An ESOP's Tale
by Carol Lippert Gray

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Big Accounting Headaches
But there were accounting problems - unprecedented and massive ones. Link explains, "The AICPA SOP76-03 provided that when a company has an ESOP and those shares are allocated each year, the P&L charge the company takes should equal the original cost of the shares. But in 1993 the AICPA changed to SOP93-06, which requires mandatory redemption liability to be recorded as a liability. That, in effect, wiped out our entire retained earnings. The AICPA also said the annual allocation of shares had to be recorded at fair market value, so the P&L charge rises with the stock price, creating an earnings headache for us. We met with the SEC in Washington for three days prior to the IPO, going over our ESOP accounting. We're one of the few companies with such a dominant ESOP, and the SEC had never really encountered a private company with pre- and post-IPO ESOP shares recorded under different accounting standards."

With the SEC's knowledge, the company decided to redesign its ESOP, reversing the order of its shares, and rewrite its prospectus. "Older shares are normally allocated first," Link says. "Two days before the IPO, the SEC didn't object to our flushing out the 1994 shares with a one-time charge. The $11.2 million non-cash charge to the results of operation for that year pre-IPO allowed us to go forward with the remaining shares on SOP76-03. The amended plan with a non-mandatory redemption issue took away our liability."

A 1997 follow-on public offering allowed employees to sell approximately 35 percent of their ESOP shares. The resulting cash was invested in 11 different mutual funds to diversify employees' retirement accounts. Still, Sawtek's ESOP remains its largest shareholder. According to Link, it holds about 30 percent of shares worth about $400 million, and the average balance in the ESOP of the company's approximately 400 domestic employees and 50 retirees is over $800,000. (Although the company has a facility in Costa Rica, the ESOP is limited to U.S. employees. "We have a fairly rich profit-sharing program for our Costa Rican employees," Link says.)

What's Ahead
The ESOP will run out in 2003, when all of its shares will have been allocated. "We have four more good years of ESOP allocations to use as a recruiting tool," Link notes. "In 2003, we'll have to look at alternative forms of equity compensation, maybe broad-based stock options a la Intel, although nothing has been finalized." Still, the explosion in dual-band wireless-phone use, the fact that the company markets a broad line of filters for digital wireless phones and planned new product offerings mean the prospects for growth are good.

"They have an upside still," notes Daniel Koontz, an analyst with Freimark Blair & Co. in Ramsey, N.J. "There's broad secular growth worldwide in their markets. They have exceptional financial performance on a fundamental, company-specific basis. And they hit their numbers. What else can an analyst want?"

"We have a motivated work force," Link explains. When an employee is also an owner, he adds, "the way you look at things is very different than when you're an hourly employee. Our employees have a huge vested interest in the company. Some have 20,000, 30,000 or 50,000 shares in our ESOP, which is more than some of our institutions have."

Ongoing employee education stresses the value of the ESOP, the company's values and how all the pieces fit together. There's an annual employee ESOP meeting in a rented hall in Orlando, complete with entertainment. "The ESOP is the culture of our company," Link says. "It can't be replicated, because the shares were purchased so long ago on such a cheap basis, and new accounting rules would impose huge P&L charges."

Still, Link concludes, "At Sawtek, the employees are kings."

Carol Lippert Gray is managing editor of Financial Executive.