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. At year-end 2016, 10,300,000 shares of common stock had been reserved under the Plan and 959,702 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 stock 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 2016, 2015 and 2014 was approximately $2.8 million, $2.8 million and $3.1 million, respectively, of which expense for stock options was $0.1 million, $0.3 million and $0.8 million in 2016, 2015 and 2014, respectively. In 2015, the Company recognized no tax benefits from stock option exercises, restricted stock vesting or disqualifying Buying Plan transactions. In 2014, the Company recognized $0.2 million in tax benefits from stock options exercised, restricted stock vesting 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 included as part of cash flow from financing activities. The tax benefit was included in the Company’s consolidated statement of income for the same period. Share-based compensation of $0.4 million was included in capitalized indirect inventory in 2016, $0.4 million in 2015 and $0.4 million in 2014.

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



(in thousands)	2016		2015		2014
Cost of goods sold	$	431	$	448	$	429
Selling, general and administrative expense	2,348		2,339		2,680
Share-based compensation expense	$	2,779	$	2,787	$	3,109

Stock Options

West Marine awarded 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 expired five years following the grant date. Grants in 2011, 2012 and 2013 vested over three years and expired seven years from the grant date. Prior to 2011, options granted to non-employee directors vested after six months and expired five years from the grant date. Options granted to non-employee directors in 2012 vested 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. One non-employee director elected to receive options in 2016. Following the grant in 2016, the Company stopped awarding option grants. The Company has determined the fair value of options awarded by applying the Black-Scholes Merton option pricing valuation model and using following assumptions:



	2016		2015		2014
Expected price volatility	33	%	—	%	—	%
Risk-free interest rate	1.2	%	—	%	—	%
Weighted-average expected term (years)	4.0		0.0		0.0
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 2016, 2015 and 2014 is as follows:



	Number of Shares		Weighted Average Exercise Price	Weighted Average Option Grant Date Fair Value
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
Granted	—		—	—
Exercised	(106,783	)	10.69	4.18
Forfeited	(17,823	)	11.19	4.09
Expired	(345,984	)	11.12	4.49
Outstanding at year-end 2015 (575,015 stock options exercisable at a weighted-average exercise price of $10.82)	620,488		10.88	4.26
Granted	10,123		8.99	2.47
Exercised	(124	)	10.36	4.27
Forfeited	(2,670	)	11.69	4.08
Expired	(109,288	)	10.56	4.15
Outstanding at year-end 2016 (508,629 stock options exercisable at a weighted-average exercise price of $10.94)	518,529		10.91	4.25

The weighted-average grant date fair value of options granted in 2016 was $2.47 per share. There were no stock options granted in 2015 and 2014. The aggregate fair value of options vested during 2016, 2015 and 2014 was $0.5 million, $1.6 million and $2.5 million, respectively.

As of market close December 31, 2016, the aggregate intrinsic value of stock options was $0.1 million, and less than $0.1 million for exercisable options. The total intrinsic value of options actually exercised was $0.0 million in 2016, $0.1 million in 2015 and $1.0 million in 2014. There were 128,349 options that vested in 2016 with an aggregate grant date fair value of $0.5 million. At December 31, 2016, unrecognized compensation expense for stock options, net of expected forfeitures, was less than $0.1 million, with a weighted-average remaining expense recognition period of 0.40 years.

Additional information for options outstanding at year-end 2016 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	299,420	1.9	10.27		289,297	1.8	10.32
10.76 – 15.54	219,109	3.0	11.77		219,332	3.0	11.77
$ 7.01 – 15.54	518,529	2.4	$	10.91	508,629	2.3	$	10.94

In fiscal year 2016, there were 127,884 stock options that were vested, and expected to vest in the future, with no intrinsic value, a weighted-average exercise price of $11.56 per share and a weighted-average remaining contractual term of 0.03 years.

Restricted Stock Units

The Plan also allows for awards of time-released restricted stock units (“RSUs”) to eligible associates and non-employee directors that are subject to the recipient's continuing service to the Company. RSUs granted to eligible associates in 2016, 2015 and 2014 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date. RSUs granted to non-employee directors in 2016, 2015 and 2014 vest the earlier of either the one-year anniversary of the grant date or the Company's annual stockholder meeting date following the grant date. Compensation expense for 2016, 2015 and 2014 was $2.2 million, $2.1 million and $2.1 million, respectively. Unrecognized compensation expense for unvested RSUs, net of expected forfeitures, was $2.6 million in 2016, and the Company expects to recognize this expense within less than two years. A summary of RSU activity in 2016, 2015 and 2014 is as follows:



	Number of RSU's		Weighted Average Grant Date Fair Value
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
Granted	251,164		10.66
Vested	(169,692	)
Forfeited	(41,479	)	11.71
Unvested at year-end 2015 (weighted-average remaining vesting period of 1.6 years)	388,156		11.11
Granted	258,036		9.17
Vested	(189,763	)
Forfeited	(33,831	)	10.98
Unvested at year-end 2016 (weighted-average remaining vesting period of 1.6 years)	422,598		9.92

The total fair value of RSUs vested in 2016 and 2015 was $2.1 million and $1.9 million, respectively.

Performance-based Restricted Stock Units

Starting in 2014, performance-based restricted stock units (“PSUs”) were granted to certain eligible associates and are subject to the Company satisfying a performance metric approved by the Compensation and Leadership Development Committee of the Board of Directors and the recipient's continuing service to the Company. The PSUs represent a promise to deliver shares to the associates at a future date if both the performance and time-based vesting conditions were met. PSUs do not consist of legally issued shares until all vesting criteria are satisfied. During 2014, 82,324 PSUs were granted, however, the minimum performance hurdle was not met and, as a result, the 82,324 PSUs were canceled. Accordingly, there was no compensation expense in 2014. PSUs granted to certain eligible associates in 2016 and 2015 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date, unless the minimum performance hurdle is not met and such PSUs are cancelled. Compensation expense for PSUs was $0.3 million and $0.2 million in 2016 and 2015, respectively. Unrecognized compensation expense for unvested PSUs, net of expected forfeitures, was $0.7 million in 2016 and the Company expects to recognize this expense within less than two years. A summary of PSU activity in 2016, 2015 and 2014 is as follows:



	Number of PSU's		Weighted Average Grant Date Fair Value
Unvested at year-end 2013	—
Granted	82,324		12.03
Vested	—
Canceled	(82,324	)	12.03
Unvested at year-end 2014	—
Granted	83,991		11.03
Vested	—
Forfeited	(3,333	)	11.03
Unvested at year-end 2015 (weighted-average remaining vesting period of 2.3 years)	80,658		11.02
Granted	93,440		9.20
Vested	(17,564	)	10.99
Forfeited	(14,844	)	10.89
Unvested at year-end 2016 (weighted-average remaining vesting period of 1.9 years)	141,690		9.82

Associates Stock Buying Plan

The Company has the Buying Plan under which 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 2016, 2015 and 2014 were 81,111, 69,980 and 75,119, respectively. Expense recognized in each of the years 2016, 2015 and 2014 was $0.2 million. Shares available for future issuance under the Buying Plan at the end of 2016, 2015 and 2014 were 195,890, 277,001 and 346,981, respectively. Assumptions used in determining the fair value of shares issued under the Buying Plan during 2016, 2015 and 2014 were as follows:



	2016	2015	2014
Expected price volatility	27%-37%	35%-36%	30%-34%
Risk-free interest rate	0.4% - 0.5%	0.1% - 0.3%	0.1	%
Weighted-average expected term (years)	0.5	0.5	0.5
Dividend yield	—	—	—

Manager Share Appreciation Plan

In November 2015, West Marine ended the Manager Share Appreciation Plan ("MSAP") as the plan was not meeting the Company's goals. The plan was introduced in 2012, and was a long-term cash incentive plan. The MSAP award was a cash incentive which was tied to appreciation in West Marine's stock price. The appreciation on MSAP awards was capped. The plan was a cash-settled plan and earned by associates over a number of years; therefore, it was within the scope of ASC 718, Compensation - Stock Compensation, because the amount earned by the associates was based on the price of the Company's stock. Additionally, since the award was settled in cash, the fair value of the award was recorded as a liability, rather than equity. As such, the Company re-measured the awards at fair value each reporting period until the award was 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 were used to determine the fair values of the awards that had been granted. The Company used the forfeiture rate of its non-qualified stock options, since the Company did not have sufficient history of the MSAP awards. The Company believed this was a reasonable interim assumption until the Company had sufficient forfeiture history on these awards. The fair value at January 3, 2015 and December 28, 2013 (the only dates awards were made under the MSAP) was $2.04 and $2.59 per award, respectively. Assumptions used in determining the fair value of the MSAP awards during 2016, 2015 and 2014 were as follows:



	2016		2015	2014
Expected price volatility	—	%	32%-39%	34%-37%
Risk-free interest rate	—	%	0.5%-1.2%	0.8%-1.4%
Weighted-average expected term (years)			4.2	4.1
Dividend yield	—		—	—

A summary of the MSAP award activity in 2016, 2015 and 2014 is as follows:



	Number of MSAP's
Unvested at year-end 2013	237,770
Granted	244,750
Vested	(78,911	)
Forfeited	(73,250	)
Unvested at year-end 2014	330,359
Granted	242,400
Vested	(103,648	)
Awards paid out	(382,054	)
Forfeited	(87,057	)
Unvested at year-end 2015	—
Granted	—
Vested	—
Awards paid out	—
Forfeited	—
Unvested at year-end 2016	—

The MSAP compensation expense recorded for 2015 was $0.2 million and the plan ended in November 2015; therefore, the liability did not exist at January 2, 2016. The MSAP compensation expense recorded for 2014 was $0.4 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)	2016		2015			2014
Cost of goods sold			$	(11	)	$	33
Selling, general and administrative expense			(216		)	388
MSAP compensation expense	$	—	$	(227	)	$	421