Financial Information
3. SHARE-BASED COMPENSATION
Under our Stock and Cash Incentive Plan (the “Stock Plan”), we award: (1) stock options (our “Stock Option Program”) to purchase our Class A Common Stock (our “common stock”); (2) stock appreciation rights (“SARs”) for our common stock (our “SAR Program”); (3) restricted stock units (“RSUs”) of our common stock; and (4) deferred stock units. We grant awards at exercise prices or strike prices that equal the market price of our common stock on the date of grant.
For all share-based awards, applicable accounting guidance requires that we measure compensation costs for our share-based payment transactions at fair value on the grant date and that we recognize those costs in our Financial Statements over the vesting period during which the employee provides service (“the service period”) in exchange for the award.
During 2012, we granted 3.2 million RSUs, 1.0 million SARs, 0.3 million stock options, and 27,000 deferred stock units.
We recorded share-based compensation expense for award grants of $77 million in 2012, $86 million in 2011, and $90 million in 2010. Deferred compensation costs for unvested awards totaled $122 million at year-end 2012 and $101 million at year-end 2011. As of year-end 2012, we expect to recognize these deferred compensation expenses over a weighted average period of two years.
Under the guidance for share-based compensation, we present the tax benefits and costs resulting from the exercise or vesting of share-based awards as financing cash flows. The exercise of share-based awards resulted in tax benefits of $71 million in 2012 and $51 million in 2010. Due to tax losses in 2011, we recorded no tax benefit in that year.
We received cash from the exercise of Marriott stock options of $179 million in 2012, $124 million in 2011, and $147 million in 2010.
Adjustments for the Timeshare Spin-off
Effective with the spin-off (see Footnote No. 16, “Spin-off,” for further information), each holder of Marriott RSUs, stock options, and SARs on the November 10, 2011 record date for the spin-off received MVW RSUs, MVW stock options and/or MVW SARs, as applicable, consistent with the distribution ratio of one share of MVW common stock for every ten shares of Marriott common stock, with terms and conditions substantially similar to the terms and conditions applicable to the Marriott RSUs, stock options and SARs. In order to preserve the aggregate intrinsic value of the Marriott stock options and SARs those persons held, we adjusted the exercise prices of our awards by using the proportion of the Marriott ex-distribution closing stock price to the sum of the Marriott ex-distribution and MVW when issued closing stock prices on the distribution date. We accounted for these adjustments, which were designed to equalize the fair value of each award before and after spin-off, as modifications to the original awards. Comparing the fair value of the modified awards with the fair value of the original awards immediately before the modification did not yield incremental value. Accordingly, we did not record any incremental compensation expense as a result of the modifications to the awards on the spin-off date.
The equity award adjustments that occurred as a result of the spin-off also did not significantly impact our share-based compensation expense. Deferred compensation costs as of the date of spin-off reflected the unamortized balance of the original grant date fair value of the equity awards held by Marriott employees (regardless of whether those awards are linked to Marriott stock or MVW stock). MVW employees who participated in the Stock Plan before the spin-off continued to hold their Marriott granted awards as non-employees after the spin-off. We do not record any share-based compensation expense for these unvested awards held by MVW employees after the spin-off.
RSUs
We issue Marriott RSUs under the Stock Plan to certain officers and key employees and those units generally vest over four years in equal annual installments commencing one year after the date of grant. We recognize compensation expense for RSUs over the service period equal to the fair market value of the stock units on the date of issuance. Upon vesting, Marriott RSUs convert to shares which we distribute from treasury shares. Beginning in 2012, we now also issue service and performance Marriott RSUs (“S&P RSUs”) to named executive officers under the Stock Plan. In addition to generally being subject to pro-rata annual vesting conditioned on continued service consistent with the standard form of Marriott RSUs, Marriott S&P RSUs are also subject to the satisfaction of a performance condition, expressed as an EBITDA goal, for a fiscal year during the applicable service vesting period. The following information on RSUs includes S&P RSUs.
We had deferred compensation costs for RSUs of approximately $111 million at year-end 2012 and $94 million at year-end 2011. The weighted average remaining term for RSU grants outstanding at year-end 2012 was two years.
The following table provides additional information on Marriott RSUs for the last three fiscal years:
The following table shows the 2012 changes in our outstanding Marriott RSU grants and the associated weighted average grant-date fair values:
(1) Includes 0.4 million Marriott RSUs held by MVW employees.
(2) Includes 0.2 million S&P RSUs granted to named executive officers.
Stock Options and SARs
We may grant employee stock options to officers and key employees at exercise prices or strike prices that equal the market price of our common stock on the grant date. Non-qualified options generally expire 10 years after the grant date, except those we issued from 1990 through 2000, which expire 15 years after their grant date. Most stock options under the Stock Option Program may be exercised in cumulative installments of one quarter at the end of each of the first four years following the grant date.
We recognized compensation expense for employee stock options of $1 million in 2012, less than $1 million in 2011, and less than $1 million in 2010. We had deferred compensation costs for employee stock options of $3 million at year-end 2012 and approximately $1 million at year-end 2011. When holders exercise Marriott stock options we issue shares from treasury shares.
The following table shows the 2012 changes in our outstanding Marriott Stock Option Program awards and the associated weighted average exercise prices:
(1) Includes 0.2 million Marriott stock options held by MVW employees.
(2) Included in these stock options are 0.2 million granted to key employees that vest 100% at the end of three years.
The following table shows the Marriott stock options issued under the Stock Option Program awards outstanding at year-end 2012, as well as those exercisable on that date (those where the exercise price was less than the market price of our common stock on that date):
The following table shows the number of Marriott stock options we granted in the last three fiscal years and the associated weighted average grant-date fair values and weighted average exercise prices:
The following table shows the intrinsic value (the amount by which the market price of the underlying common stock exceeded the aggregate exercise price of the stock option) of all outstanding Marriott stock options and of exercisable Marriott stock options at year-end 2012 and 2011:
Marriott stock options exercised during the last three years had total intrinsic values of approximately $158 million in 2012, $124 million in 2011, and $149 million in 2010.
We may grant Marriott SARs to officers and key employees (“Employee SARs”) at base values (exercise prices or strike prices) equal to the market price of our common stock on the grant date. Employee SARs expire ten years after the grant date and both vest and may be exercised in cumulative installments of one quarter at the end of each of the first four years following the grant date. We may grant Marriott SARs to directors (“Director SARs”) at exercise prices or strike prices equal to the market price of our common stock on the grant date. Director SARs generally expire ten years after the date of grant and vest upon grant; however, they are generally not exercisable until one year after grant. On exercise of Marriott SARs, holders receive the number of shares of our common stock equal to the number of SARs that are being exercised multiplied by the quotient of (a) the final value minus the base value, divided by (b) the final value.
We recognized compensation expense for Employee SARs and Director SARs of $9 million in 2012, $12 million in 2011, and $12 million in 2010. We had deferred compensation costs related to SARs of approximately $8 million in 2012 and $6 million in 2011. Upon the exercise of Marriott SARs, we issue shares from treasury shares.
The following table shows the 2012 changes in our outstanding Marriott SARs and the associated weighted average exercise prices:
(1) Includes 0.3 million Marriott SARs held by MVW employees.
The following tables show the number of Employee Marriott SARs and Director Marriott SARs we granted in the last three fiscal years, the associated weighted average exercise prices, and the associated weighted average grant-date fair values:
Holders forfeited 5,000 Marriott SARs in 2012 and 63,000 Marriott SARs in 2011. Outstanding Marriott SARs had total intrinsic values of $37 million at year-end 2012 and less than $1 million at year-end 2011. Exercisable Marriott SARs had total intrinsic values of $24 million at year-end 2012 and zero at year-end 2011. Marriott SARs exercised during 2012 had total intrinsic values of $2 million and SARs exercised in 2011 had total intrinsic values of $280,000.
On the grant date, we use a binomial lattice-based valuation model to estimate the fair value of each SAR and option granted. This valuation model uses a range of possible stock price outcomes over the term of the SAR and option, discounted back to a present value using a risk-free rate. Because of the limitations with closed-form valuation models, such as the Black-Scholes model, we have determined that this more flexible binomial model provides a better estimate of the fair value of our options and SARs because it takes into account employee exercise behavior based on changes in the price of our stock and also allows us to use other dynamic assumptions.
We used the following assumptions to determine the fair value of the SARs and stock options we granted to employees and non-employee directors in 2012, and to employees in 2011, and 2010 (we did not grant SARs to non-employee directors in 2011 or 2010):
In making these assumptions, we base expected volatility on the weighted average historical stock volatility. We base risk-free rates on the corresponding U.S. Treasury spot rates for the expected duration at the date of grant, which we convert to a continuously compounded rate. The dividend yield assumption takes into consideration both historical levels and expectations of future payout. The weighted average expected terms for SARs and options are an output of our valuation model which utilizes historical data in estimating the period of time that the SARs and options are expected to remain unexercised. We calculate the expected terms for SARs and options for separate groups of retirement eligible and non-retirement eligible employees. Our valuation model also uses historical data to estimate exercise behaviors, which includes determining the likelihood that employees will exercise their SARs and options before expiration at a certain multiple of stock price to exercise price.
Deferred Stock Units
We also issue Marriott deferred stock units to non-employee directors. These non-employee director deferred stock units vest within one year and are distributed upon election. We had deferred costs for non-employee director deferred stock units of approximately zero at year-end 2012 and approximately $279,000 at year-end 2011.
The following table shows the share-based compensation expense, the number of deferred stock units we granted, the weighted average grant-date fair value, and the aggregate intrinsic value for the last three fiscal years for non-employee director Marriott deferred stock units:
We had 245,000 outstanding non-employee Marriott deferred stock units at year-end 2012, and 247,000 outstanding at year-end 2011. The weighted average grant-date fair value of those outstanding deferred stock units was $27 for 2012 and $25 for 2011.
Other Information
Although the Stock Plan also allows us to issue deferred stock bonus awards, deferred stock awards, and restricted stock awards, our Compensation Policy Committee indefinitely suspended our issuance of deferred bonus stock beginning in 2001 and our issuance of both deferred stock awards and restricted stock awards beginning in 2003. At both year-end 2012 and year-end 2011, we had no deferred compensation costs for these suspended award programs. Our share-based compensation expense for these suspended award programs was zero in 2012, less than $1 million in 2011, and $1 million in 2010.
At year-end 2012, we reserved 39 million shares under the Stock Plan, including 16 million shares under the Stock Option Program and the SAR Program.