Share-Based Compensation Plans

3 Months Ended

Mar. 31, 2018

Disclosure of Compensation Related Costs, Share-based Payments [Abstract]

Share-based compensation expense was $9 million and $6 million during the three months ended March 31, 2018 and 2017, respectively. The unrecognized compensation expense related to our stock options, restricted stock units and performance share units was $9 million, $29 million and $25 million, respectively, at March 31, 2018 and is expected to be recognized over a weighted average period of 2.3, 2.4 and 2.2 years, respectively. The amount of cash received from the exercise of stock options was $3 million and $1 million for the three months ended March 31, 2018 and 2017, respectively.

Stock Option Grants

The following is a summary of the changes in outstanding stock options for the three months ended March 31, 2018.



	Share units (in thousands)		Weighted Average Exercise Price / Share		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (in millions)
Outstanding at January 1, 2018	2,076		$	37.44	7.0
Granted	309		75.18
Exercised	(97	)	35.81
Forfeited and expired	(29	)	44.57
Outstanding at March 31, 2018	2,259		$	42.58	7.2	$	78
Options exercisable at March 31, 2018	1,515		$	35.21	6.2	$	63
Vested and expected to vest as of March 31, 2018	2,150		$	40.92	5.9	$	76

The total intrinsic value of options exercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during the three months ended March 31, 2018 was $3.7 million.

Stock Option Fair Value

The fair value of each option grant was estimated on the date of grant using the binomial lattice pricing model which incorporates multiple and variable assumptions over time, including assumptions such as employee exercise patterns, stock price volatility and changes in dividends. The following are weighted-average assumptions for 2018 grants.



Volatility	23.40		%
Risk-free interest rate	2.76		%
Dividend yield	1.12		%
Expected term (in years)	5.1
Weighted-average fair value / share	$	17.81

Expected volatility is calculated based on a weighted analysis of historic and implied volatility measures for a set of peer companies and Xylem. We use historical data to estimate option exercise and employee termination behavior within the valuation model. Employee groups and option characteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options are expected to remain outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of option grant.

Restricted Stock Unit Grants

The following is a summary of restricted stock unit activity for the three months ended March 31, 2018. The fair value of the restricted stock units is equal to the closing share price on the date of the grant.



	Share units (in thousands)		Weighted Average Grant Date Fair Value /Share
Outstanding at January 1, 2018	779		$	35.39
Granted	225		75.18
Vested	(404	)	39.56
Forfeited	(20	)	42.04
Outstanding at March 31, 2018	580		$	57.04

ROIC Performance Share Unit Grants

The following is a summary of Return on Invested Capital ("ROIC") performance share unit grants for the three months ended March 31, 2018. The fair value of the ROIC performance share units is equal to the closing share price on the date of the grant.



	Share units (in thousands)		Weighted Average Grant Date Fair Value /Share
Outstanding at January 1, 2018	298		$	41.48
Granted	76		75.18
Forfeited	(93	)	36.69
Outstanding at March 31, 2018	281		$	52.14

TSR Performance Share Units Grants

The following is a summary of our Total Shareholder Return ("TSR") performance share unit grants for the three months ended March 31, 2018.



	Share units (in thousands)		Weighted Average Grant Date Fair Value /Share
Outstanding at January 1, 2018	213		$	47.04
Granted	76		99.24
Forfeited	(8	)	45.50
Outstanding at March 31, 2018	281		$	61.15

The fair value of TSR performance share units was calculated on the date of grant using a Monte Carlo simulation model utilizing several key assumptions, including expected Company and peer company share price volatility, correlation coefficients between peers, the risk-free rate of return, the expected dividend yield and other award design features. The following are weighted-average assumptions for 2018 grants.



Volatility	26.8	%
Risk-free interest rate	2.44	%