6. STOCK-BASED COMPENSATION

Our stock-based compensation plans are designed to promote stock ownership in NW Natural by employees and officers. These 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 2012.

Long-Term Incentive Plan

The LTIP is intended to provide a flexible, competitive compensation program for eligible officers and key employees. Under the 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 850,000 shares were authorized for issuance as of December 31, 2013. Shares awarded under the LTIP may be purchased on the open market or issued as new shares.

Of the 850,000 shares of common stock authorized for LTIP awards at December 31, 2013, there were 241,169 shares available for issuance under any type of award. This assumes that market, performance, and service based grants currently outstanding are awarded at the target level. Additionally, 250,000 shares of common stock were available for option grants at December 31, 2013. There were no outstanding grants of restricted stock or stock options under the LTIP at December 31, 2013 or 2012. 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 of 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 with three-year performance periods. The following table summarizes performance share expense information:



Expense in millions	Shares⁽¹⁾	Expense During Award Year⁽³⁾		Total Expense for Award
Estimated award:
2011-2013 grant⁽²⁾	9,516	$	0.4	$	1.0
Actual award:
2010-2012 grant	9,924	0.5		1.2
2009-2011 grant	8,428	0.4		0.8

⁽¹⁾In addition to common stock shares, a participant also receives 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.

⁽²⁾This represents the estimated number of shares to be awarded as of December 31, 2013 as certain performance share measures had been achieved. Amounts are subject to change with final payout amounts authorized by the Board of Directors in February 2014.

⁽³⁾Amount represents the expense recognized in the third year of the vesting period noted above.

The aggregate number of performance shares granted and outstanding at the target and maximum levels were as follows:



Dollars in thousands	Performance Share Awards Outstanding		2013		Cumulative Expense
Performance Period	Target	Maximum	Expense		December 31, 2013
2011-13	37,950	75,900	$	390	$	960
2012-14	35,340	70,680	603		1,238
2013-15	37,300	74,600	486		486
Total	110,590	221,180	$	1,479

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-based compensation and calculated based on performance levels achieved and an estimated fair value using the Monte-Carlo method. The weighted-average grant date fair value of unvested shares at December 31, 2013 and 2012 was $43.39 and $51.42 per share, respectively. The weighted-average grant date fair value of shares vested during the year was $30.86 per share and for shares granted during the year was $38.96 per share. As of December 31, 2013, there was $1.6 million of unrecognized compensation cost related to the unvested portion of performance awards expected to be recognized through 2015.

Restricted Stock Units

In 2012, the Company began granting RSUs under the LTIP instead of stock options under the Restated SOP. The majority of RSUs include a performance-based threshold and generally have 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. The fair value of the RSU is equal to the closing market price of the Company's common stock on the grant date.

Information regarding the RSU activity is summarized as follows:



	Number of RSUs		Weighted - Average Price Per RSU
Nonvested, Dec. 31, 2011	—		$	—
Granted	25,224		47.58
Vested	—		—
Forfeited	(360	)	48.00
Nonvested, Dec. 31, 2012	24,864		47.57
Granted	25,748		45.38
Vested	(5,455	)	48.01
Forfeited	(590	)	46.58
Nonvested, Dec. 31, 2013	44,567		46.27

As of December 31, 2013, there was $1.5 million of unrecognized compensation cost from grants of RSUs, which is expected to be recognized over a period extending through 2017.

Restated Stock Option Plan

The Restated SOP was terminated for new option grants in 2012; however, options that had been granted before the plan 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. We did not grant new stock options during 2012 or 2013.

At December 31, 2013, a total of 492,150 shares of common stock remained reserved for issuance under the Restated SOP. As the plan is closed, there are no additional shares 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
Risk-free interest rate	2.0		%
Expected life (in years)	4.5
Expected market price volatility factor	24.5		%
Expected dividend yield	3.8		%
Forfeiture rate	3.1		%
Weighted average grant date fair value	$	6.73

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 is summarized as follows:



	Option Shares		Weighted - Average Price Per Share		Intrinsic Value (In millions)
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
Exercised	(33,800	)	32.16		0.3
Forfeited	(3,975	)	43.72		n/a
Balance outstanding, Dec. 31, 2013	492,150		42.89		0.6
Exercisable, Dec. 31, 2013	409,036		42.41		0.6

During 2013, cash of $1.1 million was received for option shares exercised and $0.2 million related tax benefit was realized. During 2013, 2012, and 2011, the total fair value of options that vested was $0.5 million, $0.6 million and $0.6 million, respectively. The weighted average remaining life of options exercisable and outstanding at December 31, 2013, was 4.8 years and 5.1 years, respectively. As of December 31, 2013, there was $0.2 million of unrecognized compensation cost related to the unvested portion of outstanding stock option awards expected to be recognized during 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 $21,236 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

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	2013			2012			2011
Operations and maintenance expense, for stock-based compensation	$	1,876		$	1,668		$	1,477
Income tax benefit	(765		)	(707		)	(597		)
Net stock-based compensation effect on net income	$	1,111		$	961		$	880
Amounts capitalized for stock-based compensation	$	331		$	294		$	261