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November 11, 2005

The bill for options expensing comes due

Steve Rosenbush

Cisco's new earnings report shows that the bill for options reform is coming due. We will continue to pay this bill well into the future. In retrospect, it will probably be viewed as an emotional victory and a fiscal and economic mistake.

Companies didn't have to record an expense for employee stock options until recently. The idea is to give investors a better idea of how companies are actually performing. That's laudable. But the new rules will discourage the use of options, which will eliminate an important perk that has drawn talent to the tech sector and to startups in particular. The new expenses will lower reported earnings as well. The new rules also put U.S. companies at a disadvantage to rivals in countries that don't impose such regulations.

Cisco disappointed investors with earnings growth of 8%. They were expecting growth in the low double digits. After the announcement, the shares fell 60 cents to $17.15, although they have since rebounded to $17.41. Options expensing was a part of the problem, although it's also clear that the growth of the router business is maturing. The company reported net income for the first quarter of fiscal '06 of $1.3 billion, or 20 cents a share. That includes a charge of $228 million, or 4 cents a share, for options expensing.

It's a good bet that options expensing will continue to hurt tech earnings and stock prices for some time. The intentions were good. Bringing more clarity and honesty to corporate financial filings is a noble cause. And in the aftermath of the the tech market downturn the subsequent scandals it was crucal to crack down on the manipulation of corporate earnings. But the passage of the Sarbanes-Oxley Act and the overhaul of Wall Street's research industry got the job done. Using options expensing to hammer away at the tech sector's ablity to lure fresh talent, innovate and grow probably created more problems than it solved.

It's not a fatal problem. The recent success of Google and other tech companies shows the sector is coming back in a big way. But it will be just a bit harder for the bulk of tech companies to retain talent and grow in a perilously competitive global market.

03:14 PM

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Stock options is thing of the past and should be outlawed. I see it a way to skim investors money. There is no justification for dishing out millions of dollars in this fashion.I do not of any CEO who is underpaid. There should be a different and simple method to reward outstanding employees.

Posted by: Najeeb Rehman at November 11, 2005 06:43 PM

It's about time someone recognized that options have been a way for these companies to ensure insiders get massive payoffs from working at a company, and in fact investors need to know just what sort of liabilities are accruing and how much the company has committed itself to. Insiders walked away with the vast majority of the profits during the last dot-com boom, not outside investors. Billions of dollars worth. BusinessWeek has reported on this before, or do you not read your own publication?

Google is the latest company of that dot-com era that's stock is hugely over-valued. It's currently a one-trick company that is benefitting from advertising revenue only, it doesn't really have a 'product' or 'service' that is worth anything. Trust me, in 5 years time people are going to be asking what happened to that valuation. The investment in this company just is not warranted. There is nothing to show at this time that any of the new ideas they are working on will pan out into anything. Google's price is a get-rich-quick investment until the bubble bursts.

Posted by: burgesjl at November 11, 2005 07:45 PM

SOX, is like any other law will under go revisions.

How about making expensing Options mandatory once employee count crosses 1000 OR number of years since incorporation cross 6 yrs OR revenues cross $ 500 mn or a combination of other criteria?

This way we are encouraging startups and also making sure medium-large corporations account for all their expenses.

Posted by: Samba Yarlagadda at November 13, 2005 06:43 AM

Has anyone in this audience actually tried to do business with Cisco? After several attempts to purchase products from Cisco, it is no surprise its stock price is a disappointment. Hubris reigns here and it is displayed by company employees answering the telephone when this potential purchaser tried to find out what equipment would meet my needs. The attempted conversation failed to produce anything close to communication between two people. I tried to find out which Cisco product would perform the specific task i needed its equipment for. The person on the telephone proceeded to ask me what I wanted. If i knew which model number i wanted i would not have had to call and ask my question. Then i was finally transferred to a sales person after much frustrating back and forth non productive dialogue. The sales person attempted to ask me what i wanted and i again explained what i was trying to accomplish via voice over ip and intra office telephony. Finally i was told a specialist would call me back within two weeks. that was months ago.

while Cisco may have the best equipment on the market, Cisco does not know how to get its products to the market place. technology and software producers and vendors in the it sector have long suffered with mental self gratification, whereby the software is designed for the WOW factor inside the office, but with no clue, or sensitivity to its impact on its usability to the end user. it is obvious Cisco has yet to learn the market is king. If Cisco continues to to market its products to techies who are wowed by the newness of the technology and the thought of having another toy to play with, and not with the utility of the product in the market place, some manufacturer or reseller who is better able to communicate with the market WILL replace Cisco, and all of these options will be worth just what AT&T options are worth today, that is unless printed on soft tissue, not even worth a roll of scotts tissue.

Posted by: keriheb at November 13, 2005 06:04 PM

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