& cplSiteName &

Cisco Renews Options Parade

Light Reading
News Analysis
Light Reading
8/24/2004

Cisco Systems Inc. (Nasdaq: CSCO) has cranked up the stock option printing machine for its employees and its CEO. As it did last year, Cisco disclosed the results of its annual "merit-based, company-wide stock option grant" in a filing with the SEC late Monday.

Cisco's filing states that the networking giant has granted 162 million stock options to employees. Its CEO, John Chambers received 1.5 million options at a strike price of $19.18.

The announcement shows Cisco isn't being coy in its approach to stock options. Cisco has traditionally been generous with options grants and has so far resisted pressure from the Financial Accounting Standards Board (FASB) and some shareholder groups to account for its options as an expense. Other cash-rich tech companies, most notably Microsoft Corp. (Nasdaq: MSFT), have made the decision to carry options on the books as a direct expense and have taken other measures to appease shareholders such as paying out dividends. Cisco does not pay a dividend.

In the past, Cisco has argued that if stock options were expensed, it would drag on corporate earnings and companies would stop issuing options. That expense -- and failure to offer options as an incentive -- would force more companies to find cheaper labor in other countries (see Chambers Attacks Accounting Plans).

Large options grants are often viewed as dilutive to shareholder earnings potential, because those options will increase the corporate share count when they are exercised. Cisco shares fell $0.21 (1.10%) to $18.97 on the news in afternoon trading.

"We view the increase in total options, options per employee and dilution as slightly negative for Cisco given the increased concern on stock option expensing heading into 2005," writes UBS analyst Nikos Theodosopoulos in a note to clients this morning.

Last year, Cisco granted employees 141 million options, of which Chambers received 4 million, at a strike price of $19.59. "This grant represents 2.34% of diluted shares at the end of July 2004, compared to 1.98% of diluted shares at the end of July 2003," writes Theodosopoulos. Cisco's grant this year results in 4,713 options per employee, compared to last year's total of 4,091 options per employee (see Cisco's Chambers Gets More Options).

Cisco critics grouse that, since Cisco does not record the cost of its stock options in its books, it overstates its earnings, which leads to an inflated stock price and an inflated ability to attract talent.

No laws exist that will change Cisco's mind in the near future. The House of Representatives did pass a bill requiring companies to expense options granted to senior executives, but that bill has yet to become law. And the FASB has tried to require companies to count stock options as an ordinary business expense.

Had Cisco expensed its stock options during the nine months that ended May 1, its net income would have been $2.1 billion instead of $3 billion, according to Cisco's SEC filings.

If companies such as Cisco instead issued restricted stock directly to employees as a way of rewarding them, the game might change a bit. The employees wouldn't have to worry about their options becoming worthless.

But Cisco's employees, in emails to the FASB, have cheered the possibility of someday cashing in on options, despite tax consequences (see Poll: Options Tax Problems Are Common).

"To use a common cliché, I am betting the farm on stock options," wrote one Cisco employee.

"My salary is moderate and I look forward to stock options as a reward from my company," another Cisco employee writes.

But there is another catch to Cisco's options approach -- it may be influencing the company's decision to use cash to buy back stock, which consumes the company's cash. When the options come in the money, Cisco employees exercise them in droves, which increases the share count and dilutes earnings. Cisco recently has been buying back billions of dollars of its own shares (see Cisco Goes Buyback Happy).

Meanwhile, Cisco CEO John Chambers, who has drawn a $1 salary and no bonus since April 2001, has made the options-based compensation plan quite lucrative. In 2003, Chambers hauled in about $34.8 million in total compensation, including stock option grants from Cisco Systems. In an average work week, that's about $16,725 an hour. Chambers has another $214 million worth of unexercised stock options from previous years, according to the AFL-CIO's Executive Paywatch database.

— Phil Harvey, News Editor, Light Reading

(36)  | 
Comment  | 
Print  | 
Newest First  |  Oldest First  |  Threaded View        ADD A COMMENT
Page 1 / 4   >   >>
Sisyphus
Sisyphus
12/5/2012 | 1:20:28 AM
re: Cisco Renews Options Parade
...aren't these options part of the war-chest for M&A, too? Is this increase over last year an indication of Cisco's intent to again grow through aquisition? Worked pre-2000.. :-)

Never been to sure how these stock option pools work for M&A - I just assume they're used for those aquisitons where it's stated it's "in stock". The 160M options represent roughly $3B. That would result in *very* generous grants to employees if it really is all used for that purpose... so the math does not quite pan out in my book, but perhaps I am underestimating how quickly they go away if one considers the usual multipliers from Sr Director upwards, and Cisco sure has a lot of VPs these days!
DoTheMath
DoTheMath
12/5/2012 | 1:20:22 AM
re: Cisco Renews Options Parade
Sisyphus wrote>Never been to sure how these stock option pools work for M&A - I just assume they're used for those aquisitons where it's stated it's "in stock". The 160M options represent roughly $3B. That would result in *very* generous grants to employees if it really is all used for that purpose... so the math does not quite pan out in my book, but perhaps I am underestimating how quickly they go away if one considers the usual multipliers from Sr Director upwards, and Cisco sure has a lot of VPs these days!
-------------------

I don't believe these represent the war-chest for M&A. That is not (mostly) from the *option* pool, that is just straight stock, though employees of acquired companies may get some options exchanged.

So the 160M options don't mean $3 billion to employees, because the employees only have the *option* to purchase it at current prices (approx. $20) - they still have to come up with the $20/share. Still, there is definite value transferred here. I estimate that these options are worth at least $4-5 per option, so as of grant date, but almost all of it is the "time value" of having such an option. If they were to expense it as they should (there is value transferred to employees from the shareholders), it would wipe out a substantial portion of one quarter's profits.

Cisco is defiantly bucking the trend towards options expensing. They seem to think this issue will blow over; I believe the next stock market downturn will put paid to such hopes.

jim_smith
jim_smith
12/5/2012 | 1:20:18 AM
re: Cisco Renews Options Parade
Cisco is defiantly bucking the trend towards options expensing.

I keep hearing conflicting remarks about the options expensing thingy.

So, is the new options expensing law going into effect Jan 1, 2005 or not?
particle_man
particle_man
12/5/2012 | 1:20:16 AM
re: Cisco Renews Options Parade
It suddenly struck me that if Cisco expensed options that they would write off the expense. I wonder what the tax difference is for the Feds if Cisco's FASB income drops from $3B to $2.1B? At a 20% tax rate you are talking about $180M. If the entire F500 did this you are into multiple billions!

Expensing options will not influence cash flow, so I wonder why more corporations don't support it just for the tax angle?

Maybe one of the financial guys lurking on this board can weigh in.
green
green
12/5/2012 | 1:20:15 AM
re: Cisco Renews Options Parade
hi,

I doubt if any of the tech companies pay taxes. it is perfectly legal to report earning under GAAP for investors but report zero income to the IRS using different accounting rules. I don't blame them. anything you give to the government goes down the black hole and you will never see even 1 cent of benefit. politicans either want to spend on war or social programs.
beowulf888
beowulf888
12/5/2012 | 1:20:15 AM
re: Cisco Renews Options Parade
If the options do not get exercised before they expire (and sizeable percentage expire without being exercised), does the company have to count those expired options as income?

Curious minds want to know...
--Beo
startup_shutup
startup_shutup
12/5/2012 | 1:20:07 AM
re: Cisco Renews Options Parade
I hope this does -- this "right to print money"
got to stop. Not expensing option is a huge
loophole.....
Stevery
Stevery
12/5/2012 | 1:20:06 AM
re: Cisco Renews Options Parade
It suddenly struck me that if Cisco expensed options that they would write off the expense.

I seem to remember that options are expensed for the purposes of taxes, just not for for the purpose of reporting to the investors.

It's really pretty silly that companies aren't required to report the IRS-income as the bottom line, because it provides a natural check and balance. Chambers can inflate the earnings all he wants, and the CFO can then point out that a huge chunk of change then needs to be paid to the taxman.

Several reporting problems would then take care of themselves, unless there's a burning desire on the part of executive leadership to contribute $$ for high payback ventures such as Iraq.

steve
steve
12/5/2012 | 1:20:03 AM
re: Cisco Renews Options Parade
This is the problem with the idea of expensing stock options. Research analysts, when doing there eps projections, include all options in the denominator (perhaps using the treasury stock method to net out the effect of money received for the exercise of stock options). So they are already reducing earnings by showing up in the denominator. The proposal to expense options would put in a (relatively arbitrary) cash charge, reducing net income, now reducing the numerator. This is why expensing is so stupid - you are double counting option expense by reducing the numerator (net income) and increasing the denominator (shares). If you had some kind of economically rational vehicle to value them, sure go ahead. But Black Scholes and other methods are ridiculous, particularly when applied to a technology stock.
lightbay
lightbay
12/5/2012 | 1:20:02 AM
re: Cisco Renews Options Parade
Are these options counted in the total outstanding shares that is used when Cisco reports next quarter ? Are they counted

- only when vested ?
- only when vested and not underwater ?
- always counted in the total # of shares ?
Page 1 / 4   >   >>
Featured Video
Upcoming Live Events
November 5, 2019, London, England
November 7, 2019, London, UK
November 14, 2019, Maritim Hotel, Berlin
December 3-5, 2019, Vienna, Austria
December 3, 2019, New York, New York
March 16-18, 2020, Embassy Suites, Denver, Colorado
May 18-20, 2020, Irving Convention Center, Dallas, TX
All Upcoming Live Events