Easy $80 million for Qwest
Telco benefits from 'accelerated vesting' of stock options
By David Milstead, Rocky Mountain News

Thursday, August 25, 2005

Qwest has found an easy way to add $80 million to its profits in the next several years.

The company's board voted last week to allow its employees, including executives, to exercise more than 50 million stock options earlier than they normally could have.
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The practice is called "accelerated vesting," and the purpose, Qwest acknowledges, "is to avoid recognizing future compensation expense" from the options when it reports its profits to shareholders.

In the near term, not too many of the options will be exercised.  That's because Qwest only accelerated options with exercise prices higher than the $3.79 closing price last Thursday.  When a stock option has an exercise price higher than the market price, there's no reason to use it.

But with Qwest stock remaining in the doldrums, the company has accelerated nearly all its remaining outstanding options, according to figures in last year's annual report.

In making the move, disclosed Wednesday in a filing with the Securities and Exchange Commission, Qwest joins more than 200 other companies, including some in Colorado.

In a July 26 report, analysts at Bear Stearns said accelerated vesting was "shift(ing) into high gear," with 234 companies having engaged in the practice.  Comcast, International Paper, Sun Microsystems and Xerox are among the large companies that accelerated options.

Qwest's elimination of $80 million in option expenses would make it crack the top 10 nationally, according to Bear Stearns.  Sun is first with $400 million in avoided expenses.

The companies are reacting to the ongoing battle over the expensing of stock options, a long-running fight that reignited after the stock market collapse of 2000-2002.

Currently, companies do not have to record any expense in their income statement for employee stock options.  Instead, they must show the cost of options in a footnote to the financial statements.

That is scheduled to change, as the Financial Accounting Standards Board created a rule requiring expensing.  The SEC will implement the rule for companies with fiscal years starting in mid-2006.

Accelerated vesting takes advantage of a quirk in the accounting rules for stock awards.  Costs are not fully recorded when the grant is made.

Instead, they show up in four pieces, as the stock awards vest, sometimes over four or five years.  (Qwest used a four-year schedule.)

By accelerating the vesting, companies move the costs into the current period.  Since option costs are still being footnoted, rather than expensed, they avoid having the hit to profits that will occur as options vest in the next several years.

Options, however, are supposed to be long-term compensation.  An extended vesting schedule is designed to retain and reward employees for several years' performance.

Jack T. Ciesielski, an accountant and chartered financial analyst who writes The Analyst's Accounting Observer, refers to accelerated vesting as "waiving work requirements for earning the rights to options."

"In an acceleration, the employee technically has no work left to do in order to earn the options," he said in a May 17 report on the practice.  "What about that oft-cited 'alignment with shareholders' as the reason for granting options in the first place?  Out the window with the vesting requirements, it seems."

Qwest's action includes 10.5 million options held by executives.

The company has given CEO Dick Notebaert nearly 11 million options since his 2002 arrival.  The Rocky Mountain News calculates that roughly half already had vested before last week's action, and another 1 million were not subject to accelerated vesting because the exercise price was just $3.44.

The board's move, then, means Notebaert gets early access to almost 4.9 million options that would have vested as late as 2009.

David Milstead is finance editor of the Rocky Mountain News. He can be reached at 303-892-2648 or milstead@RockyMountainNews.com.