Illuminating Stock Option Problems

I'm a Rule Breaker at heart. I understand that companies like Vertex Pharmaceuticals (Nasdaq: VRTX  ) and Seattle Genetics (Nasdaq: SGEN  ) have to reward their employees with stock compensation to preserve cash. Google (Nasdaq: GOOG  ) repricing stock options doesn't give me warm and fuzzy feelings, but it's an understandable necessity to keep employees motivated.

But Illumina's (Nasdaq: ILMN  ) stock options are getting a little ridiculous. My Foolish colleague, Jim Mueller, pointed out the problem in the third quarter last year, and it doesn't seem to be going away.

Revenue from sales of the company's DNA sequence analysis equipment and consumables was up 36% year over year, continuing its strong showing against Affymetrix (Nasdaq: AFFX  ) , Life Technologies (Nasdaq: LIFE  ) , and others. Not bad, not bad at all.

But stock-based compensation was up 37%. The company is rewarding employees at the expense of shareholders. And remember, those options hurt twice: they lower earnings initially and then they dilute shareholders' claim on future earnings when employees cash them in. Unless, of course, the company retires shares by buying them on the open market -- which comes out of shareholders' equity, a third source of pain made worse if the company overpays for its own stock.

It's not like Illumina needs to pay its employees with stock options to conserve cash; the company brought in $38 million in free cash flow this quarter and has $351 million in cash and equivalents tucked away for a rainy day. Sure, DNA sequencing is a fast-moving technology and Illumina may need to buy or license a new technology to stay ahead of the curve. However, I'd rather see the company cut back on stock options, pay its employees a little extra in cash, and use its high-priced stock -- it's P/E is close to triple digits -- to pay for any potential acquisition.

You're no longer a money sinkhole, Illumina; now it's time to get those stock options under control.

More Foolish options:

• Intel's option plan: only half right.
• The next millionaire-maker megatrend.
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