SHARE-BASED COMPENSATION

West Marine’s Omnibus Equity Incentive Plan, as amended (the “Plan”) is intended to provide flexibility to the Company in its ability to motivate, attract and retain the services of associates and non-employee directors. The Plan permits a variety of compensation methods, including non-qualified stock options, incentive stock options, restricted stock, and other share-based awards, such as time-based and performance-based restricted stock units. Key associates and non-employee directors are eligible to participate under the Plan, with the exception of Randolph K. Repass, Chairman of the Company’s Board of Directors and a significant, but not controlling, stockholder. At year-end 2014, 10,300,000 shares of common stock had been reserved under the Plan and 1,538,853 shares were available for future issuance.

The Company recognizes compensation expense for share-based payments based on the grant date fair value of the awards. Share-based payments consist of stock option grants, restricted share awards, restricted stock units, performance-based restricted stock units and Associates Stock Buying Plan ("Buying Plan") issuances, each as described further below.

Share-based compensation expense for 2014, 2013 and 2012 was approximately $3.1 million, $3.2 million and $3.1 million, respectively, of which expense for stock options was $0.8 million, $1.5 million and $1.9 million in 2014, 2013 and 2012, respectively. In 2014, the Company recognized $0.2 million in tax benefits from stock options exercised, restricted stock vested and disqualifying Buying Plan transactions, of which $0.2 million was recognized as excess tax benefits in additional paid-in capital and $0.2 million was recognized as cash flow from financing activities. In 2013, the Company recognized $0.8 million in tax benefits from stock options exercised, restricted stock vested and disqualifying Buying Plan transactions, of which $1.2 million was recognized as excess tax benefits in additional paid-in capital and $1.2 million was recognized as cash flow from financing activities. In 2012, the Company recognized $0.4 million in tax benefits from stock options exercised, restricted stock vested and disqualifying Buying Plan transactions, of which $0.4 million was recognized as excess tax benefits in additional paid-in capital and $0.4 million was recognized as cash flow from financing activities. The tax benefit was included in the Company’s consolidated statement of operations for the same period. Share-based compensation of $0.4 million was included in capitalized indirect inventory in 2014, $0.6 million in 2013 and $0.5 million in 2012.

Included in cost of goods sold and SG&A expense is share-based compensation expense, net of estimated forfeitures, that have been included in the statements of operations for all share-based compensation arrangements as follows:



(in thousands)	2014		2013		2012
Cost of goods sold	$	429	$	609	$	542
Selling, general and administrative expense	2,680		2,598		2,586
Share-based compensation expense	$	3,109	$	3,207	$	3,128

Stock Options

West Marine awards options to purchase shares of common stock to its non-employee directors and to certain eligible associates employed at the time of the grant. For fiscal 2007 through 2010, options granted to associates under the Plan vested over three years and expire five years following the grant date. Grants in 2006 vested over four years and generally expired five years from the grant date. Grants in 2011, 2012 and 2013 vest over three years and expire seven years from the grant date. Prior to 2011, options granted to non-employee directors vested after six months and expire five years from the grant date. Options granted to non-employee directors in 2012 vest after one year and expire seven years from the grant date. Options granted to non-employee directors in 2011 vested after six months and expire seven years from the grant date. Effective 2014, the Company stopped awarding option grants to certain eligible associates and non-employee directors as a method of compensation. The Company has determined the fair value of options awarded by applying the Black-Scholes Merton option pricing valuation model and using following assumptions:



	2013		2012
Expected price volatility	41	%	49	%
Risk-free interest rate	0.6% - 0.9%		0.5% - 0.6%
Weighted-average expected term (years)	4.5		4.5
Dividend yield	—		—

Expected price volatility: This is the percentage amount by which the price of West Marine common stock is expected to fluctuate annually during the estimated expected life for stock options. Expected price volatility is calculated using historical monthly closing prices over a period matching the weighted-average expected term, as management believes such changes are the best indicator of future volatility. An increase in expected price volatility would increase compensation expense.

Share issuance: The Company’s policy is to issue new shares of common stock for purchase under the Plan. Shares of common stock are authorized by the Company’s Board of Directors, subject to stockholder approval, for issuance under the Plan. Subject to adjustment, the maximum number of shares currently available for grant under the Plan may not exceed 10,300,000 shares.

Risk-free interest rate: This is the U.S. Treasury zero-coupon rate, as of the grant date, for issues having a term equal to the expected life of the stock option. An increase in the risk-free interest rate would increase compensation expense.

Expected term: This is the period of time over which stock options are expected to remain outstanding. The Company calculates expected term based on the average of the vesting period and the full contractual term. An increase in the expected term would increase compensation expense.

Dividend yield: The Company historically has not made any dividend payments nor does it expect to pay dividends in the foreseeable future. An increase in the dividend yield would decrease compensation expense.

A summary of the Company’s stock option activity in 2014, 2013 and 2012 is as follows:



	Number of Shares		Weighted Average Exercise Price	Weighted Average Option Grant Date Fair Value
Outstanding at year-end 2011 (2,492,684 stock options exercisable at a weighted-average exercise price of $11.72)	3,534,540		11.14	5.24
Granted	361,636		10.69	4.28
Exercised	(642,246	)	6.07	2.04
Forfeited	(35,256	)	10.01	3.91
Expired	(701,943	)	15.92	7.84
Outstanding at year-end 2012 (1,678,468 stock options exercisable at a weighted-average exercise price of $11.25)	2,516,731		11.05	5.21
Granted	208,834		11.70	4.08
Exercised	(649,305	)	6.79	2.48
Forfeited	(61,763	)	10.75	4.15
Expired	(314,611	)	14.52	9.19
Outstanding at year-end 2013 (1,179,770 stock options exercisable at a weighted-average exercise price of $12.63)	1,699,886		12.13	5.43
Granted	—		—	—
Exercised	(236,052	)	7.14	2.54
Forfeited	(47,924	)	10.96	4.12
Expired	(324,832	)	19.86	11.39
Outstanding at year-end 2014 (896,687 stock options exercisable at a weighted-average exercise price of $10.87)	1,091,078		10.95	4.32

There were no stock options granted in 2014 and the weighted-average grant date fair value of options granted in 2013 and 2012 was $4.08 and $4.28 per share, respectively. The aggregate fair value of options vested during 2014, 2013 and 2012 was $2.5 million, $3.9 million and $3.3 million, respectively.

As of market close January 3, 2015, the aggregate intrinsic value for stock options outstanding was $1.7 million, and $1.5 million for exercisable options. The total intrinsic value of options actually exercised was $1.0 million in 2014, $3.4 million in 2013 and $3.0 million in 2012. The Company did not grant any options in 2014. There were 594,081 options that vested in 2014 with an aggregate grant date fair value of $2.5 million. At January 3, 2015, unrecognized compensation expense for stock options, net of expected forfeitures, was $0.5 million, with a weighted-average remaining expense recognition period of 1.06 years.

Additional information for options outstanding at year-end 2014 is as follows:



	Outstanding Options				Exercisable Options
Range of Exercise Prices	Shares Underlying	Weighted Average Remaining Contractual Term (Years)	Weighted Average Exercise Price		Exercisable Shares	Weighted Average Remaining Contractual Term (Years)	Weighted Average Exercise Price
$ 7.01 – 10.75	439,829	3.8	10.32		382,350	3.6	10.33
10.76 – 15.54	642,249	2.3	11.29		505,337	1.5	11.17
15.55 – 22.00	9,000	0.3	17.27		9,000	0.3	17.27
$ 7.01 – 22.00	1,091,078	2.9	$	10.95	896,687	2.4	$	10.87

At January 3, 2015, there were 725,494 stock options expected to vest in the future, with an intrinsic value of $1.3 million, a weighted-average exercise price of $10.78 per share and a weighted-average remaining contractual term of 0.4 years.

Restricted Share Awards

The Plan also provides for awards of shares to eligible associates and non-employee directors that are subject to restrictions on transfer for a period of time (“restricted shares”). Vesting of restricted shares for eligible associates and non-employee directors is subject to continuing service to West Marine. Restricted shares granted to non-employee directors in 2011 vested 100% one year after the grant date. No restricted shares were awarded in 2012 and 2013. There was no compensation expense for restricted share awards in 2014. There was no unrecognized compensation expense for unvested restricted share awards, net of expected forfeitures, in 2014. A summary of restricted share activity in 2012 is as follows:



	Number of Shares		Weighted Average Grant Date Fair Value
Unvested at year-end 2011 (weighted-average remaining vesting period of 0.5 years)	13,347		9.95
Granted	—		—
Vested	(13,347	)	9.95
Forfeited	—
Unvested at year-end 2012	—		—

There were no restricted shares granted in 2012, 2013 and 2014. The total fair value of restricted shares vested in 2012 was $0.1 million.

Restricted Stock Units

The Plan also allows for awards of restricted stock units (“RSU's”) to eligible associates and non-employee directors that are subject to the recipient's continuing service to the Company. RSU's granted to eligible associates in 2014, 2013 and 2012 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date. RSU's granted to eligible non-employee directors in 2012, 2013 and 2014 vest the earlier of either the one-year anniversary of the grant date or annual meeting stockholder's meeting date. Compensation expense for RSU's was $2.1 million in 2014. Unrecognized compensation expense for unvested RSU's, net of expected forfeitures, was $2.7 million in 2014 and the Company expects to recognize this expense within less than two years. A summary of RSU activity in 2014, 2013 and 2012 is as follows:



	Number of RSU's		Weighted Average Grant Date Fair Value
Unvested at year-end 2011 (weighted-average remaining vesting period of 2.4 years)	133,138		10.36
Granted	188,001		10.56
Vested	(44,052	)
Forfeited	(2,236	)	10.34
Unvested at year-end 2012 (weighted-average remaining vesting period of 2.0 years)	274,851		10.50
Granted	228,488		11.76
Vested	(116,504	)
Forfeited	(40,451	)	11.02
Unvested at year-end 2013 (weighted-average remaining vesting period of 1.8 years)	346,384		11.31
Granted	220,777		11.78
Vested	(163,990	)
Forfeited	(55,008	)	11.56
Unvested at year-end 2014 (weighted-average remaining vesting period of 1.6 years)	348,163		11.60

The total fair value of RSUs vested in 2014 and 2013 was $1.8 million and $1.2 million, respectively. Effective March 1, 2014, the Company began awarding performance-based restricted stock units to certain eligible associates and non-employee directors as a method of compensation.

Performance-based Restricted Stock Units

Starting in fiscal year 2014, performance-based restricted stock units (“PSU's”) were granted to certain eligible associates who were subject to the recipient's continuing service to the Company. The PSU's represented a promise to deliver shares to the associates at a future date if certain vesting conditions were met. These PSU's did not consist of legally issued shares until the vesting event, which was performance and time-based, had occurred. During 2014, 82,324 PSU's were granted, however, the minimum performance hurdle was not met and as a result, the 82,324 PSU's were canceled. There was no compensation expense in 2014.

Associates Stock Buying Plan

The Company has a Buying Plan under which all eligible associates may elect to participate on semiannual grant dates. Participating associates purchase West Marine shares at 85% of the lower of the closing price on (a) the grant date or (b) the purchase date. The Buying Plan includes a twelve calendar month holding period for all purchases beginning on the date on which shares are purchased by participants under the Buying Plan. The number of shares purchased under the Buying Plan in 2014, 2013 and 2012 were 75,119, 82,643 and 87,095, respectively. Expense recognized in each of the years 2014, 2013 and 2012 was $0.2 million. Shares available for future issuance under the Buying Plan at the end of 2014, 2013 and 2012 were 346,981, 422,100 and 504,743, respectively. Assumptions used in determining the fair value of shares issued under the Buying Plan during 2014, 2013 and 2012 were as follows:



	2014		2013		2012
Expected price volatility	30%-34%		22%-28%		39%-49%
Risk-free interest rate	0.1	%	0.1	%	0.1%-0.2%
Weighted-average expected term (years)	0.5		0.5		0.5
Dividend yield	—		—		—

Manager Share Appreciation Plan

During 2012, West Marine introduced and awarded a new form of compensation, the Manager Share Appreciation Plan (“MSAP”). This award is a long-term cash incentive intended to both motivate and reward certain West Marine associates. The MSAP award is a cash incentive which is tied to appreciation in West Marine's stock price. The appreciation on MSAP awards is capped. The plan is a cash-settled plan and earned by associates over a number of years; therefore, it is within the scope of ASC 718, Compensation - Stock Compensation because the amount earned by the associates is based on the price of the Company's stock. Additionally, since the award is settled in cash, the fair value of the award is recorded as a liability, rather than equity. As such, the Company re-measures the awards at fair value each reporting period until the award is settled. The awards vest 33%, 33% and 34% over a three-year period.

Fair value was determined using a Monte Carlo simulation model. A Monte Carlo simulation is a generally accepted statistical technique used, in this instance, to simulate a range of possible future stock prices for West Marine. These stock prices are used to determine the fair values of the awards that have been granted. The Company is using the forfeiture rate of its non-qualified stock options, since the Company does not have sufficient history of the MSAP awards. The Company believes this is a reasonable interim assumption until the Company has sufficient forfeiture history on these awards. The fair value at January 3, 2015, December 28, 2013 and December 29, 2012 was $2.04, $2.59 and $2.04 per award, respectively. Assumptions used in determining the fair value of the MSAP awards during 2014, 2013 and 2012 were as follows:



	2014	2013		2012
Expected price volatility	34%-37%	34	%	45	%
Risk-free interest rate	0.8%-1.4%	1.4	%	0.6	%
Weighted-average expected term (years)	4.1	4.2		4.2
Dividend yield	—	—		—

A summary of the MSAP award activity in 2014, 2013 and 2012 is as follows:



	Number of MSAP's
Unvested at year-end 2011	—
Granted	162,125
Vested	—
Forfeited	(13,375	)
Unvested at year-end 2012	148,750
Granted	163,125
Vested	(43,230	)
Forfeited	(30,875	)
Unvested at year-end 2013	237,770
Granted	244,750
Vested	(78,911	)
Forfeited	(73,250	)
Unvested at year-end 2014	330,359

The MSAP compensation expense recorded for 2014 was $0.4 million and the corresponding liability at January 3, 2015 was $0.5 million. The MSAP compensation expense recorded for 2013 was $0.1 million and the corresponding liability at December 28, 2013 was $0.1 million. The MSAP compensation expense recorded for 2012 was $0.1 million and the corresponding liability at December 29, 2012 was also $0.1 million.

Included in cost of goods sold and SG&A expense is MSAP compensation expense, net of estimated forfeitures, that have been included in the statements of operations for all MSAP compensation arrangements as follows:



(in thousands)	2014		2013		2012
Cost of goods sold	$	33	$	18	$	4
Selling, general and administrative expense	388		77		48
MSAP compensation expense	$	421	$	95	$	52