Letter Published in Financial Times.

Sir, your Lex column touted Maxim Integrated as a "beacon of resilient profitability" (January 31). Your columnist falls prey to the accounting illusions Lex takes pride in avoiding.

Rather than debating whether an option is an expense or not, why don't we see if Maxim generates any free cash flow? Let us do this over a three year period. Free cash flow for the past three years (2000 to 2002) amounted to $630m. It would be wrong to accept this number at face value. It is not free and unfettered cash flow.

Maxim is a prolific user of stock options when it comes to remunerating employees. This explains why one could identify Maxim as a beacon of resilient profitability - a kind of one dimensional view.

As a shareholder, one is not overly concerned whether the company pays employees in cash or kind, as long as one's ownership interest is not diluted. The stock price might rise despite the dilution, but that is only because the press misinforms the public about the company's true profitability. In the end, the story collapses under the weight of an ever-increasing number of outstanding shares.

During the three years under review, Maxim spent $530m, net of employee contributions (options times strike price at date of exercise) and tax subsidies (so-called "tax benefits"), to buy back 30m shares. During the same period, 40m shares were issued to employees. The cost of buying back an additional 10m shares would have been $460m using the average repurchase price for the past three years. Calculated in this manner, the economic cost of the stock option program over this period was roughly $990m ($530 plus $460).

This $990m compares against reported net income of $970m and free cash flow of $630m, excluding the tax subsidies, which were applied to reduce the cost of repurchases. Clearly, Maxim is not profitable and does not produce free and unfettered cash flow.

Furthermore, Maxim employees realized $1.7bn in pre-tax gains from stock options during the past three years. Even if they required only half as much in cash compensation in lieu of stock options, it would have cost Maxim approximately $550m after tax in hard cash. Coincidentally, it comes close to the $530m spent on stock repurchases. The Financial Accounting Standards Board's much maligned footnote disclosure estimates a stock option cost of $380m during the past three years.

The numbers above give a rough approximation of Maxim's profitability, or lack thereof. These are less flattering than the numbers Lex upholds as veritable truth. Any company can fake profitability as long as salaries are paid in stock, and analysts turn a blind eye.

Albert J. Meyer