17. Stock-based Compensation and Outstanding Awards

Prior to the Spin-Off, the Company participated in NOV’s stock-based compensation plan known as the National Oilwell Varco, Inc. Long-Term Incentive Plan (the “NOV Plan”) and the Company’s employees were issued NOV equity awards. Under the NOV Plan, the Company’s employees were granted stock options, RSUs, PSAs and/or RSAs. In connection with the Spin-Off, the Company established the NOW Inc. Long-Term Incentive Plan (the “Plan”). The Plan was adopted by the Company’s board of directors and approved by NOV, as the Company’s sole stockholder, on May 1, 2014. Under the terms of the Plan, 16 million shares of Company common stock were authorized for grant and the Company’s employees are eligible to be granted stock options, RSAs, RSUs and PSAs. As a result of the Spin-Off, stock-based compensation awards granted under the NOV Plan and held by Company employees as of May 30, 2014, were adjusted or substituted as follows:

Stock option awards held by Company employees were replaced with substitute awards to purchase NOW common stock.

Unvested RSAs and RSUs under the NOV plan were replaced with adjusted, substitute awards for NOW RSAs or RSUs, as applicable.

PSAs received were replaced entirely with substitute NOW RSAs.

These adjustments were intended to preserve the intrinsic value of the awards on May 30, 2014. Adjustment and substitution of the awards did not result in additional compensation expense.

The determination of fair value of share-based payment awards on the date of grant using option-pricing models is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise activity, risk-free interest rate, expected dividends and expected term.

Stock-based compensation expense recognized in the years ended December 31, 2015, 2014 and 2013 totaled $27 million, $18 million and $6 million, respectively.

As of December 31, 2015, the Company has granted stock options, RSAs, RSUs and PSAs to its employees which are described in more detail below.

Stock Options

The goal of the stock option program is to provide a compensation program that is competitive within the industry while directly linking a significant portion of the employee’s compensation to the enhancement of stockholder value. The ultimate value of any stock option is based solely on the increase in value of the shares of the Company’s common stock over the grant price. Accordingly, stock options have value only if the Company’s stock price appreciates from the date of grant. Additionally, the option holder must remain employed during the period required for the option to “vest”, thus providing an incentive for an option holder to remain employed by the Company. This at-risk component of compensation focuses executives on the creation of stockholder value over the long-term and is therefore inherently performance-based compensation.

Stock option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Stock option awards generally have either a 7-year or a 10-year contractual term and vest over a 3-year period from the grant date on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. The grant-date fair value of stock options is determined using the Black-Scholes framework. Additionally, the Company’s stock options provide for full vesting of unvested outstanding options, in the event of a change of control of the Company and a change in the holder’s responsibilities following a change in control of the Company.

For the stock options granted in 2015, the fair value of each option award was estimated on the date of grant using the Black-Scholes framework that uses the assumptions noted in the table below. The expected volatility was based on the implied volatility on the Company’s stock, historical volatility of the Company’s stock, and the historical volatility of other, similar companies. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant for the period consistent with the expected term. The expected dividends were based on the Company’s history and expectation of dividend payouts. The expected term was based on the average of the vesting period and contractual term.

For the stock options granted in 2014 and 2013, the fair value of each option award was estimated on the date of grant using the Black-Scholes framework that uses the assumptions noted in the table below. The expected volatility was based on NOV’s actual volatility for traded options for the past 10 years prior to grant date. The risk-free rate was based on observed interest rates appropriate for the term of the employee stock options. The expected dividends were based on NOV’s history and expectation of dividend payouts. The expected term was based on NOV’s actual employee exercise activity for the past ten years.

	Year Ended December 31,
	2015			2014			2013
Valuation Assumptions:
Expected volatility		41.2	%		50.0	%		50.1	%
Risk-free interest rate		1.4	%		0.9	%		0.9	%
Expected dividends (per share)	$	—		$	0.75		$	0.75
Expected term (in years)		4.5			3.4			3.4

A summary of stock option activity under the Plan as of December 31, 2015, and changes from December 31, 2014 through December 31, 2015 are presented below:

Stock Options⁽¹⁾	Shares			Weighted- Average Exercise Price		Weighted- Average Grant-Date Fair Value		Aggregate Intrinsic Value (in millions)

Outstanding as of December 31, 2014		3,530,635		$	30.86
Granted		534,929			22.44	$	8.06
Forfeited		(60,586	)		29.51
Exercised or settled		(15,077	)		13.98
Expired or canceled		—			—
Outstanding as of December 31, 2015		3,989,901		$	29.81	$	—	$	—
Exercisable at December 31, 2015		2,437,226		$	31.04	$	—	$	—

⁽¹⁾

All stock option awards presented in this table are for NOW stock only.

The weighted-average remaining contractual terms of outstanding options and exercisable options at December 31, 2015, were 6.6 years and 6.2 years, respectively. The total intrinsic value of options exercised for the years ended December 31, 2015 and 2014 was less than $1 million. As of December 31, 2015, unrecognized compensation cost related to stock option awards was $8 million, which is expected to be recognized over a weighted average period of 1.3 years.

Restricted Stock Awards and Restricted Stock Units

The goal of time-based restricted stock grants is to serve as a key retention tool for the Company to retain its executives and key employees. Restricted stock will have value to the executive even if the Company’s stock price falls below the price on the date of grant, provided that the executive remain employed during the period required for the award to “vest.”

Restricted stock generally cliff vests after 1, 3, 4 or 6 years. The grant-date fair value of restricted stock grants is determined using the closing quoted market price on the grant date. Additionally, the Company’s restricted stock agreements provide for full vesting of restricted stock in the event of a change of control of the Company and a change in the holder’s responsibilities following a change in control of the Company.

A summary of the status of the Company’s nonvested shares of RSAs and RSUs as of December 31, 2015, and changes for the period from December 31, 2014 through December 31, 2015 are presented below:

RSAs / RSUs⁽¹⁾	Shares			Weighted- Average Grant-Date Fair Value

Nonvested as of December 31, 2014		2,443,126		$	30.24
Granted		157,538			22.59
Vested⁽²⁾		(199,813	)		35.20
Forfeited		(16,400	)		31.09
Expired or canceled		—			—
Nonvested as of December 31, 2015		2,384,451		$	29.31

⁽¹⁾

All RSUs and RSAs presented in this table are for NOW stock only.

⁽²⁾

63,209 shares withheld and retired from the vesting of shares to employees to satisfy minimum tax withholding.

The weighted average grant-date fair value was $22.59 and $29.02 for RSA and RSU granted during the year ended December 31, 2015 and 2014, respectively. As of December 31, 2015, unrecognized compensation cost related to RSAs and RSUs was $43 million, which is expected to be recognized over a weighted average period of 3.2 years. The total vest-date fair value of shares vested during the year ended December 31, 2015 and for the period from May 30, 2014 through December 31, 2014 was $4 million and $0, respectively.

Performance Stock Awards

The goal of the performance-based share award program is to provide a compensation program that is also competitive within the industry while directly linking a significant portion of the executive’s compensation to the financial performance of the Company. The performance-based share awards received by the executives have value only if the Company’s designated financial performance objectives are met and exceeded. Additionally, the holder must also remain employed during the period required for the award to “vest”, thus providing an additional incentive for the award holder to remain employed by the Company. This at-risk component of compensation focuses executives on achieving strong financial performance for the Company over the long-term.

Performance stock awards generally have a 3-year vesting period from the grant date and vest at the end of the vesting period. The grant-date fair value of market-condition performance stock grants is determined using a Monte Carlo simulation probabilistic model. The grant-date fair value of performance-condition performance stock grants is determined using the closing quoted market price on the grant date. Additionally, the Company’s performance award agreements provide for full vesting of performance awards in the event of a change of control of the Company and a change in the holder’s responsibilities following a change in control of the Company.

For the year ended December 31, 2015, the Company granted PSAs to senior management employees with potential payouts varying from zero to 146,486 shares. The PSAs were granted on February 24, 2015 and can be earned based on performance against established metrics over a three-year performance period. The PSAs are divided into three equal, independent parts that are subject to three separate performance metrics: (i) one-third of the PSAs have a Total Shareholder Return (TSR) metric (market-condition), (ii) one-third of the PSAs have an EBITDA metric (performance-condition), and (iii) one-third of the PSAs have a Working Capital (WC) metric (performance-condition).

Performance against the TSR metric is determined by comparing the performance of the Company’s TSR with the TSR performance of designated peer companies for the three year performance period. Performance against the EBITDA metric is determined by comparing the performance of the Company’s actual EBITDA average for each of the three-years of the performance period against the EBITDA metrics set by the Company’s Compensation Committee of the Board of Directors. Performance against the WC metric is determined by comparing the performance of the Company’s actual WC average for each of the three-years of the performance period against the WC metrics set by the Company’s Compensation Committee of the Board of Directors.

A summary of the status of the Company’s nonvested shares of PSAs as of December 31, 2015, and changes for the period from December 31, 2014 through December 31, 2015 are presented below:

PSAs	Shares		Weighted- Average Grant-Date Fair Value

Nonvested as of December 31, 2014		—	$	—
Granted		73,243		24.34
Vested		—		—
Forfeited		—		—
Expired or canceled		—		—
Nonvested as of December 31, 2015		73,243	$	24.34

As of December 31, 2015, unrecognized compensation cost related to PSAs was $1 million, which is expected to be recognized over a weighted average period of 2.2 years.