UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

FORM 10-Q

(Mark One)

 

x         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2006

OR

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to

Commission File Number: 0-13468

EXPEDITORS INTERNATIONAL OF WASHINGTON, INC.

(Exact name of registrant as specified in its charter)

Washington

 

91-1069248

(State or other jurisdiction of

 

(IRS Employer Identification Number)

incorporation or organization)

 

 

 

 

 

1015 Third Avenue, 12th Floor, Seattle, Washington

 

98104

(Address of principal executive offices)

 

(Zip Code)

 

(206) 674-3400
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý        No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.   (Check one):

Large accelerated filer  ý                          Accelerated filer  o                             Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)  Yes o  No ý

At August 4, 2006, the number of shares outstanding of the issuer’s Common Stock was 213,285,940

 




PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

EXPEDITORS INTERNATIONAL OF WASHINGTON, INC.
AND SUBSIDIARIES

Condensed Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)

 

 

June 30,
2006

 

December 31,
2005

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

454,694

 

$

463,894

 

Short-term investments

 

415

 

123

 

Accounts receivable, less allowance for doubtful accounts of $13,397 at June 30, 2006 and $12,777 at December 31, 2005

 

751,929

 

709,331

 

Deferred Federal and state income taxes

 

6,679

 

7,208

 

Other current assets

 

28,191

 

21,405

 

 

 

 

 

 

 

Total current assets

 

1,241,908

 

1,201,961

 

 

 

 

 

 

 

Property and equipment, less accumulated depreciation and amortization of $163,939 at June 30, 2006 and $152,304 at December 31, 2005

 

444,285

 

333,787

 

Goodwill, less accumulated amortization of $765 at June 30, 2006 and December 31, 2005

 

7,774

 

7,774

 

Other intangibles, net

 

8,367

 

8,997

 

Other assets, net

 

13,216

 

13,525

 

 

 

 

 

 

 

 

 

$

1,715,550

 

$

1,566,044

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

529,518

 

479,546

 

Accrued expenses, primarily salaries and related costs

 

128,516

 

103,674

 

Federal, state and foreign income taxes

 

28,754

 

29,281

 

 

 

 

 

 

 

Total current liabilities

 

686,788

 

612,501

 

 

 

 

 

 

 

Deferred Federal and state income taxes

 

29,019

 

13,278

 

 

 

 

 

 

 

Minority interest

 

30,142

 

13,883

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, par value $.01 per share

 

 

 

 

 

Authorized 2,000,000 shares; none issued

 

 

 

 

 

 

 

 

 

Common stock, par value $.01 per share

 

 

 

 

 

Authorized 320,000,000 shares; issued and outstanding 213,258,504 shares at June 30, 2006, and 213,227,042 shares at December 31, 2005

 

2,133

 

2,132

 

Additional paid-in capital

 

132,120

 

180,905

 

Retained earnings

 

831,090

 

745,984

 

Accumulated other comprehensive income

 

4,258

 

(2,639

)

 

 

 

 

 

 

Total shareholders’ equity

 

969,601

 

926,382

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,715,550

 

$

1,566,044

 

 

See accompanying notes to condensed consolidated financial statements.

Certain 2005 amounts have been restated as required by the modified retrospective method in connection with the implementation of SFAS 123R and other amounts have been reclassified to conform to the 2006 presentation.

All share and per share amounts have been adjusted for the 2-for-1 stock split effective June 2006.

2




EXPEDITORS INTERNATIONAL OF WASHINGTON, INC.
AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings
(In thousands, except share data)

(Unaudited)

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Airfreight

 

$

545,273

 

$

421,213

 

$

1,036,271

 

$

794,098

 

Ocean freight and ocean services

 

380,280

 

336,934

 

724,939

 

634,078

 

Customs brokerage and other services

 

203,771

 

169,852

 

392,706

 

324,987

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

1,129,324

 

927,999

 

2,153,916

 

1,753,163

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Airfreight consolidation

 

429,976

 

330,269

 

810,557

 

614,707

 

Ocean freight consolidation

 

300,780

 

277,259

 

571,659

 

521,229

 

Customs brokerage and other services

 

84,998

 

69,811

 

161,933

 

135,884

 

Salaries and related costs

 

172,453

 

145,624

 

333,427

 

278,515

 

Rent and occupancy costs

 

13,372

 

13,457

 

27,095

 

27,205

 

Depreciation and amortization

 

8,626

 

7,603

 

16,679

 

14,942

 

Selling and promotion

 

8,957

 

7,120

 

16,914

 

14,666

 

Other

 

21,359

 

18,127

 

41,448

 

36,838

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

1,040,521

 

869,270

 

1,979,712

 

1,643,986

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

88,803

 

58,729

 

174,204

 

109,177

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(10

)

(219

)

(37

)

(248

)

Interest income

 

4,390

 

2,725

 

8,664

 

4,872

 

Other, net

 

465

 

874

 

2,132

 

2,070

 

 

 

 

 

 

 

 

 

 

 

Other income, net

 

4,845

 

3,380

 

10,759

 

6,694

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes and minority interest

 

93,648

 

62,109

 

184,963

 

115,871

 

Income tax expense

 

35,503

 

24,083

 

72,555

 

45,745

 

 

 

 

 

 

 

 

 

 

 

Net earnings before minority interest

 

$

58,145

 

$

38,026

 

$

112,408

 

$

70,126

 

 

 

 

 

 

 

 

 

 

 

Minority interest

 

(1,816

)

(1,328

)

(3,727

)

(2,382

)

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

56,329

 

$

36,698

 

$

108,681

 

$

67,744

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.26

 

$

.17

 

$

.51

 

$

.32

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

.25

 

$

.17

 

$

.49

 

$

.31

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

.11

 

$

.075

 

$

.11

 

$

.075

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic shares outstanding

 

213,725,395

 

213,552,092

 

213,574,773

 

213,504,726

 

 

 

 

 

 

 

 

 

 

 

Weighted average diluted shares outstanding

 

224,374,720

 

220,901,114

 

224,051,286

 

221,160,880

 

 

See accompanying notes to condensed consolidated financial statements.

Certain 2005 amounts have been restated as required by the modified retrospective method in connection with the implementation of SFAS 123R and other amounts have been reclassified to conform to the 2006 presentation.

All share and per share amounts have been adjusted for the 2-for-1 stock split effective June 2006.

3




EXPEDITORS INTERNATIONAL OF WASHINGTON, INC.
AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows
(In thousands)

(Unaudited)

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Operating activities:

 

 

 

 

 

 

 

 

 

Net earnings

 

$

56,329

 

$

36,698

 

$

108,681

 

$

67,744

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

Provision for losses on accounts receivable

 

647

 

(394

)

493

 

(358

)

Deferred income tax expense

 

20,790

 

8,117

 

33,597

 

14,902

 

Excess tax benefits from employee stock plans

 

(14,973

)

(4,747

)

(21,008

)

(6,322

)

Stock compensation expense

 

9,418

 

9,576

 

17,816

 

16,684

 

Depreciation and amortization

 

8,626

 

7,603

 

16,679

 

14,942

 

Gain on sale of property and equipment

 

(68

)

(26

)

(215

)

(45

)

Minority interest in earnings of consolidated entities

 

1,815

 

833

 

4,011

 

1,670

 

Other

 

789

 

1,220

 

1,577

 

293

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Increase in accounts receivable

 

(49,838

)

(45,318

)

(28,999

)

(1,648

)

Increase in other current assets

 

(11,394

)

(4,539

)

(6,300

)

(1,746

)

Increase in accounts payable and other current liabilities

 

33,437

 

33,183

 

67,379

 

30,225

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

55,578

 

42,206

 

193,711

 

136,341

 

 

 

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

(Increase) decrease in short-term investments

 

(275

)

631

 

(283

)

(12

)

Purchase of property and equipment

 

(100,334

)

(14,175

)

(121,833

)

(43,192

)

Proceeds from sale of property and equipment

 

87

 

107

 

265

 

249

 

Other

 

692

 

(673

)

486

 

(1,339

)

 

 

 

 

 

 

 

 

 

 

Net cash used in investing activities

 

(99,830

)

(14,110

)

(121,365

)

(44,294

)

 

 

 

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

Proceeds (repayments) of short-term debt, net

 

 

43

 

 

(2,130

)

Proceeds from issuance of common stock

 

20,513

 

8,700

 

26,020

 

11,075

 

Repurchases of common stock

 

(86,669

)

(35,486

)

(113,628

)

(50,013

)

Excess tax benefits from employee stock plans

 

14,973

 

4,747

 

21,008

 

6,322

 

Dividends paid

 

(23,575

)

(16,055

)

(23,576

)

(16,055

)

 

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

(74,758

)

(38,051

)

(90,176

)

(50,801

)

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

6,016

 

(8,562

)

8,630

 

(11,356

)

 

 

 

 

 

 

 

 

 

 

(Decrease) increase in cash and cash equivalents

 

(112,994

)

(18,517

)

(9,200

)

29,890

 

Cash and cash equivalents at beginning of period

 

567,688

 

457,390

 

463,894

 

408,983

 

Cash and cash equivalents at end of period

 

$

454,694

 

$

438,873

 

$

454,694

 

$

438,873

 

 

 

 

 

 

 

 

 

 

 

Interest and taxes paid:

 

 

 

 

 

 

 

 

 

Interest

 

$

8

 

$

214

 

$

32

 

$

234

 

Income taxes

 

30,376

 

18,444

 

43,051

 

28,560

 

 

See accompanying notes to condensed consolidated financial statements.

Certain 2005 amounts have been restated as required by the modified retrospective method in connection with the implementation of SFAS 123R and other amounts have been reclassified to conform to the 2006 presentation.

 

4




EXPEDITORS INTERNATIONAL OF WASHINGTON, INC.
AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

Note 1.  Summary of Significant Accounting Policies

The attached condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. As a result, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted.  The Company believes that the disclosures made are adequate to make the information presented not misleading.  The condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented.  These condensed consolidated financial statements should be read in conjunction with the financial statements and related notes included in the Company’s Form 10-K as filed with the Securities and Exchange Commission on or about March 16, 2006.

Prior to January 1, 2006, the Company applied APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option and its employee stock purchase rights plans.  Accordingly, no compensation cost had been recognized for its fixed stock option or employee stock purchase rights plans.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123R) using the modified retrospective transition method.  Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented.  The Company has elected to restate all periods presented to include compensation expense for all unvested stock options and share awards.  Accordingly, salaries and related costs for the three and six-month periods ended June 30, 2005 have been increased to include compensation expense for the fair value of unvested stock options.  See Note 6 for further discussion of the impact of the adoption of SFAS 123R on the consolidated balance sheet, the consolidated results of operations, earnings per share and consolidated statement of cash flows.

Certain 2005 amounts have been reclassified to conform to the 2006 presentation.

Note 2.  Comprehensive Income

Comprehensive income consists of net income and other gains and losses affecting shareholders’ equity that, under generally accepted accounting principles in the United States, are excluded from net income.  For the Company, these consist of foreign currency translation gains and losses and unrealized gains and losses on securities, net of related income tax effects.

The components of total comprehensive income for interim periods are presented in the following table:

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

(in thousands)

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

56,329

 

$

36,698

 

$

108,681

 

$

67,744

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments net of tax of: $(2,586) and $4,125 for the 3 months ended June 30, 2006 and 2005, and $(3,732) and $6,252 for the 6 months ended June 30, 2006 and 2005.

 

4,802

 

(7,660

)

6,930

 

(11,611

)

Unrealized loss on securities net of tax of $9 and $10 for the 3 months ended June 30, 2006 and 2005, and $52 and $37 for the 6 months ended June 30, 2006 and 2005.

 

(13

)

(13

)

(33

)

(51

)

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

$

61,118

 

$

29,025

 

$

115,578

 

$

56,082

 

 

Note 3.  Business Segment Information

Statement of Financial Accounting Standards (SFAS) No. 131, “Disclosure about Segments of an Enterprise and Related Information” establishes standards for the way that public companies report selected information about segments in their financial statements.

The Company is organized functionally in geographic operating segments.  Accordingly, management focuses its attention on revenues, net revenues, operating income, identifiable assets, capital expenditures, depreciation and amortization and equity generated in each of these geographical areas when evaluating the effectiveness of geographic management.  The Company charges its subsidiaries and affiliates for services rendered in the United States on a cost recovery basis.  Transactions among the Company’s various offices are conducted using the same arms-length pricing methodologies the Company uses when its offices transact business with independent agents.

5




Financial information regarding the Company’s operations by geographic area for the three and six-months ended June 30, 2006 and 2005 are as follows:

 

(in thousands)

 

UNITED
STATES

 

OTHER
NORTH
AMERICA

 

ASIA

 

EUROPE

 

AUSTRAL-
ASIA

 

LATIN
AMERICA

 

MIDDLE
EAST

 

ELIMI-
NATIONS

 

CONSOLI-
DATED

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from unaffiliated customers

 

$

230,158

 

30,254

 

629,016

 

156,268

 

13,435

 

16,801

 

53,392

 

 

1,129,324

 

Transfers between geographic areas

 

27,485

 

1,962

 

4,171

 

7,900

 

1,621

 

2,111

 

2,680

 

(47,930

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

257,643

 

32,216

 

633,187

 

164,168

 

15,056

 

18,912

 

56,072

 

(47,930

)

1,129,324

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

126,161

 

15,871

 

88,945

 

53,330

 

8,024

 

8,287

 

12,952

 

 

313,570

 

Operating income

 

$

27,659

 

3,864

 

40,855

 

10,051

 

2,127

 

1,665

 

2,582

 

 

88,803

 

Identifiable assets at quarter end

 

$

839,926

 

57,363

 

369,930

 

329,676

 

22,431

 

32,241

 

58,371

 

5,612

 

1,715,550

 

Capital expenditures

 

$

91,578

 

198

 

4,467

 

3,096

 

109

 

468

 

418

 

 

100,334

 

Depreciation and amortization

 

$

4,417

 

345

 

1,210

 

1,729

 

189

 

382

 

354

 

 

8,626

 

Equity

 

$

1,106,283

 

24,124

 

276,872

 

95,304

 

14,245

 

13,256

 

25,951

 

(586,434

)

969,601

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from unaffiliated customers

 

$

182,105

 

23,405

 

519,774

 

133,903

 

11,745

 

15,561

 

41,506

 

 

927,999

 

Transfers between geographic areas

 

19,232

 

1,178

 

3,126

 

5,583

 

1,425

 

1,879

 

1,926

 

(34,349

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

201,337

 

24,583

 

522,900

 

139,486

 

13,170

 

17,440

 

43,432

 

(34,349

)

927,999

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

101,950

 

12,839

 

66,894

 

44,724

 

7,054

 

6,885

 

10,314

 

 

250,660

 

Operating income

 

$

16,617

 

2,781

 

28,297

 

6,652

 

1,592

 

1,367

 

1,423

 

 

58,729

 

Identifiable assets at quarter end

 

$

666,572

 

47,503

 

317,473

 

289,708

 

23,903

 

23,256

 

43,215

 

5,619

 

1,417,249

 

Capital expenditures

 

$

10,465

 

207

 

1,074

 

1,309

 

469

 

361

 

290

 

 

14,175

 

Depreciation and amortization

 

$

3,713

 

362

 

1,216

 

1,499

 

172

 

286

 

355

 

 

7,603

 

Equity

 

$

911,406

 

19,831

 

245,979

 

85,294

 

15,106

 

8,606

 

20,623

 

(463,612

)

843,233

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from unaffiliated customers

 

$

449,380

 

58,635

 

1,185,711

 

296,633

 

25,788

 

32,910

 

104,859

 

 

2,153,916

 

Transfers between geographic areas

 

52,927

 

3,692

 

7,854

 

15,225

 

3,030

 

4,004

 

5,062

 

(91,794

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

502,307

 

62,327

 

1,193,565

 

311,858

 

28,818

 

36,914

 

109,921

 

(91,794

)

2,153,916

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

251,860

 

30,553

 

169,694

 

101,933

 

15,424

 

15,474

 

24,829

 

 

609,767

 

Operating income

 

$

52,227

 

7,203

 

82,139

 

20,624

 

4,108

 

2,939

 

4,964

 

 

174,204

 

Identifiable assets at period end

 

$

839,926

 

57,363

 

369,930

 

329,676

 

22,431

 

32,241

 

58,371

 

5,612

 

1,715,550

 

Capital expenditures

 

$

108,764

 

295

 

7,221

 

3,810

 

346

 

791

 

606

 

 

121,833

 

Depreciation and amortization

 

$

8,485

 

696

 

2,400

 

3,265

 

387

 

747

 

699

 

 

16,679

 

Equity

 

$

1,106,283

 

24,124

 

276,872

 

95,304

 

14,245

 

13,256

 

25,951

 

(586,434

)

969,601

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from unaffiliated customers

 

$

350,776

 

43,614

 

961,787

 

260,743

 

23,485

 

28,665

 

84,093

 

 

1,753,163

 

Transfers between geographic areas

 

35,626

 

2,347

 

5,848

 

10,998

 

2,647

 

3,438

 

3,783

 

(64,687

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

386,402

 

45,961

 

967,635

 

271,741

 

26,132

 

32,103

 

87,876

 

(64,687

)

1,753,163

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

196,019

 

24,195

 

127,551

 

86,894

 

13,769

 

12,543

 

20,372

 

 

481,343

 

Operating income

 

$

27,261

 

4,801

 

57,144

 

11,764

 

3,220

 

2,232

 

2,755

 

 

109,177

 

Identifiable assets at period end

 

$

666,572

 

47,503

 

317,473

 

289,708

 

23,903

 

23,256

 

43,215

 

5,619

 

1,417,249

 

Capital expenditures

 

$

36,437

 

512

 

2,150

 

2,519

 

537

 

552

 

485

 

 

43,192

 

Depreciation and amortization

 

$

7,222

 

729

 

2,386

 

3,012

 

326

 

547

 

720

 

 

14,942

 

Equity

 

$

911,406

 

19,831

 

245,979

 

85,294

 

15,106

 

8,606

 

20,623

 

(463,612

)

843,233

 

 

6




Note 4.  Basic and Diluted Earnings per Share

The following table reconciles the numerator and the denominator of the basic and diluted per share computations for earnings per share for the three and six-months ended June 30, 2006 and 2005:

 

 

Three months ended June 30,

 

 

 

 

 

 

 

 

 

(Amounts in thousands, except
share and per share amounts)

 

Net
Earnings

 

Weighted
Average
Shares

 

Earnings
Per Share

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

56,329

 

213,725,395

 

$

.26

 

Effect of dilutive potential common shares

 

 

10,649,325

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

56,329

 

224,374,720

 

$

.25

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

36,698

 

213,552,092

 

$

.17

 

Effect of dilutive potential common shares

 

 

7,349,022

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

36,698

 

220,901,114

 

$

.17

 

 

 

 

Six months ended June 30,

 

 

 

 

 

 

 

 

 

(Amounts in thousands, except
share and per share amounts)

 

Net
Earnings

 

Weighted
Average
Shares

 

Earnings
Per Share

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

108,681

 

213,574,773

 

$

.51

 

Effect of dilutive potential common shares

 

 

10,476,513

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

108,681

 

224,051,286

 

$

.49

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

67,744

 

213,504,726

 

$

.32

 

Effect of dilutive potential common shares

 

 

7,656,154

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

67,744

 

221,160,880

 

$

.31

 

 

The following shares have been excluded from the computation of diluted earnings per share because the effect would have been antidilutive:

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Shares

 

128,000

 

128,000

 

128,000

 

 

 

Note 5. Stock and Cash Dividends

On May 3, 2006, the Board of Directors declared a 2-for-1 stock split, effected in the form of a stock dividend of one share of common stock for every share outstanding.  The stock dividend was distributed on June 23, 2006 to shareholders of record on June 9, 2006.  All share and per share information, except par value per share, has been adjusted for all years to reflect the stock split.

7




On May 3, 2006, the Board of Directors declared a semi-annual cash dividend of $.11 per share payable on June 15, 2006 to shareholders of record as of June 1, 2006.  The dividend of $24 million was paid on June 15, 2006.

On May 9, 2005, the Board of Directors declared a semi-annual cash dividend of $.075 per share payable on June 15, 2005 to shareholders of record as of June 1, 2005.  The dividend of $16 million was paid on June 15, 2005.

Note 6.  Shareholders’ Equity

A.   Stock Option Plans

At June 30, 2006, the Company has two stock option plans (the “1985 Plan” and the “2006 Plan”) for employees under which the Board of Directors may grant officers and key employees options to purchase common stock at prices equal to or greater than market value on the date of grant.  On May 3, 2006, the shareholders approved the Company’s 2006 Plan, which made available a total of 3,000,000 shares of the Company’s common stock for purchase upon exercise of options granted under the 2006 Plan.  The 1985 Plan provides for non-qualified grants.  The 2006 Plan provides for qualified and non-qualified grants. Under the 1985, 2005 and 2006 Plans, outstanding options generally vest and become exercisable over periods up to five years from the date of grant and expire no more than 10 years from the date of grant. Grants under the 2006 Plan are limited to not more than 100,000 shares per person.  No additional shares can be granted under the 2006 Plan after April 30, 2007.  Under the terms of the 2005 and 2006 Plans, no options can be granted after April 30th of the year following shareholder approval.  Accordingly, no options were granted under the 2005 Plan after April 30, 2006.

The Company also has a stock option plan (“Directors’ Plan”) under which non-employee directors elected at each annual meeting are granted non-qualified options to purchase 32,000 shares of common stock at prices equal to the market value on the date of grant on the first business day of the month following the meeting.  On May 3, 2006, the Directors’ Plan was amended by shareholder vote to require a one year vesting period.  Previously, options granted under the Directors’ Plan vested immediately.

Upon the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options, the Company derives a tax deduction measured by the excess of the market value over the option price at the date of exercise.  The portion of the benefit from the deduction which equals the estimated fair value of the options (previously recognized as compensation expense) is recorded as a credit to the deferred tax asset for non-qualified stock options and is recorded as a credit to current tax expense for any disqualifying dispositions of incentive stock options.  All of the tax benefit received upon option exercise which exceeds the estimated fair value of the options is credited to additional paid-in capital.

B.  Stock Purchase Plan

In May 2002, the shareholders approved the Company’s 2002 Employee Stock Purchase Plan (“2002 Plan”), which became effective August 1, 2002 upon the expiration of the 1988 Employee Stock Purchase Plan (“1988 Plan”) on July 31, 2002.  The Company’s 2002 Plan provides for 4,305,452 shares of the Company’s common stock, including 305,452 remaining shares transferred from the 1988 Plan, to be reserved for issuance upon exercise of purchase rights granted to employees who elect to participate through regular payroll deductions beginning August 1 of each year.  The purchase rights are exercisable on July 31 of the following year at a price equal to the lesser of (1) 85% of the fair market value of the Company’s stock on July 31 or (2) 85% of the fair market value of the Company’s stock on the preceding August 1.

C.  Adoption of SFAS 123R

As described in Note 1, effective January 1, 2006, the Company adopted SFAS 123R, requiring the recording of compensation expense based on an estimate of the fair value of options awarded under its fixed stock option or employee stock purchase rights plans.  The Company elected to utilize the modified retrospective method of transitioning to SFAS 123R and has restated all prior periods to recognize the required stock compensation expense.

In applying the modified retrospective method, the Company has recorded compensation expense as previously stated in the Company’s pro forma SFAS 123 disclosures in the footnotes to its prior period financial statements.  The fair value of options used to determine this compensation expense was originally determined using the Black-Scholes model and no changes have been made to the compensation expense as originally stated in the pro forma disclosures.  The original measurements and assumptions previously disclosed in the footnotes to the Company’s financial statement included in its annual Form 10-K filings and, in more recent years, in its Form 10-Q filings, also have not been changed.    In the process of recording the associated deferred tax assets related to this compensation expense, as required by SFAS 123R, the Company made its computations on a “grant by grant” basis.  As a result of this exercise, the Company determined that the tax benefit amounts previously included in determining the disclosed pro forma net earnings figures, if actually recorded into the Company’s financial statements, would have overstated deferred tax assets on the Company’s balance sheet that would have been incorrect under that provisions of SFAS No. 109, “Accounting for Income Taxes”.  Accordingly, in restating the results of prior years, management has elected to record adjustments to income tax expense and to properly record deferred tax assets.

Prior to the adoption of SFAS 123R, in the statement of cash flows, the tax benefits received by the Company from the exercise of certain employee stock options were added back to net earnings in determining net cash provided by operating activities.  SFAS 123R requires a different presentation for that portion of the tax benefit received upon option exercise which exceeds the tax

8




benefit originally recorded based on the estimated fair value of the options previously recognized as compensation expense.  Accordingly, the Company has reclassified this excess tax benefit from cash provided by operating activities to cash provided by financing activities in the statement of cash flows.

The following tables summarize the adjustments to certain line items in the Company’s consolidated financial statements as a  result of adopting SFAS 123R for all periods presented:

Restated line items in the condensed consolidated balance sheet:

 

 

December 31, 2005

 

 

 

As
previously
reported

 

SFAS
123R
Adjustments

 

Reclassifications

 

As restated

 

 

 

 

 

 

 

 

 

 

 

Deferred Federal and state income taxes

 

$

25,939

 

$

(12,661

)

 

$

13,278

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

 

Additional paid-in capital

 

18,663

 

162,242

 

 

180,905

 

Retained earnings

 

$

895,565

 

$

(149,581

)

 

$

745,984

 

 

Restated line items in the condensed consolidated statement of earnings:

 

 

Three months ended June 30, 2005

 

 

 

As
previously
reported

 

SFAS
123R
Adjustments

 

Reclassifications

 

As restated

 

 

 

 

 

 

 

 

 

 

 

Salaries and related costs

 

$

134,841

 

$

9,576

 

$

1,207

 

$

145,624

 

Other operating expenses

 

19,334

 

 

(1,207

)

18,127

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

859,694

 

9,576

 

 

869,270

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

68,305

 

(9,576

)

 

58,729

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes andminority interest

 

71,685

 

(9,576

)

 

62,109

 

Income tax expense

 

25,712

 

(1,630

)

1

 

24,083

 

Net earnings before minority interest

 

45,973

 

(7,946

)

(1

)

38,026

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

44,644

 

(7,946

)

 

36,698

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.21

 

 

 

$

.17

 

Diluted earnings per share

 

$

.20

 

 

 

$

.17

 

 

 

 

Six months ended June 30, 2005

 

 

 

As
previously
reported

 

SFAS
123R
Adjustments

 

Reclassifications

 

As restated

 

 

 

 

 

 

 

 

 

 

 

Salaries and related costs

 

$

259,395

 

$

16,684

 

$

2,436

 

$

278,515

 

Other operating expenses

 

39,273

 

 

(2,435

)

36,838

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

1,627,301

 

16,684

 

1

 

1,643,986

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

125,862

 

(16,684

)

(1

)

109,177

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes andminority interest

 

132,556

 

(16,684

)

(1

)

115,871

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

47,786

 

(2,040

)

(1

)

45,745

 

Net earnings before minority interest

 

84,770

 

(14,644

)

 

70,126

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

82,388

 

(14,644

)

 

67,744

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

.39

 

 

 

$

.32

 

Diluted earnings per share

 

$

.37

 

 

 

$

.31

 

 

9




Restated line items in the condensed consolidated statement of cash flows:

 

 

Three months ended June 30, 2005

 

 

 

As
previously
reported

 

SFAS
123R
Adjustments

 

Reclassifications

 

As restated

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

44,644

 

$

(7,946

)

 

$

36,698

 

 

 

 

 

 

 

 

 

 

 

Deferred income tax expense

 

3,728

 

4,389

 

 

8,117

 

Excess tax benefits from employee stock plans

 

 

(4,747

)

 

(4,747

)

Tax benefits from employee stock plans

 

6,019

 

(6,019

)

 

 

Stock compensation expense

 

 

9,576

 

 

9,576

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

46,953

 

(4,747

)

 

42,206

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefits from employee stock plans

 

 

4,747

 

 

4,747

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(42,798

)

$

4,747

 

 

$

(38,051

)

 

 

 

Six months ended June 30, 2005

 

 

 

As
previously
reported

 

SFAS
123R
Adjustments

 

Reclassifications

 

As restated

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

82,388

 

$

(14,644

)

 

$

67,744

 

 

 

 

 

 

 

 

 

 

 

Deferred income tax expense

 

7,987

 

6,915

 

 

14,902

 

Excess tax benefits from employee stock plans

 

 

(6,322

)

 

(6,322

)

Tax benefits from employee stock plans

 

8,955

 

(8,955

)

 

 

Stock compensation expense

 

 

16,684

 

 

16,684

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

142,663

 

(6,322

)

 

136,341

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefits from employee stock plans

 

 

6,322

 

 

6,322

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(57,123

)

$

6,322

 

 

$

(50,801

)

 

The following tables summarize information about fixed-price stock options for the six months ended June 30, 2006:

 

 

Number of
shares

 

Weighted
average
exercise price
per share

 

Weighted
average
remaining
contractual life

 

Aggregate
intrinsic value
(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2005

 

22,266,646

 

$

14.64

 

 

 

Options granted

 

3,109,000

 

44.20

 

 

 

Options exercised

 

(2,455,434

)

10.60

 

 

 

Options forfeited

 

(184,250

)

19.66

 

 

 

Options expired

 

(11,750

)

10.45

 

 

 

Outstanding at June 30, 2006

 

22,724,212

 

$

19.08

 

6.27 years

 

$

839,222

 

Exercisable at June 30, 2006

 

12,120,987

 

$

11.65

 

4.47 years

 

$

537,642

 

 

10




 

 

 

Unvested Options

 

 

 

Number of shares

 

Weighted average fair
value per share

 

 

 

 

 

 

 

Balance at December 31, 2005

 

11,368,450

 

$

9.57

 

Options granted

 

3,109,000

 

22.69

 

Options vested

 

(3,689,975

)

7.74

 

Options forfeited

 

(184,250

)

9.91

 

Balance at June 30, 2006

 

10,603,225

 

$

14.05

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants issued during the six months ended June 30, 2006 and 2005:

 

 

For the six months ended June 30,

 

 

 

2006

 

2005

 

Dividend yield

 

.51

%

.56

%

Volatility

 

41 — 43

%

44 — 49

%

Risk-free interest rates

 

5.03 — 5.11

%

3.64 — 4.14

%

Expected life (years) — stock option plans

 

7.21 — 8.89

 

6.67 — 9.36

 

Weighted average fair value of stock options granted during the period

 

$

22.69

 

$

25.38

 

 

No grants were issued under the stock purchase plan during the six months ended June 30, 2006 and 2005.

The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 was $67 million and $22 million, respectively.  The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $90 million and $33 million, respectively.

As of June 30, 2006, the total unrecognized compensation cost related to unvested stock options is $124,531 and the weighted average period over which that cost is expected to be recognized is 2.16 years.

Total stock compensation expense and the total related tax benefit recognized in the three and six-months ended June 30, 2006 and 2005 are as follows:

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Stock compensation expense

 

$

9,418

 

$

9,576

 

$

17,816

 

$

16,684

 

 

 

 

 

 

 

 

 

 

 

Recognized tax benefit, net

 

$

2,247

 

$

1,630

 

$

2,556

 

$

2,040

 

                Shares issued as a result of stock option exercises and employee stock plan purchases are issued as new shares outstanding by the Company’s transfer agent.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER SECURITIES LITIGATION
                REFORM ACT OF 1995; CERTAIN CAUTIONARY STATEMENTS

Certain portions of this report on Form 10-Q including the section entitled “Currency and Other Risk Factors” and “Liquidity and Capital Resources” contain forward-looking statements which must be considered in connection with the discussion of the important factors that could cause actual results to differ materially from the forward-looking statements.  In addition to risk factors identified elsewhere in this report, attention should be given to the factors identified and discussed in the report on Form 10-K filed on or about March 16, 2006.

EXECUTIVE SUMMARY

Expeditors International of Washington, Inc. is engaged in the business of global logistics management, including international freight forwarding and consolidation, for both air and ocean freight.  The Company acts as a customs broker in all domestic offices, and in many of its international offices.  The Company also provides additional services for its customers including value-added distribution, purchase order management, vendor consolidation and other logistics solutions.  The Company does not compete for overnight courier or small parcel business.  The Company does not own or operate aircraft or steamships.

International trade is influenced by many factors, including economic and political conditions in the United States and abroad, currency exchange rates, and United States and foreign laws and policies relating to tariffs, trade restrictions, foreign investments and

11




taxation.  Periodically, governments consider a variety of changes to current tariffs and trade restrictions.  The Company cannot predict which, if any, of these proposals may be adopted, nor can the Company predict the affects adoption of any such proposal will have on the Company’s business.  Doing business in foreign locations also subjects the Company to a variety of risks and considerations not normally encountered by domestic enterprises.  In addition to being influenced by governmental policies concerning international trade, the Company’s business may also be affected by political developments and changes in government personnel or policies in the nations in which it does business.

The Company derives its revenues from three principal sources: 1) airfreight, 2) ocean freight and 3) customs brokerage and other services and these are the revenue categories presented in the financial statements.

As a non-asset based carrier, the Company does not own transportation assets.  Rather, the Company generates the major portion of its air and ocean freight revenues by purchasing transportation services from direct (asset-based) carriers and reselling those services to its customers.   The difference between the rate billed to customers (the sell rate), and the rate paid to the carrier (the buy rate) is termed “net revenue” or “yield.”  By consolidating shipments from multiple customers and concentrating its buying power, the Company is able to negotiate favorable buy rates from the direct carriers, while at the same time offering lower sell rates than customers would otherwise be able to negotiate themselves.

Customs brokerage and other services involves providing services at destination, such as helping customers clear shipments through customs by preparing required documentation, calculating and providing for payment of duties and other taxes on behalf of the customers as well as arranging for any required inspections by governmental agencies, and arranging for delivery.   This is a complicated function requiring technical knowledge of customs rules and regulations in the multitude of countries in which the Company has offices.

The Company’s ability to provide services to its customers is highly dependent on good working relationships with a variety of entities including airlines, ocean steamship lines, and governmental agencies.  The significance of maintaining acceptable working relationships with governmental agencies and asset-based providers involved in global trade has gained increased importance as a result of ongoing concern over terrorism.  As each carrier labors to comply with governmental regulations implementing security policies and procedures, inherent conflicts emerge which can and do affect global trade to some degree.  A good reputation helps to develop practical working understandings that will effectively meet security requirements while minimizing potential international trade obstacles.  The Company considers its current working relationships with these entities to be satisfactory.  However, changes in space allotments available from carriers, governmental deregulation efforts, “modernization” of the regulations governing customs brokerage, and/or changes in governmental quota restrictions could affect the Company’s business in unpredictable ways.

Historically, the Company’s operating results have been subject to a seasonal trend when measured on a quarterly basis.  The first quarter has traditionally been the weakest and the third and fourth quarters have traditionally been the strongest.  This pattern is the result of, or is influenced by, numerous factors including climate, national holidays, consumer demand, economic conditions and a myriad of other similar and subtle forces.  In addition, this historical quarterly trend has been influenced by the growth and diversification of the Company’s international network and service offerings.  The Company cannot accurately forecast many of these factors nor can the Company estimate accurately the relative influence of any particular factor and, as a result, there can be no assurance that historical patterns, if any, will continue in future periods.

A significant portion of the Company’s revenues are derived from customers in retail industries whose shipping patterns are tied closely to consumer demand, and from customers in industries whose shipping patterns are dependent upon just-in-time production schedules.  Therefore, the timing of the Company’s revenues are, to a large degree, impacted by factors out of the Company’s control, such as a sudden change in consumer demand for retail goods and/or manufacturing production delays.  Additionally, many customers ship a significant portion of their goods at or near the end of a quarter, and therefore, the Company may not learn of a shortfall in revenues until late in a quarter.  To the extent that a shortfall in revenues or earnings was not expected by securities analysts, any such shortfall from levels predicted by securities analysts could have an immediate and adverse effect on the trading price of the Company’s stock.

As further discussed under liquidity and capital resources, total capital expenditures in 2006 are expected to exceed $165 million.

In terms of the opportunities, challenges and risks that management is focused on in 2006, the Company operates in 58 countries throughout the world in the competitive global logistics industry and Company activities are tied directly to the global economy.  From the inception of the Company, management has believed that the elements required for a successful global service organization can only be assured through recruiting, training, and ultimately retaining superior personnel.  The Company’s greatest challenge is now and always has been perpetuating a consistent global culture which demands:

·                           Total dedication, first and foremost, to providing superior customer service;

·                           Aggressive marketing of all of the Company’s service offerings;

 

12




·                           Ongoing development of key employees and management personnel via formal and informal means;

·                           Creation of unlimited advancement opportunities for employees dedicated to hard work, personal growth and continuous improvement;

·                           Individual commitment to the identification and mentoring of successors for every key position so that when inevitable change is required, a qualified and well-trained internal candidate is ready to step forward; and

·                           Continuous identification, design and implementation of system solutions, both technological and otherwise, to meet and exceed the needs of our customers while simultaneously delivering tools to make our employees more efficient and more effective.

The Company has reinforced these values with a compensation system that rewards employees for profitably managing the things they can control.  There is no limit to how much a key manager can be compensated for success.   The Company believes in a “real world” environment in every operating unit where individuals are not sheltered from the profit implications of their decisions.  At the same time, the Company insists on continued focus on such things as accounts receivable collection, cash flow management and credit soundness in an attempt to insulate managers from the sort of catastrophic errors that might end a career.

Any failure to perpetuate this unique culture on a self-sustained basis throughout the Company, provides a greater threat to the Company’s continued success than any external force, which would be largely beyond our control.  Consequently, management spends the majority of its time focused on creating an environment where employees can learn and develop while also building systems and taking preventative action to reduce exposure to negative events.   The Company strongly believes that it is nearly impossible to predict events that, in the aggregate, could have a positive or a negative impact on future operations.  As a result our focus is on building and maintaining a global culture of well-trained employees and managers that are prepared to identify and react to subtle changes as they develop and thereby help the Company adapt and thrive as major trends emerge.

Critical Accounting Policies and Estimates

Management believes that the nature of the Company’s business is such that there are few, if any, complex challenges in accounting for operations.

While judgments and estimates are a necessary component of any system of accounting, the Company’s use of estimates is limited primarily to the following areas that in the aggregate are not a major component of the Company’s statement of earnings:

·                  accounts receivable valuation;

·                  the useful lives of long-term assets;

·                  the accrual of costs related to ancillary services the Company provides;

·                  establishment of adequate insurance liabilities for the portion of the freight related exposure which the Company has self-insured; and

·                  accrual of tax expense on an interim basis.

Management believes that the methods utilized in all of these areas are non-aggressive in approach and consistent in application.  Management believes that there are limited, if any, alternative accounting principles or methods which could be applied to the Company’s transactions.  While the use of estimates means that actual future results may be different from those contemplated by the estimates, the Company believes that alternative principles and methods used for making such estimates would not produce materially different results than those reported.

As described in Note 1 in the condensed consolidated financial statements in this quarterly report, effective January 1, 2006, the Company adopted SFAS 123R. This accounting standard requires the recognition of compensation expense based on an estimate of the fair value of options granted to employees and directors under the Company’s stock option and employee stock purchase plans.

This expense is recorded ratably over the option vesting periods. The Company elected to utilize the modified retrospective method of adoption and has restated all prior periods to recognize the required stock compensation expense in accordance with the requirements of SFAS 123R.

Determining the appropriate option pricing model to use to estimate stock compensation expense requires judgment. Any option pricing model requires assumptions that are subjective and these assumptions also require judgment. Examples include assumptions about long-term stock price volatility, employee exercise patterns, pre-vesting option forfeitures, post-vesting option terminations, and the future interest rates and dividend yields.

The Company has historically used the Black-Scholes model for estimating the fair value of stock options in providing pro forma fair value disclosures pursuant to SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). After a review of alternatives, a