Stock-Based Compensation and Stock Awards

Stock Options

On May 13, 2004, the Company’s stockholders approved the 2004 Incentive Plan of Dril-Quip, Inc. (as amended in 2012 and approved by the Company’s stockholders on May 10, 2012, the “2004 Plan”), which reserved up to 2,696,294 shares of common stock to be used in connection with the 2004 Plan. Persons eligible for awards under the 2004 Plan are employees holding positions of responsibility with the Company or any of its subsidiaries and members of the Board of Directors. Options granted under the 2004 Plan have a term of ten years and become exercisable in cumulative annual increments of one-fourth of the total number of shares of common stock subject thereto, beginning on the first anniversary of the date of the grant.

The fair value of stock options granted was estimated on the grant date using the Black-Scholes option pricing model. The expected life was based on the Company’s historical trends, and volatility is based on the historical volatility over the expected life of the options. The risk-free interest rate is based on U.S. Treasury yield curve at the grant date. The Company does not pay dividends and, therefore, there is no assumed dividend yield.

Option activity for the year ended December 31, 2016 was as follows:



	Number of Options		Weighted Average Price		Aggregate intrinsic value (in millions)		Weighted Average Remaining Contractual Life (in years)
Outstanding at December 31, 2015	415,122		55.64
Granted	—		—
Exercised	(54,350	)	40.61
Forfeited	(8,813	)	67.71
Outstanding at December 31, 2016	351,959		$	57.66	$	2.5	3.5
Exercisable at December 31, 2016	351,959		$	57.66	$	2.5	3.5

The total intrinsic value of stock options exercised in 2016, 2015 and 2014 was $1.0 million, $0.8 million and $2.0 million, respectively. The income tax benefit realized from stock options exercised was $357,000, $263,000 and $718,000 for the years ended December 31, 2016, 2015 and 2014, respectively. There were no anti-dilutive stock option shares on December 31, 2016.

Stock-based compensation is recognized as selling, general and administrative expense in the accompanying Consolidated Statements of Income. For the year ended December 31, 2016, there was no stock-based compensation expense for stock option awards. During the years ended December 31, 2015 and 2014, stock-based compensation expense for stock option awards was $1.1 million and $2.5 million, respectively. No stock-based compensation expense was capitalized during 2016, 2015 and 2014.

Options granted to employees vest over four years and the Company recognizes compensation expense on a straight-line basis over the vesting period of the options. At December 31, 2016, there was no unrecognized compensation expense related to nonvested stock options as all outstanding options were fully vested.

Restricted Stock Awards

On October 28, 2016 and 2015, pursuant to the 2004 Plan, the Company awarded officers, directors and key employees restricted stock awards (RSAs), which is an award of common stock subject to time vesting. In May 2012, the Board of Directors amended the 2004 Plan to include non-employee directors as eligible for RSAs. The awards issued under the 2004 Plan are restricted as to transference, sale and other disposition. These RSAs vest ratably over a three year period. The RSAs may also vest in case of a change of control. Upon termination, whether voluntary or involuntary, the RSAs that have not vested will be returned to the Company resulting in stock forfeitures. The fair market value of the stock on the date of grant is amortized and charged to selling, general and administrative expense over the stipulated time period over which the RSAs vest on a straight-line basis, net of estimated forfeitures.

The Company’s RSA activity and related information is presented below:



	RSA Number of Shares		Weighted Average Grant Date Fair Value Per Share
Nonvested balance at December 31, 2015	193,596		$	77.91
Granted	165,063		48.45
Vested	(84,513	)	84.98
Forfeited	(4,763	)	80.60
Nonvested balance at December 31, 2016	269,383		$	57.59

RSA compensation expense for the years ended December 31, 2016 and 2015 totaled $7.2 million and $6.3 million for 2014. For 2016, 2015 and 2014, the income tax benefit recognized in net income for RSAs was $1.2 million, $1.8 million and $2.2 million, respectively. As of December 31, 2016, there was $14.0 million of total unrecognized compensation cost related to nonvested RSAs, which is expected to be recognized over a weighted average period of 2.2 years. There were 108,561 anti-dilutive restricted shares on December 31, 2016.

Performance Unit Awards

On October 28, 2016 and 2015, pursuant to the 2004 Plan, the Company awarded performance unit awards (Performance Units) to officers and key employees. The Performance Units were valued based on a Monte Carlo simulation at $53.46 for the 2016 grants and $79.00 for the 2015 grants, approximately 110.3% and 120.2%, respectively, of the grant share price. Under the plan, participants may earn from 0% to 200% of their target award based upon the Company’s relative total share return (TSR) in comparison to the 15 component companies of the Philadelphia Oil Service Index. The TSR is calculated over a three year period from October 1, 2015 and 2016 to September 30, 2018 and 2019, respectively, and assumes reinvestment of dividends for companies within the index that pay dividends, which Dril-Quip does not. Assumptions used in the Monte Carlo simulation are as follows:



	2015	2016
Grant date	October 28, 2015	October 28, 2016
Performance period	October 1, 2015 to September 30, 2018	October 1, 2016 to September 30, 2019
Volatility	29.5%	32.5%
Risk-free interest rate	0.9795%	1.0100%
Grant date price	$65.72	$48.45

The Company’s Performance Unit activity and related information is presented below:



	Number of Performance Units		Weighted Average Grant Date Fair Value Per Unit
Nonvested balance at December 31, 2015	135,969		$	106.49
Granted	87,503		53.46
Vested	(27,253	)	138.31
Forfeited	—		—
Nonvested balance at December 31, 2016	196,219		$	78.42

Performance Unit compensation expense was $4.6 million for the year ended December 31, 2016, $4.5 million for 2015 and $3.1 million for 2014. For 2016, 2015 and 2014, the income tax benefit recognized in net income for Performance Units was $462,000, $1.1 million and none, respectively. As of December 31, 2016, there was $8.9 million of total unrecognized compensation expense related to nonvested Performance Units which is to be recognized over a weighted average period of 2.1 years. There were 64,546 anti-dilutive Performance Units at December 31, 2016.

Director Stock Compensation Awards

In June 2014, the Board of Directors authorized a stock compensation program for the directors pursuant to the 2004 Plan. Under this program, the Directors may elect to receive all or a portion of their fees in the form of restricted stock awards (DSA) in an amount equal to 125% of the fees in lieu of cash. The awards are made quarterly on the first business day after the end of each calendar quarter and vest on January 1 on the second year after the grant date.

The Company DSA activity for December 31, 2016 is presented below:



	DSA Number of Shares		Weighted Average Grant Date Fair Value Per Share
Nonvested balance at December 31, 2015	6,162		$	71.77
Granted	8,174		58.47
Vested	(914	)	89.39
Forfeited	—		—
Nonvested balance at December 31, 2016	13,422		$	62.46

Director stock compensation awards expense for 2016 was $405,000 as compared to $328,000 for 2015 and $21,600 for 2014. For 2016, 2015 and 2014, the income tax benefit recognized in net income for DSAs was $19,000, $41,000 and none, respectively. There was $300,000 of unrecognized compensation expense related to nonvested DSAs, which is expected to be recognized over a weighted average period of one year. There were 2,162 anti-diluted DSA shares on December 31, 2016.

The following table summarizes information for equity compensation plans in effect as of December 31, 2016:



	Number of securities to be issued upon exercise of outstanding options(1)	Weighted-average exercise price of outstanding options		Number of securities remaining available for future issuance under equity compensation plan (excluding securities reflected in column (a))
Plan category	(a)	(b)		(c)
Equity compensation plans approved by stockholders
Stock options	351,959	$	57.66	184,773
Equity compensation plans not approved by stockholders	—	—		—
Total	351,959	$	57.66	184,773


(1)	Excludes 282,805 shares of unvested RSAs and DSAs and 196,219 of unvested Performance Units, which were granted pursuant to the 2004 Plan approved by the stockholders.