Companies Shuffle Options Plans

Juniper Networks Inc. (Nasdaq: JNPR) and Cisco Systems Inc. (Nasdaq: CSCO) are on opposite sides of yet another hot industry debate. This time it’s not over which company has more market share (see Router Numbers Support Cisco) or which router performed better in an independent test (see Juniper Wins Monster Router Test). This debate is over what to do with employee stock option plans in the wake of a tumbling stock market.

On Monday, Juniper filed a tender offer statement with the Securities and Exchange Commission (SEC) to offer employees the opportunity to exchange their stock options for new ones. Cisco rejects this idea completely and instead says that it is simply issuing additional options at the current strike price to its employees.

"Cisco does not intend to reprice employee stock options,” says Abby Smith, a Cisco spokesperson. "We believe that employees should not have the opportunity to benefit from repricing options if all other shareholders can't do the same."

Throughout the technology boom of the late 1990s and much of 2000, companies relied on employee stock options to recruit, incentivize and retain valuable employees. During that time, employees came to rely on their options as being part of one's total compensation package rather than just an added bonus.

Now as the stock market plunges to new lows, companies are looking for ways to make stock option plans more attractive to employees. According to the September poll on Light Work, Option Plans, nearly 40 percent of the 758 respondents say their stock options are now worthless.

"When you reset the price of options you are basically saying, ‘The stock didn’t go up, so here’s another try,’" says Stephen Kamman, an analyst with CIBC World Markets. "To be honest, I think options have been a tax-friendly form of compensation. That’s not how they should be used. And this resetting and exchanging of options is starting to become standard operating procedure."

Juniper, which saw its stock plunge to just under $10 from over $200 a year ago, isn’t the only equipment company opting for the option exchange solution. Other companies like Nortel Networks Corp. (NYSE/Toronto: NT), which has seen its stock fall to roughly $5 a share from about $60, and Sycamore Networks Inc. (Nasdaq: SCMR), which has watched its stock dip to $3 from just over $100 a share within a year, have instituted their own plans since earlier this year. In all of these option exchange programs, employees trade in their current for new options, which are issued by the company six months and a day after the old options have been traded in. Those new options are then market-priced on the day they are issued, whatever that may be.

This method, used by Sycamore, Nortel, and Juniper, has two benefits. First, it allows employees to reset their options at a potentially lower strike price. Second, by waiting six months to re-issue the options, companies can avoid unfavorable accounting rules that would go into effect if the options were simply repriced as soon as the old options are handed in.

But there are also downsides. For one, employees run the risk of the company’s stock rising above the original price of their options -- however remote that may seem at the moment.

"There are no guarantees with this plan," admits Adam Stein, director of corporate marketing for Juniper. "That’s why it’s an optional program."

There are other potential drawbacks as well. For example, Sycamore restarted the vesting clock when the new options were issued. Juniper, on the other hand, plans to keep the current vesting clock ticking as it cancels the old options and re-issues new ones.

Those opposed to option exchanges say they do not benefit shareholders, because employees might actually try to keep the company’s stock price low during the six-month interval to get a lower strike price. Some companies like Sycamore have tried to offset those worries by offering restricted stock grants along with the option exchange. However, by offering restricted stock, the company has been forced to take a $12.6 million charge, which will be amortized over a four-year period.

"We offered the restricted shares to ensure that investors and employees had the same interest in driving the company toward success," says Rich Williams, a spokesperson for Sycamore.

Cisco, which has seen its stock plunge from about $70 a share in August of 2000 to around $10 a share recently, also sees the need to retain employees in the face of difficult economic times. In its latest quarterly filing with the SEC, the company notes this topic as a concern.

"Volatility or lack of positive performance in our stock price may also adversely affect our ability to retain key employees, all of whom have been granted stock options. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly engineers and sales personnel, could make it difficult to meet key objectives, such as timely product introductions."

Cisco's approach is completely different from that of Juniper, Sycamore or Nortel. The networking giant says it will not reprice or exchange employee options because the company feels that all of its shareholders should benefit, not just its employees.

Some analysts agree with Cisco’s take on the situation and object to the idea of exchanging options and re-issuing new ones "It’s a massive loophole in the accounting rules that should be fixed," says Kamman. "I don’t think that an individual company should be punished for it, but it’s a ludicrous situation and the fault lies with the accountants that allow companies to take advantage of it."

Instead of exchanging options, Cisco simply continues to issue additional options to its employees. Accounting experts say this approach also has its downsides. The biggest issue is that printing up additional options can dilute the value of the stock for all shareholders.

"From a strict accounting perspective, this is a simpler scenario, but it increases the potential for dilution. Because there are many more shares on the market, it is apt to drop the price of the stock," says Doug Reynolds, a practice fellow with the Financial Accounting Standards Board (FASB).

With about 7.3 billion shares already outstanding, Cisco's stock is less susceptible to weakness through the addition of employee options, more so even than smaller companies with fewer outstanding shares. What’s more, Cisco seems confident that its stock will bounce back. Earlier this month, it announced a plan to buy back $3 billion worth of stock over the next two years (see Cisco Sets Stock Buyback).

At any rate, the amount of activity with employee stock options indicates one thing: companies are concerned about retaining employees, and options continue to be one of the primary tools for motivating them.

— Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com