How might the grant affect the company's cash flow, tax expense, and earnings per share?

Short answer:

The grant of non‑qualified stock options (NSOs) to four new employees will not affect Viridian’s cash flow at the moment the grant is announced, but it will generate a non‑cash compensation expense that reduces reported earnings (and therefore EPS) in the periods in which the options vest. For tax purposes the company will eventually be able to claim a deduction when the options are exercised, which will lower its future cash‑tax outflow (i.e., the tax expense will be reduced in the year of exercise). Because the options can later be exercised for new shares, the diluted earnings‑per‑share (EPS) figure will be diluted once the options are outstanding (or when they are exercised and the shares become outstanding).

Below is a step‑by‑step breakdown of how the grant impacts the three items you asked about: cash flow, tax expense, and EPS.

1. Cash‑flow impact

Bottom‑line on cash flow:

At the moment of the grant there is no cash outflow. The first cash‑flow impact occurs when (and if) the options are exercised – at which point the company will receive cash equal to the exercise price minus any withholding taxes it must remit.

2. Tax‑expense impact

a) Accounting (financial‑statement) tax expense

Key points for the tax side

1. No immediate tax deduction when the grant is made. The tax deduction is delayed until the options are exercised.
   
2. The cash tax payment (payroll tax, federal and state income tax withholding) occurs at exercise, not at grant.
   
3. Because the expense is recognized in the financial statements before it is tax‑deductible, a deferred‑tax asset (or liability, depending on the timing of the eventual deduction) is created on the balance sheet.
   

b) How the grant changes the company’s “tax expense” line

• Current period (grant & early vesting):
  
  Net income will be reduced by the stock‑based compensation expense (e.g., if the fair‑value of the 181,450 options is $2 million, the company will record a $2 million expense over the vesting period).
  
  Tax expense (the cash taxes the company pays that period) will not change because the expense is not yet deductible. The net effect is a larger effective tax rate for the period because the company has a larger book expense with no corresponding tax deduction.

• At exercise (future):
  
  Tax-deductible expense reduces taxable income → lower cash tax out‑flow (lower tax expense). The earlier “deferred tax asset” will be used to offset the taxable income, reducing cash taxes.

3. Earnings‑Per‑Share (EPS) impact

3.1. Dilution of shares

• Current period:
  The grant creates potentially dilutive securities. In the diluted‑EPS calculation, the “Treasury‑stock method” is applied to estimate the number of shares that could be issued. The number of shares that would be added is:
  

[
\text{Potential shares} = \frac{\text{Option shares} \times \text{(Market price – Exercise price)}}{\text{Market price}}
]

Since the exercise price is not disclosed, we cannot compute the exact incremental shares, but the maximum potential dilution is the full 181,450 shares (if the exercise price is zero). The actual dilution will be less if the exercise price is higher or if some options lapse.

• Impact on EPS:
  Diluted EPS = (Net Income – Preferred Dividends) ÷ (Weighted‑average shares outstanding + incremental shares from options).
  

Because the denominator will increase, diluted EPS will be lower (i.e., diluted earnings per share decline).

The effect can be roughly illustrated (assuming no other changes):
- Current shares outstanding (publicly known from recent filings) ≈ 20 million (illustrative).

- Incremental shares ≈ 181,450 → about a 0.9% increase in the share count.

- If net income were $10 million, diluted EPS would fall from $0.50 ($10 M / 20 M) to roughly $0.496 ($10 M / 20.181 M).

The actual impact will depend on the precise number of shares currently outstanding and the exercise price.

3.2. Impact on Basic EPS

• Basic EPS counts only shares actually outstanding, so at the grant date there is no effect on basic EPS because no new shares have been issued yet.
  
• Once the options are exercised (or if the company chooses to treat the options as “settled” in cash rather than issuing shares), the share count increases, and both basic and diluted EPS will be diluted.

3.3. Timing of the EPS impact

• During the vesting period:
  
  The stock‑based compensation expense is recognized in the income statement each period. That reduces net income, which lowers both basic and diluted EPS even though the number of shares has not yet changed. This is a pure earnings‑dilution effect (often called “virtual dilution”): lower net income divided by the same share count yields a lower EPS.

• When the option is exercised (or the company chooses a cash settlement):
  
  If the options are exercised for cash: the share count increases (dilution) and the company receives cash (affects cash flow). The EPS declines because of a higher share denominator, but the net income is not impacted (the exercise does not generate a new expense— the expense was already recognized).

If the option is settled in cash (a “cash‑settlement” arrangement) without issuing new shares: there is no dilution to EPS, but the cash received (if any) reduces cash‑flow out‑flows (no new shares) but the company still records the prior expense.

4. Putting it all together – What the analyst should keep in mind

5. Example numbers (illustrative only)

Assume the following for illustration (the real numbers depend on the actual fair‑value of the options, the vesting schedule, and the eventual exercise price):

Effect during the first year of vesting
- Non‑cash expense: $500,000 → reduces net income → EPS declines from $0.50 to $0.475 (if net income originally $10 M).
- Tax effect: No cash tax benefit yet; a deferred‑tax asset of ~ $500,000 * (tax rate) is created.
- Cash flow: 0

Effect at exercise (if all 150k exercised)
- Cash inflow: 150,000 × $5 = $750,000 cash (plus any withholding tax).
- Tax deduction: 150,000 × ($30‑$5) = $3,750,000 * (company’s payroll‑tax share) → reduces taxable income, so cash tax out‑flow falls.
- Shares outstanding: 20 M + 150,000 = 20.15 M → Diluted EPS falls further.

6. Bottom‑line summary for the analyst

1. Cash flow: No impact at the grant date; later cash inflow when options are exercised, offset by payroll‑tax cash out‑flow; no cash out‑flow at the time of vesting.

2. Tax expense: The company will record non‑cash compensation expense over the vesting period, which reduces net income now but does not reduce cash taxes until the options are exercised (when the expense becomes tax‑deductible). The net effect is a future reduction in cash tax at the time of exercise, and a deferred‑tax asset now.

3. Earnings per share:

   • During vesting: EPS (both basic and diluted) falls because of the stock‑based compensation expense.
     
   • When the options are exercised: Diluted EPS falls further because the share count will increase (up to 181,450 new shares). Basic EPS is unchanged until the shares actually issue (exercise).
     

In short, the NSO grant is a non‑cash, expense‑driven, future‑cash‑generating transaction that reduces current earnings and will dilute shareholders’ ownership once exercised, while giving the company a future cash inflow and a future reduction in cash taxes when the options are exercised. This pattern is typical for NSO grants and should be reflected in the company’s cash‑flow statement (operating vs. financing), its income‑statement (compensation expense), its tax footnotes (deferred tax assets), and its diluted‑EPS calculations.