2. Stock-based Compensation

The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company’s share-based awards have also included both cash-settled and share-settled performance unit awards. Cash-settled performance unit awards are accounted for as liability awards. Share-settled performance unit awards are accounted for as equity awards. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest.

On February 21, 2014, the Company’s Board of Directors adopted the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”), subject to approval by the Company’s stockholders. In addition, on the same date, the Board of Directors approved, subject to and effective upon the approval by the stockholders of the 2014 Plan, the termination of any future grants under all existing equity plans of the Company. On April 17, 2014, the Company’s stockholders approved the 2014 Plan. The aggregate number of shares of Common Stock authorized for grant under the 2014 Plan is 9,100,000, reduced by the number of shares that were subject to awards granted under existing equity plans of the Company during the period commencing on January 1, 2014 and ending on the date the 2014 Plan was approved by the stockholders.

Stock Options — The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. Weighted-average assumptions used to estimate the grant date fair values for stock options granted for the three and nine month periods ended September 30, 2014 and 2013 follow:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014			2013	2014			2013
Volatility		35.64	%	NA		35.89	%		41.36	%
Expected term (in years)		5.00		NA		5.00			5.00
Dividend yield		1.18	%	NA		1.17	%		0.89	%
Risk-free interest rate		1.62	%	NA		1.76	%		0.70	%

Stock option activity from January 1, 2014 to September 30, 2014 follows:

				Weighted
				Average
	Underlying			Exercise
	Shares			Price
Outstanding at January 1, 2014		7,319,695		$	21.23
Granted		491,750		$	32.32
Exercised		(1,715,195	)	$	20.59
Cancelled		—		$	—
Expired		—		$	—
Outstanding at September 30, 2014		6,096,250		$	22.30
Exercisable at September 30, 2014		5,117,764		$	21.48

Restricted Stock — For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period.

Restricted stock activity from January 1, 2014 to September 30, 2014 follows:

				Weighted
				Average
				Grant Date
	Shares			Fair Value
Non-vested restricted stock outstanding at January 1, 2014		1,496,692		$	20.84
Granted		778,100		$	33.40
Vested		(713,210	)	$	21.75
Forfeited		(45,616	)	$	23.43
Non-vested restricted stock outstanding September 30, 2014		1,515,966		$	26.79

Restricted Stock Units — For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period.

Restricted stock unit activity from January 1, 2014 to September 30, 2014 follows:

				Weighted
				Average
				Grant Date
	Shares			Fair Value
Non-vested restricted stock units outstanding at January 1, 2014		20,256		$	20.67
Granted		21,550		$	34.67
Vested		(9,754	)	$	22.13
Forfeited		(667	)	$	21.09
Non-vested restricted stock units outstanding September 30, 2014		31,385		$	29.82

Performance Unit Awards — In 2011, 2012, 2013 and 2014 the Company granted stock-settled performance unit awards to certain executive officers (the “Stock-Settled Performance Units”). The Stock-Settled Performance Units provide for the recipients to receive a grant of shares of stock upon the achievement of certain performance goals established by the Compensation Committee during the performance period. The performance period for the Stock-Settled Performance Units is the three year period commencing on April 1 of the year of grant. For the 2012 and 2013 Stock-Settled Performance Units, the performance period can extend for an additional two years in certain circumstances. The performance goals for the Stock-Settled Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the performance units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return is positive and, when compared to the peer group, is at the 50^th percentile and two times the target if at the 75^th percentile or higher. If the Company’s total shareholder return is positive, and, when compared to the peer group, is at the 25^th percentile, the recipients will only receive one-half of the target number of shares. The grant of shares when achievement is between the 25^th and 75^th percentile will be determined on a pro-rata basis. The target number of shares with respect to the 2011 Stock-Settled Performance Units was 144,375. The performance period for the 2011 Stock-Settled Performance Units ended on March 31, 2014, and the Company’s total shareholder return was at the 94^th percentile. In April 2014, 288,750 shares were issued to settle the 2011 Stock-Settled Performance Units.

The total target number of shares with respect to the Stock-Settled Performance Units is set forth below:

	2014		2013		2012		2011
	Performance		Performance		Performance		Performance
	Unit Awards		Unit Awards		Unit Awards		Unit Awards
Target number of shares		154,000		236,500		192,000		144,375

Because the Stock-Settled Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Stock-Settled Performance Units is set forth below (in thousands):

	2014		2013		2012		2011
	Performance		Performance		Performance		Performance
	Unit Awards		Unit Awards		Unit Awards		Unit Awards
Fair value at date of grant	$	5,388	$	5,564	$	3,065	$	5,569

These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Stock-Settled Performance Units is shown below (in thousands):

	2014		2013		2012		2011
	Performance		Performance		Performance		Performance
	Unit Awards		Unit Awards		Unit Awards		Unit Awards
Three months ended September 30, 2013	NA		$	464	$	255	$	464
Three months ended September 30, 2014	$	449	$	464	$	255	NA
Nine months ended September 30, 2013	NA		$	927	$	766	$	1,392
Nine months ended September 30, 2014	$	898	$	1,391	$	766	$	464