Stock-Based Compensation

6 Months Ended

Jun. 30, 2012

Stock-Based Compensation Activity

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 represents30 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 are12,315,394 as of June 30, 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 June 30, 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				Six months ended
	June 30,				June 30,
(Millions)	2012		2011		2012		2011
Cost of sales	$	5	$	6	$	17	$	20
Selling, general and administrative expenses	31		44		109		131
Research, development and related expenses	6		6		19		21
Stock-based compensation expenses	$	42	$	56	$	145	$	172
Income tax benefits	$	(12)	$	(15)	$	(44)	$	(56)
Stock-based compensation expenses, net of tax	$	30	$	41	$	101	$	116

The following table summarizes stock option activity during the six months ended June 30, 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)	74,211		88.16
		Other	653		89.60
	Exercised		(6,449,565)		65.08
	Canceled		(299,879)		82.65
	June 30		63,244,025	$	79.48	58	$	641
Options exercisable
	June 30		51,829,163	$	77.94	47	$	605

As of June 30, 2012, there was $82 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 years. The total intrinsic values of stock options exercised were $147 million and $256 million during the six months endedJune 30, 2012 and 2011, respectively. Cash received from options exercised was $420 million and $694 million for the six months ended June 30, 2012 and 2011, respectively. The Company's actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $55million and $74 million for the six months ended June 30, 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 six months endedJune 30, 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	81,016		84.04
		Vested		(2,553,435)		63.54
		Forfeited		(49,791)		81.49
	As of June 30			3,305,284	$	84.85

As of June 30, 2012, there was $113million 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 2.3years. The total fair value of restricted stock and restricted stock units that vested during the six months endedJune 30, 2012 and 2011 was $162 million and $74million, respectively. The Company's actual tax benefits realized for the tax deductions related to the vesting of restricted stock and restricted stock units was $84million and $23million for the six months endedJune 30, 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 six months of 2012. Performance share grants resumed in 2010 and continued thereafter.

The following table summarizes performance share activity during the six months endedJune 30, 2012:

				Weighted Average
			Number of	Grant Date
Performance Shares			Awards	Fair Value
Undistributed balance —
	As of January 1		878,872	$	78.55
		Granted	441,055		81.20
		Performance change	(32,847)		81.10
		Forfeited	(63,535)		80.04
	As of June 30		1,223,545	$	79.36

As of June 30, 2012, there was $28million 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 0.8years. There were no performance shares distributed or related tax benefits realized during thesix months endedJune 30, 2012. For the six months endedJune 30, 2011, the total fair value of performance shares that were distributed was $18million and actual tax benefits realized for the tax deductions related to the distribution of performance shares was $5million.