HP 2006 Annual Report Download - page 92

HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 2: Stock-Based Compensation (Continued)
exercise price of a stock option is equal to the fair market value of HP’s common stock on the option
grant date (as determined by the average of the highest and lowest reported sale prices of HP’s
common stock on that date). The contractual term of options granted since fiscal 2003 was generally
eight years, while the contractual term of options granted prior to fiscal 2003 was generally ten years.
Under the principal option plans, HP may choose, in certain cases, to establish a discounted exercise
price at no less than 75% of fair market value on the grant date. HP has not granted any discounted
options since fiscal 2003.
Under the principal option plans, HP granted certain employees cash, restricted stock awards, or
both. Restricted stock awards are nonvested stock awards that may include grants of restricted stock or
grants of restricted stock units. Cash and restricted stock awards are independent of option grants and
are generally subject to forfeiture if employment terminates prior to the release of the restrictions.
Such awards generally vest one to three years from the date of grant. During that period, ownership of
the shares cannot be transferred. Restricted stock has the same cash dividend and voting rights as other
common stock and is considered to be currently issued and outstanding. Restricted stock units have
dividend equivalent rights equal to the cash dividend paid on restricted stock. Restricted stock units do
not have the voting rights of common stock, and the shares underlying the restricted stock units are not
considered issued and outstanding. HP expenses the cost of the restricted stock awards, which HP has
determined to be the fair market value of the shares at the date of grant, ratably over the period
during which the restrictions lapse. In fiscal 2006, HP granted 1,492,000 shares of restricted stock with
a weighted-average grant date fair value of $32. In fiscal 2005, HP granted 6,773,000 shares of
restricted stock with a weighted-average grant date fair value of $21. HP had 5,492,000 shares of
restricted stock outstanding at October 31, 2006, 7,099,000 shares of restricted stock outstanding at
October 31, 2005 and 1,533,000 shares of restricted stock outstanding at October 31, 2004. In fiscal
2006, HP granted 33,000 shares of restricted stock units with a weighted-average grant date fair value
of $30. In fiscal 2005, HP granted 1,820,000 shares of restricted stock units with a weighted-average
grant date fair value of $21. HP had restricted stock units covering 873,000 shares outstanding at
October 31, 2006, 1,780,000 shares outstanding at October 31, 2005 and no shares outstanding at
October 31, 2004.
In light of new accounting guidance under SFAS 123R, beginning in the second quarter of fiscal
2005 HP reevaluated its assumptions used in estimating the fair value of employee options granted. As
part of this assessment, management determined that implied volatility calculated based on actively
traded options on HP common stock is a better indicator of expected volatility and future stock price
trends than historical volatility. Therefore, expected volatility in fiscal 2006 and 2005 was based on a
market-based implied volatility.
As part of its SFAS 123R adoption, HP also examined its historical pattern of option exercises in
an effort to determine if there were any discernable activity patterns based on certain employee
populations. From this analysis, HP identified three employee populations. HP used the Black-Scholes
option pricing model to value the options for each of the employee populations. The table below
presents the weighted average expected life in months of the combined three identified employee
populations. The expected life computation is based on historical exercise patterns and post-vesting
termination behavior within each of the three populations identified. The risk-free interest rate for
periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at
the time of grant.
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