Stock-Based Compensation

3 Months Ended

Mar. 31, 2012

Stock-Based Compensation

Stock-Based Compensation

NOTE 11. 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 30 percent of the 2012 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 12,022,073 as of March 31, 2012.

In addition to the annual grants, the Company makes other minor grants of stock options, restricted stock units and other stock-based grants. 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.

Amounts recognized in the financial statements with respect to stock-based compensation programs, which include stock options, restricted stock, restricted stock units, performance shares and the General Employees’ Stock Purchase Plan (GESPP), are provided in the following table. Capitalized stock-based compensation amounts were not material at March 31, 2012. 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
	March 31,
(Millions)	2012			2011
Cost of sales	$	12		$	14
Selling, general and administrative expenses	78			87
Research, development and related expenses	13			15
Stock-based compensation expenses	$	103		$	116
Income tax benefits	$	(32	)	$	(41	)
Stock-based compensation expenses, net of tax	$	71		$	75

The following table summarizes stock option activity during the three months ended March 31, 2012:

Stock Option Program

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (months)	Aggregate Intrinsic Value (millions)
Under option —
January 1	64,148,415		$	77.28
Granted:
Annual	5,770,190		87.91
Progressive (Reload)	27,555		87.65
Exercised	(2,818,401	)	63.68
Canceled	(54,173	)	82.53
March 31	67,073,586		$	78.77	58	$	704
Options exercisable `
March 31	55,524,130		$	77.18	48	$	700

As of March 31, 2012, there was $98 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 2.1 years. The total intrinsic values of stock options exercised were $67 million and $135 million during the three months ended March 31, 2012 and 2011, respectively. Cash received from options exercised was $179 million and $355 million for the three months ended March 31, 2012 and 2011, respectively. The Company’s actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $25 million and $42 million for the three months ended March 31, 2012 and 2011, respectively.

For the primary 2012 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	2012
Exercise price	$	87.89
Risk-free interest rate	1.1		%
Dividend yield	2.6		%
Expected volatility	24.5		%
Expected life (months)	74
Black-Scholes fair value	$	14.94

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2012 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 three months ended March 31, 2012:

Restricted Stock and Restricted Stock Units

			Weighted Average
Restricted Stock and	Number of		Grant Date
Restricted Stock Units	Awards		Fair Value
Nonvested balance —
As of January 1	4,858,972		$	73.02
Granted:
Annual	968,522		87.92
Other	15,267		86.92
Vested	(1,763,719	)	57.79
Forfeited	(20,803	)	77.82
As of March 31	4,058,239		$	83.23

As of March 31, 2012, there was $128 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 2.3 years. The total fair value of restricted stock and restricted stock units that vested during the three months ended March 31, 2012 and 2011 was $102 million and $14 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 $58 million and $6 million for the three months ended March 31, 2012 and 2011, 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.

Performance Shares

Beginning in 2008, the Company grants certain members of executive management performance shares on an annual basis. The performance criteria, which were modified in 2010, are designed to focus management attention on three key factors that create long-term stockholder value: Organic Sales Growth, Return on Invested Capital and sales from new products. The number of shares of 3M common stock that could actually be delivered at the end of the three-year performance period may be anywhere from 0% to 200% of each performance share granted, depending on the performance of the Company during such performance period. Non-substantive vesting requires that expense for the performance shares be recognized over one or three years depending on when each individual became a 3M executive. The first performance shares, which were granted in 2008, were distributed in 2011. Performance shares do not accrue dividends during the performance period. Therefore, the grant date fair value is determined by reducing the closing stock price on the date of grant by the net present value of dividends during the performance period. As a result of the significant uncertainty due to the economic crisis of 2008-2009, the Company granted restricted stock units instead of performance shares in 2009. Therefore, since there were no performance shares in 2009, there were also no related distributions in the first quarter of 2012. Performance share grants resumed in 2010 and continued thereafter.

The following table summarizes performance share activity during the three months ended March 31, 2012:

			Weighted Average
	Number of		Grant Date
Performance Shares	Awards		Fair Value
Undistributed balance —
As of January 1	878,872		$	78.55
Granted	412,964		81.00
Performance change	78,166		81.07
Forfeited	(5,815	)	79.03
As of March 31	1,364,187		$	79.43

As of March 31, 2012, there was $39 million of compensation expense that has yet to be recognized related to performance shares. This expense is expected to be recognized over the remaining weighted-average earnings period of 1.3 years. There were no performance shares distributed or related tax benefits realized during the three months ended March 31, 2012. For the three months ended March 31, 2011, the total fair value of performance shares that were distributed was $18 million and actual tax benefits realized for the tax deductions related to the distribution of performance shares was $5 million.