Stock-Based Compensation

On July 24, 2014, the Company's shareholders approved the Heritage Financial Corporation 2014 Omnibus Equity Plan ("Equity Plan") that provides for the issuance of 1,500,000 shares of the Company's common stock in the form of stock options, stock appreciation rights, stock awards (which includes restricted stock units, restricted stock awards, performance units, performance shares or bonus shares) and cash incentive awards. The Company issues new shares of common stock to satisfy share option exercises and restricted stock awards. As of December 31, 2018, shares remain available for future issuance under the Equity Plan totaled 955,282.

(a) Stock Option Awards

Stock options generally vest ratably over three years and expire five years after they become exercisable or vest ratably over four years and expire ten years from date of grant. For the years ended December 31, 2018, 2017 and 2016, the Company did not recognize any compensation expense or related tax benefit related to stock options as all of the compensation expense related to the outstanding stock options had been previously recognized. The intrinsic value from options exercised during the years ended December 31, 2018, 2017 and 2016 was $202,000, $161,000 and $177,000, respectively. The cash proceeds from options exercised during the years ended December 31, 2018, 2017 and 2016 were $132,000, $164,000 and $540,000, respectively.

The following table summarizes the stock option activity for the years ended December 31, 2018, 2017 and 2016:



	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (In years)	Aggregate Intrinsic Value (In thousands)
Outstanding at December 31, 2015	79,408		$	14.19
Exercised	(37,713	)	14.31
Forfeited or expired	(4,200	)	16.80
Outstanding at December 31, 2016	37,495		13.77
Exercised	(12,662	)	12.97
Forfeited or expired	(1,602	)	13.76
Outstanding at December 31, 2017	23,231		14.21
Exercised	(9,842	)	13.45
Forfeited or expired	(831	)	14.77
Outstanding, vested and expected to vest and exercisable at December 31, 2018	12,558		$	14.77	1.39	$	188

(b) Restricted Stock Awards

Restricted stock awards granted generally have a four-year cliff vesting or four-year ratable vesting schedule. For the years ended December 31, 2018, 2017 and 2016 the Company recognized compensation expense related to restricted stock awards of $907,000, $1.4 million and $1.8 million, respectively, and a related tax benefit of $191,000, $488,000 and $644,000, respectively. As of December 31, 2018, the total unrecognized compensation expense related to non-vested restricted stock awards was $556,000 and the related weighted average period over which the compensation expense is expected to be recognized is approximately 0.88 years. The vesting date fair value of the restricted stock awards that vested during the years ended December 31, 2018, 2017 and 2016 was $2.2 million, $2.9 million and $2.0 million, respectively.

The following table summarizes the restricted stock award activity for the years ended December 31, 2018, 2017 and 2016:



	Shares		Weighted-Average Grant Date Fair Value
Nonvested at December 31, 2015	264,521		$	15.92
Granted	121,039		17.60
Vested	(112,516	)	15.62
Forfeited	(11,748	)	16.62
Nonvested at December 31, 2016	261,296		16.80
Vested	(113,479	)	16.55
Forfeited	(10,418	)	16.80
Nonvested at December 31, 2017	137,399		17.00
Vested	(67,877	)	16.74
Forfeited	(3,489	)	16.92
Nonvested at December 31, 2018	66,033		$	17.28

During 2017, the Company began issuing stock-settled restricted stock unit awards ("RSU") and performance-based stock-settled restricted stock unit awards ("PRSU"), collectively called "units". RSUs granted vest ratably over three years. PRSUs granted generally have a three-year cliff vesting schedule. Additionally, PRSU grants may be subject to performance-based vesting as well as other approved vesting conditions. The number of shares of actually delivered pursuant to the PRSUs depends on the performance of the Company's Total Shareholder Return and Return on Average Assets over the performance period in relation to the performance of the common stock of a predetermined peer group. The conditions of the grants allow for an actual payout ranging between no payout and 150% of target. The payout level is calculated based on actual performance achieved during the performance period compared to a defined peer group. The fair value of such PRSUs was determined using a Monte Carlo simulation and will be recognized over the subsequent three years. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided.

Expected volatilities in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant. The Company used the following assumptions to estimate the fair value of PRSUs granted during February 2018 and 2017:



	2018		2017
Shares issued	5,550		6,089
Expected Term in Years	2.84		2.85
Weighted-Average Risk Free Interest Rate	2.39	%	1.40	%
Expected Dividend Yield	—	%	—	%
Weighted-Average Fair Value	27.69		24.39
Correlation coefficient	ABA NASDAQ Community Bank Index		ABA NASDAQ Community Bank Index
Range of peer company volatilities	18.99% - 51.42%		17.8% - 63.1%
Range of peer company correlation coefficients	28.16% - 94.29%		8.24% - 89.79%
Heritage volatility	22.30	%	21.80	%
Heritage correlation coefficient	76.44	%	75.93	%

For the year ended December 31, 2018 and 2017, the Company recognized compensation expense related to the units of $1.8 million and $712,000, respectively, and a related tax benefit of $387,000 and $249,000, respectively. As of December 31, 2018, the total unrecognized compensation expense related to non-vested units was $3.5 million and the related weighted-average period over which the compensation expense is expected to be recognized is approximately 2.17 years. The vesting date fair value of the units that vested during the year ended December 31, 2018 was $1.0 million. There were no PRSUs that vested during the years end December 31, 2018 and 2017.

The following table summarizes the unit activity for the year ended December 31, 2018 and 2017:



	Units		Weighted-Average Grant Date Fair Value
Nonvested at December 31, 2016	—		$	—
Granted	92,356		25.31
Forfeited	(1,812	)	25.35
Nonvested at December 31, 2017	90,544		25.31
Granted	125,633		30.62
Vested	(32,375	)	25.44
Forfeited	(4,617	)	27.82
Nonvested at December 31, 2018	179,185		$	28.94