6. STOCK-BASED COMPENSATION

Our stock-based compensation plans include a Long-Term Incentive Plan (LTIP), an ESPP, and a Restated SOP. A variety of equity programs may be granted under the LTIP. The Restated SOP was terminated for new stock option grants in the second quarter of 2012. Together these plans are designed to promote stock ownership in NW Natural by employees and officers.

Long-Term Incentive Plan

The LTIP is intended to provide a flexible, competitive compensation program for eligible officers and key employees. Under the amended LTIP, shares of common stock are authorized for equity incentive grants in the form of stock, restricted stock, restricted stock units, stock options, or performance shares.

An aggregate of 600,000 shares were authorized for issuance as of December 31, 2011. An additional 250,000 shares were authorized for issuance as stock options in 2012. Shares awarded under the LTIP may be purchased on the open market or issued as new shares.

Of the 850,000 shares authorized for any LTIP award at December 31, 2012, 311,571 shares of common stock were available for any type of award under the LTIP, assuming that market, performance, and service based grants currently outstanding are awarded at the target level. Additionally, the 250,000 shares of common stock added in 2012 were available for option grants at December 31, 2012. There were no outstanding grants of restricted stock or stock options under the LTIP at December 31, 2012 or 2011. The LTIP stock awards are compensatory awards for which compensation expense is based on the fair value of stock awards, with expense being recognized over the performance and vesting period for the outstanding awards.

Performance Shares

Since the LTIP’s inception in 2001, performance shares which incorporate market, performance, and service-based factors, have been granted annually based on three-year performance periods. At December 31, 2012, certain performance share measures had been achieved for the 2010-12 award period. Accordingly, participants are estimated to receive 9,022 shares of common stock and a dividend equivalent cash payment equal to the number of shares of common stock received on the award payout multiplied by the aggregate cash dividends paid per share during the performance period. At December 31, 2011 and 2010, we awarded 8,428 and 8,007 shares of common stock, respectively, for the 2009-11 and 2008-10 award periods, plus a dividend equivalent cash payment equal to the number of shares of common stock received on the award payout multiplied by the aggregate cash dividends paid per share during the performance period. In 2011 and 2010, we expensed $0.4 million and $0.2 million, respectively, for both the 2009-11 and 2008-10 performance share award periods, and on a cumulative basis we accrued a total of $0.8 million and $0.7 million, respectively, related to the 2009-11 and 2008-10 performance periods.

At December 31, 2012, the aggregate number of performance shares granted and outstanding at the target and maximum levels were as follows:



	Performance Shares Awards Outstanding				2012		Cumulative Expense
Performance Period	Target		Maximum		Expense		At Dec. 31, 2012
2010-12	$	41,500	$	83,000	$	452	$	1,170
2011-13	37,950		75,900		294		570
2012-14	35,340		70,680		635		635
Total	$	114,790	$	229,580	$	1,381

For each of these performance periods, awards will be based on total shareholder return relative to a peer group of gas distribution companies over the three-year performance period and on performance results achieved relative to specific core and non-core strategies. Compensation expense is recognized in accordance with the accounting standard for stock compensation based on performance levels achieved and an estimated fair value using a Black-Scholes or binomial model. The weighted-average grant date fair value of unvested shares at December 31, 2012 and 2011 was $51.42 and $25.06 per share, respectively. The weighted-average grant date fair value of shares vested during the year was $45.05 per share and for shares granted during the year was $22.35 per share.

Restricted Stock Units

In 2012, the Company began granting RSUs under the LTIP instead of stock options under the Restated SOP. RSUs include a performance based threshold and a vesting period of four years from the grant date. An RSU obligates the Company upon vesting to issue the RSU holder one share of common stock plus a cash payment equal to the total amount of dividends paid per share between the grant date and vesting date of the RSU. During the year ended December 31, 2012, the Company granted 25,224 RSUs under the LTIP with grant date fair values ranging from $44.43 to $48.25 per share.

Restated Stock Option Plan

The Restated SOP was terminated for new option grants in 2012; however, options that had been granted before the Restated SOP was terminated will remain outstanding until the earlier of their expiration, forfeiture or exercise. Any new grants of stock options would be made under the LTIP. No new stock options were granted during 2012.

At December 31, 2012, a total of 529,925 shares of common stock remained reserved for issuance under the Restated SOP with none available for grant. Options under the Restated SOP were granted only to officers and key employees designated by a committee of our Board of Directors. All options were granted at an option price equal to the closing market price on the date of grant and may be exercised for a period up to 10 years and 7 days from the date of grant. Option holders may exchange shares they have owned for at least six months, valued at the current market price, to purchase shares at the option price.

The fair value of each stock option is estimated on the grant date using the Black-Scholes option pricing model with the following weighted average assumptions and outcomes:



	2011			2010
Risk-free interest rate	2.0		%	2.3		%
Expected life (in years)	4.5			4.7
Expected market price volatility factor	24.5		%	23.2		%
Expected dividend yield	3.8		%	3.8		%
Forfeiture rate	3.1		%	3.2		%
Weighted average grant date fair value	$	6.73		$	6.36

The expected life of our grants was calculated based on our actual experience with previously exercised option grants. The risk-free interest rate was based on the implied yield currently available on U.S. Treasury zero-coupon issues with a life equal to the expected life of the options. Historical data was used to estimate the volatility factor, measured on a daily basis, for a period equal to the duration of the expected life of the option awards. The dividend yield was based on management’s current estimate for future dividend payouts at the time of grant. We expense the total cost of stock option awards granted to retirement eligible employees at the date of grant in accordance with stock option accounting guidance and the retirement vesting provisions of our option agreements.

Information regarding the Restated SOP activity for the three years ended December 31, 2012 is summarized as follows:



	Option Shares		Weighted - Average Price Per Share		Intrinsic Value (In millions)
Balance outstanding, Dec. 31, 2009	484,935		$	39.57	$	2.7
Granted	119,750		44.25		n/a
Exercised	(111,525	)	39.01		0.9
Forfeited	(2,700	)	43.00		n/a
Balance outstanding, Dec. 31, 2010	490,460		40.82		2.8
Granted	122,700		45.74		n/a
Exercised	(24,185	)	33.88		0.3
Forfeited	(9,750	)	44.38		n/a
Balance outstanding, Dec. 31, 2011	579,225		42.09		3.4
Exercised	(46,825	)	40.62		0.4
Forfeited	(2,475	)	43.78		n/a
Balance outstanding, Dec. 31, 2012	529,925		42.22		1.3
Exercisable, Dec. 31, 2012	366,887		41.16		1.2

In the year ended December 31, 2012, cash of $0.7 million was received for option shares exercised and $0.1 million related tax benefit was realized. For the years ended December 31, 2012, 2011, and 2010, the total fair value of options that vested was $0.6 million, $0.6 million and $0.5 million, respectively. The weighted average remaining life of options exercisable and outstanding at December 31, 2012 was 5.1 years and 5.8 years, respectively. As of December 31, 2012, there was $0.5 million of unrecognized compensation cost related to the unvested portion of outstanding stock option awards expected to be recognized over a period extending through 2014.

Employee Stock Purchase Plan

The ESPP allows employees to purchase common stock at 85% of the closing price on the trading day immediately preceding the initial offering date, which is set annually. Each eligible employee may purchase up to $21,244 worth of stock through payroll deductions over a 12-month period, with shares issued at the end of the 12-month subscription period.

Stock-based compensation expense is recognized as operations and maintenance expense or is capitalized as part of construction overhead. The following table summarizes the financial statement impact of stock-based compensation under our LTIP, Restated SOP and ESPP:



In thousands	2012			2011			2010
Operations and maintenance expense, for stock-based compensation	$	1,668		$	1,477		$	1,032
Income tax benefit	(707		)	(597		)	(418		)
Net stock-based compensation effect on net income	$	961		$	880		$	614
Amounts capitalized for stock-based compensation	$	294		$	261		$	182