7.  Share-Based Compensation and Cash-Based Incentive Compensation

In 2010, the W&T Offshore, Inc. Amended and Restated Incentive Compensation Plan (the “Plan”) was approved by our shareholders, and amendments to the Plan were approved by our shareholders in May 2013.  As allowed by the Plan, during the nine months ended September 30, 2014, and in 2013 and 2012, the Company granted restricted stock units (“RSUs”) to certain of its employees.  RSUs are a long-term compensation component of the Plan, which are granted to only certain employees, and are subject to adjustments at the end of the applicable performance period based on the achievement of certain predetermined criteria.  In addition to share-based compensation, the Company may grant to its employees cash-based incentive awards, which are a short-term component of the Plan and are based on the Company and the employee achieving certain pre-defined performance criteria.

During the nine months ended September 30, 2014, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) net income before income tax expense, net interest expense, depreciation, depletion, amortization, accretion and certain other items (“Adjusted EBITDA”) for 2014 and (ii) Adjusted EBITDA as a percent of total revenue (“Adjusted EBITDA Margin”) for 2014.  Adjustments range from 0% to 100% dependent upon actual results compared against pre-defined performance levels.  

During 2013, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) Adjusted EBITDA for 2013; (ii) Adjusted EBITDA Margin for 2013; and (iii) the Company’s total shareholder return (“TSR”) ranking against peer companies’ TSR for 2013, 2014 and January 1, 2015 to October 31, 2015.  TSR is determined based upon the change in the entity’s stock price plus dividends for the applicable performance period.  For 2013, the Company exceeded the target for Adjusted EBITDA, was approximately at target for 2013 Adjusted EBITDA Margin and was below target for TSR ranking.  

During 2012, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) earnings per share for 2012; and (ii) the Company’s TSR ranking against peer companies’ TSR for 2012, 2013 and January 1, 2014 to October 31, 2014.  Pursuant to the Plan, discretionary authority was exercised for certain non-executive employees, which reduced the forfeitures that would have occurred through application of the pre-defined performance measurement.

All RSUs granted to date are subject to employment-based criteria and vesting occurs in December of the second year after the grant.  For example, the RSUs granted during 2012 will vest in December 2014 to eligible employees.

The 2014 annual incentive plan award for the Chief Executive Officer (“CEO”) will be settled in shares of common stock based on a price of $14.66 per share, subject to pre-defined performance measures and approval of the Compensation Committee.  As the number of shares cannot be determined and a grant has not yet been made, the CEO’s 2014 award is accounted for as a liability award and adjusted to fair value using the Company’s closing price at the end of each reporting period. The compensation related to the 2013 annual incentive plan for the CEO was determined based on pre-defined company and individual performance measures pursuant to the terms of his award and was settled in shares of common stock in March 2014.  The performance measures for the CEO’s award were the same as the performance measures established for the other eligible Company employees for 2014 and 2013, respectively.  

Under the Director Compensation Plan, shares of restricted stock (“Restricted Shares”) were granted to the Company’s non-employee directors during 2014 and prior years.  The Restricted Shares are subject to service conditions and vesting occurs at the end of specified service periods.

At September 30, 2014, there were 5,032,939 shares of common stock available for issuance in satisfaction of awards under the Plan and 500,564 shares of common stock available for issuance in satisfaction of awards under the Director Compensation Plan. The shares available for both plans are reduced when Restricted Shares or shares of common stock are granted.  RSUs will reduce the shares available in the Plan only when RSUs are settled in shares of common stock.  Although the Company has the option to settle RSUs in stock or cash at vesting, only common stock has been used to settle vested RSUs to date.

We recognize compensation cost for share-based payments to employees and non-employee directors over the period during which the recipient is required to provide service in exchange for the award, based on the fair value of the equity instrument on the date of grant.  We are also required to estimate forfeitures, resulting in the recognition of compensation cost only for those awards that are expected to actually vest.

Awards Based on Restricted Stock to Non-Employee Directors.  As of September 30, 2014, all of the unvested shares of Restricted Shares outstanding were issued to the non-employee directors.  Restricted Shares are subject to forfeiture until vested and cannot be sold, transferred or disposed of during the restricted period. The holders of Restricted Shares generally have the same rights as a shareholder of the Company with respect to such Restricted Shares, including the right to vote and receive dividends or other distributions paid with respect to the Restricted Shares.  The fair value of Restricted Shares was estimated by using the Company’s closing price on the grant date.

A summary of activity in 2014 related to Restricted Shares awarded to non-employee directors is as follows:

Subject to the satisfaction of service conditions, the outstanding Restricted Shares issued to the non-employee directors as of September 30, 2014 are expected to vest as follows:

The grant date fair value of Restricted Shares granted during the nine months ended September 30, 2014 and 2013 was $0.3 million and $0.3 million, respectively.  The fair value of Restricted Shares that vested during the nine months ended September 30, 2014 and 2013 was $0.3 million and $0.4 million, respectively.  

Awards Based on Restricted Stock Units.  As of September 30, 2014, the Company had outstanding RSUs issued to certain employees.  As described above, the RSUs granted during the nine months ended September 30, 2014 are subject to pre-defined performance measures which cannot be determined at this time; therefore, no portion has been determined to be eligible for vesting as of September 30, 2014.  A portion of the RSUs granted during 2013 and 2012 remains subject to certain pre-defined performance measures of TSR for the defined periods in 2014 and 2015; therefore, the number of RSUs may be adjusted upon determination of the respective performance.  These RSU adjustments related to TSR performance will not affect unrecognized expense, as the fair value of the portion related to market-based awards was established at the date of grant (described below) and actual performance does not affect expense recognition for this portion.  The portion of RSUs subject to performance measurement and adjustment ranges are disclosed in the second table below.  

The fair value for the RSUs granted during the nine months ended September 30, 2014 was determined using the Company’s closing price on the grant date.  The fair value for the 2013 RSUs was determined separately for the component related to the Company specific performance measures (Adjusted EBITDA and Adjusted EBITDA Margin) and the component related to TSR targets.  The fair value of the 2013 RSUs component related to the Company specific performance measures was determined using the Company’s closing price on the grant date.  The fair value for the 2013 RSUs component related to TSR targets was determined by using a Monte Carlo simulation probabilistic model.  The inputs used in the probabilistic model for the Company and the peer companies were: average closing stock prices during January 2013; risk-free interest rates using the London Interbank Offered Rate (“LIBOR”) ranging from 0.27% to 0.91% over the service period; expected volatilities ranging from 30% to 63%; expected dividend yields ranging from 0.0% to 3.1%; and correlation factors ranging from (84%) to 95%.  The expected volatilities, expected dividends and correlation factors were developed using historical data.

A methodology similar to that employed for the 2013 RSUs was used to determine the fair value for the 2012 RSUs.  The inputs used in the probabilistic model for the Company and the peer companies were: average closing stock prices during January 2012; risk-free interest rates using the LIBOR ranging from 0.15% to 0.72% over the service period; expected volatilities ranging from 33% to 74%; expected dividend yields ranging from 0.0% to 2.5%; and correlation factors ranging from (67%) to 94%.  The expected volatilities, expected dividends and correlation factors were developed using historical data.

All RSUs awarded are subject to forfeiture until vested and cannot be sold, transferred or otherwise disposed of during the restricted period.  Dividend equivalents are earned at the same rate as dividends paid on our common stock after achieving the specified performance requirement for that component of the RSUs.

A summary of activity in 2014 related to RSUs is as follows:

All of the outstanding RSUs are subject to the satisfaction of service conditions and a portion of the outstanding RSUs are also subject to pre-defined performance measurements.  The RSUs outstanding as of September 30, 2014 potentially eligible to vest are listed in the table below:    

The grant date fair value of RSUs granted during the nine months ended September 30, 2014 and 2013 was $20.0 million and $12.8 million, respectively.  The fair value of RSUs that vested during the nine months ended September 30, 2014 was $0.1 million and resulted from a retirement.  During the nine months ended September 30, 2013, there was no vesting of RSUs.

Awards Based on Common Stock.  A grant and issuance of 42,547 shares of common stock was made in March 2014 to the CEO pursuant to the terms of his 2013 annual incentive compensation award.  The number of shares was determined after deductions for withholding and payroll taxes and the shares were valued at the Company’s closing price as of the date of grant.   

Share-Based Compensation.  A summary of incentive compensation expense under share-based payment arrangements and the related tax benefit is as follows (in thousands):  

Unrecognized Share-Based Compensation.  As of September 30, 2014, unrecognized share-based compensation expense related to our awards of Restricted Shares, RSUs and common stock was $0.6 million, $21.7 million and $0.2 million, respectively.   Unrecognized share-based compensation expense will be recognized through April 2017 for Restricted Shares, November 2016 for RSUs and February 2015 for awards based on common shares.

Cash-Based Incentive Compensation. As defined by the Plan, annual incentive awards may be granted to eligible employees and payable in cash.  (In the case of the award to the CEO, the awards for 2014 and 2013 are paid in shares of common stock as described above.)  These awards are performance-based awards consisting of one or more business criteria or individual performance criteria and a targeted level or levels of performance with respect to each of such criteria.  Generally, the performance period is the calendar year and determination and payment is made in cash in the first quarter of the following year.

Share-Based Compensation and Cash-Based Incentive Compensation Expense.  A summary of incentive compensation expense is as follows (in thousands):