Stock-based Compensation Plans

The effect of stock-based compensation on our statements of operations is presented below.



	2016		2015		2014
	(in millions, except per share data)
Decrease in operating income	$	9.1	$	7.0	$	13.2
Decrease in net income	5.8		4.4		8.1
Decrease in earnings per basic share	0.04		0.03		0.05
Decrease in earnings per diluted share	0.04		0.03		0.05

We excluded 867,065, 1,165,414 and 1,103,845 instruments from the calculation of diluted earnings per share for 2016, 2015 and 2014, respectively, because the effect of including them would have been antidilutive.

At September 30, 2016, there was approximately $4.6 million of unrecognized compensation expense related to stock-based awards not yet vested. We expect to recognize this expense over a weighted average life of approximately 1.3 years.

The Mueller Water Products, Inc. 2006 Stock Incentive Plan (“2006 Plan”) authorizes an aggregate of 20,500,000 shares of common stock that may be granted through the issuance of stock-based awards. Any awards canceled are available for reissuance. Generally, all of our employees and members of our board of directors are eligible to participate in the 2006 Plan. At September 30, 2016, 7,319,621 shares of common stock were available for future grants of awards under the 2006 Plan. This total assumes that the maximum number of shares will be earned for awards for which the final number of shares to be earned has not yet been determined.

An award granted under the 2006 Plan vests at such times and in such installments as set by the Compensation and Human Resources Committee of the board of directors, but no award will be exercisable after the ten-year anniversary of the date on which it is granted. Management expects some instruments will be forfeited prior to vesting. Grants to members of our board of the directors are expected to vest fully. Based on historical forfeitures, we expect grants to others to be forfeited at an annual rate of 2%.

Restricted Stock Units. Depending on the specific terms of each award, restricted stock units generally vest on the three-year anniversary of the grant date, or ratably over the life of the award, usually three years, on each anniversary date of the original grant. Compensation expense for restricted stock units is recognized between the grant date and the vesting date (or the date on which a participant becomes Retirement-eligible, if sooner) on a straight-line basis for each tranche of each award. Fair values of restricted stock units are determined using the closing price of our common stock on the respective dates of grant. Restricted stock unit activity under the 2006 Plan is summarized below.



	Restricted stock units		Weighted average grant date fair value per unit		Weighted average remaining contractual term (years)	Aggregate intrinsic value (millions)
Outstanding at September 30, 2013	1,925,340		$	4.30	0.9
Granted	381,012		8.51
Vested	(1,099,591	)	4.94			$	9.4
Cancelled	—		—
Outstanding at September 30, 2014	1,206,761		5.04		0.7
Granted	459,659		9.70
Vested	(793,630	)	3.99			7.7
Cancelled	—		—
Outstanding at September 30, 2015	872,790		8.45		0.8
Granted	360,255		9.33
Vested	(510,535	)	7.94			4.7
Cancelled	(59,062	)	8.23
Outstanding at September 30, 2016	663,448		$	9.34	1.0

Performance Shares. Performance-based restricted stock units (“PRSUs”) represent a target number of units that may be paid out at the end of a multi-year award cycle consisting of annual performance periods coinciding with our fiscal years. As determined at the date of award, PRSUs may settle in cash-value equivalent of, or directly in, shares of our common stock. Settlement will range from zero to two times the number of PRSUs granted, depending on our financial performance against predetermined targets. The Compensation and Human Resources Committee of our board of directors (“Committee”) establishes performance goals within 90 days of the beginning of each performance period, with such date referred to as the “grant date”. At the end of each annual performance period, the Committee confirms performance against the applicable performance targets. PRSUs do not convey voting rights or earn dividends. PRSUs vest on the last day of an award cycle, unless vested sooner due to a “Change of Control” of the Company, or the death, disability or Retirement of a participant.

There were 243,992 cash-settled PRSUs awarded in the quarter ended December 31, 2012 that settled in the quarter ended December 31, 2014 for $4.0 million. Compensation expense for cash-settled PRSUs was recognized over the applicable performance periods based on the estimated performance factor and the closing price of our common stock at each balance sheet date.

We recognize compensation expense for stock-settled PRSUs starting on the first day of the applicable performance period and ending on the respective vesting dates. We base the recognized compensation expense upon the number of units awarded for each performance period, the closing price of our common stock on the grant date and the estimated performance factor. In 2016, we issued 542,212 shares to settle the PRSUs awarded November 27, 2012. Stock-settled PRSUs activity under the 2006 Plan is summarized below.



Award date	Settlement year	Performance period	Grant date per unit fair value		Units awarded	Units forfeited		Net units	Performance factor	Shares earned
November 27, 2012	2016	2013	$	5.22	135,553	—		135,553	2.000	271,106
		2014	$	8.52	135,553	—		135,553	2.000	271,106
		2015	$	9.78	135,552	—		135,552	0.000	—
December 3, 2013	2017	2014	$	8.52	90,841	(5,401	)	85,440	2.000	170,880
		2015	$	9.78	90,841	(5,401	)	85,440	0.000	—
		2016	$	9.38	90,849	(5,402	)	85,447	1.021	87,241
December 2, 2014	2018	2015	$	9.78	80,233	(7,318	)	72,915	0.000	—
		2016	$	9.38	80,229	(7,318	)	72,911	1.021	74,442
		2017			80,229	(7,319	)	72,910
December 1, 2015	2019	2016	$	9.38	77,821	(3,997	)	73,824	1.021	75,374
		2017			77,821	(3,997	)	73,824
		2018			77,829	(3,999	)	73,830

Stock Options. Stock options generally vest ratably over three years on each anniversary date of the original grant. Stock options granted since November 2007 also vest upon the Retirement of a participant. Compensation expense for stock options is recognized between the grant date and the vesting date (or the date on which a participant becomes Retirement-eligible, if sooner) on a straight-line basis for each tranche of each award. Stock option activity under the 2006 Plan is summarized below.



	Options		Weighted average exercise price per option		Weighted average remaining contractual term (years)	Aggregate intrinsic value (millions)
Outstanding at September 30, 2013	5,124,706		$	6.22	5.9	$	14.6
Granted	86,904		8.58
Exercised	(587,964	)	4.61			—
Cancelled	(71,411	)	12.92
Outstanding at September 30, 2014	4,552,235		6.37		5.0	13.6
Granted	97,119		9.97
Exercised	(506,632	)	3.42			3.2
Cancelled	(150,056	)	13.90
Outstanding at September 30, 2015	3,992,666		6.54		4.2	9.3
Granted	—		—
Exercised	(270,599	)	6.83			0.8
Cancelled	(167,759	)	17.82
Outstanding at September 30, 2016	3,554,308		$	5.99	3.4	$	23.8

Exercisable at September 30, 2016	3,471,004		$	5.90	3.3	$	23.5

Expected to vest after September 30, 2016	83,304		$	9.54	8.0	$	0.3

Stock option exercise prices are equal to the closing price of our common stock on the relevant grant date. The ranges of exercise prices for stock options outstanding at September 30, 2016 are summarized below.



Exercise price						Options	Weighted average exercise price		Weighted average remaining contractual term (years)	Exercisable options	Weighted average exercise price
	$	0.00	-	$	4.99	1,343,036	$	3.34	4.4	1,343,036	$	3.34
	$	5.00	-	$	9.99	1,644,230	6.03		3.4	1,560,926	5.84
	$	10.00	-	$	14.99	440,984	11.31		1.0	440,984	11.31
	$	15.00	-	$	20.99	126,058	15.09		0.2	126,058	15.09
						3,554,308	$	5.99	3.4	3,471,004	$	5.90

Compensation expense attributed to stock options is based on the fair value of the awards on their respective grant dates, as determined using a Black-Scholes model. The weighted average grant-date fair values of stock options granted and the weighted average assumptions used to determine these fair values are indicated below.



	2015			2014
Grant-date fair value	$	5.93		$	5.13
Risk-free interest rate	1.74		%	2.44		%
Dividend yield	0.80		%	1.10		%
Expected life (years)	8.0			8.0
Expected annual volatility	0.6199			0.6386

The risk-free interest rate is based on the U.S. Treasury zero-coupon yield in effect at the grant date with a term equal to the expected life. The expected dividend yield is based on our estimated annual dividend and stock price history at the grant date. The expected term represents the period of time the awards are expected to be outstanding.

Employee Stock Purchase Plan. The Mueller Water Products, Inc. 2006 Employee Stock Purchase Plan (“ESPP”) authorizes the sale of up to 5,800,000 shares of our common stock to employees. Generally, all full-time, active employees are eligible to participate in the ESPP, subject to certain restrictions. Employee purchases are funded through payroll deductions, and any excess payroll withholdings are returned to the employee. The price for shares purchased under the ESPP is 85% of the lower of the closing price on the first day or the last day of the offering period. At September 30, 2016, 3,051,778 shares were available for issuance under the ESPP.

Phantom Plan. Under the Mueller Water Products, Inc. Phantom Plan we adopted in 2012 (“Phantom Plan”), we have awarded “phantom shares” to certain non-officer employees. A phantom share settles in cash equal to the price of one share of our common stock on the vesting date. Phantom shares vest ratably over three years on each anniversary date of the original grant. We recognize compensation expense for phantom shares on a straight-line basis for each tranche of each award based on the closing price of our common stock at each balance sheet date. The outstanding phantom shares had a fair value of $12.55 per award at September 30, 2016 and our accrued liability for such awards was $4.1 million. Phantom Plan activity is summarized below.



	Phantom Plan units		Weighted average grant date fair value per unit		Weighted average remaining contractual term (years)	Aggregate intrinsic value (millions)
Outstanding at September 30, 2013	608,982		$	4.03	1.0
Granted	304,815		8.52
Vested	(240,739	)				$	2.1
Cancelled	(29,770	)	5.29
Outstanding at September 30, 2014	643,288		6.22		0.8
Granted	289,524		9.78
Vested	(317,409	)				3.1
Cancelled	(56,525	)	8.29
Outstanding at September 30, 2015	558,878		8.49		0.8
Granted	302,875		9.84
Vested	(270,822	)				2.5
Cancelled	(56,905	)	9.28
Outstanding at September 30, 2016	534,026		$	9.60	0.9