EMPLOYEE STOCK AND INCENTIVE PLANS

Employee Stock Ownership Plan. We sponsor an ESOP within the RSOP. Eligible employees may contribute to the RSOP plan as of their date of hire. The dividends received by the ESOP are distributed to participants. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings. ESOP employer allocations are funded with contributions paid in either cash or the issuance of ALLETE common stock at the Company’s discretion. We record compensation expense equal to the cash or current market price of stock contributed. ESOP compensation expense was $11.4 million in 2018 ($11.0 million in 2017; $9.2 million in 2016).

According to the accounting standards for stock compensation, unallocated shares of ALLETE common stock held and purchased by the ESOP were treated as unearned ESOP shares and not considered outstanding for earnings per share computations. All ESOP shares have been allocated to participants as of December 31, 2018, 2017 and 2016.

Stock-Based Compensation. Stock Incentive Plan. Under our Executive Long-Term Incentive Compensation Plan (Executive Plan), share-based awards may be issued to key employees through a broad range of methods, including non-qualified and incentive stock options, performance shares, performance units, restricted stock, restricted stock units, stock appreciation rights and other awards. There are 0.9 million shares of ALLETE common stock reserved for issuance under the Executive Plan, of which 0.7 million of these shares remain available for issuance as of December 31, 2018.

The following types of share-based awards were outstanding in 2018, 2017 or 2016:

Non-Qualified Stock Options. Stock options have not been granted since 2008 and none were outstanding as of December 31, 2018 (none in 2017 and an immaterial amount in 2016). These options allow for the purchase of shares of common stock at a price equal to the market value of our common stock at the date of grant. Options become exercisable beginning one year after the grant date, with one-third vesting each year over three years. Options may be exercised up to ten years following the date of grant. In the case of qualified retirement, death or disability, options vest immediately and the period over which the options can be exercised is three years. Employees have up to 3 months to exercise vested options upon voluntary termination or involuntary termination without cause. All options are canceled upon termination for cause. All options vest immediately upon retirement, death, disability or a change of control, as defined in the award agreement. We determine the fair value of options using the Black-Scholes option-pricing model. The estimated fair value of options, including the effect of estimated forfeitures, is recognized as expense on the straight-line basis over the options’ vesting periods, or the accelerated vesting period if the employee is eligible for retirement.

The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the grant date. Expected volatility is estimated based on the historic volatility of our stock and the stock of our peer group companies. We utilize historical option exercise and employee pre-vesting termination data to estimate the option life. The dividend growth rate is based upon historical growth rates in our dividends.

NOTE 16. EMPLOYEE STOCK AND INCENTIVE PLANS (Continued)

Stock-Based Compensation (Continued)

Performance Shares. Under the performance share awards, the number of shares earned is contingent upon attaining specific market goals over a three-year performance period. Market goals are measured by total shareholder return relative to a group of peer companies. In the case of qualified retirement, death, or disability during a performance period, a pro rata portion of the award will be earned at the conclusion of the performance period based on the market goals achieved. In the case of termination of employment for any reason other than qualified retirement, death, or disability, no award will be earned. If there is a change in control, a pro rata portion of the award will be paid based on the greater of actual performance up to the date of the change in control or target performance. The fair value of these awards is determined by the probability of meeting the total shareholder return goals. Compensation cost is recognized over the three-year performance period based on our estimate of the number of shares which will be earned by the award recipients.

Restricted Stock Units. Under the restricted stock unit awards, shares for participants eligible for retirement vest monthly over a three-year period. For participants not eligible for retirement, shares vest at the end of the three-year period. In the case of qualified retirement, death or disability, a pro rata portion of the award will be earned. In the case of termination of employment for any reason other than qualified retirement, death or disability, no award will be earned. If there is a change in control, a pro rata portion of the award will be earned. The fair value of these awards is equal to the grant date fair value. Compensation cost is recognized over the three-year vesting period based on our estimate of the number of shares which will be earned by the award recipients.

Employee Stock Purchase Plan (ESPP). Under our ESPP, eligible employees may purchase ALLETE common stock at a 5 percent discount from the market price; we are not required to apply fair value accounting to these awards as the discount is not greater than 5 percent.

RSOP. The RSOP is a contributory defined contribution plan subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended, and qualifies as an employee stock ownership plan and profit sharing plan. The RSOP provides eligible employees an opportunity to save for retirement.

The following share-based compensation expense amounts were recognized in our Consolidated Statement of Income for the periods presented.



Share-Based Compensation Expense
Year Ended December 31	2018		2017		2016
Millions
Performance Shares		$2.3		$2.1		$1.8
Restricted Stock Units	0.9		1.0		0.8
Total Share-Based Compensation Expense		$3.2		$3.1		$2.6
Income Tax Benefit		$0.9		$0.9		$1.1

There were no capitalized share-based compensation costs during the years ended December 31, 2018, 2017 or 2016.

As of December 31, 2018, the total unrecognized compensation cost for the performance share awards and restricted stock units not yet recognized in our Consolidated Statement of Income was $3.0 million and $1.0 million, respectively. These amounts are expected to be recognized over a weighted-average period of 1.7 years and 1.6 years respectively.

NOTE 16. EMPLOYEE STOCK AND INCENTIVE PLANS (Continued)

Stock-Based Compensation (Continued)

Performance Shares. The following table presents information regarding our non-vested performance shares.



	2018				2017				2016
	Number of Shares		Weighted- Average Grant Date Fair Value		Number of Shares		Weighted- Average Grant Date Fair Value		Number of Shares		Weighted- Average Grant Date Fair Value
Non-vested as of January 1	127,898			$58.23	127,580			$52.56	119,540			$52.72
Granted (a)	66,557			$76.42	50,729			$62.90	57,189			$52.43
Awarded	(58,293	)	$59.82		—		—		—		—
Unearned Grant Award	—		—		(40,801	)		$46.27	(42,126	)		$52.70
Forfeited	(6,469	)		$72.99	(9,610	)		$58.29	(7,023	)		$53.45
Non-vested as of December 31	129,693			$66.12	127,898			$58.23	127,580			$52.56

(a) Shares granted include accrued dividends.

There were 31,843 performance shares granted in January 2019 for the three-year performance period ending in 2021. The ultimate issuance is contingent upon the attainment of certain goals of ALLETE during the performance periods. The grant date fair value of the performance shares granted was $2.3 million. There were 73,532 performance shares awarded in February 2019. The grant date fair value of the shares awarded was $3.9 million.

Restricted Stock Units. The following table presents information regarding our available restricted stock units.



	2018				2017				2016
	Number of Shares		Weighted- Average Grant Date Fair Value		Number of Shares		Weighted- Average Grant Date Fair Value		Number of Shares		Weighted- Average Grant Date Fair Value
Available as of January 1	55,248			$56.18	54,728			$51.79	57,694			$49.86
Granted (a)	16,573			$71.11	21,241			$62.20	20,351			$50.25
Awarded	(18,881	)		$55.78	(17,281	)		$49.72	(19,661	)		$44.33
Forfeited	(3,169	)		$64.92	(3,440	)		$56.00	(3,656	)		$52.87
Available as of December 31	49,771			$60.74	55,248			$56.18	54,728			$51.79

(a) Shares granted include accrued dividends.

There were 12,924 restricted stock units granted in January 2019 for the vesting period ending in 2021. The grant date fair value of the restricted stock units granted was $1.0 million. There were 14,307 restricted stock units awarded in February 2019. The grant date fair value of the shares awarded was $0.7 million.