Apple (AAPL)

Special Committee Review into Stock Option Grant Practices and Restatement

As discussed in the Explanatory Note preceding Part I and in Note 2 in Notes to Consolidated Financial Statements of this Form 10-K, the Company on June 29, 2006, announced that an internal review had discovered irregularities related to the issuance of certain past stock option grants, including a grant to its CEO Steve Jobs. The Company also announced that a Special Committee of outside directors (“Special Committee”) had been formed and had hired independent counsel to conduct a full investigation of the Company’s past stock option granting practices. As a result of the internal review and the independent investigation, management has concluded, and the Audit and Finance Committee of the Board of Directors agrees, that incorrect measurement dates were used for financial accounting purposes for certain stock option grants made in prior periods. Therefore, the Company has recorded additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants, and the Company is restating previously filed financial statements in this Form 10-K.

The internal review and the Special Committee’s independent investigation identified a number of occasions between October 1996 and January 2003 (the “relevant period”) when the Company used incorrect measurement dates for stock option grants. The independent investigation also found that during the relevant period:

·       Procedures for granting, accounting, and reporting of stock option grants did not include sufficient safeguards to prevent manipulation

·       The grant dates for a number of grants were intentionally selected in order to obtain favorable exercise prices

·       Two former officers of the Corporation engaged in conduct that raises serious concerns in connection with the granting, accounting, recording, and reporting of stock options

·       CEO Steve Jobs was aware or recommended the selection of some favorable grant dates, but he did not receive or financially benefit from these grants or appreciate the accounting implications

From 2003 through 2005, the Company implemented improvements to procedures, processes, and systems to provide additional safeguards and greater internal control over the stock option granting and administration function in compliance with the Sarbanes-Oxley Act (“SOX”) and evolving accounting guidance. These improvements included:

·       Documenting and assessing the design and operation of internal controls

·       Segregating responsibilities, adding reviews and reconciliations, and redefining roles and responsibilities

·       Upgrading systems and system controls that support the processes

·       Obtaining training in the stock administration function

·       Implementing before the adoption of SFAS No. 123R the practice of using the receipt of the final Board or Compensation Committee approval as the grant and measurement date for stock option grants

·       Identifying key controls, developing test plans, and testing controls in the stock granting and administration function

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·       Certifying stock administration and other controls for SOX Section 404 compliance in fiscal year 2005

The internal review and the independent investigation discovered no stock option grant after January 2003 that required accounting adjustments.

In coming to the conclusion that the Company’s disclosure controls and procedures and the Company’s internal control over financial reporting were effective as of September 30, 2006, management considered, among other things, the impact of the restatement to the financial statements and the effectiveness of the internal controls in this area as of the fiscal years ended 2006 and 2005. Management has concluded, therefore, that control deficiencies resulting in the restatement of previously issued financial statements did not constitute a material weakness in disclosure controls and procedures, or internal controls and procedures over financial reporting, as of September 30, 2006.

In addition to the significant improvements implemented between 2003 and 2005 discussed above, the Company will adopt other measures identified by the Special Committee and management to enhance the oversight of the stock option granting and administration function and the review and preparation of financial statements, including:

·       The Company will engage experienced General Counsel, increase the resources of the Corporate Legal Department, and review the adequacy of its procedures and practices

·       The CFO will arrange for senior management to undertake professional training to enhance awareness and understanding of standards and principles for accounting and financial reporting, particularly those relevant to stock options

·       The Company will review all current policies, practices, and controls related to the granting of stock options and provide education and training to those who implement those policies and processes, as needed

·       The Company will establish improved procedures for regular communication among the General Counsel, the CFO, and stock administrators to improve monitoring of all Company practices with regard to stock option grants, including formal written confirmation that all grant dates correspond precisely with the dates authorized

·       The Company will also establish improved procedures for the review of the preparation and presentation of financial statements by senior management

Special Committee
Review into Stock Option Grant Practices and Restatement

As discussed in the Explanatory Note preceding Part I
and in Note 2 in Notes to Consolidated Financial Statements of this Form 10-K,
the Company on June 29,
2006, announced that an internal review had discovered irregularities related
to the issuance of certain past stock option grants, including a grant to its
CEO Steve Jobs. The Company also announced that a Special Committee of outside
directors (“Special Committee”) had been formed and had hired independent
counsel to conduct a full investigation of the Company’s past stock option
granting practices. As a result of the internal review and the independent
investigation, management has concluded, and the Audit and Finance Committee of
the Board of Directors agrees, that incorrect measurement dates were used for
financial accounting purposes for certain stock option grants made in prior
periods. Therefore, the Company has recorded additional non-cash stock-based
compensation expense and related tax effects with regard to past stock option
grants, and the Company is restating previously filed financial statements in
this Form 10-K.

The internal review
and the Special Committee’s independent investigation identified a number of
occasions between October 1996 and January 2003 (the “relevant period”)
when the Company used incorrect measurement dates for stock option grants. The
independent investigation also found that during the relevant period:

·       Procedures
for granting, accounting, and reporting of stock option grants did not include
sufficient safeguards to prevent manipulation

·       The
grant dates for a number of grants were intentionally selected in order to
obtain favorable exercise prices

·       Two
former officers of the Corporation engaged in conduct that raises serious
concerns in connection with the granting, accounting, recording, and reporting
of stock options

·       CEO
Steve Jobs was aware or recommended the selection of some favorable grant
dates, but he did not receive or financially benefit from these grants or
appreciate the accounting implications

From 2003 through
2005, the Company implemented improvements to procedures, processes, and
systems to provide additional safeguards and greater internal control over the
stock option granting and administration function in compliance with the
Sarbanes-Oxley Act (“SOX”) and evolving accounting guidance. These improvements
included:

·       Documenting
and assessing the design and operation of internal controls

·       Segregating
responsibilities, adding reviews and reconciliations, and redefining roles and
responsibilities

·       Upgrading
systems and system controls that support the processes

·       Obtaining
training in the stock administration function

·       Implementing
before the adoption of SFAS No. 123R the practice of using the receipt of
the final Board or Compensation Committee approval as the grant and measurement
date for stock option grants

·       Identifying
key controls, developing test plans, and testing controls in the stock granting
and administration function

120

·       Certifying
stock administration and other controls for SOX Section 404 compliance in
fiscal year 2005

The internal review and the independent investigation
discovered no stock option grant after January 2003 that required
accounting adjustments.

In coming to the conclusion that the Company’s
disclosure controls and procedures and the Company’s internal control over
financial reporting were effective as of September 30, 2006, management
considered, among other things, the impact of the restatement to the financial
statements and the effectiveness of the internal controls in this area as of
the fiscal years ended 2006 and 2005. Management has concluded, therefore, that
control deficiencies resulting in the restatement of previously issued
financial statements did not constitute a material weakness in disclosure
controls and procedures, or internal controls and procedures over financial
reporting, as of September 30, 2006.

In addition to the
significant improvements implemented between 2003 and 2005 discussed above, the
Company will adopt other measures identified by the Special Committee and
management to enhance the oversight of the stock option granting and
administration function and the review and preparation of financial statements,
including:

·       The
Company will engage experienced General Counsel, increase the resources of the
Corporate Legal Department, and review the adequacy of its procedures and
practices

·       The
CFO will arrange for senior management to undertake professional training to
enhance awareness and understanding of standards and principles for accounting
and financial reporting, particularly those relevant to stock options

·       The
Company will review all current policies, practices, and controls related to
the granting of stock options and provide education and training to those who
implement those policies and processes, as needed

·       The
Company will establish improved procedures for regular communication among the
General Counsel, the CFO, and stock administrators to improve monitoring of all
Company practices with regard to stock option grants, including formal written
confirmation that all grant dates correspond precisely with the dates
authorized

·       The Company will also
establish improved procedures for the review of the preparation and
presentation of financial statements by senior management

Special Committee Review into Stock Option Grant Practices and Restatement

As discussed in the Explanatory Note preceding Part I and in Note 2 in Notes to Condensed Consolidated Financial Statements of this Form 10-Q, the Company on June 29, 2006, announced that an internal review had discovered irregularities related to the issuance of certain past stock option grants, including a grant to its CEO Steve Jobs.  The Company also announced that a Special Committee of outside directors (“Special Committee”) had been formed and had hired independent counsel to conduct a full investigation of the Company’s past stock option granting practices.  As a result of the internal review and the independent investigation, management has concluded, and the Audit and Finance Committee of the Board of Directors agrees, that incorrect measurement dates were used for financial accounting purposes for certain stock option grants made in prior periods.  Therefore, the Company has recorded additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants, and the Company is restating previously filed financial statements in this Form 10-Q.

The internal review and the Special Committee’s independent investigation identified a number of occasions between October 1996 and January 2003 (the “relevant period”) when the Company used incorrect measurement dates for stock option grants.  The independent investigation also found that during the relevant period:

From 2003 through 2005, the Company implemented improvements to procedures, processes, and systems to provide additional safeguards and greater internal control over the stock option granting and administration function in compliance with the Sarbanes-Oxley Act (“SOX”) and evolving accounting guidance.  These improvements included:

44

·                  Documenting and assessing the design and operation of internal controls

·                  Segregating responsibilities, adding reviews and reconciliations, and redefining roles and responsibilities

·                  Upgrading systems and system controls that support the processes

·                  Obtaining training in the stock administration function

·                  Implementing before the adoption of SFAS No. 123R the practice of using the receipt of the final Board or Compensation Committee approval as the grant and measurement date for stock option grants

·                  Identifying key controls, developing test plans, and testing controls in the stock granting and administration function

·                  Certifying stock administration and other controls for SOX Section 404 compliance in fiscal year 2005

The internal review and the independent investigation discovered no stock option grant after January 2003 that required accounting adjustments.

In coming to the conclusion that the Company’s disclosure controls and procedures and the Company’s internal control over financial reporting were effective as of September 30, 2006, management considered, among other things, the impact of the restatement to the financial statements and the effectiveness of the internal controls in this area as of the fiscal years ended 2006 and 2005.  Management has concluded, therefore, that control deficiencies resulting in the restatement of previously issued financial statements did not constitute a material weakness in disclosure controls and procedures, or internal controls and procedures over financial reporting, as of September 30, 2006.

In addition to the significant improvements implemented between 2003 and 2005 discussed above, the Company will adopt other measures identified by the Special Committee and management to enhance the oversight of the stock option granting and administration function and the review and preparation of financial statements, including:

·                  The Company will engage experienced General Counsel, increase the resources of the Corporate Legal Department, and review the adequacy of its procedures and practices

·                  The CFO will arrange for senior management to undertake professional training to enhance awareness and understanding of standards and principles for accounting and financial reporting, particularly those relevant to stock options

·                  The Company will review all current policies, practices, and controls related to the granting of stock options and provide education and training to those who implement those policies and processes, as needed

·                  The Company will establish improved procedures for regular communication among the General Counsel, the CFO, and stock administrators to improve monitoring of all Company practices with regard to stock option grants, including formal written confirmation that all grant dates correspond precisely with the dates authorized

·                  The Company will also establish improved procedures for the review of the preparation and presentation of financial statements by senior management