SHARE-BASED COMPENSATION

On December 29, 2009, the Company, in conjunction with the corporate reorganization, adopted the 2009 Stock Incentive Plan. The plan terms are similar to the Company's previous 2008 Plan, except that the new plan has a maximum amount of shares available for issuance of 12,000,000 with a soft cap of 12% of the outstanding shares available for issuance. The 2009 plan provides for the issuance of stock options, restricted stock and restricted stock units.

On August 15, 2012, the shareholders approved the 2013 KEYW Holding Corporation Stock Incentive Plan. The 2013 plan, which takes effect on January 1, 2013, replaces the 2009 plan and provides for the issuance of restricted stock, stock options, and restricted stock units with a maximum of 2,000,000 shares available for issuance.

Stock Options

The Company generally issues stock option awards that vest over varying periods, ranging from three to five years, and have a ten-year life. We estimate the fair value of stock options using the Black-Scholes option-pricing model. Because our common stock did not have a sufficient trading history, we did not use historical data to determine volatility of our stock until the fourth quarter of 2012. Prior to that, we determined volatility by using the historical stock volatility of public companies in our industry with similar characteristics. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. All option awards terminate within ninety days or sooner after termination from the Company except as provided in certain circumstances with regard to our senior executive employment agreements.

The option grants during 2012 and 2011 consist of options issued to new hires, employees acquired through acquisitions and discretionary awards. All equity issuances are priced at market value based upon our publicly-traded share price on the date of grant.

The option grants during 2010 consist of options issued to new hires, employees acquired through acquisitions and discretionary awards. The options issued prior to the IIT acquisition were issued with a $5.50 strike price, options associated with the IIT acquisition and hires through July 15th were issued with a $9.25 strike price, and all options after July 15th through September 30th were issued with a $10.00 strike price. All equity issuances after September 30, 2010 were granted with a strike price equal to the fair market value on the date of grant. Stock prices prior to July 15, 2010 were determined by using the most recent third party valuation as provided by our acquisitions. The $10.00 price used effective July 15, 2010 was determined based on the low end of the IPO range.

The Black-Scholes model requires certain inputs related to dividend yield, risk-free interest rate, expected volatility and forfeitures in order to price the option values. During 2012, 2011 and 2010 our assumptions related to these inputs were as follows:



	2012	2011	2010
Dividend yield	—%	—%	—%
Risk-free interest rate	0.62% - 1.03%	0.87% – 2.24%	1.00% – 3.00%
Expected volatility	28.35% - 52.82%	28.35% – 36.35%	28.35% – 38.55%
Forfeitures	15.00% - 39.00%	15.00% – 39.00%	15.00% – 30.00%

A summary of stock option activity is as follows:



	Number of Shares		Option Exercise Price	Weighted Average Exercise Price
Outstanding 01/01/2010	1,032,250
Granted	811,400		$5.50 - $14.33	$10.72
Exercised	(11,878	)	$5.00 - $12.65	$7.57
Cancelled	(98,810	)	$5.00 - $12.65	$6.66
Outstanding 12/31/2010	1,732,962
Granted	726,200		$6.90 - $14.57	$12.03
Exercised	(50,296	)	$5.00 - $11.99	$5.76
Cancelled	(170,193	)	$5.00 - $14.57	$9.82
Options Outstanding 12/31/2011	2,238,673
Granted	1,393,700		$7.06 - $13.00	$10.62
Exercised	(81,674	)	$5.00 - $12.28	$6.22
Cancelled	(364,285	)	$5.00 - $14.57	$9.50
Options Outstanding 12/31/2012	3,186,414

All stock based compensation has been recorded as part of operating expenses. Accounting standards require forfeitures to be estimated at the time an award is granted and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeiture estimates are disclosed in the information surrounding the option grants. For the periods ended December 31, 2012, 2011, and 2010 share-based compensation expense is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. The total unrecognized stock compensation expense at December 31, 2012 is approximately $8.2 million which will be recognized over three years.

As of December 31, 2012, outstanding stock options were as follows:



Exercise Price	Options Outstanding	Intrinsic Value		Options Vested	Intrinsic Value		Weighted Average Remaining Life (Years)
$5.00	109,950	$	845,515	94,250	$	724,783	5.80
$5.50	752,725	5,412,093		645,378	4,640,268		6.83
$6.90 - $7.66	384,386	2,025,213		36,820	194,467		9.07
$7.96 - $8.14	92,274	433,819		42,045	198,213		8.90
$9.17 - $10.98	415,205	1,249,234		219,658	690,737		8.14
$11.18 - $11.99	176,350	170,430		108,924	98,292		8.23
$12.28 - $12.65	121,274	29,777		68,517	14,595		8.22
$12.69 - $14.57	1,134,250	—		327,692	—		9.20
	3,186,414	$	10,166,081	1,543,284	$	6,561,355



2009 STOCK INCENTIVE PLAN
Total equity available to issue		4,336,265
Total equity outstanding or exercised		3,070,192
Total equity remaining⁽¹⁾		1,266,073

(1) These shares will not be issued as the 2009 plan is now frozen.

Restricted Stock Awards

During 2012, the Company issued restricted stock for employee incentive plans and strategic hires. The Company issued 259,200 shares of restricted common stock to existing employees under the long-term incentive plan. These shares cliff vest in three years. The Company issued an additional 55,500 restricted shares to new hires, employee discretionary awards and board members. The majority of these shares cliff vest in three years. The expense for these shares will be recognized over the vesting life of each individual tranche of shares based upon the fair value of a share of stock at the date of grant. All restricted stock awards have no exercise price.

During 2011, the Company issued restricted stock for employee incentive plans, strategic hirings and related to the FASI acquisition. The Company issued 37,800 shares of restricted common stock to existing employees under the long-term incentive plan. These shares cliff vest in three years. The Company issued an additional 27,000 restricted shares to three other employees. The majority of these shares cliff vest in three years. Another 84,000 shares were issued in conjunction with the FASI acquisition in May 2011 and 4,000 shares in August 2011. These shares vest 25% on June 15, 2013, 25% on December 15, 2013, 25% on June 15, 2014 and 25% on December 15, 2014. The expense for these shares will be recognized over the vesting life of each individual tranche of shares based upon the fair value of a share of stock at the date of grant. All restricted stock awards have no exercise price.

As of December 31, 2012, outstanding unvested restricted stock awards were as follows:



	Unvested Shares
Outstanding 01/01/10	539,940
Granted	77,500
Vested	(167,480	)
Cancelled	(800	)
Outstanding 12/31/10	449,160
Granted	152,800
Vested	(186,414	)
Cancelled	(12,000	)
Outstanding 12/31/11	403,546
Granted	314,700
Vested	(221,263	)
Cancelled	(44,400	)
Outstanding 12/31/12	452,583

Employee Stock Purchase Plan

Effective January 1, 2011, the Company offered an Employee Stock Purchase Plan (“ESPP”) to employees. Under the terms of the ESPP, employees may purchase up to 1,000 shares per quarter at a 15% discount to the market price on the last trading day of the quarter. The Company has elected to use open market purchases for all shares issued under the ESPP. In 2012 and 2011, the Company recognized expense of $163,000 and $242,000, respectively, under the plan.