Baker Hughes 2007 Annual Report Download - page 132

2007 Form 10-K 49
The following table illustrates the pro forma effect on
net income and earnings per share for the year ended Decem-
ber 31, 2005 if we had recognized compensation expense by
applying the fair value based method to all awards as provided
for under SFAS 123:
2005
Net income, as reported $ 878.4
Add: Stock-based compensation for restricted
stock awards and units included in reported
net income, net of tax 6.1
Deduct: Stock-based compensation determined
under SFAS 123, net of tax (35.0)
Pro forma net income $ 849.5
Basic EPS:
As reported $ 2.59
Pro forma 2.50
Diluted EPS:
As reported $ 2.57
Pro forma 2.49
Stock Options
Our stock option plans provide for the issuance of incentive
and non-qualified stock options to directors, officers and other
key employees at an exercise price equal to the fair market value
of the stock at the date of grant. Although subject to the terms
of the stock option agreement, substantially all of the stock
options become exercisable in three equal annual installments,
beginning a year from the date of grant, and generally expire
ten years from the date of grant. The stock option plans pro-
vide for the acceleration of vesting upon the employee’s retire-
ment; therefore, the service period is reduced for employees
that are or will become retirement eligible during the vest-
ing period and, accordingly, the recognition of compensation
expense for these employees is accelerated. Compensation cost
related to stock options is recognized on a straight-line basis
over the vesting or service period and is net of forfeitures.
The fair value of each stock option granted is estimated on
the date of grant using the Black-Scholes option pricing model.
The following table presents the weighted average assumptions
used in the option pricing model for options granted. The
expected life of the options represents the period of time the
options are expected to be outstanding. For the year 2005, the
expected life was based on historical trends. For the years ended
December 31, 2007 and 2006, the expected life is based on
our historical exercise trends and post-vest termination data
incorporated into a forward-looking stock price model. For
the year 2005, our expected volatility is based on the historical
volatility of our stock for a period approximating the expected
life. For the years ended December 31, 2007 and 2006, as
allowed under the Securities and Exchange Commission’s Staff
Accounting Bulletin 107 (“SAB 107”), the expected volatility
is based on our implied volatility, which is the volatility forecast
that is implied by the prices of our actively traded options to
purchase our stock observed in the market. The risk-free inter-
est rate is based on the observed U.S. Treasury yield curve in
effect at the time the options were granted. The dividend yield
is based on our history of dividend payouts.
2007 2006 2005
Actual Actual Pro Forma
Expected life (years) 5.1 5.0 3.7
Risk-free interest rate 4.8% 4.8% 3.7%
Volatility 28.6% 31.1% 35.0%
Dividend yield 0.7% 0.7% 1.0%
Weighted average
fair value per share
at grant date $ 24.20 $ 26.15 $ 14.62
A summary of our stock option activity and related informa-
tion is presented below (in thousands, except per option prices):
Weighted Average
Number of Exercise Price
Options Per Option
Outstanding at December 31, 2006 4,296 $ 46.35
Granted 690 75.12
Exercised (1,657) 40.94
Forfeited (80) 53.28
Expired (78) 46.79
Outstanding at December 31, 2007 3,171 $ 55.25
The total intrinsic value of stock options (defined as the
amount by which the market price of the underlying stock on
the date of exercise exceeds the exercise price of the option)
exercised in 2007, 2006 and 2005 was $72.5 million, $73.6
million and $84.6 million, respectively. The income tax benefit
realized from stock options exercised was $18.5 million for the
year ended December 31, 2007. The total fair value of options
vested in 2007, 2006 and 2005 was $19.6 million, $20.2 mil-
lion and $20.4 million, respectively. As of December 31, 2007,
there was $10.4 million of total unrecognized compensation
cost related to nonvested stock options which is expected to
be recognized over a weighted average period of 1.9 years.