Stock-Based Compensation

9 Months Ended

Sep. 30, 2011

Stock-Based Compensation

Stock-Based Compensation

NOTE 12. Stock-Based Compensation

The Company’s annual stock option and restricted stock unit grant is made in February to provide a strong and immediate link between the performance of individuals during the preceding year and the size of their annual stock compensation grants. The grant to eligible employees uses the closing stock price on the grant date. Stock options vest over a period from one year to three years with the expiration date at 10 years from date of grant. Accounting rules require recognition of expense under a non-substantive vesting period approach, requiring compensation expense recognition when an employee is eligible to retire. Employees are considered eligible to retire at age 55 and after having completed five years of service. This retiree-eligible population represents 28 percent of the 2011 annual grant stock-based compensation award expense dollars; therefore, higher stock-based compensation expense is recognized in the first quarter. The remaining total shares available for grant under the 2008 Long Term Incentive Plan Program are 21,936,920 as of September 30, 2011.

Amounts recognized in the financial statements with respect to stock-based compensation programs, which include stock options, restricted stock, restricted stock units and the General Employees’ Stock Purchase Plan (GESPP), are provided in the following table. The income tax benefits shown in the table can fluctuate by period due to the amount of employee “disqualifying dispositions” related to Incentive Stock Options (ISOs). The Company last granted ISOs in 2002.

Stock-Based Compensation Expense

	Three months ended						Nine months ended
	September 30,						September 30,
(Millions)	2011			2010			2011			2010
Cost of sales	$	5		$	6		$	25		$	26
Selling, general and administrative expenses	28			45			159			174
Research, development and related expenses	5			6			26			28
Stock-based compensation expenses	$	38		$	57		$	210		$	228
Income tax benefits	$	(12	)	$	(13	)	$	(68	)	$	(68	)
Stock-based compensation expenses, net of tax	$	26		$	44		$	142		$	160

The following table summarizes stock option activity during the nine months ended September 30, 2011:

Stock Option Program

					Remaining	Aggregate
	Number of		Exercise		Contractual	Intrinsic Value
	Options		Price*		Life* (months)	(millions)
Under option —
January 1	70,335,044		$	74.80
Granted
Annual	5,514,500		89.46
Progressive (Reload)	234,639		94.21
Other	5,667		90.42
Exercised	(11,408,114	)	68.55
Canceled	(281,801	)	74.24
September 30	64,399,935		$	77.24	57	$	192
Options exercisable
September 30	52,765,533		$	76.81	47	$	152

*Weighted average

As of September 30, 2011, there was $71 million of compensation expense that has yet to be recognized related to non-vested stock option based awards. This expense is expected to be recognized over the remaining weighted-average vesting period of 1.8 years. The total intrinsic values of stock options exercised were $283 million and $214 million during the nine months ended September 30, 2011 and 2010, respectively. Cash received from options exercised was $782 million and $433 million for the nine months ended September 30, 2011 and 2010, respectively. The Company’s actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $86 million and $63 million for the nine months ended September 30, 2011 and 2010, respectively. Capitalized stock-based compensation amounts were not material at September 30, 2011.

For the primary 2011 annual stock option grant, the weighted average fair value at the date of grant was calculated using the Black-Scholes option-pricing model and the assumptions that follow.

	Annual
Stock Option Assumptions	2011
Exercise price	$	89.47
Risk-free interest rate	2.8		%
Dividend yield	2.6		%
Expected volatility	22.0		%
Expected life (months)	72
Black-Scholes fair value	$	16.10

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2011 annual grant date, the Company estimated the expected volatility based upon the average of the most recent one year volatility, the median of the term of the expected life rolling volatility, the median of the most recent term of the expected life volatility of 3M stock, and the implied volatility on the grant date. The expected term assumption is based on the weighted average of historical grants.

The following table summarizes restricted stock and restricted stock unit activity during the nine months ended September 30, 2011:

Restricted Stock and Restricted Stock Units	Number of Awards		Grant Date Fair Value*
Nonvested balance —
As of January 1	5,573,302		$	70.43
Granted
Annual	889,448		89.46
Performance shares	375,146		83.34
Other	335,164		87.55
Vested	(1,277,111	)	72.33
Forfeited	(106,367	)	71.58
As of September 30	5,789,582		$	74.74

*Weighted average

As of September 30, 2011, there was $121 million of compensation expense that has yet to be recognized related to non-vested restricted stock and restricted stock units. This expense is expected to be recognized over the remaining weighted-average vesting period of 2.0 years. The total grant date fair value of restricted stock and restricted stock units that vested during the nine months ended September 30, 2011 and 2010 was $92 million and $60 million, respectively. The Company’s actual tax benefits realized for the tax deductions related to the vesting of restricted stock and restricted stock units was $42 million and $20 million for the nine months ended September 30, 2011 and 2010, respectively.

Restricted stock units granted under the 3M 2008 Long-Term Incentive Plan generally vest three years following the grant date assuming continued employment. The one-time “buyout” restricted stock unit grant in 2007 vests at the end of five years. Restricted stock unit grants issued in 2008 and prior did not accrue dividends during the vesting period. Beginning in 2009, dividend equivalents equal to the dividends payable on the same number of shares of 3M common stock accrue on these restricted stock units during the vesting period, although no dividend equivalents are paid on any of these restricted stock units that are forfeited prior to the vesting date. Dividends are paid out in cash at the vest date on restricted stock units, except for performance shares which do not earn dividends. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average restricted stock unit shares outstanding are included in the computation of diluted earnings per share.

In addition, the Company issues cash settled Restricted Stock Units and Stock Appreciation Rights in certain countries. These grants do not result in the issuance of Common Stock and are considered immaterial by the Company.