DREAMWORKSANIMATIONSKG,INC. NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued) The following table reflects pro forma net income and net income per share for the year ended December 31, 2004 had the Company elected to adopt the fair-value based method for the stock option awards granted to its employees at the Separation and its initial public offering (in thousands, except per share data). Net income: Asreported .................................................................... $333,000 Fair value based compensation cost for stock options granted to employees, net of taxes ....... (434) Pro forma net income ........................................................ $332,566 Basic net income per share: Asreported .................................................................... $ 4.09 Pro forma ..................................................................... $ 4.08 Diluted net income per share: Asreported .................................................................... $ 4.05 Proforma ...................................................................... $ 4.05 These pro forma amounts may not be representative of future disclosures since the estimated fair value of the stock option awards are amortized to expense over the vesting periods, and additional stock option awards may be granted in future years. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average fair value of stock options granted to Company employees was $13.40 for the year ended December 31, 2004. Values were estimated using a zero dividend yield, expected volatility of 50%, risk free interest rate range of 2.23% to 3.78% and weighted average expected lives of 5.5 years. Recent Accounting Pronouncements In December 2004, the FASB issued FAS No. 123R “Share-Based Payments” (“FAS 123R”) which is a revision of FAS No. 123 “Accounting for Stock Based Compensation. FAS 123R supersedes Accounting Principals Board (“APB”) Opinion No 25, “Accounting for Stock Issued to Employees”, and amends FAS No. 95, “Statement of Cash Flows”. FAS No. 123R requires all share-based payments to employees, including grants of employee stock options to be recognized in the financial statements based on their fair values. FAS123Riseffective for public companies at the beginning of the first interim or annual period beginning after June 15, 2005. The Company has elected to adopt FAS 123R as of January 1, 2005. The Company anticipates that the adoption of this new standard will have a material impact to its financial position and results of operations. Management estimates that stock compensation expense for the year ended December 31, 2005 will be approximately $25.0 million for equity awards granted to date. The Company measured the fair value of these equity awards at the date of grant using a Black-Scholes option pricing model. FAS 123R offers alternative adoption methods. The Company has determined that it will use the modified prospective transition method. Changes to our underlying stock price or satisfaction of performance criteria for performance-based awards granted to our employees could significantly impact compensation expense to be recognized in 2005 and future periods. In addition, future grants of equity awards will result in additional compensation expense in 2005 and future periods. 2. Relationship to DreamWorks Studios As an operating division of DreamWorks Studios prior to October 27, 2004, the Company has historically been allocated a portion of DreamWorks Studios overhead expenses including executive management, domestic theatrical marketing and distribution, oversight of international theatrical distribution and worldwide home video 79