Public companies normally fight against increased accounting regulation. But sometimes, they rush to comply, especially when it allows them to avoid hefty expenses on their income statements.
Last week, El Segundo-based chip maker International Rectifier Corp. added its name to a list of more than 100 public companies that have accelerated vesting of employee stock options rushing to dole out $106 million to employees before implementation of an accounting change requires the expense to be counted against net income.
“I can’t believe they did this,” said one enraged analyst who didn’t want to be named. “They gave away 30 percent of the company when they issued the options in the first place,” he said, referring to almost 22 million options issued over the past two years. “Now, it’s going to dilute shareholder value by the same percentage.”
In June, public companies will begin having to account for employee stock option grants as expenses against income, according to a rule passed last year by the Financial Accounting Standards Board.
The new rule was going to take effect for any fiscal quarter beginning after June 15, but earlier this month, the Securities and Exchange Commission decided to delay it for most companies. Now the rule takes effect for any fiscal year beginning after June 15.
For International Rectifier, whose next fiscal year begins on July 1, the rule change didn’t affect the timing of its decision. It said last week it would accelerate vesting of the options, many of them in the hands of high-ranking executives, to spare the company of future earnings hits.
Company executives declined to comment beyond a press release issued last week, which said it was moving up its vesting schedule “to avoid recognizing in its income statement compensation expense associated with these options in future periods.”
Company spokesman Graham Robertson said executives were observing a quiet period before an April 28 quarterly earnings announcement. “It’s a major part of our disclosure, and we will expand on it after our earnings release,” Robertson said.
If it had not accelerated vesting of the 7 million options, their vesting on natural schedules would have reduced fiscal 2006 earnings by $58 million, International Rectifier said (with the remainder vesting later). By comparison, over the past four quarters, the company has reported net income of $133.2 million.
Judging by a Bear Stearns report earlier this month, other companies will follow when the options-expensing rule change takes effect mostly with the first quarter of 2006.
Analyst Pat McConnell issued a report entitled “Spring Cleaning,” listing 102 companies that have accelerated options vesting since the rule was first issued by FASB in December.
More than a third were tech companies, which use options as a way to attract and retain employees. Also on the list: Viacom Inc., Comcast Corp., Gannett Co. and Whole Foods Market Inc. Many of the accelerated options were out-of-the-money, meaning their exercise price was higher than the stock’s price at the time vesting occurred.
“By vesting out-of-the-money options, the future stock option expense will vanish from the income statement,” McConnell wrote in his research report. He estimated that by accelerating, more than $1 billion of stock option expense circumvented income statement recognition in future periods.
The companies are required to explain the reasons for vesting the options in filings with the Securities and Exchange Commission. Despite such transparency, some shareholder rights advocates are fuming.
Shareholders approve the issuance of options through proxy votes, but shareholder advocates claim those proxies don’t cover after-the-fact changes. Once options are approved, some companies feel they’re free to re-price them or accelerate the vesting schedules, said Robert A.G. Monks, partner in the law firm Lend Governance Advisors. This hurts other shareholders, he said, noting, “Once options have been approved, it’s a free hunting game.”
Monks said that for some companies, the accelerated vesting is “perfectly credible,” given that the FASB requirements will make options accounting more difficult in the future so it could be in the company’s best interest to vest them now. But Monks said there will be other companies who use it as an excuse to take advantage. He said it has to be looked at on a case-by-case basis.
“It may not be illegal, it may not be unethical, but the question is, is it appropriate?” said Ed Merino, chief executive of corporate governance firm Office of the Chairman. “You have to be able to defend your actions.”
Merino pointed out that particularly for tech firms, which use stock options to maintain high tech talent, it may be in the company’s best interest to accelerate the options.
“Let’s say the options you’re vesting went to your R & D; group, and if that resulted in four new patents and two new chips, it sounds to me like that would be a pretty good investment,” Merino explained. “But if it’s a bunch of fat cats at the top raking in a lot of money with very little benefit to investors, then it’s just a sham,” he said.
-Hilary Potkewitz
Mutual Departure
DaVita Inc. announced last week that its chief financial official was leaving her job just seven months after joining the company amid several government probes and a big merger.
Yet Wall Street shrugged its shoulders.
Shares of the Los Angeles-based company closed at $41 on April 21, two days after the announcement, above a $40 trading floor the stock has set since the beginning of the year.
The reason? While the official company announcement only cited a “mutual agreement” for the departure of Denise Fletcher and praised her for her “many contributions,” behind the scenes the company was saying something different.
“I would characterize this as having more to do with just the chemistry of the various players in the senior management team. It was just not a good fit with them and Denise Fletcher,” said Darren Lehrich, an analyst with Piper Jaffray Cos. who spoke later with management of the company.
That kind of analysis overrode initial worries on Wall Street that the departure could have something to do with one of several government probes dogging the company.
The firm has been hit with three subpoenas in four years by the U.S. Attorney’s office on matters ranging from its use of Vitamin D therapy to its physician relationships. It’s also trying to pass muster with the Federal Trade Commission for its proposed $3 billion acquisition of Gambro Healthcare, which would make it the No. 1 operator of dialysis clinics in the nation.
Lehrich added that the only disappointment to come from the departure was that the company had spent many months searching for a new chief financial officer before settling on Fletcher, a former chief financial officer of MasterCard International Inc.
Laurence Darmiento
