Armageddon in the form of stock option expensing is fast-approaching for Orange County’s technology companies.
At least that’s how most tech businesses view the rules, which require public companies to count stock options as expenses on earnings reports after June 15.
The rules, set by the Financial Accounting Standards Board, stand to have big consequences for public companies.
Irvine computer maker Gateway Inc. reported in its most recent filing that stock option expensing will “affect our future earnings per share and could limit Gateway’s willingness to use equity-based compensation plans, which could affect our ability to attract and retain employees.”
Technology companies are among the biggest users of options, which they offer to lure software developers, computer scientists and other sought-after workers.
Investor groups have been among the biggest backers of the option expensing rules. They argue that options dilute earnings per share, a common gauge of a company’s health, and should be accounted for clearly.
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Stock options give employees the right to buy company shares at a future date based on a set price. If the company’s stock price rises, then employees who choose to “exercise,” then sell their options make the difference between the set price and the price on the trade date. Once the options are exercised, they increase the pool of shares in the market, lowering earnings per share.
Industry groups such as TechNet Southern California have lobbied hard against options expensing.
“The timing of these requirements is creating a real time crunch,” said Doug Farry, executive director of the group. “Companies have had to devote greater internal resources within their internal accounting departments to comply with the new regulations.”
The latest action in the several-year process toward options expensing came last week after the Securities and Exchange Commission issued guidelines on how to value stock options. Detractors of the new rules long have argued that there isn’t a fair way to value options.
In its guidelines, the SEC noted that valuing options requires “considerable judgment” on the part of companies and requires the heavy use of historical data as a baseline for valuation.
The San Jose-based Semiconductor Industry Association said last week that the expensing rule is “fatally flawed.” The trade group said the Financial Accounting Standards Board’s rule “is premised on the false assumption that employee stock options can be valued in a manner similar to options that can be publicly traded on the open market.”
But the SEC said that it won’t hold companies to the fire for options accounting if they do “reasonable” fair value estimates made in good faith.
Under the current system, companies are allowed to account for the potential impact of stock options in the footnotes of their financial statements.
But after accounting scandals at WorldCom and Enron roiled the markets, the accounting standards board pushed for rules to reflect the cost of stock option compensation on the company’s income statement.
Supporters for expensing say that since options have value to employees, they should be accounted for on an income statement.
The rule has drawn support of a number of industry sectors with the notable exception of technology companies, which say that stock options accounting would cause expenses to be overstated.
Several OC companies already have gotten a taste of life after the regulation goes into effect.
In early March, Irvine-based chipmaker Broadcom Corp. said it would have had to expense about $677 million in stock options for 2004. That would have turned its $218.7 million profit into a loss of $383 million.
Additionally, earlier losses in 2003 and 2002 would have increased from $3.1 billion to $4.2 billion, the company said.
“There’s so much emotion around this issue that started with the Enron collapse,” said Bill Ruehle, Broadcom’s chief financial officer. “You have one side that says ‘options are evil’ and then the other side that says ‘if you make us expense it, the economy will collapse.'”
And in its most recent SEC filing, Quest Software Inc., which is moving from Irvine to Aliso Viejo noted that “inclusion of the compensation cost related to the fair value of stock option grants in our financial results would have reduced 2004 net income from $47.2 million to $20.5 million and would have reduced 2003 net income from $21.5 million to a $5.7 million loss.”
OC’s tech companies, through the local operation of TechNet, fought to stave off the new rules. The deadline for compliance, originally set for Jan. 1, was pushed back to June thanks to all the lobbying efforts. TechNet is hoping it gets pushed back further, according to Farry, though it looks like an uphill battle.
Members of TechNet’s local operation include Ted Smith, founder of Costa Mesa-based FileNet Corp.; Matt Massengill, chairman and chief executive of Lake Forest-based Western Digital Corp.; Dwight Decker, chairman and chief executive of Newport Beach-based Conexant Systems Inc.; and Henry Samueli, chairman and chief technology officer of Broadcom.
