Part IV

Item 15.

Exhibits and Financial Statement Schedules

XTO ENERGY INC. Notes to Consolidated Financial Statements

12. Employee Benefit Plans

401(k) Plan

We sponsor a 401(k) benefit plan that allows employees to contribute and defer a portion of their wages. We match employee contributions up to 10% of wages, subject to annual dollar maximums established by the federal government. Employee contributions vest immediately while our matching contributions vest 100% upon completion of three years of service. All employees over 21 years of age may participate. Company contributions under the plan were $14 million in 2007, $11 million in 2006 and $9 million in 2005.

Post-Retirement Health Plan

Effective January 1, 2001, we adopted a medical plan for employees who retire at age 55 or over, as well as directors age 55 or over, with a minimum of five years service. During 2003, our retiree medical plan was amended to provide benefits to employees and directors when their combined age and qualified years of service total 60, with a minimum age of 45 and a minimum of five years of service. During 2007, our retiree medical plan was again amended to extend the minimum age to 50 and a minimum of 10 years of service for current employees. However, employees who were eligible under previous eligibility rules were grandfathered in under the previous rules. Also, directors are still eligible to receive benefits under the previous eligibility rules. Benefits under the plan are the same as for active employees, and continue until the retired employee or director or dependents are eligible for Medicare or another similar state health insurance program. Post-retirement medical benefits are not prefunded but are paid when incurred. The plan’s benefit obligation, funded status and net periodic benefit cost for 2007, 2006 and 2005 were as follows:

 
December 31
(in millions)
2007
2006
2005
Benefit obligation at December 31 $ 17 $ 8 $ 7
Funded status $ (17) $ (8) $ (7)
Net periodic benefit cost $ 2 $ 1 $ 1
Accrued benefit liability, as recognized in the consolidated balance sheet
at December 31		 $ (17) $ (8) $ (5)

During December 2006, we adopted the provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements No. 87, 88, 106, and 132R, that required us to recognize in our consolidated balance sheet a liability for the underfunded status of our postretirement health plan as of December 31, 2007 and 2006. This liability, which is equal to the amount shown in the table above, is included as part of other long-term liabilities. The unrecognized portion of the liability of $8 million, net of a deferred tax asset of $3 million as of December 31, 2007, and of $3 million, net of a deferred tax asset of $1 million as of December 31, 2006, was recorded as a reduction to accumulated other comprehensive income (loss).

Unrecognized net actuarial loss is amortized to expense over the estimated average remaining service life of plan participants and prior service cost is amortized over a remaining life of eight years. Including such amortization, the 2008 accrued benefit cost is expected to be approximately $3 million.

The following are assumptions used by us to determine our benefit obligation as of December 31 of each of the years presented:

 
2007
2006
2005
Weighted average discount rate 6% 6% 6%
Health care cost trend rate assumed for the following year 8.5% 9% 8.5%
Rate to which the cost trend rate is assumed to decline (ultimate trend rate) 6% 6% 6%
Year that the rate reaches the ultimate trend rate 2013 2013 2010

Assumed health care cost trends have a significant effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend rates would have a $2 million or less effect on both total service and interest cost and the post-retirement benefit obligation as of December 31, 2007.

Through 2017, projected benefit payments, which reflect expected future service, are not expected to exceed $2 million in any one year and are less than $10 million in total.

Stock Incentive Plans

In November 2004, stockholders approved the 2004 Stock Incentive Plan under which 30 million shares of common stock were available for grants of stock awards. In May 2006, stockholders approved certain amendments to the 2004 Plan including increasing the shares available for grants of stock awards to 42.2 million shares. Prior to approval of the 2004 Plan, grants of stock awards were made pursuant to the 1998 Stock Incentive Plan. No further grants will be made under the 1998 Plan. Stock award grants are subject to certain limitations as specified in the Plan. The maximum term of stock awards is ten years under the 1998 Plan and seven years under the 2004 Plan. As a result of the May 12, 2006 distribution of the Hugoton Royalty Trust units (Note 9), appropriate antidilution adjustments were made to stock awards outstanding on that date.

Stock awards under the 2004 Plan include stock options, performance shares, restricted shares and unrestricted shares. The table below summarizes stock incentive compensation expense included in the consolidated financial statements and related amounts for each year:

 
December 31
(in millions)
2007
2006
2005
Non-cash stock option compensation expense $ 42 $ 53 $ –
Non-cash performance share and unrestricted share compensation expense 4 8 34
Non-cash restricted stock compensation expense 19 2 –
Related tax benefit recorded in income statement 24 23 12
Intrinsic value of stock option exercises 170 136 60
Income tax benefit on exercise of stock options or vesting of stock awards (a) 64 50 21
Grant date fair value of stock options vested 35 24 78

(a) Recorded as additional paid-in-capital

Included in stock option compensation expense in 2006 is $36 million related to options granted during May 2006, which were subject to accelerated vesting provisions upon retirement under employment agreements. Under SFAS No. 123R, stock option awards subject to such vesting provisions granted to retirement-eligible employees are expensed upon grant rather than over the expected vesting period (Note 6). In 2005 and prior, before adoption of SFAS No. 123R, performance share compensation was recorded at the vesting price, recognized ratably over the estimated vesting period or at actual vesting, if earlier or if the vesting period could not be reasonably assessed.

Stock Options

Stock options granted under the 2004 Plan generally vest and become exercisable ratably over a three-year period, and may include a provision for accelerated vesting when the common stock price reaches specified levels as determined by the Compensation Committee of the Board of Directors. Some stock options granted in 2007 and 2006 vest only when the common stock reaches specified levels. There was a total of 23.0 million options outstanding under the 2004 and 1998 Plans at December 31, 2007, including 14.5 million that were exercisable at that date. Of the remaining options, 6.5 million vest over three years at a rate of one-third at each grant anniversary date, 1.0 million vested when the stock price closed above $56 in January 2008 and 1.0 million vest when the stock price closes at or above $60.

The following summarizes option activity and balances for the year ended December 31, 2007:

 
Weighted-
Average
Exercise
Price
  
Stock
Options
(in thousands)
  
Weighted-
Average
Remaining
Term (in years)
  
Aggregate
Intrinsic
Value
(in millions)
Balance at January 1, 2007 $ 23.73   24,782  
Grants 50.01   4,278  
Exercises 18.22   (5,864)  
Forfeitures 32.75   (196)  
Balance at December 31, 2007 $ 29.94   23,000   5.0   $ 493
Exercisable at December 31, 2007 $ 23.25   14,502   4.3   $ 408

 

As a result of options exercised in 2007, outstanding common stock increased by 3.1 million shares and stockholders’ equity increased by $38 million.

Performance Shares

Performance shares granted under the 2004 Plan are subject to restrictions determined by the Compensation Committee of the Board of Directors and are subject to forfeiture if performance criteria are not met. Otherwise, holders of performance shares generally have all the voting, dividend and other rights of other common stockholders. To date, the performance criteria for all awards has been the achievement of specified increases in the common stock price above the market price at the grant date. Performance share grants in 2006 were to key employees other than executive officers.

Restricted Shares

We granted 1,388,000 restricted shares in 2007 and 1,309,000 restricted shares in 2006 to key employees other than executive officers. These shares vest over three years, with one-third vesting at each grant anniversary date. Holders of restricted shares generally have all the voting, dividend and other rights of other common stockholders.

Nonemployee Director Awards

Nonemployee directors are each eligible to receive discretionary stock awards under the 2004 Plan covering up to 25,000 shares annually, as approved by the Corporate Governance and Nominating Committee and the Board of Directors. Nonemployee directors received 4,166 shares each totaling approximately 25,000 unrestricted shares in 2007 and 2006 and 4,166 shares to five directors and 2,083 to one director totaling approximately 23,000 unrestricted shares in 2005 under the 2004 Plan. In November 2005, nonemployee directors received 20,000 stock options each totaling 120,000 stock options, 50% of which vested in 2005 when the common stock price closed above the target price of $36 and 50% which vested in 2006 when the common stock price closed above the target price of $40. In November 2006, nonemployee directors received 20,000 stock options each totaling 120,000 stock options, 50% of which vested in 2007 when the stock closed above the target price of $42 and 50% which vested in 2007 when the common stock price closed above the target price of $46. In November 2007, nonemployee directors received 20,000 stock options each totaling 120,000 stock options, 50% of which vested when the common stock price closed above the target price of $56 in January 2008 and 50% of which vest when the common stock price closes at or above the target price of $60.

Nonvested Stock Awards

The following summarizes the status of the nonvested stock options, performance shares and restricted shares as of December 31, 2007 and changes for the year ended December 31, 2007:

 
Stock Options
  
Performance Shares
  
Restricted Shares
(in thousands, except
per share amounts)
Weighted-
Average
Grant Date
Fair Value
  
Number
of Shares
  
Weighted-
Average
Grant Date
Fair Value
  
Number
of Shares
  
Weighted-
Average
Grant Date
Fair Value
  
Number
of Shares
Nonvested at
January 1, 2007		 $ 10.58   7,715   $ 26.81   181   $ 38.28   1,309
Vested 10.57   (3,299)   26.86   (166)   38.28   (427)
Grants 15.29   4,278   –   –   50.02   1,388
Forfeitures 10.82   (196)   26.19   (15)   39.75   (48)
Nonvested at
December 31, 2007		 $ 12.95   8,498   $ –   –   $ 45.58   2,222

 

As of December 31, 2007, the remaining unrecognized compensation expense related to nonvested stock options was $70 million. Total deferred compensation at December 31, 2007 related to restricted shares was $89 million. For these nonvested stock awards at December 31, 2007, we estimate that stock incentive compensation for service periods after December 31, 2007 will be $92 million in 2008, $46 million in 2009 and $21 million in 2010. The weighted-average remaining vesting period is 1.5 years for stock options and 2.5 years for restricted shares.

Estimated Fair Value of Grants

Prior to adoption of SFAS No. 123R, we used the Black-Scholes option-pricing model to estimate the fair value of stock options and the intrinsic value method of valuing performance shares. Beginning January 1, 2006, we began using a lattice model to value stock option grants that time vest and a Monte Carlo simulation model to value performance shares and stock options that vest, or include a provision for accelerated vesting, when the common stock price reaches specified levels.

During 2007 and 2006, we used both a trinomial lattice model and a Monte Carlo simulation model to determine the fair value of options granted, and during 2006, we used a Monte Carlo simulation model to determine the fair value of performance shares granted. For restricted stock grants, the fair value is equal to the closing price of our common stock on the grant date.

The trinomial lattice model requires inputs for risk-free interest rate, dividend yield, volatility, contract term, average vesting period, post-vest turnover rate and suboptimal exercise factor. Both expected life and fair value are outputs of this model. The Monte Carlo simulation model requires inputs for risk-free interest rate, dividend yield, volatility, contract term, target vesting price, post-vest turnover rate and suboptimal exercise factor. The suboptimal exercise factor does not affect the valuation of the performance shares since ownership is transferred at vesting. Expected life, derived vesting period and fair value are outputs of this model.

The risk-free interest rate is based on the constant maturity nominal rates of U.S. Treasury securities with remaining lives throughout the contract term on the day of the grant. The dividend yield is the expected common stock annual dividend yield over the expected life of the option or performance share, expressed as a percentage of the stock price on the date of grant. The volatility factors are based on a combination of both the historical volatilities of our stock and the implied volatility of traded options on our common stock. Contract term is seven years. For options subject to time vesting, the average vesting period is two years, based on each grant vesting ratably over a three-year period. For options subject to vesting when the common stock reaches a specified price, the target vesting price is specified by the award. The post-vesting turnover rate is 4.1% and the suboptimal exercise factor is 1.7, and are both based on actual historical exercise activity. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by certain employees who receive stock option grants, and subsequent events are not indicative of the reasonableness of the original fair value estimates.

We record stock incentive compensation only for awards expected to vest. During 2007, we estimated annual forfeitures using a rate of 3.8% for stock options and 2.7% for restricted shares.

For the fair value of stock options awarded before 2006, we used the Black-Scholes option pricing model which utilizes assumptions different from those described above. The expected term was based on the historical exercise activity. The risk-free interest rate was the yield available on U.S. Treasury securities with a remaining term equal to the expected life of the option. The dividend yield was determined in the same manner as described above for the lattice model. The volatility factor was based on the historical volatility of our common stock over the expected life of the option.

During the year ended December 31, 2007, we granted 4.3 million options with an estimated total grant-date fair value of $65 million and a weighted-average fair value of $15.29. During 2006, we granted 6.8 million options with an estimated total grant-date fair value of $74 million and a weighted-average fair value of $10.89 per option. During the year ended December 31, 2005, we granted 5.2 million options with a weighted-average fair value of $8.15. Fair values were determined using the following assumptions:

 
2007
2006
2005
Weighted-average expected term (years) 4.6 4.4 3.5
Range of risk-free interest rates 3.4% – 5.0% 4.3% – 5.2% –
Weighted-average risk-free interest rates 3.8% 4.9% 4.0%
Dividend yield 0.8% 0.7% 0.7%
Range of volatility 26% – 33% 29% – 35% –
Weighted-average volatility 32% 32% 35%