NOTE 15. Stock-Based Compensation

The 3M 2016 Long-Term Incentive Plan provides for the issuance or delivery of up to 123,965,000 shares of 3M common stock pursuant to awards granted under the plan. Awards may be issued in the form of incentive stock options, nonqualified stock options, progressive stock options, stock appreciation rights, restricted stock, restricted stock units, other stock awards, and performance units and performance shares. The remaining shares available for grant under the LTIP Program are 25.9 million as of March 31, 2018.

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. 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 ten years of service. This retiree-eligible population represents 38 percent of the annual grant stock-based compensation award expense dollars; therefore, higher stock-based compensation expense is recognized in the first quarter.

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 for the three months ended March 31, 2018 and 2017.

Stock-Based Compensation Expense


	Three months ended
	March 31,
(Millions)	2018		2017
Cost of sales	$	23	$	23
Selling, general and administrative expenses		109		98
Research, development and related expenses		27		26
Stock-based compensation expenses	$	159	$	147
Income tax benefits	$	(98)	$	(148)
Stock-based compensation expenses (benefits), net of tax	$	61	$	(1)

Stock Option Program

The following table summarizes stock option activity during the three months ended March 31, 2018:


				Weighted
				Average
		Weighted		Remaining	Aggregate
	Number of	Average		Contractual	Intrinsic Value
(Shares in thousands)	Options	Exercise Price		Life (months)	(millions)
Under option —
January 1	34,965	$	125.73
Granted:
Annual	3,174		233.62
Exercised	(1,844)		90.20
Forfeited	(22)		180.69
March 31	36,273	$	136.94	73	$	3,040
Options exercisable
March 31	27,757	$	120.20	63	$	2,757

Stock options vest over a period from one year to three years with the expiration date at 10 years from date of grant. As of March 31, 2018, there was $123 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 25 months. The total intrinsic values of stock options exercised were $283 million and $286 million during the three months ended March 31, 2018 and 2017, respectively. Cash received from options exercised was $166 million and $271 million for the three months ended March 31, 2018 and 2017, respectively. The Company’s actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $61 million and $106 million for the three months ended March 31, 2018 and 2017, respectively.

For the primary 2018 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.

Stock Option Assumptions


	Annual
	2018
Exercise price	$	233.63
Risk-free interest rate		2.7	%
Dividend yield		2.4	%
Expected volatility		21.0	%
Expected life (months)		78
Black-Scholes fair value	$	41.59

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2018 annual grant date, the Company estimated the expected volatility based upon the following three volatilities of 3M stock: the median of the term of the expected life rolling volatility; the median of the most recent term of the expected life volatility; and the implied volatility on the grant date. The expected term assumption is based on the weighted average of historical grants.

Restricted Stock and Restricted Stock Units

The following table summarizes restricted stock and restricted stock unit activity during the three months ended March 31, 2018:


		Weighted
		Average
	Number of	Grant Date
(Shares in thousands)	Awards	Fair Value
Nonvested balance —
As of January 1	1,994	$	162.60
Granted
Annual	467		233.61
Vested	(611)		165.67
Forfeited	(6)		171.27
As of March 31	1,844	$	179.55

As of March 31, 2018, there was $131 million of compensation expense that has yet to be recognized related to non-vested restricted stock units and restricted stock. This expense is expected to be recognized over the remaining weighted-average vesting period of 26 months. The intrinsic value of restricted stock units and restricted stock that vested during the three months ended March 31, 2018 and 2017 was $150 million and $127 million, respectively. The Company’s actual tax benefits realized for the tax deductions related to the vesting of restricted stock units and restricted stock was $28 million and $47 million for the three months ended March 31, 2018 and 2017, respectively.

Restricted stock units granted generally vest three years following the grant date assuming continued employment. 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. 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

Instead of restricted stock units, the Company makes annual grants of performance shares to members of its executive management. The 2018 performance criteria for these performance shares (organic volume growth, return on invested capital, free cash flow conversion, and earning per share growth) were selected because the Company believes that they are important drivers of long-term stockholder value. 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 2018 performance share grant accrues dividends, therefore the grant date fair value is equal to the closing stock price on the date of grant. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average performance shares whose performance period is complete are included in computation of diluted earnings per share.

The following table summarizes performance share activity during the three months ended March 31, 2018:


		Weighted
		Average
	Number of	Grant Date
(Shares in thousands)	Awards	Fair Value
Undistributed balance —
As of January 1	686	$	171.90
Granted	156		231.34
Distributed	(206)		159.82
Performance change	28		205.82
Forfeited	(2)		181.11
As of March 31	662	$	191.02

As of March 31, 2018, there was $60 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 11 months. The total fair values of performance shares that were distributed were $48 million and $55 million for the three months ended 2017, respectively. The Company’s actual tax benefits realized for the tax deductions related to the distribution of performance shares were $11 million and $15 million for the three months ended March 31, 2018 and 2017, respectively.