If you blinked, you may have missed it. Last week, Cisco Systems (NASDAQ:CSCO) reported its first-quarter earnings for fiscal 2006 with options expense included on the income statement. Also last week, Starbucks (NASDAQ:SBUX) put out a press release adjusting its 2006 earnings-per-share expectations downward because of options expensing. After the announcements, shareholders didn't sell and run for the hills.
I'm not surprised. That's exactly what I expected to happen once option expensing finally became a reality. But executives at Cisco, Intel (NASDAQ:INTC), Qualcomm (NASDAQ:QCOM), Cypress Semiconductor (NYSE:CY), and other companies at one time or another all pooh-poohed the idea of option expensing. In 2004, at the height of the option-battle silliness, Craig Barrett, who was then CEO of Intel, went so far as to write in The Wall Street Journal that America would lose its competitive edge to not just China, but Communist China! There's nothing quite like using scare tactics to get your way.
Aside from the greed on display at tech companies with large option grants in the '90s and into the 2000s, what always amazed me about the fight that so many of these companies and their executives put up is that if option grants were kept in the range of 2%-3% per year, they really didn't have much to hide from. Intel and Cisco, for example, are tremendous businesses. Both are scuffling a bit now, but they generate absolutely enormous sums of free cash flow. Historically, they haven't always been the best at allocating that capital, but that's fixable, and judging by the last couple of years, they are getting better. One could definitely argue that they simply had to get better, but it's worth remembering that businesses that generate huge sums of free cash flow are rarer than they seem.
The accounting treatment for options may not be perfect. But accounting by its very nature isn't an exact science. It is full of estimates and judgment calls made by management. The truth is that these companies were already being valued by analysts with some form of accounting for options grants taking place. I have always factored in a certain amount of option-grant dilution into my discounted cash flow analysis. But now there is a standard for everyone to follow. It's being practiced, and the world didn't come to an end. Imagine that.
For related Foolishness on stock-option expensing:
Nathan Parmelee owns shares in Starbucks but has no financial stake in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
