Employee exercises $50 option when market value is $100. Firm buys back 1 share the same day for $100. No dilution = no expense?

FWIW, I always try a cash flow approach where I consider repurchase programs that are pretty nakedly set up (in my estimation) as defacto option dilution schemes.

I wrote about this a few years ago, though the article formatting looks crap today for some reason.

http://www.fool.com/investing/small-cap/2006/09/28/the-dark-...

A current example I'd point to is LOGI. My notes from just before the most recent quarter:

Over the past 5 years (20 quarters), LOGI has spent $842MM to repurchase 48.2MM shares. Yet the actual share count has fallen by only 707K. Now, there was a convertible debt issue that converted into 10.9MM shares in FY06, but even pulling that out, that's still only 11.6MM of the actual supposed benefit of repurchases accruing to the shareholders (or less than a quarter of the total).

                             Average       Shares     End-of-Qtr   Actual Share  
              Repurchase    Repurchase   Repurchased    Shares     Differential
Qtr-End      Amount ($MM)     Price        ('000)      O/S ('000)     ('000)
---------------------------------------------------------------------------------
30-Sep-03                                              179,155 
31-Dec-03      $  6.3         $10.53          600      179,879        (  704)  
31-Mar-04      $ 25.8         $12.51        2,060      179,998        (  119)
30-Jun-04      $ 34.2         $11.43        2,988      177,922         2,076
30-Sep-04      $ 57.8         $11.26        5,132      174,385         3,537
31-Dec-04      $ 26.8         $13.51        1,980      175,731        (1,346)
31-Mar-05      $ 15.8         $15.84        1,000      176,964        (1,234)
30-Jun-05      $ 31.5         $15.29        2,062      176,363           601
30-Sep-05      $ 21.5         $18.83        1,140      180,243        (3,880)
31-Dec-05      $ 24.1         $21.44        1,122      188,876*       (8,633)
31-Mar-06      $164.3         $20.66        7,952      182,651         6,224
30-Jun-06      $ 24.5         $20.11        1,220      182,245           406
30-Sep-06      $ 24.7         $20.75        1,190      182,499        (  254)  
31-Dec-06      $ 36.3         $27.52        1,320      182,815        (  316)  
31-Mar-07      $ 52.6         $27.95        1,880      182,243           572
30-Jun-07      $ 52.0         $26.81        1,940      181,582           661
30-Sep-07      $ 41.6         $27.23        1,526      181,286           295
31-Dec-07      $ 44.3         $34.77        1,275      181,449        (  163)
31-Mar-08      $ 81.9         $26.90        3,043      179,176         2,274
30-Jun-08      $ 49.0         $31.58        1,552      178,682           493
30-Sep-08      $ 27.0         $25.69        1,051      178,448           234
---------------------------------------------------------------------------------
               $841.8         $17.48       48,169                     11,604**

*  Convertible debt was converted at $11.86/shr strike price.  Conversion created net new
   10.9MM shares, which were largely bought back the following quarter.  

** Added the 10.9MM shares generated from the conversion of convertible debt in Q3-FY06.

Now LOGI generates some serious green when things are going well (in economic downturns, apparently folks aren't exactly lining up to buy $300 universal remotes for their home theatres...who knew?) Still, by my estimate, LOGI's generated about $172MM in FCF over the past twelve months. But the repurchase imperative to offset dilution amounts to about 40% of this total (and your mileage may vary - I think you could argue any number in the range of 30%-50% over the past few years).

Stripping out that 40%, leaves me with about $103MM of FCF supposedly available to investors. That's the number that I base my valuation modeling on - treating that 'lost' 40% as de-facto 'deferred compensation expense'.

So, I suppose I address the in-or-out GAAP arguments by basically ignoring them....

Best,

Jim