Stock-based Compensation Plans

12 Months Ended

Dec. 31, 2022

Share-Based Payment Arrangement [Abstract]

Stock-Based Compensation Plans

In connection with the Separation, and in accordance with the Employee Matters Agreement, Organon's employees with outstanding former Merck stock-based awards received replacement stock-based awards under the 2021 Incentive Stock Plan at Separation. The ratio used to convert the Merck stock-based awards was designed to preserve the aggregate intrinsic value of the award immediately after the Separation when compared to the aggregate intrinsic value of the award immediately prior to Separation. Due to the conversion, Organon incurred $17 million of incremental stock-based compensation expense in 2021. Of this amount, $4 million was related to vested option awards and was recognized immediately into earnings in connection with the Separation, and the remainder is recognized ratably over the option awards' remaining weighted average vesting period.

The Company grants stock option awards, performance share units ("PSUs") and restricted share units ("RSUs") pursuant to its 2021 Incentive Stock Plan.

Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. Generally, stock options have a contractual term of ten years and vest one-third each year over a three-year period, subject to limited exceptions.

RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. RSU awards generally vest one-third each year over a three-year period. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Company's stock price.

The terms of the Company's PSU awards allow the recipients of such awards to earn a variable number of common shares based on the cumulative results of specified performance factors. The Company has PSU awards based on the following performance factors:

•total stockholder return of the Company relative to an index of peer companies ("relative TSR") specified in the awards

•the results of the cumulative free cash flow ("FCF") of the Company over a three year period

For FCF and TSR awards, the Company recognizes compensation costs ratably over the performance period. The PSU Awards will generally vest at the end of the three year performance period, however, the number of shares delivered will vary based upon the attained level of performance. For PSUs with a performance-based FCF goal, stock-based compensation expense is recognized based on the probability of the achievement of the financial performance metric for the respective vesting period and is assessed at each reporting date. For PSUs with a market-based relative TSR goal, stock-based compensation expense is recognized based on the estimated fair value of the award at the grant date regardless of the actual number of shares earned. PSU awards generally vest after three years.

For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards.

Stock-based compensation expense incurred by the Company was as follows:


	Year Ended December 31,
($ in millions)		2022		2021		2020
Stock-based compensation expense recognized in:
Cost of sales		$	13	$	11	$	17
Selling, general and administrative		51		36		19
Research and development		11		12		4
Total		$	75	$	59	$	40

Income tax benefits		$	16	$	12	$	8

In connection with the Separation, in 2021, Merck's PSUs and RSUs were converted into 3.3 million Organon RSUs at a weighted average grant date fair value of $36.77 and Merck's stock options were converted into 4.1 million Organon stock options at a weighted average grant date fair value of $8.55. Stock options at Separation were valued using a combination of option models. The Company used the Black-Scholes model as the basis for the original fair value of the options, and the Hull-White I Lattice option pricing model calculated the incremental fair value. In applying these models, the Company used both historical data and current market data to estimate the fair value of its options. The Black-Scholes model assumptions include expected dividend yield, risk-free interest rate, volatility, and term of the options. The Hull-White I Lattice model requires several assumptions including expected exercise barrier, dividend yield, risk-free interest rate, remaining vesting life and remaining contractual life. These fair value assumptions were based on the awards and terms previously granted under the Merck incentive compensation plans to Organon employees. At December 31, 2022, the unrecognized portion of the incremental stock-based expense was $5 million.

The Company uses the Black-Scholes model to determine the fair value of the stock options as of the grant date. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The expected dividend yield is based on forecasted patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using historical volatility. Due to the lack of trading history of Organon's stock at the time of valuation efforts, the historical component of expected volatility is based on historical monthly price changes of the peer group within the industry. Merck's historical data for Organon employees was used to estimate equity award exercise and employee termination behavior within the valuation model. The expected term represents the amount of time that options granted are expected to be outstanding based on historical and forecasted exercise behavior.

The weighted average fair value of options was determined using the following assumptions:


	Year Ended December 31,
	2022		2021
Expected dividend yield	3.12	%	3.22	%
Risk-free interest rate	2.47		0.92
Expected volatility	43.43		45.80
Expected life (years)	5.89		5.89

A summary of the equity award transactions for the year ended December 31, 2022 are as follows:


	Stock Options					Restricted Share Units			Performance Share Units
(shares in thousands)	Shares	Weighted average exercise price		Weighted average grant date fair value		Shares	Weighted average grant date fair value		Shares	Weighted average grant date fair value
Outstanding as of January 1, 2022	4,394	$	34.35	$	8.63	3,280	$	36.69	120	$	51.63
Granted	556	34.93		11.34		3,269	31.65		373	45.23
Vested/Exercised	(15)	37.39		9.72		(1,259)	37.48		—	—
Forfeited/Cancelled	(206)	35.80		9.47		(242)	35.76		(7)	51.63
Outstanding as of December 31, 2022	4,729	$	34.34	$	8.91	5,048	$	33.27	486	$	46.72

The following table summarizes information about equity awards outstanding that are vested and expected to vest and equity awards outstanding that are exercisable as of December 31, 2022:


	Equity Awards Vested and Expected to Vest						Equity Awards That are Exercisable
(shares in thousands; aggregate intrinsic value in millions)	Awards	Weighted Average Exercise Price		Aggregate Intrinsic Value		Remaining Term	Awards	Weighted Average Exercise Price		Aggregate Intrinsic Value		Remaining Term
Stock Options	4,576	$	34.34	$	1	7.22	2,383	$	32.92	$	1	5.94
Restricted Share Units	4,730			141		1.92
Performance Share Units	380			12		2.39

The amount of unrecognized compensation costs as of December 31, 2022 was $145 million, which will be recognized in operating expense ratably over the weighted average vesting period of 1.93 years.