Managing Your Stock Options Speakers name is 24pt Speakers position is 24pt Welcome, and thank you for attending our presentation. Practically every day there is discussion on TV, in the newspapers, and at work related to stock options. What was once thought of as a privilege and opportunity for management and executives, has now moved into the mainstream. Nowadays, more and more companies are giving options to most or all of their employees—they’re not just for the executives anymore. Today we’re going to discuss some of the basics of stock options: -What is a stock option? -Vesting -How to exercise options -Tax implications -The need for diversification This is information that every investor with stock options should understand. To start, let me tell you a little about myself. My name is . I’m a in the office of ___________, and a Registered Representative with (add Broker-Dealer name). (Briefly summarize your experience: years in the financial industry, years with firm, etc.) Date

Not Just for Executives Broadly granted stock option plans are found both in smaller companies and in large public companies More than just the tech companies are offering stock options to their employees (Starbucks, Gap, Pepsi) Up to 10 million option holders today, compared to one million back in 1990* As I said, stock options are not just a privilege for executives. Broadly granted stock option plans are found both in smaller closely held companies and in large public companies. It’s not just the tech companies that are offering stock options to their employees. Heavy hitters like Starbucks, Gap, and Pepsi offer them. Many of you in this room have probably been offered stock options. There are up to 10 million option holders today compared to one million back in 1990—you can see the growth. *Source: National Center for Employee Ownership

Could This Be Me Some Day? It used to be that stock option recipients could dream of one day being millionaires—with all of the stories of Microsoft millionaires, or the Home Depot employees who cashed in on huge option windfalls during the good times. But today it seems that all you hear about from one day to the next are accounting scandals, corporations filing for bankruptcy, and the average investor losing his or her retirement nest egg. This has left many people questioning the ethics of corporate America. Now more than ever, investors need an understanding and proper guidance when it comes to managing their stock options. Unfortunately, many employees have little frame of reference for what an options grant can mean—or why they are receiving one in the first place. Stocks do carry higher risks than other types of investments, but when managed properly, they can offer a wealth of opportunity. One big pitfall for investors is that they do not have enough diversification across their investments. So let’s get into some stock option basics.

What Is a Stock Option? A stock option is the right, but not the obligation, to purchase a specific number of shares of stock at a set price within a set time period For example: ABC company grants its employees options to purchase 100 ABC shares at $25 per share The options will vest 20% each year for five consecutive years So what is a stock option? A stock option is the right, but not the obligation, to purchase a specific number of shares of stock at a set price within a set time period. For example: ABC company grants its employees options to purchase 100 ABC shares at $25 per share. The options will vest 20% each year for five consecutive years. The “grant date” is the date ABC company give its employees stock options. The “vesting date” is the date the employees will be eligible to exercise their options. So in this case, 20% in year one, 20% in year two, and so on. The “exercise date” is the date of the actual transaction, made at the employee’s election, which converts the option to buy into an actual purchase of company stock.

A Stock Option = A Share of Stock A stock option is not the same thing as a share of stock. Many people confuse the two. A share of stock represents an ownership interest in a corporation. Ownership of a corporation is divided into many pieces or “shares.” It entitles the owners or “shareholders” to vote on certain corporate matters, such as the election of members of the company’s board of directors, or to participate in the market performance of the stock and to receive any dividends declared by the company. A stock option is not an ownership interest in a corporation. It represents only an opportunity to become an owner or shareholder in the future. Once options become vested, employees can exercise them and purchase up to a specified number of shares within a set time period at the price established on the option grant date. Also, unlike shares of stock, you cannot transfer options to another person, and they can’t be sold.

Why Do Companies Issue Stock? Recruitment Retention Company performance Companies issue company stock for a few reasons. To recruit and keep key talent. And as a performance-based incentive—encouraging employees to work harder and better because they have a vested interest in the company doing well.

Types of Options Two types: Nonqualified stock options (NSOs) Incentive stock options (ISOs) There are two types of options: nonqualified stock options, and incentive stock options

Types of Options Nonqualified stock options (NSOs) Most common type Pay ordinary income tax on the difference between the exercise price and the fair market value on the date of exercise May also pay capital gains tax on any additional gain if you hold the stock after you exercise Most common practice is to exercise and sell on the same day—cashless exercise Nonqualifed stock options are the most common type. You will pay ordinary income tax on the difference between the exercise price and the fair market value on the date of exercise. If you hold onto the stock after you exercise, you may also pay capital gains tax on any additional gain. The most common practice is the exercise and sell on the same day. This is called cashless exercise. In this scenario, you would only pay ordinary income tax.

Types of Options Incentive stock options (ISOs) Carry several restrictions: Exercise period may not exceed 10 years from date of grant No more than $100,000 in options may be exercised in any one year Must hold onto the stock for at least a year after the exercise and two years after the grant date Generally, no ordinary income tax when you exercise options May generate alternative minimum tax (AMT) You pay long-term capital gains tax on excess of sales price over exercise price, where holding period is met Incentive stock options carry several restrictions. The exercise period may not exceed 10 years from date of grant. No more than $100,000 in options may be exercised in any one year. Must hold onto the stock for at least a year after the exercise and two years after the grant date. Generally, no ordinary income tax when you exercise options, but may trigger alternative minimum tax (AMT). AMT is a separate tax calculation that the Internal Revenue Service requires to prevent high-income taxpayers from receiving too many tax breaks. The intent of the tax is to ensure that all individuals pay at least some tax on their income. You pay long-term capital gains tax on excess of sale price over exercise price, where holding period is met. If you don’t meet these requirements, your incentive stock option is automatically converted to a nonqualifed stock option and carries the same tax implications.

What is Vesting? Straight vesting Cliff vesting Step vesting Performance vesting The vesting date of your options is an important part of your stock option plan. Vesting is the date the options become eligible to be exercised. There are different types of vesting schedules. These are the most common: straight vesting cliff vesting step vesting performance vesting

Straight Vesting Most companies use this method Options vest at the same percentage each year 20% Year 1 500 Shares Year 2 Year 3 Year 4 Year 5 Most companies use the straight vesting method. Options vest at the same percentage each year. So you may exercise that percentage of your options each year. For example, if your company grants you an option for 2,500 shares and five-year vesting at the same percentage each year, 500 shares or 20% become exercisable each year.

Cliff Vesting All stock options become eligible for exercise at the same time and on the same date You cannot exercise your options until that date % Vested 1st Year 0 Shares 100 % 75 % 50 % 25 % 0 % 0% 2nd Year 3rd Year 4th Year 5th Year 2,500 Shares 100% With cliff vesting, all stock options become eligible for exercise at the same time and on the same date. You cannot exercise your options until that date. For example, if your company grants you options for 2,500 shares to vest over a five-year cliff vesting schedule, all 2,500 shares will be exercisable in the fifth year.

Step Vesting Your options become vested at a specific percentage each year Generally not suitable for Incentive Stock Options (ISOs) 0% 40% 65% 85% 100% 1st Year 0 Shares 2nd Year 1,000 Shares 3rd Year 625 Shares 4th Year 500 Shares 5th Year 375 Shares With step vesting, your options become vested at a specific percentage each year. Generally not suitable for ISOs. For example, your company may grant you options for 2,500 shares vesting over a five-year step vesting schedule. Then: No shares would be exercisable in the first year. You could exercise 40% or 1,000 shares in the second year. 65% or 625 shares in the third year. 85% or 500 shares in the fourth year, and The remaining 375 shares in the fifth year.

Performance Vesting The options become fully vested in the year the company achieves a particular goal 0% 100% 1st Year 0 Shares 2nd Year 3rd Year 2,500 Shares 4th Year 5th Year With performance vesting, the options become fully vested in the year the company achieves a particular goal. These goals typically reflect certain earnings or revenue expectations. For example, an option grant of 2,500 shares awarded through a performance vesting schedule would vest when the company’s performance target has been met—in this case, in the 3rd year when the company reaches X amount in revenue. So you see how important it is to understand the vesting schedule for your particular plan.

How to Pay for Your Stock Options Cashless exercise Most common method Stock is bought and sold at the same time Do not need to use your own cash to buy the stock Okay, so once you’ve decided to exercise your options, how do you pay for your stock options? There are a couple of different ways. The first is called “cashless exercise.” This is the most common method. The stock is bought and sold at the same time. You do not need to use your own cash to buy the stock.

How to Pay for Your Stock Options Cash purchase and hold You pay for the stock using your own funds Stock is held by you Stock is sold by you whenever you wish— could increase odds of selling at a more advantageous price The second way is called “cash purchase and hold.” You pay for the stock using your own funds. The stock is then held by you. The stock is then sold whenever you wish. This could increase the odds of selling at a more advantageous price.

How to Pay for Your Stock Options Sell to cover A combination of the previous two methods Sell enough options to cover the purchase price, taxes, and commissions on the transaction Don’t need to put out cash up front The last option is “sell to cover.” This is a combination of the previous two methods. You sell enough options to cover the purchase price, taxes, and commissions on the transaction. You don’t need to put out cash up front.

The Stock Option Process Exercised Option Granted Option Vested Stock Purchased To recap, here’s an example of a common process. The option plan will dictate how your options can be exercised. You are granted options by your employer. You would then wait for the options to vest. The options may vest by one of the methods previously mentioned (straight, cliff, step, performance). Once your options have vested, you may exercise them for a specified period of time. This means that you will have the right to purchase a certain number of shares of the stock at a specific price during the time frame stated in the option. Once the stock is purchased, in general, you may either sell it immediately or hold onto it in the hopes of greater appreciation. Stock Held Or Sold

Tax Implications Nonqualified Incentive Grant of Option Generally, no tax due No tax due Exercise of Option Ordinary income Exercise may create AMT liability Sale of Stock Long-term or short-term capital gains tax depending on holding period from exercise Tax will depend on whether holding period is met I touched upon the tax implications earlier, but I want to discuss them a bit further because they’re a major factor to consider when exercising your options. For nonqualified stock options: -Generally, no tax is due upon the grant of the options. -When you exercise the options, the difference between the grant price and the fair market value on the exercise date will be taxed as ordinary income. -When you sell the shares, any appreciation after the exercise date will be taxed as capital gain. Long-term or short-term capital gains tax will depend on holding period from exercise. For incentive stock options: No tax is due upon the grant of the options. Exercise may create Alternative Minimum Tax (AMT) liability. When you sell the stock, the tax will depend on whether the holding period is met. If the requisite holding period is met, long-term capital gains will apply on the excess of the sale price over the exercise price. If the requisite holding period is not met, ordinary income tax will apply on the difference between the exercise price and the fair market value at time of exercise. Any appreciation from the time of exercise to the time of sale will be taxed as long-term and short-term capital gains, depending on the holding period from exercise.

Some Tips Pay attention to the expiration date Termination of employment will affect when and how you exercise Exercising your options carries tax implications Stocks fluctuate Overallocation of company stock is risky Here are some tips to keep in mind. Pay attention to the expiration date. Most options have a maximum time period for exercising. Termination of employment will affect when and how you can exercise your options. You’ll have a limited amount of time after your last day of employment to exercise remaining options. Exercising your options carries tax implications. You can lose a significant portion of your gain to taxes if you haven’t carefully planned your schedule of exercising options. Stocks fluctuate. There’s no guarantee that the stock will go up. Overallocation of company stock is risky. I think everyone has learned that as a result of the Enron situation.

If You Have a Stock Option Plan Now… Are you comfortable with your understanding of the details we discussed today? Do you feel confident that you know when and how to exercise your options? For those of you who have stock option plans now: Are you comfortable with your understanding of the details we discussed today? Do you feel confident that you know when and how to exercise your options? If you’re not comfortable, I can help you.

I Can Help Determine the best time to exercise and sell Identify tax consequences Recommend diversification strategies Create a customized, comprehensive plan— including your stock options, based on your goals and risk tolerance Stock options offer a wealth of opportunity if managed properly. I can help you do that by: -determining the best time to exercise and sell -identifying tax implications -recommending diversification strategies -creating a customized comprehensive plan, that includes your stock options, based on your goals and risk tolerance

Thank You We hope you found this seminar useful and informative. Education is an integral part of helping people build strong financial futures for themselves and for their families. We are committed to education as a service to our investors, as well as the larger community. This seminar was provided compliments of Prudential Investments Management Services LLC, Three Gateway Center, 14th Floor, Newark, NJ 07102-4077. PIMS is a Prudential Financial Company. Investments are not insured by FDIC or any federal agency, not a deposit of or guaranteed by a bank or any bank affiliate, and may lose value. I’d like to thank you for taking the time to attend this presentation. I’d be happy to meet with you one-on-one to review your individual situations.