NOTE 17. 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. As of December 31, 2018, the remaining shares available for grant under the LTIP Program are 26.3 million and there were approximately 7,700 participants with outstanding options, restricted stock, or restricted stock units.

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 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.

Beginning in 2016, as a result of the Company’s application of ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, certain excess tax benefits at the time of exercise (for an option) or upon vesting (for restricted stock units) are recognized as income tax benefits in the statement of income. These amounts totaled $100 million, $228 million, and $184 million for 2018, 2017 and 2016, respectively, and are reflected in the “income tax benefits” line within the stock-based compensation table below.

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.

Stock-Based Compensation Expense


	Years ended December 31
(Millions)	2018		2017		2016
Cost of sales	$	48	$	49	$	47
Selling, general and administrative expenses		207		229		206
Research, development and related expenses		47		46		45
Stock-based compensation expenses	$	302	$	324	$	298
Income tax benefits	$	(154)	$	(327)	$	(272)
Stock-based compensation expenses (benefits), net of tax	$	148	$	(3)	$	26

Stock Option Program

The following table summarizes stock option activity for the years ended December 31:


	2018			2017			2016
		Weighted			Weighted			Weighted
	Number of	Average		Number of	Average		Number of	Average
(Options in thousands)	Options	Exercise Price		Options	Exercise Price		Options	Exercise Price
Under option —
January 1	34,965	$	125.73	36,196	$	112.07	38,552	$	102.01
Granted:
Annual	3,211		233.19	5,410		175.93	5,592		147.99
Exercised	(3,482)		91.01	(6,474)		90.37	(7,716)		86.76
Forfeited	(125)		188.00	(167)		162.36	(232)		148.43
December 31	34,569	$	138.98	34,965	$	125.73	36,196	$	112.07
Options exercisable
December 31	26,117	$	121.98	24,281	$	108.50	25,241	$	95.65

Stock options vest over a period from one to three years with the expiration date at 10 years from date of grant. As of December 31, 2018, there was $66 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 20 months. For options outstanding at December 31, 2018, the weighted-average remaining contractual life was 66 months and the aggregate intrinsic value was $1.918 billion. For options exercisable at December 31, 2018, the weighted-average remaining contractual life was 55 months and the aggregate intrinsic value was $1.791 billion.

The total intrinsic values of stock options exercised during 2018, 2017 and 2016 was $469 million, $703 million and $608 million, respectively. Cash received from options exercised during 2018, 2017 and 2016 was $316 million, $585 million and $665 million, respectively. The Company’s actual tax benefits realized for the tax deductions related to the exercise of employee stock options for 2018, 2017 and 2016 was $99 million, $238 million and $224 million, respectively.

For the primary 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			2017			2016
Exercise price	$	233.63		$	175.76		$	147.87
Risk-free interest rate		2.7	%		2.1	%		1.5	%
Dividend yield		2.4	%		2.5	%		2.5	%
Expected volatility		21.0	%		17.3	%		20.8	%
Expected life (months)		78			78			77
Black-Scholes fair value	$	41.59		$	23.51		$	22.47

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 for the years ended December 31:


	2018			2017			2016
		Weighted			Weighted			Weighted
		Average			Average			Average
	Number of	Grant Date		Number of	Grant Date		Number of	Grant Date
(Shares in thousands)	Shares	Fair Value		Shares	Fair Value		Shares	Fair Value
Nonvested balance —
As of January 1	1,994	$	162.60	2,185	$	145.64	2,441	$	127.47
Granted
Annual	467		233.61	604		176.10	749		148.20
Other	8		207.76	21		233.77	8		169.00
Vested	(640)		164.83	(769)		127.21	(960)		101.64
Forfeited	(40)		186.48	(47)		158.25	(53)		145.95
As of December 31	1,789	$	180.02	1,994	$	162.60	2,185	$	145.64

As of December 31, 2018, there was $74 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 21 months. The total fair value of restricted stock and restricted stock units that vested during 2018, 2017 and 2016 was $155 million, $136 million and $149 million, respectively. The Company’s actual tax benefits realized for the tax deductions related to the vesting of restricted stock and restricted stock units for 2018, 2017 and 2016 was $29 million, $45 million and $56 million, 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 earnings 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. When granted, these performance shares are awarded at 100% of the estimated number of shares at the end of the three-year performance period and are reflected under “Granted” in the table below. 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 performance share grants accrue 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 for the years ended December 31:


	2018			2017			2016
		Weighted			Weighted			Weighted
		Average			Average			Average
	Number of	Grant Date		Number of	Grant Date		Number of	Grant Date
(Shares in thousands)	Shares	Fair Value		Shares	Fair Value		Shares	Fair Value
Undistributed balance —
As of January 1	686	$	171.90	656	$	142.98	871	$	120.89
Granted	166		229.13	201		191.28	219		160.17
Distributed	(206)		159.82	(314)		124.88	(367)		99.06
Performance change	(56)		198.39	155		173.91	(38)		155.98
Forfeited	(28)		204.09	(12)		171.36	(29)		149.08
As of December 31	562	$	188.96	686	$	171.90	656	$	142.98

As of December 31, 2018, there was $18 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 10 months. The total fair value of performance shares that were distributed were $48 million, $55 million, and $54 million for 2018, 2017 and 2016, respectively. The Company’s actual tax benefits realized for the tax deductions related to the distribution of performance shares was $11 million per year for 2018 and $15 million per year for both 2017 and 2016.

General Employees’ Stock Purchase Plan (GESPP):

As of December 31, 2018, shareholders have approved 60 million shares for issuance under the Company’s GESPP. Substantially all employees are eligible to participate in the plan. Participants are granted options at 85% of market value at the date of grant. There are no GESPP shares under option at the beginning or end of each year because options are granted on the first business day and exercised on the last business day of the same month.

The weighted-average fair value per option granted during 2018, 2017 and 2016 was $31.91, $30.07 and $24.72, respectively. The fair value of GESPP options was based on the 15% purchase price discount. The Company recognized compensation expense for GESSP options of $30 million in 2018, $26 million in 2017 and $24 million in 2016.