Share-Based Compensation Plans

In accordance with the Employee Matters Agreement related to the Separation, compensation awards based on ConocoPhillips stock and granted before April 30, 2012 (the Separation Date) were converted to compensation awards based on both ConocoPhillips and Phillips 66 stock if, on the Separation Date, the awards were: (1) options outstanding and exercisable; or (2) restricted stock or restricted stock units (RSUs) awarded for completed performance periods under the ConocoPhillips Performance Share Program. Phillips 66 restricted stock, RSUs and options issued in this conversion became subject to the “Omnibus Stock and Performance Incentive Plan of Phillips 66” (the 2012 Plan) on the Separation Date, whether held by grantees working for Phillips 66 or grantees that remained employees of ConocoPhillips. Some of these awards based on Phillips 66 stock and held by employees of ConocoPhillips are outstanding and appear in the activity tables for the Stock Option and the Performance Share Programs presented later in this footnote.

In May 2013, shareholders approved the 2013 Omnibus Stock and Performance Incentive Plan of Phillips 66 (the P66 Omnibus Plan). Subsequent to this approval, all new share-based awards are granted under the P66 Omnibus Plan, which authorizes the Human Resources and Compensation Committee (HRCC) of our Board of Directors to grant stock options, stock appreciation rights, stock awards (including restricted stock and RSU awards), cash awards, and performance awards to our employees, non-employee directors and other plan participants. The number of new shares that may be issued under the P66 Omnibus Plan to settle share-based awards may not exceed 45 million.

We recognize share-based compensation expense over the shorter of: (1) the service period (i.e., the stated period of time required to earn the award); or (2) the period beginning at the start of the service period and ending when an employee first becomes eligible for retirement, but not less than six months as this is the minimum period of time required for an award not to be subject to forfeiture. Our equity-classified programs generally provide accelerated vesting (i.e., a waiver of the remaining period of service required to earn an award) for awards held by employees at the time they become eligible for retirement (at age 55 with 5 years of service). We have elected to recognize expense on a straight-line basis over the service period for the entire award, irrespective of whether the award was granted with ratable or cliff vesting, and have elected to recognize forfeitures of awards when they occur.

Total share-based compensation expense recognized in income and the associated income tax benefit for the years ended December 31 were:



	Millions of Dollars
	2018			2017		2016

Share-based compensation expense	$	100		142		156
Income tax benefit	(45		)	(74	)	(59	)

Stock Options

Stock options granted under the provisions of the P66 Omnibus Plan and earlier plans permit purchases of our common stock at exercise prices equivalent to the average of the high and low market price of our stock on the date the options were granted. The options have terms of 10 years and vest ratably, with one-third of the options becoming exercisable on each anniversary date for the three years following the date of grant. Options awarded to employees eligible for retirement are not subject to forfeiture six months after the grant date.

The following table summarizes our stock option activity from January 1, 2018, to December 31, 2018:



							Millions of Dollars
	Options		Weighted- Average Exercise Price		Weighted-Average Grant-Date Fair Value		Aggregate Intrinsic Value

Outstanding at January 1, 2018	4,838,855		$	58.34
Granted	650,000		94.85		$	20.69
Forfeited	(49,027	)	89.93
Exercised	(687,020	)	57.61				$	37
Outstanding at December 31, 2018	4,752,808		$	63.11

Vested at December 31, 2018	3,941,271		$	57.79			$	109

Exercisable at December 31, 2018	3,331,259		$	53.51			$	106

The weighted-average remaining contractual terms of vested options and exercisable options at December 31, 2018, were 4.87 years and 4.29 years, respectively. During 2018, we received $39 million in cash and realized an income tax benefit of $7 million from the exercise of options. At December 31, 2018, the remaining unrecognized compensation expense from unvested options was $6 million, which will be recognized over a weighted-average period of 21 months, the longest period being 25 months. The calculations of realized income tax benefits and weighted-average periods include awards based on both Phillips 66 and ConocoPhillips stock held by Phillips 66 employees.

During 2017 and 2016, we granted options with a weighted-average grant-date fair value of $16.95 and $16.94, respectively. During 2017 and 2016, employees exercised options with an aggregate intrinsic value of $62 million and $58 million, respectively.

The following table provides the significant assumptions used to calculate the grant-date fair values of options granted over the years shown below, as calculated using the Black-Scholes-Merton option-pricing model:



	2018		2017	2016

Risk-free interest rate	2.81	%	2.28	1.71
Dividend yield	2.80	%	2.90	3.00
Volatility factor	25.41	%	26.91	28.68
Expected life (years)	7.18		7.22	7.08

We calculate the volatility factor using historical Phillips 66 end-of-week closing stock prices since the Separation Date. We periodically calculate the average period of time elapsed between grant dates and exercise dates of past grants to estimate the expected life of new option grants.

Restricted Stock Units

Generally, RSUs are granted annually under the provisions of the P66 Omnibus Plan and cliff vest at the end of three years. The grant date fair value is equal to the average of the high and low market price of our stock on the grant date. The recipients receive a quarterly dividend equivalent cash payment until the RSU is settled by issuing one share of our common stock for each RSU at the end of the service period. RSUs granted to retirement-eligible employees are not subject to forfeiture six months after the grant date. Special RSUs are granted to attract or retain key personnel and the terms and conditions may vary by award.

The following table summarizes our RSU activity from January 1, 2018, to December 31, 2018:



					Millions of Dollars
	Stock Units		Weighted-Average Grant-Date Fair Value		Total Fair Value

Outstanding at January 1, 2018	2,496,425		$	77.20
Granted	822,457		96.16
Forfeited	(63,977	)	84.61
Issued	(995,076	)	75.77		$	102
Outstanding at December 31, 2018	2,259,829		$	84.52

Not Vested at December 31, 2018	1,565,641		$	84.99

At December 31, 2018, the remaining unrecognized compensation cost from unvested RSU awards was $53 million, which will be recognized over a weighted-average period of 22 months, the longest period being 36 months.

During 2017 and 2016, we granted RSUs with a weighted-average grant-date fair value of $78.49 and $78.56, respectively. During 2017 and 2016, we issued shares with an aggregate fair value of $85 million and $109 million, respectively, to settle RSUs.

Performance Share Units

Under the P66 Omnibus Plan, we annually grant to senior management restricted performance share units (PSUs) with three-year performance periods that vest when the HRCC approves the three-year performance results on the grant date. PSUs granted under the P66 Omnibus Plan are classified as liability awards and compensation expense is recognized beginning on the authorization date and ending on the vesting date.

PSUs granted under the P66 Omnibus Plan are settled by cash payments equal to the fair value of the awards, which is based on the market prices of our stock near the end of the performance periods. The HRCC must approve the three-year performance results prior to payout. Dividend equivalents are not paid on these awards.

PSUs granted under prior incentive compensation plans were classified as equity awards. These equity awards are settled upon an employee’s retirement by issuing one share of our common stock for each PSU held. Dividend equivalents are paid on these awards.

The following table summarizes our PSU activity from January 1, 2018, to December 31, 2018:



					Millions of Dollars
	Performance Share Units		Weighted-Average Grant-Date Fair Value		Total Fair Value

Outstanding at January 1, 2018	2,558,278		$	52.06
Granted	494,277		99.74
Forfeited	(16,716	)	69.90
Issued	(639,060	)	59.15		$	70
Cash settled	(494,277	)	99.74		49
Outstanding at December 31, 2018	1,902,502		$	49.52

Not Vested at December 31, 2018	153,236		$	65.59

At December 31, 2018, the remaining unrecognized compensation cost from unvested PSU awards was $1 million, which will be recognized over a weighted-average period of 14 months, with the longest period being 4 years. The calculations of unamortized expense and weighted-average periods include awards based on both Phillips 66 and ConocoPhillips stock held by Phillips 66 employees.

During 2017 and 2016, we granted PSUs with a weighted-average grant-date fair value of $86.88 and $78.62, respectively. During 2017 and 2016, we issued shares with an aggregate fair value of $54 million and $26 million, respectively, to settle PSUs. During 2017 and 2016, we cash settled PSUs with an aggregate fair value of $56 million and $60 million, respectively.