13. Stock Options and Awards

Stock Options

On September 19, 1997, the Company adopted the Dril-Quip, Inc. 1997 Incentive Plan (as amended, the “1997 Plan”) and the Company reserved 3,400,000 shares of Common Stock for use in connection with the 1997 Plan. During 2001, the Company reserved an additional 1,400,000 shares for use in connection with the 1997 Plan. Some options remain outstanding under the 1997 Plan as the last grants were made in 2003; however, no additional grants will be awarded under this plan. On May 13, 2004, the Company’s stockholders approved the 2004 Incentive Plan of Dril-Quip, Inc. (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 1997 Plan and 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 1997 Plan and 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 is estimated on the grant date using the Black-Scholes option pricing model. The expected life is 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.

On October 28, 2011 and 2010, the Company granted options to purchase 213,000 and 237,484 shares, respectively, of Common Stock pursuant to the 2004 Plan to certain officers and employees. There were no stock options granted in 2012. The following table presents the assumptions used in the option pricing model.


	2011			2010
Expected life (years)		6.0			5.8
Volatility		49.5	%		50.1	%
Risk-free interest rate		1.13	%		1.23	%
Dividend yield		0.0	%		0.0	%
Fair value of each option	$	32.38		$	31.76

Option activity for the year ended December 31, 2012 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, 2011		1,085,906		$	49.50
Granted		—			—
Exercised		(280,969	)		38.47
Forfeited		(53,250	)		61.90

Outstanding at December 31,2012		751,687		$	52.74	$	15.3		6.72

Exercisable at December 31,2012		498,878		$	46.46	$	13.3		5.96

The total intrinsic value of stock options exercised in 2012, 2011 and 2010 was $7.6 million, $4.9 million and $13.1 million, respectively. The income tax benefit realized from stock options exercised was $2.7 million for the year ended December 31, 2012.

Stock-based compensation is recognized as selling, general and administrative expense in the accompanying Consolidated Statements of Income. During the years ended December 31, 2012, 2011 and 2010, stock-based compensation expense for stock option exercises totaled $3.8 million, $4.5 million and $5.0 million, respectively. Stock option expense for 2011 excludes $1.4 million of non-cash expense due to the vesting of Mr. J. Mike Walker’s stock options as a result of his retirement. Stock option expense for 2010 excludes $2.0 million of non-cash expense due to the vesting of Mr. Larry E. Reimert’s stock options as a result of his termination with the Company. These expenses for early vesting are included in Special items on the Consolidated Statements of Income and discussed in Note 15 of Notes to Consolidated Financial Statements. No stock-based compensation expense was capitalized during 2012, 2011 or 2010.

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, 2012, there was $7.2 million of total unrecognized compensation expense related to nonvested stock options. This expense is expected to be recognized over a weighted average of 1.60 years.

Restricted Stock Awards

On December 8, 2011 pursuant to the 2004 Plan, the Company awarded certain officers and key employees restricted share awards (“RSA”), 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 restricted stock awards. Restricted shares issued under this plan are restricted as to transference, sale and other disposition. These restrictions vest ratably over a 3-year period. The restrictions may also lapse in case of a change of control. Upon termination, whether voluntary or involuntary, the shares on which restrictions have not lapsed 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 restrictions lapse on a straight-line basis, net of estimated forfeitures.

On May 10, 2012, the three non-employee members of the Board of Directors were awarded an aggregate of 4,800 RSAs. The terms and conditions are substantially the same as the shares awarded in December 2011 to the officers. The awards were valued at $65.34 which represents the closing price on the date of the grant. On October 26, 2012, the Company awarded 84,250 RSAs to key employees and 4,800 to non-employee members of the Board of Directors. The shares were valued at $69.55 which is the closing price on the date of the grant.

On November 15, 2012 the Company awarded 1,600 RSAs to its newly elected director. These shares were valued at the closing price of $67.56 on the date of grant. The newly awarded shares will vest on the same time period as the RSAs granted on October 26, 2012.

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, 2011		60,000		$	69.59
Granted		95,450			69.34
Vested		(18,666	)		69.59
Forfeited		(4,000	)		69.59

Nonvested balance at December 31, 2012		132,784		$	69.41

Restricted stock awards compensation expense for the year ended December 31, 2012 totaled $1.7 million and $87,000 for 2011. There were no grants or expense in 2010. Total income tax benefit recognized in net income for restricted stock awards was $460,000. As of December 31, 2012, there was $8.6 million of total unrecognized compensation cost related to non-vested RSAs, which is expected to be recognized over a weighted average period of 1.75 years.

Performance Unit Awards

On October 26, 2012, the Company awarded 46,350 performance unit awards (“Performance Units”) pursuant to the 2004 Plan to certain officers and key employees. The Performance Units were valued based on a Monte Carlo simulation at $84.66 which is approximately 121% 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”) to the 15 component companies of the Philadelphia Oil Service Index (“OSX index”). Each year on October 1, the Company’s TSR will be calculated and compared to the OSX Index. Based upon the result, the compensation expense for the remainder of the period will be adjusted accordingly. The TSR is calculated over a 3-year period from October 1, 2012 to September 30, 2015 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:


Grant date		October 26, 2012
Performance period		October 1, 2012 to September 30, 2015
Volatility		40.2%
Risk-free interest rate		0.40%
Grant date price		$69.55

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


	Number of Performance Units		Weighted Average Grant Date Fair Value Per Performance Unit
Nonvested balance at December 31, 2011		—	$	—
Granted		46,350		84.66
Vested		—		—
Forfeited		—		—

Nonvested balance at December 31, 2012		46,350	$	84.66

Performance Unit compensation expense for the year ended December 31, 2012 totaled $235,000 and none for 2011. Total income tax benefit recognized in net income for Performance Units was $82,000. As of December 31, 2012, there was $3.7 million (based on 100% result rate) of total unrecognized compensation expense related to non-vested Performance Units which is to be recognized over a weighted average period of 1.88 years.

The following table summarizes information for equity compensation plans in effect as of December 31, 2012:


	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		751,687	$	52.74		871,698
Equity compensation plans not approved by stockholders		—		not applicable		—

Total		751,687	$	52.74		871,698

(1)	Excludes 132,784 shares of unvested restricted stock awards and 46,350 of unvested performance units, which were granted pursuant to the 2004 Plan approved by the stockholders.