Apple Says Options Questions Require Restatements

Apple said it has discovered additional irregularities in the past granting of employee stock options and as a result will likely be forced to restate some past earnings, including those as recent as the second quarter of this year.

The move and the resulting restatement will delay Apple’s formal quarterly report to the SEC for its most recent quarter.

More Evidence

Apple said Thursday that a special committee of outside directors that hired an independent lawyer to investigate past stock options practices discovered “additional evidence of irregularities.”

Though the investigation originally centered on stock option grants made between 1997 and 2001, Apple said the inquiry has cast doubts on the company’s financial statements for the fiscal years that ended in 2003, 2004 and 2005 and for the quarters that ended in Dec. of 2005 and April of 2006.

“In light of this, management has concluded, and the audit committee of the board of directors agrees, that the company will likely need to restate its historical financial statements to record non-cash charges for compensation expense relating to past stock option grants,” Apple said in a statement.

The company also filed a statement with the Securities and Exchange Commission (SEC) that earnings reports issued starting in September of 2002 “should not be relied upon.”

The options woes have slowed what has otherwise been a speeding locomotive as Apple continues to roll up sales of its iPod music player, and as its Macintosh line of computers is gaining market share on PC-based rivals. Apple shares were down nearly 6 percent in midday trading Friday to US$65.62.

Caught in the Web

Apple is just one of dozens of companies currently dealing with options accounting questions, many of them focused on the timing of options grants and whether they were given at times when the stock was trading at relatively low prices. Such a practice enables employees to capture more value from their options because the gap between their option price and the market price is wider.

Apple did not give details on what the impacts of the restatements might be, but most analysts believe there will be little adverse impact on Apple earnings. The company has turned in more than $2 billion in profits over the past three years.

“We do not find this update surprising and anticipate a minor impact to financials,” American Technology Research analyst Shaw Wu said in a research note on Friday. In the past two years, total stock compensation has made up between 5 and 10 percent of per-share earnings, with the adjustments likely to be below that level, Wu added.

Apple appears to be insulated against dire scenarios in which top-ranking executives, such as CEO Steve Jobs, are drawn into the options scandal, Wu continued. It has long used independent directors to set its compensation policies, he concluded.

One of the options grants already known to have been in question was made to Jobs, but Apple has said that the grant was later canceled because Apple stock fell and as a result it did not result in any profit for Jobs. Jobs is one of many tech CEOs who essentially takes no salary each year but is compensated handsomely in the form of restricted stock and stock options.

The Sooner the Better

Apple first revealed in June that it had discovered stock option granting irregularities. That disclosure came amid a flurry of lawsuits and regulatory action aimed at stock-option timing.

Apple has taken a proactive approach, one that will likely enable it to avoid any run-ins with the SEC or other regulatory agencies, and to get the issues behind the company as quickly as possible.

Meanwhile, the broader options scandal continues to ensnare major companies, including several high-profile tech firms. Chip maker Broadcom has already made a restatement that wiped out $750 million in profits for the period from 2000 to 2002. Others with options issues being investigated either internally or by regulators include Monster.com parent Monster Worldwide, Rambus and PC security firm McAfee.

Apple’s estimated exposure to additional stock-based compensation is likely far more modest. One report said it would be $25 million or less, an amount easily absorbed by Apple’s profits over the same period.

The options timing scandals may be the death knell for large stock options grants, with many firms now turning instead to restricted stock units and other means of compensation, according to Joseph Rich, president of executive compensation consulting firm Pearl Meyers & Associates.

“These issues speak directly to the call for revamping executive compensation,” Rich said. “Tech firms relied heavily on stock options so they’re the ones now in the crosshairs as this unfolds.”