7. SHARE-BASED COMPENSATION

Overview

Prior to the Merger on May 4, 2012, the Great Wolf Resorts 2004 Incentive Stock Plan (the Old Plan) authorized us to grant up to 3,380,740 options, stock appreciation rights or shares of our common stock to employees and directors. Upon consummation of the Merger, the Old Plan was terminated. We have not issued any stock options or made any stock grants from Old Plan since the Merger.

Under the Old Plan, we recognized share-based compensation expense of $3,348, and $868, net of estimated forfeitures, for the periods January 1, 2012 – May 4, 2012, and May 5, 2012 – September 30, 2012, respectively. The total income tax (benefit) expense recognized related to share-based compensation was $43, and $49, for the periods January 1, 2012 – May 4, 2012, and May 5, 2012 – September 30, 2012, respectively.

Under the Old Plan, we recognized share-based compensation expense of $507 and $1,638, net of estimated forfeitures, for the three months and nine months ended September 30, 2011, respectively. The total income tax expense recognized related to share-based compensation was $11 and $36 for the three and nine months ended September 30, 2011, respectively.

On August 13, 2012, the board of directors of K-9 adopted the K-9 Holdings, Inc. 2012 Equity Incentive Plan (the K-9 Plan). The purpose of the K-9 Plan is to provide a means for K-9 and K-9’s subsidiaries, including the Company, to attract and retain key personnel and for K-9 and its subsidiaries’ directors, officers, employees, consultants and advisors to acquire and maintain an equity interest in K-9. The K-9 Plan will terminate automatically on August 13, 2022. No awards will be granted under the K-9 Plan after that date, but awards granted prior to that date may extend beyond that date.

Under the K-9 Plan, K-9 may grant awards of stock options, including both incentive stock options and nonqualified stock options, stock appreciation rights, restricted stock and restricted stock units, stock bonus awards and performance compensation awards. Subject to adjustment for certain corporate events, K-9 has authorized and reserved for issuance a maximum of 2,436,182 shares of Common Stock under the K-9 Plan.

Under the K-9 Plan, we recognized share-based compensation of $252, net of estimated forfeitures, for the three months ended September 30, 2012 and the period May 5, 2012. The total income tax expense recognized related to share-based compensation under the K-9 Plan was $9 for the three months ended September 30, 2012 and the period May 5, 2012.

We recognize compensation expense on grants of share-based compensation awards on a straight-line basis over the requisite service period of each award recipient. As of September 30, 2012, total unrecognized compensation cost related to share-based compensation awards was $10,266, which we expect to recognize over a weighted average period of approximately 5.1 years.

We anticipate that K-9 would have to issue new shares of its common stock for stock option exercises.

Stock Options

Prior to the Merger, we had granted non-qualified stock options to purchase our common stock under the Old Plan at prices equal to the fair market value of the common stock on the grant dates. The exercise price for options granted under the Old Plan could be paid in cash, shares of common stock or a combination of cash and shares. Stock options expired ten years from the grant date and vested ratably over three years.

We recorded no stock option expense for the periods January 1, 2012 – May 4, 2012; May 5, 2012 – September 30, 2012; and the three and nine months ended September 30, 2011. There were no stock options granted during the periods January 1, 2012 – May 4, 2012; May 5, 2012 – September 30, 2012; and the three and nine months ended September 30, 2011. Upon the consummation of the Merger, all of our outstanding stock options under the Old Plan were cancelled for no consideration.

A summary of stock option activity under the Old Plan during the period January 1, 2012 – May 4, 2012:


	Predecessor
	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Number of shares under option:
Outstanding at beginning of period		15,500		$	17.44		3.02 years
Exercised		0
Cancelled		(15,500	)	$	17.44

Outstanding at end of period		0
Exercisable at end of period		0

Under the K-9 Plan, K-9 has granted non-qualified stock options to purchase K-9’s common stock. These stock options have been issued in three Tranches:

•

Tranche A options will vest and become exercisable in equal installments on each of the first five anniversaries of May 4, 2012.

•

Tranche B options will vest and become exercisable at such time as K-9 Investors, L.P., (K-9’s Principal Stockholder), realizes an internal rate of return that equals or exceeds 20% and a return on invested capital that equals or exceeds two, in each case, based on cash proceeds received by K-9’s Principal Stockholder.

•

Tranche C options will vest and become exercisable at such time as K-9’s Principal Stockholder realizes an internal rate of return that equals or exceeds 25% and a return on invested capital that equals or exceeds three, in each case, based on cash proceeds received by K-9’s Principal Stockholder.

The exercise price for the stock options granted under the K-9 Plan may be paid in cash or shares of common stock. Stock options under the K-9 Plan expire ten years after the date of grant.

Stock options were granted as follows:

•

Tranche A options – 598,771 stock options, with a per share fair market value of $6.27 per share. The fair market value was estimated using the Black-Scholes pricing model and the following assumptions:


Dividend yield	0	%
Risk free interest rate	0.71	%
Expected life of option	5 years
Expected equity volatility	78.5	%

•

Tranche B options – 598,748 stock options, with a per share fair market value of $5.64 per share. The fair market value was estimated using the Monte Carlo pricing model and the following assumptions:


Dividend yield	0	%
Risk free interest rate	0.82	%
Expected life of option	5.5 years
Expected equity volatility	75.2	%

•

Tranche C options – 598,748 stock options, with a per share fair market value of $5.30 per share. The fair market value was estimated using the Monte Carlo pricing model and the following assumptions:


Dividend yield	0	%
Risk free interest rate	0.82	%
Expected life of option	5.5 years
Expected equity volatility	75.2	%

We recorded stock option expense related to the K-9 Plan of $145 for the three and nine months ended September 30, 2012.

A summary of stock option activity under the K-9 Plan during the period August 13, 2012 – September 30, 2012:


	Successor
	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Number of shares under option:
Outstanding at beginning of period		0
Granted		1,796,267	$	10.000		5.17 years
Exercised		0
Cancelled		0

Outstanding at end of period		1,796,267	$	10.000		5.17 years
Exercisable at end of period		0	$	10.000		5.17 years

Market Condition Share Awards

Prior to the Merger, under the Old Plan, certain employees were eligible to receive shares of our common stock in payment of market condition share awards granted to them in accordance with the terms thereof.

We granted 407,593 and 444,002 market condition share awards during the period January 1, 2012 – May 4, 2012 and the nine months ended September 30, 2011, respectively. We recorded share-based compensation expense of $1,493 and $868 for the periods January 1, 2012 – May 4, 2012, and May 5, 2012 – September 30, 2012, respectively. We recorded share-based compensation expense of $183 and $572 for the three and nine months ended September 30, 2011, respectively.

Of the 2012 market condition shares granted:

•

255,107 were based on our common stock’s performance in 2012 relative to a stock index, as designated by the Compensation Committee of the Board of Directors. For shares that are earned, 1/3 of the shares were to vest on December 31, 2012, 1/3 vest on December 31, 2013, and 1/3 vest on December 31, 2014. The per share fair value of these market condition shares was $2.12 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.14	%
Expected stock price volatility	49.92	%
Expected stock price volatility (small-cap stock index)	29.14	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the .89-year treasury constant maturity. Our expected stock price volatility and the expected stock price volatility for the small cap stock index was estimated using daily returns data of our stock and the index for the period February 10, 2010 through February 9, 2012.

Upon the consummation of the Merger, all of the 2012 market condition shares granted were cancelled for no consideration. Unrecognized expense of $542 was recorded during the period May 5, 2012 – September 30, 2012.

•

76,243 were based on our common stock’s absolute performance during the three-year period 2010-2012. For shares that are earned, half of the shares were to vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.05 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.14	%
Expected stock price volatility	49.92	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the .89-year treasury constant maturity. Our expected stock price volatility was estimated using daily returns data of our stock for the period February 10, 2010 through February 9, 2012.

Upon the consummation of the Merger, all of the 2012 market condition shares granted were cancelled for no consideration. Unrecognized expense of $156 was recorded during the period May 5, 2012 – September 30, 2012.

•

76,243 were based on our common stock’s performance in 2010-2012 relative to a stock index, as designated by the Compensation Committee of the Board of Directors. For shares that are earned, half of the shares were to vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.22 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.14	%
Expected stock price volatility	49.92	%
Expected stock price volatility (small-cap stock index)	29.14	%

Upon the consummation of the Merger, all of the 2012 market condition shares granted were cancelled for no consideration. Unrecognized expense of $170 was recorded during the period May 5, 2012 – September 30, 2012.

Of the 2011 market condition shares granted:

•

277,894 were based on our common stock’s performance in 2011 relative to a stock index, as designated by the Compensation Committee of the Board of Directors. For shares that were earned, 1/3 of the shares vest on December 31, 2011, 1/3 vest on December 31, 2012, and 1/3 vest on December 31, 2013. The per share fair value of these market condition shares was $2.35 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.25	%
Expected stock price volatility	64.73	%
Expected stock price volatility (small-cap stock index)	29.39	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the 10.6-month treasury constant maturity. Our expected stock price volatility and the expected stock price volatility for the small cap stock index was estimated using daily returns data of our stock and the index for the period February 11, 2009 through February 10, 2011.

We originally granted 277,894 market condition shares for 2011 and recorded expense during 2011 associated with that estimated number of shares to be issued for these market condition awards. The original share grant amount represented the number of shares that would be earned at a target level of performance. Based on our common stock’s performance in 2011, however, the maximum performance condition for these market condition share awards was met. As a result, we issued 416,841 shares related to these market condition awards. Accordingly, we recorded $109 of additional compensation expense in the fourth quarter of 2011 related to our employees earning the maximum level of shares rather than the target level of shares for these awards.

These shares vested upon consummation of the Merger, and the remaining unrecognized expense of $544 was recorded in the period ended May 4, 2012.

•

83,054 were based on our common stock’s absolute performance during the three-year period 2010-2012. For shares that are earned, half of the shares vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.15 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.58	%
Expected stock price volatility	64.73	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the 1.89-year treasury constant maturity. Our expected stock price volatility was estimated using daily returns data of our stock for the period February 11, 2009 through February 10, 2011.

The original share grant amount represented the number of shares that would be earned at a target level of performance. In conjunction with the signing of the Merger Agreement on March 12, 2012, these shares were deemed granted at the maximum level of performance. As a result, we issued 124,581 shares related to these market condition awards. Accordingly, we recorded $37 of additional compensation expense in the first quarter of 2012 related to our employees being granted the maximum level of shares rather than the target level of shares for these awards.

These shares vested upon consummation of the Merger, and the remaining unrecognized expense of $119 was recorded in the period ended May 4, 2012.

•

83,054 were based on our common stock’s performance in 2010-2012 relative to a stock index, as designated by the Compensation Committee of the Board of Directors. For shares that are earned, half of the shares vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.19 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	0.58	%
Expected stock price volatility	64.73	%
Expected stock price volatility (small-cap stock index)	29.39	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the 1.89-year treasury constant maturity. Our expected stock price volatility and the expected stock price volatility for the small cap stock index was estimated using daily returns data of our stock and the index for the period February 11, 2009 through February 10, 2011.

The original share grant amount represented the number of shares that would be earned at a target level of performance. In conjunction with the signing of the Merger Agreement on March 12, 2012, these shares were deemed granted at the maximum level of performance. As a result, we issued 124,581 shares related to these market condition awards. Accordingly, we recorded $38 of additional compensation expense in the first quarter of 2012 related to our employees being granted the maximum level of shares rather than the target level of shares for these awards.

These shares vested upon consummation of the Merger, and the remaining unrecognized expense of $121 was recorded in the period ended May 4, 2012.

Of the 2010 market condition shares granted:

•

91,463 were based on our common stock’s absolute performance during the three-year period 2010-2012. For shares that were earned, half of the shares vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.53 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	1.27	%
Expected stock price volatility	95.21	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the 2.75-year treasury constant maturity. Our expected stock price volatility was estimated using daily returns data of our stock for the period June 29, 2007 through March 30, 2010.

The original share grant amount represented the number of shares that would be earned at a target level of performance. In conjunction with the signing of the Merger Agreement on March 12, 2012, these shares were deemed granted at the maximum level of performance. As a result, we issued 137,195 shares related to these market condition awards. Accordingly, we recorded $68 of additional compensation expense in the first quarter of 2012 related to our employees being granted the maximum level of shares rather than the target level of shares for these awards.

These shares vested upon consummation of the Merger, and the remaining unrecognized expense of $111 was recorded in the period ended May 4, 2012.

•

91,463 were based on our common stock’s performance in 2010-2012 relative to a stock index, as designated by the Compensation Committee of the Board of Directors. For shares that are earned, half of the shares vest on December 31, 2012, and the other half vest on December 31, 2013. The per share fair value of these market condition shares was $2.61 as of the grant date.

The fair value of these market condition shares was determined using a Monte Carlo simulation and the following assumptions:


Dividend yield	0
Weighted average, risk free interest rate	1.27	%
Expected stock price volatility	95.21	%
Expected stock price volatility (small-cap stock index)	37.51	%

We used an expected dividend yield of 0%, as we did not pay a dividend and did not contemplate paying a dividend in the foreseeable future. The weighted average, risk free interest rate was based on the 2.75-year treasury constant maturity. Our expected stock price volatility and the expected stock price volatility for the small cap stock index was estimated using daily returns data of our stock for the period June 29, 2007 through March 30, 2010.

The original share grant amount represented the number of shares that would be earned at a target level of performance. In conjunction with the signing of the Merger Agreement on March 12, 2012, these shares were deemed granted at the maximum level of performance. As a result, we issued 137,195 shares related to these market condition awards. Accordingly, we recorded $70 of additional compensation expense in the first quarter of 2012 related to our employees being granted the maximum level of shares rather than the target level of shares for these awards.

These shares vested upon consummation of the Merger, and the remaining unrecognized expense of $114 was recorded in the period ended May 4, 2012.

Performance Share Awards

Prior to the Merger, under the Old Plan, certain employees were eligible to receive shares of our common stock in payment of performance share awards granted to them. Grantees of performance shares were eligible to receive shares of our common stock based on the achievement of certain individual and departmental performance criteria during the calendar year in which the shares were granted. We granted 85,036 and 92,633 performance shares during the period January 1, 2012 – May 4, 2012 and nine months ended September 30, 2011, respectively. Shares granted in 2012 were to vest over a three year period, 2012-2014; and shares granted in 2011 were to vest over a three year period, 2011-2013.

The per share fair value of performance shares granted during the period January 1, 2012 – May 4, 2012 and nine months ended September 30, 2011 was $3.35 and $3.23, respectively, which represents the fair value of our common stock on the grant date. We recorded share-based compensation expense of $264 for the period January 1, 2012 – May 4, 2012. There was no share-based compensation expense for the period May 5, 2012 – September 30, 2012. We recorded share-based compensation expense of $71 and $214 for the three and nine months ended September 30, 2011, respectively. Since all shares originally granted were not earned, we recorded a reduction in expense of $19 and $16 during the period January 1, 2012 – May 4, 2012 and nine months ended September 30, 2011, respectively, related to the shares not issued.

Based on their achievement of certain individual and departmental performance goals:

•

Employees earned and were issued 75,152 performance shares in February 2012 related to the 2011 grants and

•

Employees earned and were issued 96,305 performance shares in February 2011 related to the 2010 grants.

Upon the consummation of the Merger, all of the 2012 performance share awards granted were cancelled for no consideration. Performance shares awards granted in 2010 and 2011 vested upon consummation of the Merger, and the remaining unrecognized expense of $68 and $135, respectively, was recorded in the period ending May 4, 2012.

On August 13, 2012, under the K-9 Plan, certain employees received shares of K-9’s common stock, which will vest on the date that those employees receive a bonus in respect of 2012 from the Company. To the extent the bonus payable to the employees for fiscal year 2012 is less than a certain threshold, the employees will forfeit a number of shares with a value equal to the shortfall. We granted 37,500 performance shares during the period August 13, 2012 – September 30, 2012. The per share fair value of the performance shares was $10.00, which represents the fair value of K-9’s common stock on the grant date. We recorded share-based compensation expense of $107 for the three and nine months ended September 30, 2012, respectively.

Deferred Compensation Awards

Pursuant to their employment arrangements, two executives received bonuses upon completion of our initial public offering. Executives receiving bonus payments totaling $2,200 elected to defer those payments pursuant to our deferred compensation plan. To satisfy this obligation, we contributed 129,412 shares of our common stock to the trust that holds the assets to pay obligations under our deferred compensation plan. The fair value of that stock at the date of contribution was $2,200. We have recorded the fair value of the shares of common stock, at the date the shares were contributed to the trust, as a reduction of our stockholders’ equity. In 2008, one of the executives who had deferred a bonus payment resigned from our company and our deferred compensation plan sold the shares held in that plan related to the deferred bonus payment. In 2012, the other executive who had deferred a bonus payment sold the shares in the deferred compensation plan. As a result, we have reclassified $2,200 previously recorded as deferred compensation to additional paid-in-capital.

We account for the change in fair value of the shares held in the trust as a charge to compensation cost. We recorded share-based compensation income of $34 for the period January 1, 2012 – May 4, 2012. There was no share-based compensation expense for the period May 5, 2012 – September 30, 2012. We recorded share-based compensation income of $6 and $1, for the three and nine months ended September 30, 2011, respectively.

Non-vested Shares

Prior to the Merger, we had granted non-vested shares as follows:

•

We had granted non-vested shares to certain employees and our directors. These shares vested over time periods between three and five years. We valued these non-vested shares at the closing market value of our common stock on the date of grant.

•

We had granted non-vested shares to certain employees for shares earned under the Market Condition Share Awards as described above. These shares vested ratably over a three-year period. We valued the non-vested shares related to Market Condition Shares using a Monte Carlo simulation as described above.

•

We had granted non-vested shares to certain employees for shares earned under the Performance Share Awards as described above. These shares vested ratably over a three-year period. We valued the non-vested shares related to Performance Share Awards at the closing market value of our common stock on the date of grant of the Performance Share Awards.

Upon the consummation of the Merger, each non-vested share outstanding vested, was cancelled and converted into the right to receive the Offer Price and the remaining unrecognized expense of $1,323 was recorded in the period ended May 4, 2012.

A summary of non-vested shares activity for the period January 1, 2012 – May 4, 2012 is as follows:


	Predecessor
	Shares			Weighted Average Grant Date Fair Value
Non-vested shares balance at beginning of period		910,678		$	3.13
Granted		1,015,545		$	2.43
Forfeited		(2,500	)	$	3.00
Vested		(1,923,723	)	$	2.76

Non-vested shares balance at end of period		0		$	0

We recorded share-based compensation expense related to non-vested shares of $1,644 for the period January 1, 2012 – May 4, 2012. There was no share-based compensation expense for the period May 5, 2012 – September 30, 2012. We recorded share-based compensation expense related to non-vested shares of $259 and $847 for the three and nine months ended September 30, 2011, respectively.

Subsequent to the Merger, under the K-9 Plan, we granted non-vested shares to certain employees for shares earned under the Performance Share Awards as described above.

A summary of non-vested shares activity for the period May 5, 2012—September 30, 2012 is as follows:


	Successor
	Shares		Weighted Average Grant Date Fair Value
Non-vested shares balance at beginning of period		0
Granted		37,500	$	10.00
Forfeited		0
Vested		0

Non-vested shares balance at end of period		37,500	$	10.00

Vested Shares

During the nine months ended September 30, 2011, our directors had the option to elect to have some or the entire cash portion of their annual fees paid in the form of shares of our common stock rather than cash. Directors making this election received shares having a market value equal to 125% of the cash they would otherwise receive. Shares issued in lieu of cash fee payments are fully vested upon issuance.

We recorded non-cash professional fees expense of $22 for the nine months ended September 30, 2011, related to these elections to received shares in lieu of cash. We issued 10,188 shares in the nine months ended September 30, 2011 related to these elections.