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Employment

Tellium Execs in Trouble?

Bernie Ebbers and Scott Sullivan aren't the only top executives in the dog house over loans they took from their company.

Top executives at Tellium Inc. (Nasdaq: TELM), a maker of optical switching gear, could also be in hot water now that its board of directors has officially rejected a revision to its management incentive program that would have forgiven the $30 million in loans the company made to them.

Back in the spring and summer of 2000, Tellium gave 12 executives loans to exercise their options at a strike price of $2.14. With interest, the balance of the loan totaled $32.9 million as of July 25, 2002. Harry Carr, chairman and chief executive officer, owes $15.9 million; Krishna Bala, cofounder and chief technical officer, owes $2.9 million; and Michael Losch, chief financial officer, owes $2.1 million.

Since executives used their restricted shares of stock as collateral for the loans, they now face considerable personal financial peril, because Tellium’s stock, now at less than $0.50 a share, is way below the strike price they paid.

In order to head off this threat, Tellium revised its management incentive plan back in May to effectively cancel the loans.

“Recognizing that these loans were diverting the employees' attention from our business and that these employees needed a positive incentive program that promoted retention, motivation and performance, our board of directors decided to make changes to our management incentive program, including changes relating to the loans,” says Tellium’s September 3, 2002, 8-K filing to the Securities and Exchange Commission (SEC).

The new plan would have been a sweet deal for these execs, essentially freeing them of financial risk. It had three main provisions. For one, it would have allowed participating employees to use their vested or unvested shares of restricted stock to be applied against their loans.

Secondly, the due dates of the loans would have been extended beyond each participating employee's “current and future mortgage, home equity loan and any other similar forms of debt.” In other words, the loans would have had indefinite due dates.

Finally, if the company were acquired, each participating employee who had loans outstanding would have received a cash bonus that would not only have paid off the loan itself, but would also have paid for the taxes that resulted from receiving the bonus.

However, Tellium’s 8-K goes on to say that the board decided not to go through with the revisions, because it became apparent that implementing the plan would cause certain “issues” to arise.

The document gives little insight into why the company decided to reject the new plan. But one theory for the quick change of heart is that the new incentive plan deterred potential buyers. If the company were to implement this plan it would likely cost an acquirer at least $50 million -- $32.9 million to forgive the loans, plus the additional cash for the taxes. At the low end, the company is likely only worth about $250 million. It has $206.1 million in cash, and its market capitalization is currently at $50.7 million. All told, a $50 million expense to retain executives might be a hard sell to potential buyers.

For months analysts have speculated that Tellium has been looking for a buyer. And it's not hard to see why. In July, the company reported only $3.1 million in revenues for the second quarter of 2002 (see Tellium Reports Q2). It continues to suffer from a dearth of customers. Earlier this summer it cut its staff by 37 percent (see Dude, Where's My Carr?).

The company has even been rumored to be dedicating top sales officials to the task of finding a buyer. Two executives, Darren Beers, vice president of North American sales, and Jack Kurtz, vice president of Europe, Asia, and government sales, have supposedly been reassigned. Instead of looking for potential customers, they are rumored to be working with potential acquirers.

Tellium may also be losing some executives. According to a source close to the company, Nicholas DeVito, vice president of business development, left the company last week. It is not known whether he was one of the vice presidents who had borrowed money from the company to exercise his options.

Tellium had not responded to Light Reading's requests for an interview by press time.

— Marguerite Reardon, Senior Editor, Light Reading
www.lightreading.com
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jamesbond 12/4/2012 | 9:45:08 PM
re: Tellium Execs in Trouble? Yep this used to be a common thing in silicon
valley, companies giving loans to exercise
options.
Those execs have made more than 25mil atleast
selling pre-ipo stock. Now they have to pony
up maybe 2-3 mil.
andiji 12/4/2012 | 9:45:07 PM
re: Tellium Execs in Trouble? If the execs haven't sold their shares, then it may be unlikely that they can raise this money, so any acquirer will not likely be able to recover the money anyway.

Still, I suppose this could be a spiffy retention plan. Stay, or we will bankrupt your sorry butt!
hiddentiger 12/4/2012 | 9:45:07 PM
re: Tellium Execs in Trouble? Aside from having to pay the company back for the loan of millions of dollars- do these guys have to pay uncle sam taxes as well?
HD
myresearch 12/4/2012 | 9:45:06 PM
re: Tellium Execs in Trouble? If they excised their options (buy at the option price and sold at the market for the amount to cover the base), they made millions and did not need any loan.

But a lot of them were greedy, they borrow money to excise and hold the stock - now they got what they deserved.
DoTheMath 12/4/2012 | 9:45:03 PM
re: Tellium Execs in Trouble? If they excised their options (buy at the option price and sold at the market for the amount to cover the base), they made millions and did not need any loan.

But a lot of them were greedy, they borrow money to excise and hold the stock - now they got what they deserved.

----------------------------------------------

Actually, that is now how they got into debt. These options
are the so-called "immediately exercisable" variety, where
you exercise it immediately (i.e pay for them), but
it vests over the 4 or 5 years. The "advantage" is that
the gains were subject to capital gains tax vs in normal options
where the gains would be subject to the much higher income tax because
technically you purchased the stock on day 1, just that you
don't have full rights over it.

It was very common practice for companies to provide a loan
to enable employees to exercise such options immediately.
No money changes hands, because the company provides loans
and it gets back the money in the form of the exercise. It was
all done to help exploit the tax difference. Unfortunately,
no one considered the possibility that the stock would actually trade
below that exercise price; common thinking was that the
exercise price was so low, there is little chance of the
stock going below that. The "little chance" happened ...

I happen to know some of the folks in this situation. I
sympathazie with the situation, because it is not just
executives who are in this mess; lots of ordinary employees
were offered the same deal and took it, though the
amounts involved are smaller. It is still painful.




willywilson 12/4/2012 | 9:45:02 PM
re: Tellium Execs in Trouble? I happen to know some of the folks in this situation. I
sympathazie with the situation, because it is not just
executives who are in this mess; lots of ordinary employees
were offered the same deal and took it, though the
amounts involved are smaller. It is still painful.

---------

Aw, isn't that too bad. Save the sympathy for the worker bees. The executives? It's about time they felt a little pain.
BobbyMax 12/4/2012 | 9:45:00 PM
re: Tellium Execs in Trouble? These guys at Tellium were greedy and corrupt. Thgey must take steps to repay the loan to the company. These guys have run away with millions of dollars. They are thieves and should be prosecuted to the fullest extent of the law.
Ringed? 12/4/2012 | 9:44:59 PM
re: Tellium Execs in Trouble? Bobby Max,
The analogy LR used comparing WCOM execs to Tellium execs doesn't in any way implicate wrong doing by Tellium execs. The fact that Ebbers owes WCOM $116 million isn't criminal, its just plain stupid that anyone would okay it to begin with.

The WCOM debacle is a completely different issue. Tellium execs took the carrot that was offered by the company and origionally approved by the board of directors. Improper, maybe. Criminal, no.

What I think is important is that a board of directors stepped back to the plate and did the right thing. Culture doesn't change overnight, especially in the good ole' boy ranks. The heat is squarely on boards in all sectors of publicly traded companies to do the right thing, as it should be.
Ringed?
newbee2002 12/4/2012 | 9:44:58 PM
re: Tellium Execs in Trouble? Thanks for the analysis!
DoTheMath 12/4/2012 | 9:44:57 PM
re: Tellium Execs in Trouble? Since the board is made up of respective VCs with even larger stakes/warrants which are also under water, it makes sense to avoid the loan forgiveness and possibly even call in the loans in order to make an acquisition more attractive. But then, which of these Officers would be around after an acquisition anyway, so collect while you can. Then of course there's the old protection offered by Chapter 11.

If I had a loan like this and had to liquidate personal assets to cover it you can bet I'd "Thank Heaven for Chapter 11".

--------------------------------------------

Good post. I ran into a situation where such immediately exercisable
options were offered, and fortunately most people did't do it. Mostly
that was because the company cautioned that THIS IS RISKY - i.e the
value of the shares COULD go below the exercise price (what a novel
idea!).

In effect, the company was giving a 100% margin loan to fund
the stock purchase, with the provision that the stock cannot be sold for
4 years (so you can't time your sales to repay the debt). I guess it is
as risky as it sounds, just that in the bubble era no one thought of these
as margin loans.

Still, I feel some sympathy for some of the execs caught up in this. I happen
to know one of them through a friend, and he is a decent guy who probably didn't
realize the margin debt implication.
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