466,496 $44.80 -20.00 % 291,200 174,720 448,000 398,400 739,200 573,120 $56.00 -20.00 % 364,000 218,400 560,000 488,000 924,000 706,400 $70.00 0.00 % 455,000 273,000 700,000 600,000 1,155,000 873,000 $84.00 20.00 % 546,000 327,600 840,000 712,000 1,386,000 1,039,600 $100.80 20.00 % 655,200 393,120 1,008,000 846,400 1,663,200 1,239,520 $120.96 20.00 % 786,240 471,744 1,209,600 1,007,680 1,995,840 1,479,424 $145.15 20.00 % 943,475 566,085 1,451,500 1,201,200 2,394,975 1,767,285 $174.18 20.00 % 1,132,170 679,302 1,741,800 1,433,440 2,873,970 2,112,742 Although Restricted and Owned shares do not have leverage, incremental changes in stock price can have a profound effect on their value. This table quantifies the risk and potential inherent in your company shares. Copyright Net Worth Strategies, Inc. 2016 Financial Goal Attainment Financial Goal Vested share goal status at various prices Value of Diversified Portfolio (VDP) Copyright Net Worth Strategies, Inc. 2016 Concentration Pre-Tax Values 84% of portfolio is in company stock or options Copyright Net Worth Strategies, Inc. 2016 Key Ratios This grant’s “Insight Ratio” means 96.71% of its full value is ITM Value. Low ratios indicate small upside potential and lots at risk. Grant Grant ID Type SAR2009 SAR NQ2011 NQSO NQ2013 NQSO ISO2015 ISO Total Expire Date 10/1/2019 9/1/2021 2/1/2023 5/1/2025 Exercise Vested Vested Price ITMV $ TV $ $18.0600 259,700 8,828 $24.0000 460,000 53,660 $28.0000 315,000 66,260 $49.0500 62,850 75,063 1,097,550 203,811 VaR Vested Value VaR Ratio BSV $ 76,343 11.56 % 268,528 152,685 35.14 % 513,660 114,514 57.86 % 381,260 45,806 163.87 % 137,913 389,348 1,301,361 Copyright Net Worth Strategies, Inc. 2016 Insight Ratio 3.29 % 10.45 % 17.38 % 54.43 % Insight Ratios The Insight Ratio is TV divided by BSV Represents the remaining theoretical potential 10% means 90% of theoretical potential has been achieved Provides a framework for diversifying based on risk v. reward Planning horizon and risk profile are key considerations Copyright Net Worth Strategies, Inc. 2016 Insight Ratio Factors Proximity to retirement? Bullish on company growth prospects? Concerned with negative leverage? Close to achieving a financial goal? Concentrated position? Upcoming cash-flow requirements? Copyright Net Worth Strategies, Inc. 2016 Key Ratio Considerations* Risk Profile Insight Ratio (TV/BSV) Short/Conservative 30%-50% Medium/Moderate 11%-29% Long/Aggressive <10% * These are only guidelines for establishing individual decision criteria Copyright Net Worth Strategies, Inc. 2016 Resources & Tools Copyright Net Worth Strategies, Inc. 2016 Equity Comp. Assistance Making timely & informed equity comp. decision is an ongoing process Resources: Online: www.StockOpter.com Application: Reports, Dashboards and Monitoring StockOpter University: Free Articles, Videos and White-Papers on Equity Comp. Diversification Financial Advisors (specializing in equity comp.) LinkedIn Group: Equity Compensation Recipients – Decision Support Copyright Net Worth Strategies, Inc. 2016 Next Steps To get an analysis of your equity compensation holdings: 1. Sign up at the end of the seminar 2. Provide your grant summary statement with vesting schedule 3. 4. Include number of “long/owned” shares and total cost basis Estimate the value of your other investments Copyright Net Worth Strategies, Inc. 2016 Questions? Copyright Net Worth Strategies, Inc. 2016 Thank You for Attending Copyright Net Worth Strategies, Inc. 2016