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3M Company (96OI)

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Wednesday 11 May, 2011

3M Company

1st Quarter Results

RNS Number : 3440G
3M Company
10 May 2011
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2011

 

Commission file number:  1-3285

 

3M COMPANY

(Exact name of registrant as specified in its charter)

 

DELAWARE

41-0417775

 

 

(State or other jurisdiction of


(I.R.S. Employer

 

incorporation or organization)


Identification No.)

 




 

3M Center, St. Paul, Minnesota

55144

 

(Address of principal executive offices)


(Zip Code)

 

(651) 733-1110

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

Accelerated filer o

 

 



 

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Class

Outstanding at March 31, 2011

Common Stock, $0.01 par value per share


710,577,360 shares

 

This document (excluding exhibits) contains 63 pages.

The table of contents is set forth on page 2.

The exhibit index begins on page 60.

 

 

 

3M COMPANY

Form 10-Q for the Quarterly Period Ended March 31, 2011

TABLE OF CONTENTS

 



BEGINNING
PAGE


 

PART I

FINANCIAL INFORMATION




 






 

 

ITEM 1.

Financial Statements




 






 



 


Consolidated Statement of Income...............................................................................


3


 


Consolidated Balance Sheet.......................................................................................


4


 


Consolidated Statement of Cash Flows........................................................................


5


 


Notes to Consolidated Financial Statements.................................................................




 


Note 1.   Significant Accounting Policies...................................................................


6


 


Note 2.   Acquisitions..............................................................................................


8


 


Note 3.   Goodwill and Intangible Assets...................................................................


9


 


Note 4.   Supplemental Equity and Comprehensive Income Information........................


11


 


Note 5.   Income Taxes...........................................................................................


13


 


Note 6.   Marketable Securities................................................................................


15


 


Note 7.   Long-Term Debt and Short-Term Borrowings................................................


16


 


Note 8.   Pension and Postretirement Benefit Plans...................................................


17


 


Note 9.   Derivatives................................................................................................


17


 


Note 10. Fair Value Measurements...........................................................................


22


 


Note 11. Commitments and Contingencies................................................................


26


 


Note 12. Stock-Based Compensation.......................................................................


34



Note 13. Business Segments...................................................................................


37


 


Report of Independent Registered Public Accounting Firm..............................................


39


 

 






 

ITEM 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations




 



 


Overview....................................................................................................................


40


 


Results of Operations.................................................................................................


42


 


Performance by Business Segment.............................................................................


44


 


Financial Condition and Liquidity..................................................................................


51


 


Cautionary Note Concerning Factors That May Affect Future Results..............................


55


 






 

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk...........................................


56


 






 

ITEM 4.

Controls and Procedures.............................................................................................


56


 






 

PART II

OTHER INFORMATION




 






 

ITEM 1.

Legal Proceedings......................................................................................................


57


 






 

ITEM 1A.

Risk Factors..............................................................................................................


57


 






 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds........................................


59


 






 

ITEM 3.

Defaults Upon Senior Securities..................................................................................


59


 






 

ITEM 4.

Removed and Reserved...............................................................................................


59


 






 

ITEM 5.

Other Information........................................................................................................


59


 






 

ITEM 6.

Exhibits.....................................................................................................................


60


 



 

3M COMPANY

FORM 10-Q

For the Quarterly Period Ended March 31, 2011

PART I.  Financial Information

 

 

 


Three months ended
March 31,


 


2011


2010


 

Net sales............................................................................................................

7,311


$

6,348


 

Operating expenses






 

Cost of sales....................................................................................................

3,802


3,238


 

 

Selling, general and administrative expenses.......................................................

1,533


1,323


Research, development and related expenses.....................................................

398


342


 

Total operating expenses...............................................................................

5,733


4,903


 

 

Operating income.................................................................................................

1,578


1,445








 

Interest expense and income






 

 

Interest expense...............................................................................................

43


48


Interest income.................................................................................................

(10

(6

)

 

Total interest expense (income)......................................................................

33


42


 







 

Income before income taxes.................................................................................

1,545


1,403


 

Provision for income taxes....................................................................................

442


448


 

Net income including noncontrolling interest...........................................................

1,103


$

955


 







 

Less: Net income attributable to noncontrolling interest...........................................

22


25


 







 

Net income attributable to 3M...............................................................................

1,081


$

930


 







 

Weighted average 3M common shares outstanding - basic....................................

711.5


711.8


 

Earnings per share attributable to 3M common shareholders - basic.......................

1.52


$

1.31


 







 

Weighted average 3M common shares outstanding - diluted..................................

726.4


723.5


 

Earnings per share attributable to 3M common shareholders - diluted.....................

1.49


$

1.29


 







 

Cash dividends paid per 3M common share............................................................

0.55

0.525

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.

 



 

 

(Dollars in millions, except per share amount)


Mar. 31,
2011


Dec. 31,
2010


 

Assets






 

 

Current assets






Cash and cash equivalents................................................................................


$

2,747


$

3,377


 

Marketable securities - current.........................................................................


1,285


1,101


 

 

Accounts receivable - net ...............................................................................


4,209


3,615


 

Inventories........................................................................................................






 

Finished goods.............................................................................................


1,639


1,476


 

Work in process............................................................................................


1,033


950


Raw materials and supplies............................................................................


817


729


 

Total inventories................................................................................................


3,489


3,155


 

Other current assets.........................................................................................


915


967


 

Total current assets.......................................................................................


12,645


12,215


 







 

Marketable securities - non-current......................................................................


360


540


 

 

Investments.........................................................................................................


160


146


 

Property, plant and equipment...............................................................................


20,785


20,253


Less: Accumulated depreciation........................................................................


(13,282

)

(12,974

)

 

Property, plant and equipment - net..............................................................


7,503


7,279


 

Goodwill..............................................................................................................


7,121


6,820


 

 

Intangible assets - net........................................................................................


2,004


1,820


 

Prepaid pension benefits.......................................................................................


78


74


Other assets.......................................................................................................


1,258


1,262


 

Total assets..................................................................................................


$

31,129


$

30,156


 







 

Liabilities






 

 

Current liabilities






Short-term borrowings and current portion of long-term debt..................................


$

1,133


$

1,269


 

Accounts payable.............................................................................................


1,815


1,662


 

 

Accrued payroll................................................................................................


479


778


 

Accrued income taxes......................................................................................


393


358


Other current liabilities......................................................................................


2,080


2,022


 

Total current liabilities....................................................................................


5,900


6,089


 







 

 

Long-term debt....................................................................................................


4,486


4,183


 

Pension and postretirement benefits......................................................................


1,964


2,013


Other liabilities.....................................................................................................


1,892


1,854


 

Total liabilities...............................................................................................


$

14,242


$

14,139


 







 

Commitments and contingencies (Note 11)






 

 







 

Equity






 

3M Company shareholders' equity:






Common stock par value, $.01 par value, 944,033,056 shares issued....................


$

9


$

9


 

Additional paid-in capital....................................................................................


3,599


3,468


 

 

Retained earnings.............................................................................................


26,521


25,995


 

Treasury stock, at cost: 233,455,696 shares at Mar. 31, 2011; 232,055,448 shares at Dec. 31, 2010...........................................................................................


(10,398

)

(10,266

)

Accumulated other comprehensive income (loss).................................................


(3,237

)

(3,543

)

 

Total 3M Company shareholders' equity..........................................................


16,494


15,663


 

 

Noncontrolling interest..........................................................................................


393


354


Total equity...................................................................................................


$

16,887


$

16,017


 







 

Total liabilities and equity...............................................................................


$

31,129


$

30,156


 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.

 



 

 


Three months ended
March 31,


 


2011


2010


 

Cash Flows from Operating Activities






 

Net income including noncontrolling interest...........................................................

1,103


$

955


 

Adjustments to reconcile net income including noncontrolling interest to net cash provided by operating activities






 

 

Depreciation and amortization............................................................................

289


287


 

Company pension and postretirement contributions.............................................

(61

(82

)

 

Company pension and postretirement expense....................................................

135


88


 

Stock-based compensation expense..................................................................

116


112


 

Deferred income taxes......................................................................................

3

26


 

Excess tax benefits from stock-based compensation...........................................

(15

(12

)

 

Changes in assets and liabilities........................................................................






 

Accounts receivable......................................................................................

(469

(356

)

 

Inventories....................................................................................................

(180

(190

)

 

Accounts payable.........................................................................................

80


145


 

Accrued income taxes (current and long-term).................................................

137


317


 

Product and other insurance receivables and claims.........................................

(39

(25

)

Other - net.....................................................................................................

(366

(183

)

 

Net cash provided by operating activities................................................................

733


1,082


 







 

Cash Flows from Investing Activities






 

 

Purchases of property, plant and equipment (PP&E)...............................................

(231

(157

)

 

Proceeds from sale of PP&E and other assets.......................................................

2


3


 

Acquisitions, net of cash acquired.........................................................................

(471

(17

)

 

Purchases of marketable securities and investments...............................................

(757

(1,410

)

 

Proceeds from sale of marketable securities and investments..................................

363


222


 

Proceeds from maturities of marketable securities..................................................

376


435


Other investing.....................................................................................................

(39

(63

)

 

Net cash used in investing activities.......................................................................

(757

(987

)

 







 

Cash Flows from Financing Activities






 

 

Change in short-term debt - net...........................................................................

12


(27

)

 

Repayment of debt (maturities greater than 90 days)...............................................

(104

(20

)

 

Proceeds from debt (maturities greater than 90 days)..............................................

107


9


 

Purchases of treasury stock.................................................................................

(680

(20

)

 

Reissuances of treasury stock..............................................................................

378


151


 

Dividends paid to shareholders..............................................................................

(392

(374

)

 

Excess tax benefits from stock-based compensation..............................................

15


12


Other - net........................................................................................................

-


(6

)

 

Net cash used in financing activities......................................................................

(664

(275

)

 







 

Effect of exchange rate changes on cash and cash equivalents................................

58


(12

)

 







 

Net increase (decrease) in cash and cash equivalents.............................................

(630

(192

)

 

Cash and cash equivalents at beginning of year......................................................

3,377


3,040


 

Cash and cash equivalents at end of period............................................................

2,747


$

2,848


 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.

 



 

(Unaudited)

 

NOTE 1.  Significant Accounting Policies

 

Basis of Presentation

 

The interim consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair statement of the Company's consolidated financial position, results of operations and cash flows for the periods presented. These adjustments consist of normal, recurring items. The results of operations for any interim period are not necessarily indicative of results for the full year. The interim consolidated financial statements and notes are presented as permitted by the requirements for Quarterly Reports on Form 10-Q.

 

This Quarterly Report on Form 10-Q should be read in conjunction with the Company's consolidated financial statements and notes included in its 2010 Annual Report on Form 10-K. However, as described in Note 13, during the first quarter of 2011, the Company made certain product moves between its business segments in its continuing effort to drive growth by aligning businesses around markets and customers. The Company has begun to report comparative results under the new business segment structure with the filing of this Quarterly Report on Form 10-Q. In the second quarter of 2011, the Company plans to revise its business segment disclosures in its 2010 Annual Report on Form 10-K via a Form 8-K to reflect these impacts.

 

Earnings Per Share

 

The difference in the weighted average 3M shares outstanding for calculating basic and diluted earnings per share attributable to 3M common shareholders is a result of the dilution associated with the Company's stock-based compensation plans. Certain options outstanding under these stock-based compensation plans were not included in the computation of diluted earnings per share attributable to 3M common shareholders because they would not have had a dilutive effect (3.6 million average options for the three months ended March 31, 2011 and 30.2 million average options for the three months ended March 31, 2010). The conditions for conversion related to the Company's "Convertible Notes" were not met (refer to 3M's 2010 Annual Report on Form 10-K, Note 10 to the Consolidated Financial Statements, for more detail). If the conditions for conversion are met, 3M may choose to pay in cash and/or common stock; however, if this occurs, the Company has the intent and ability to settle this debt security in cash. Accordingly, there was no impact on diluted earnings per share attributable to 3M common shareholders. The computations for basic and diluted earnings per share follow:

 

Earnings Per Share Computations

 



Three months ended
March 31,


 

(Amounts in millions, except per share amounts)


2011


2010


 

Numerator:






 

Net income attributable to 3M............................................................................


$

1,081


$

930


 







 

 

Denominator:






 

Denominator for weighted average 3M common shares outstanding - basic..........


711.5


711.8


 







Dilution associated with the Company's stock-based compensation plans.............


14.9


11.7


 







 

Denominator for weighted average 3M common shares outstanding - diluted........


726.4


723.5


 







 

Earnings per share attributable to 3M common shareholders - basic.......................


$

1.52


$

1.31


 

Earnings per share attributable to 3M common shareholders - diluted.....................


1.49


1.29


 

 



 

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force, that provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. As a result of these amendments, multiple-deliverable revenue arrangements are separated in more circumstances than under pre-existing U.S. GAAP. The ASU does this by establishing a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable is based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. A vendor is required to determine its best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. This ASU also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method, which allocates any discount in the overall arrangement proportionally to each deliverable based on its relative selling price. Expanded disclosures of qualitative and quantitative information regarding application of the multiple-deliverable revenue arrangement guidance are also required under the ASU. The ASU does not apply to arrangements for which industry specific allocation and measurement guidance exists, such as long-term construction contracts and software transactions. For 3M, ASU No. 2009-13 was effective beginning January 1, 2011. 3M elected to adopt the provisions of this standard prospectively to new or materially modified arrangements beginning on the effective date. The adoption of this standard did not have a material impact on 3M's consolidated results of operations or financial condition.

 

In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That Include Software Elements-a consensus of the FASB Emerging Issues Task Force, that reduces the types of transactions that fall within the scope of software revenue recognition guidance. Pre-existing software revenue recognition guidance required that its provisions be applied to an entire arrangement when the sale of any products or services containing or utilizing software when the software was considered more than incidental to the product or service. As a result of the amendments included in ASU No. 2009-14, many tangible products and services that rely on software are accounted for under the multiple-element arrangements revenue recognition guidance rather than under the software revenue recognition guidance. Under the ASU, the following components are excluded from the scope of software revenue recognition guidance:  the tangible element of the product, software products bundled with tangible products where the software components and non-software components function together to deliver the product's essential functionality, and undelivered components that relate to software that is essential to the tangible product's functionality. The ASU also provides guidance on how to allocate transaction consideration when an arrangement contains both deliverables within the scope of software revenue guidance (software deliverables) and deliverables not within the scope of that guidance (non-software deliverables). For 3M, ASU No. 2009-14 was effective beginning January 1, 2011. 3M elected to adopt the provisions of this standard prospectively to new or materially modified arrangements beginning on the effective date. The adoption of this standard did not have a material impact on 3M's consolidated results of operations or financial condition.

 

In January 2010, the FASB issued ASU No. 2010-6, Improving Disclosures About Fair Value Measurements, that amends pre-existing disclosure requirements under ASC 820 by adding required disclosures about items transferring into and out of levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchases, sales, issuances, and settlements relative to level 3 measurements; and clarifying, among other things, the pre-existing fair value disclosures about the level of disaggregation. For 3M, this ASU was effective for the first quarter of 2010, except for the requirement to provide level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which was effective beginning the first quarter of 2011. Since this standard impacts disclosure requirements only, its adoption did not have a material impact on 3M's consolidated results of operations or financial condition.

 

In April 2010, the FASB issued ASU No. 2010-17, Milestone Method of Revenue Recognition-a consensus of the FASB Emerging Issues Task Force that recognizes the milestone method as an acceptable revenue recognition method for substantive milestones in research or development arrangements. This standard requires its provisions be met in order for an entity to recognize consideration that is contingent upon achievement of a substantive milestone as revenue in its entirety in the period in which the milestone is achieved. In addition, this ASU requires disclosure of certain information with respect to arrangements that contain milestones. For 3M, this standard was effective prospectively beginning January 1, 2011. The adoption of this standard did not have a material impact on 3M's consolidated results of operations or financial condition.

 



 

3M makes acquisitions of certain businesses from time to time that the Company feels align with its strategic intent with respect to, among other factors, growth markets and adjacent product lines or technologies.

 

The impact on the consolidated balance sheet of the purchase price allocations related to acquisitions, including adjustments relative to other acquisitions within the allocation period, follows. Adjustments to previous acquisitions were not material and primarily related to changes in the preliminary allocations of purchase price of businesses acquired in the fourth quarter of 2010. The allocation of purchase price related to acquisitions in the first quarter of 2011, primarily Winterthur Technologie AG (Winterthur), is considered preliminary, largely with respect to certain acquired intangible assets and tax-related assets and liabilities.

 


First Quarter 2011 Acquisition Activity




 


Winterthur
Technologie AG


Other
Acquisitions


Total




 

Accounts receivable ................................


$

43


$

37


$

80





 

Inventory ................................................


76


25


101




 

 

Other current assets ...............................


6


4


10




 

Property, plant, and equipment ................


74


75


149




 

Purchased finite-lived intangible assets .....


185


28


213




 

Purchased goodwill .................................


145


45


190




 

Accounts payable and other liabilities, net of other assets ....................................


(69

)

(31

)

(100

)



 

Interest bearing debt ...............................


(79

)

(2

)

(81

)



Deferred tax asset/(liability) .....................


(20

)

(5

)

(25

)



 











 

Net assets acquired ................................


$

361


$

176


$

537




 

Noncontrolling interest .............................



(56

)


-



(56

)



 

 

Net assets acquired excluding noncontrolling interest................................................


$

305


$

176


$

481














 

Supplemental information:










 

Cash paid ..............................................


$

327


$

179


$

506




 

Less: Cash acquired ...............................


32


3


35




 

Cash paid, net of cash acquired ...............


$

295


$

176


$

471




 

Non-cash ...............................................


10


-


10




 

Net assets acquired excluding noncontrolling interest................................................


$

305


$

176


$

481




 

 

Goodwill resulting from business combinations is largely attributable to the existing workforce of the acquired businesses and synergies expected to arise after 3M's acquisition of these businesses. In-process research and development associated with these business combinations were not material. Pro forma information related to acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material.

 

In addition to business combinations, 3M periodically acquires certain tangible and/or intangible assets and purchases interests in certain enterprises that do not otherwise qualify for accounting as business combinations. These transactions are largely reflected as additional asset purchase and investment activity.

 

During the three months ended March 31, 2011, 3M completed four business combinations. The purchase price paid for these business combinations (net of cash acquired) and the impact of other matters (net) during the three months ended March 31, 2011 aggregated to $471 million.

 

(1) In January 2011, 3M (Industrial and Transportation Business) purchased certain assets of Nida-Core Corp., a manufacturer of structural honeycomb core and fiber-reinforced foam core materials based in Port St. Lucie, Florida.

 

(2) In February 2011, 3M (Industrial and Transportation Business) announced that it completed its acquisition of all of the outstanding shares of Alpha Beta Enterprise Co. Ltd., a manufacturer of box sealing tape and masking tape headquartered in Taipei, Taiwan.

 

(3) In February 2011, 3M (Consumer and Office Business) purchased all of the outstanding shares of Hybrivet Systems Inc., a provider of instant-read products to detect lead and other contaminants and toxins, which is based in Natick, Massachusetts.

 

(4) In early March 2011, 3M (Industrial and Transportation Business) acquired a controlling interest in Winterthur via completion of a public tender offer. Winterthur, based in Zug, Switzerland, is a leading global supplier of precision grinding technology serving customers in the area of hard-to-grind precision applications in industrial, automotive, aircraft and cutting tools. As of the settlement date of the tendered shares (the business acquisition date), 3M owned approximately 86 percent of Winterthur shares via the tender and previous open market share purchases. The purchase price paid in the preceding table includes non-cash consideration of $10 million representing the business acquisition date fair value of shares previously owned by 3M as of December 31, 2010 and cash consideration paid, net of cash acquired, of $295 million for subsequently tendered and open market purchased shares through the business acquisition date. Following the business acquisition date, 3M also purchased additional outstanding shares of its consolidated Winterthur subsidiary, increasing 3M's ownership interest to approximately 94% as of March 31, 2011 as discussed in Note 4.

 

Purchased identifiable finite-lived intangible assets related to acquisitions which closed in the first three months of 2011 totaled $213 million and will be amortized on a straight-line basis over a weighted-average life of 14 years (lives ranging from 3 to 17 years). Acquired identifiable intangible assets for which significant assumed renewals or extensions of underlying arrangements impacted the determination of their useful lives were not material.

 

 

Purchased goodwill related to the acquisitions which closed in the first three months of 2011 totaled $191 million, $6 million of which is deductible for tax purposes. The acquisition activity in the following table also includes the impacts of adjustments to the preliminary allocation of purchase price for prior year acquisitions, which decreased goodwill by $1 million. The amounts in the "Translation and other" column in the following table primarily relate to changes in foreign currency exchange rates. The goodwill balance by business segment as of December 31, 2010 and March 31, 2011, follow:

 

Goodwill

 

(Millions)


Dec. 31, 2010
Balance


Acquisition
activity


Translation
and other


Mar. 31, 2011
Balance


 

Industrial and Transportation.............................


$

1,783


$

181


$

10


$

1,974


 

Health Care.....................................................


1,506


(1

)

42


1,547


 

 

Consumer and Office........................................


187


12


1


200


 

Display and Graphics.......................................


994


-


(1

)

993


 

Safety, Security and Protection Services............


1,670


(2

)

41


1,709


Electro and Communications............................


680


-


18


698


 

Total Company................................................


$

6,820


$

190


$

111


$

7,121


 

 

Accounting standards require that goodwill be tested for impairment annually and between annual tests in certain circumstances such as a change in reporting units or the testing of recoverability of a significant asset group within a reporting unit. At 3M, reporting units generally correspond to a division.

 

As discussed in Note 13, effective in the first quarter of 2011, 3M made certain product moves between its business segments, with the resulting impact reflected in the goodwill balances by business segment above for all periods presented. For any product moves that resulted in reporting unit changes, the Company applied the relative fair value method to determine the impact to reporting units. During the first quarter of 2011, the Company completed its assessment of any potential goodwill impairment for reporting units impacted by this new structure and determined that no impairment existed.

 



Acquired Intangible Assets

 

For the three months ended March 31, 2011, intangible assets (excluding goodwill) acquired through business combinations increased balances by $213 million. Balances are also impacted by changes in foreign currency exchange rates. The carrying amount and accumulated amortization of acquired finite-lived intangible assets, in addition to the balance of non-amortizable intangible assets, as of March 31, 2011, and December 31, 2010, follow:

 


Mar. 31,
2011


Dec. 31,
2010


 

Patents.................................................................................................................

566


$

551


 

Other amortizable intangible assets (primarily tradenames and customer related intangibles)........................................................................................................

2,256


2,016


 

Total gross carrying amount....................................................................................

2,822


$

2,567


 







 

Accumulated amortization - patents......................................................................

(359

(345

)

 

Accumulated amortization - other..........................................................................

(587

(527

)

 

Total accumulated amortization...............................................................................

(946

$

(872

)

 

 







 

Total finite-lived intangible assets - net................................................................

1,876


$

1,695








 

Non-amortizable intangible assets (tradenames) ......................................................

128



125


 

Total intangible assets - net...............................................................................

2,004


$

1,820


 

 

Amortization expense for acquired intangible assets for the three months ended March 31, 2011 and 2010 follows:

 


Three months ended
Mar. 31,



2011


2010


Amortization expense.............................................................................................

54


$

43


 

The table below shows expected amortization expense for acquired amortizable intangible assets recorded as of March 31, 2011:

 


Last 3
Quarters
2011


2012


2013


2014


2015


2016


After
2016


Amortization expense


$

173


$

219


$

208


$

185


$

172


$

158


$

761

 

The expected amortization expense is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, changes in foreign currency exchange rates, impairment of intangible assets, accelerated amortization of intangible assets and other events. 3M expenses the costs incurred to renew or extend the term of intangible assets.



 

 





3M Company Shareholders




 

(Millions)


Total


Common
Stock and
Additional
Paid-in
Capital


Retained
Earnings


Treasury
Stock


Accumulated
Other
Comprehensive
Income
(Loss)


Non-
controlling
Interest


 

Balance at December 31, 2010


$

16,017


$

3,477


$

25,995


$

(10,266

)

$

(3,543

)

$

354


 















 

Net income.................................


1,103




1,081






22


 

 

Cumulative translation adjustment


242








248


(6

)

 

Defined benefit pension and postretirement plans adjustment


76








76


-


 

Debt and equity securities - unrealized gain (loss)...............


(1

)







(1

)

-


Cash flow hedging instruments - unrealized gain (loss)...............


(17

)







(17

)

-


 

Total comprehensive income.....


1,403












 

Dividends paid............................


(392

)



(392

)







 

 

Business combination allocation to noncontrolling interest .............


56










56


 

Purchase of subsidiary shares ....


(33

)









(33

)

 

Stock-based compensation, net of tax impacts.............................


131


131










 

Reacquired stock........................


(675

)





(675

)





Issuances pursuant to stock option and benefit plans............


380




(163

)

543






 

Balance at March 31, 2011.....


$

16,887


$

3,608


$

26,521


$

(10,398

)

$

(3,237

)

$

393


 

 




3M Company Shareholders



(Millions)


Total


Common
Stock and
Additional
Paid-in
Capital


Retained
Earnings


Treasury
Stock


Accumulated
Other
Comprehensive
Income
(Loss)


Non-
controlling
Interest


 

Balance at December 31, 2009


$

13,302


$

3,162


$

23,753


$

(10,397

)

$

(3,754

)

$

538


 















 

Net income.................................


955




930






25


 

 

Cumulative translation adjustment


(95

)







(94

)

(1

)

 

Defined benefit pension and postretirement plans adjustment


51








50


1


 

Debt and equity securities - unrealized gain (loss)...............


1








1


-


Cash flow hedging instruments - unrealized gain (loss)...............


23








23


-


 

Total comprehensive income.....


935












 

Dividends paid............................


(374

)



(374

)







 

 

Purchase of subsidiary shares and transfers from noncontrolling interest...................................


(256

)

(5

)





27


(278

)

 

Stock-based compensation, net of tax impacts.............................


112


112










 

Reacquired stock........................


(20

)





(20

)





Issuances pursuant to stock option and benefit plans............


152




(78

)

230






 

Balance at March 31, 2010.....


$

13,851


$

3,269


$

24,231


$

(10,187

)

$

(3,747

)

$

285


 





Three months ended
Mar. 31,


 


2011


2010


 

Net income including noncontrolling interest...........................................................

1,103


$

955


 

Other comprehensive income, net of tax:





 

 

Cumulative translation adjustment......................................................................

242


(95

)

 

Defined benefit pension and postretirement plans adjustment................................

76


51


 

Debt and equity securities, unrealized gain (loss)................................................

(1

1


Cash flow hedging instruments, unrealized gain (loss)..........................................

(17

23


 

Total other comprehensive income (loss), net of tax................................................

300


(20

)

 

Comprehensive income (loss) including noncontrolling interest.................................

1,403


935


 

Comprehensive (income) loss attributable to noncontrolling interest..........................

(16

(25

)

 

Comprehensive income (loss) attributable to 3M.....................................................

1,387


$

910


 

 


Mar. 31,


Dec. 31,


 


2011


2010


 

Cumulative translation adjustment.........................................................................

622


$

374


 

Defined benefit pension and postretirement plans adjustment...................................

(3,803

(3,879

)

 

 

Debt and equity securities, unrealized gain (loss)....................................................

(7

(6

)

Cash flow hedging instruments, unrealized gain (loss).............................................

(49

(32

)

 

Total accumulated other comprehensive income (loss)............................................

(3,237

$

(3,543

)

 

 

Components of Comprehensive Income (Loss) Attributable to 3M



Three months ended
Mar. 31,


 

(Millions)


2011


2010


 

Net income attributable to 3M...........................................................................


$

1,081


$

930


 







 

 

Cumulative translation..........................................................................................


221


(77

)

Tax effect............................................................................................................


27


(17

)

 

Cumulative translation - net of tax....................................................................


248


(94

)

 







 

 

Defined benefit pension and postretirement plans adjustment...................................


119


76


Tax effect............................................................................................................


(43

)

(26

)

 

Defined benefit pension and postretirement plans adjustment - net of tax.......


76


50


 







 

 

Debt and equity securities, unrealized gain (loss)....................................................


(2

)

3


Tax effect............................................................................................................


1


(2

)

 

Debt and equity securities, unrealized gain (loss) - net of tax...........................


(1

)

1


 







 

 

Cash flow hedging instruments, unrealized gain (loss).............................................


(27

)

36


Tax effect............................................................................................................


10


(13

)

 

Cash flow hedging instruments, unrealized gain (loss) - net of tax...................


(17

)

23


 







 

Total comprehensive income (loss) attributable to 3M......................................


$

1,387


$

910


 

 

Reclassification adjustments are made to avoid double counting in comprehensive income items that are also recorded as part of net income. Reclassifications to earnings from accumulated other comprehensive income that related to pension and postretirement expense in the income statement were $119 million pre-tax ($76 million after-tax) for the three months ended March 31, 2011 and $76 million pre-tax ($50 million after-tax) for the three months ended March 31, 2010. These pension and postretirement expense pre-tax amounts are shown in the table in Note 8 as amortization of transition (asset) obligation, amortization of prior service cost (benefit) and amortization of net actuarial (gain) loss. Cash flow hedging instruments reclassifications are provided in Note 9. Reclassifications to earnings from accumulated other comprehensive income for debt and equity securities were not material for the first three months of 2011 and 2010. Other reclassification adjustments were not material. Income taxes are not provided for foreign translation relating to permanent investments in international subsidiaries, but tax effects within cumulative translation does include impacts from items such as net investment hedge transactions.

 

 

As discussed in Note 2, in early March 2011, 3M acquired a controlling interest in Winterthur Technologie AG (Winterthur), making Winterthur a consolidated subsidiary as of that business acquisition date. Subsequent to this business acquisition date, 3M purchased additional outstanding shares of its Winterthur subsidiary increasing 3M's ownership interest from approximately 86 percent as of the business acquisition date to approximately 94 percent as of March 31, 2011. The $33 million of cash paid as a result of these additional purchases of Winterthur shares was classified as other investing activity in the consolidated statement of cash flows. These additional purchases did not result in a material transfer from noncontrolling interest to 3M Company shareholders' equity.

 

During the second half of 2009 and the first half of 2010, 3M effected a purchase of subsidiary shares and transfers of ownership interests to align activities in Japan and to simplify the Company's ownership structure. As a result of these activities, beginning in June 2010 the Company has a wholly owned subsidiary in the region in addition to its majority owned Sumitomo 3M Limited entity (Sumitomo 3M). Because the Company retained its controlling interest in the subsidiaries involved, these activities resulted in changes to 3M Company shareholders' equity and noncontrolling interest. These activities included the following:

 

·      During the second half of 2009, a wholly owned subsidiary that, in turn, owned a portion of the Company's majority owned Sumitomo 3M, was transferred to another subsidiary (referred to herein as 3M HC) that was majority, rather than wholly, owned. Sumitomo 3M also owned a portion of 3M HC. As a result of the transaction, 3M's effective ownership in Sumitomo 3M was reduced from 75 percent to 71.5 percent. The transfer resulted in a decrease in 3M Company shareholders' equity and an increase in noncontrolling interest of $81 million in the second half of 2009.

 

·      During the first quarter of 2010, majority owned 3M HC which, as a result of the transfer above owned a portion of the Company's majority owned Sumitomo 3M, transferred this interest to Sumitomo 3M. In addition, Sumitomo 3M purchased a portion of its shares held by its noncontrolling interest, Sumitomo Electric Industries, Ltd. (SEI), by paying cash of 5.8 billion Japanese Yen and entering into a note payable to SEI of 17.4 billion Japanese Yen (approximately $63 million and $188 million, respectively, based on applicable exchange rates at that time). As a result of these transactions, 3M's effective ownership in Sumitomo 3M was increased from 71.5 percent to 75 percent. The cash paid as a result of the purchase of Sumitomo 3M shares from SEI was classified as an investing activity in the consolidated statement of cash flows. The remainder of the purchase financed by the note payable to SEI was considered non-cash investing and financing activity in the first quarter of 2010. These transactions resulted in an increase in 3M Company shareholders' equity of $22 million and a decrease in noncontrolling interest of $278 million in the first quarter of 2010.

 

·      During the second quarter of 2010, majority owned Sumitomo 3M transferred its interest in 3M HC to 3M HC. As a result of this transaction, 3M HC became wholly owned by the Company. The transfer resulted in an increase in 3M Company shareholders' equity and a decrease in noncontrolling interest of $24 million in the second quarter of 2010.

 

The following table summarizes the effects of the 2010 transactions on equity attributable to 3M Company shareholders for the three months ended March 31, 2010.


Three months ended
Mar. 31, 2010


Net income attributable to 3M..........................................................................................................

930

Transfers from noncontrolling interest...............................................................................................

22

Change in 3M Company shareholders' equity from net income attributable to 3M and transfers from noncontrolling interest.................................................................................................................

952

 

NOTE 5.  Income Taxes

 

The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003.

 

The IRS completed its field examination of the Company's U.S. federal income tax returns for the years 2005 through 2007 in the fourth quarter of 2009. The Company protested certain IRS positions within these tax years and entered into the administrative appeals process with the IRS during the first quarter of 2010. During the first quarter of 2010, the IRS completed its field examination of the Company's U.S. federal income tax return for the 2008 year. The Company protested certain IRS positions for 2008 and entered into the administrative appeals process with the IRS during the second quarter of 2010. During the first quarter of 2011, the IRS completed its field examination of the Company's U.S. federal income tax return for the 2009 year. The Company protested certain IRS positions for 2009 and entered into the administrative appeals process with the IRS during the second quarter of 2011. Currently, the Company is under examination by the IRS for its U.S. federal income tax returns for the years 2010 and 2011. It is anticipated that the IRS will complete its examination of the Company for 2010 by the end of the first quarter of 2012, and for 2011 by the end of the first quarter of 2013. As of March 31, 2011, the IRS has not proposed any significant adjustments to the Company's tax positions for which the Company is not adequately reserved.

 

During the first quarter of 2010, the Company paid the agreed upon assessments for the 2005 tax year. During the second quarter of 2010, the Company paid the agreed upon assessments for the 2008 tax year. Payments relating to other proposed assessments arising from the 2005 through 2011 examinations may not be made until a final agreement is reached between the Company and the IRS on such assessments or upon a final resolution resulting from the administrative appeals process or judicial action. In addition to the U.S. federal examination, there is also limited audit activity in several U.S. state and foreign jurisdictions.

 

3M anticipates changes to the Company's uncertain tax positions due to the closing of the various audit years mentioned above. Currently, the Company is not able to reasonably estimate the amount by which the liability for unrecognized tax benefits will increase or decrease during the next 12 months as a result of the ongoing income tax authority examinations.

The total amounts of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of March 31, 2011 and December 31, 2010, respectively, are $358 million and $394 million.

 

The Company recognizes interest and penalties accrued related to unrecognized tax benefits in tax expense. The Company recognized in the consolidated statement of income on a gross basis approximately $2 million of benefit and $4 million of expense for the three months ended March 31, 2011 and March 31, 2010, respectively. At March 31, 2011 and December 31, 2010, accrued interest and penalties in the consolidated balance sheet on a gross basis were $54 million and $52 million, respectively. Included in these interest and penalty amounts are interest and penalties related to tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

 

The effective tax rate for the first quarter of 2011 was 28.6 percent, compared to 31.9 percent in the first quarter of 2010, a decrease of 3.3 percent. The first quarter of 2010 includes a one-time income tax charge of $84 million as a result of the March 2010 enactment of the Patient Protection and Affordable Care Act, including modifications made in the Health Care and Education Reconciliation Act of 2010, which increased the first-quarter 2010 effective tax rate by approximately 6 percent. Since future anticipated retiree health care liabilities and related tax subsidies were already reflected in 3M's financial statements, the change in law resulted in a reduction of the value of the company's deferred tax asset related to the subsidy. Other factors on a combined basis increased the effective tax rate for the first quarter of 2011 when compared to the first quarter of 2010 by 2.7 percent, with the most significant item related to international taxes. This was due primarily to the one-time 2010 tax benefits resulting from the corporate alignment transactions that allowed the Company to increase its ownership of a foreign subsidiary. These transactions are described in the section of Note 4 entitled "Purchase of Subsidiary Shares and Transfers of Ownership Interests Involving Non-Wholly Owned Subsidiaries". In addition, the Company's effective tax rate benefited during the first quarter of 2011 from the reinstatement of the research and development credit and adjustments to its income tax reserves.

 

The provision for income taxes is determined using the asset and liability approach. Under this approach, deferred income taxes represent the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities. The Company records a valuation allowance to reduce its deferred tax assets when uncertainty regarding their realizability exits. As of both March 31, 2011 and December 31, 2010, the Company had valuation allowances of $128 million on its deferred tax assets.



NOTE 6.  Marketable Securities

 

The Company invests in agency securities, corporate securities, asset-backed securities, treasury securities and other securities. The following is a summary of amounts recorded on the Consolidated Balance Sheet for marketable securities (current and non-current).

 


Mar. 31,


Dec. 31,


 


2011


2010


 





 

U.S. government agency securities........................................................................

247


$

246


 

Foreign government agency securities...................................................................

37


52


 

 

Corporate debt securities......................................................................................

248


280


 

Commercial paper................................................................................................

30


55


 

Certificates of deposit...........................................................................................

15


-


 

U.S. treasury securities........................................................................................

30


55


 

U.S. municipal securities......................................................................................

13


20


 

Asset-backed securities:






 

Automobile loan related.....................................................................................

423


253


 

Credit card related............................................................................................

163


79


 

Equipment lease related....................................................................................

17


24


Other...............................................................................................................

39


8


 

Asset-backed securities total................................................................................

642


364


 

Other securities...................................................................................................

23


29


 







 

Current marketable securities...........................................................................

1,285


$

1,101


 







 

U.S. government agency securities........................................................................

33


$

63


 

Foreign government agency securities...................................................................

3


3


 

 

Corporate debt securities......................................................................................

134


192


 

U.S. treasury securities........................................................................................

64


44


 

U.S. municipal securities......................................................................................

3


3


 

Asset-backed securities:






 

Automobile loan related.....................................................................................

91


144


 

Credit card related............................................................................................

17


70


 

Equipment lease related....................................................................................

8


14


Asset-backed securities total................................................................................

116


228


 

Auction rate securities..........................................................................................

7


7


 







 

Non-current marketable securities.....................................................................

360


$

540


 







 

Total marketable securities...............................................................................

1,645


$

1,641


 

 

Classification of marketable securities as current or non-current is dependent upon management's intended holding period, the security's maturity date and liquidity considerations based on market conditions. If management intends to hold the securities for longer than one year as of the balance sheet date, they are classified as non-current. At March 31, 2011, gross unrealized losses totaled approximately $7 million (pre-tax), while gross unrealized gains totaled approximately $4 million (pre-tax). At December 31, 2010, gross unrealized losses totaled approximately $9 million (pre-tax), while gross unrealized gains totaled approximately $5 million (pre-tax). Gross realized gains and losses on sales or maturities of marketable securities for the first three months of 2011 and 2010 were not material. Cost of securities sold use the first in, first out (FIFO) method. Since these marketable securities are classified as available-for-sale securities, changes in fair value will flow through other comprehensive income, with amounts reclassified out of other comprehensive income into earnings upon sale or "other-than-temporary" impairment.

 

3M reviews impairments associated with its marketable securities in accordance with the measurement guidance provided by ASC 320, Investments-Debt and Equity Securities, when determining the classification of the impairment as "temporary" or "other-than-temporary". A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of shareholders' equity. Such an unrealized loss does not reduce net income attributable to 3M for the applicable accounting period because the loss is not viewed as other-than-temporary. The factors evaluated to differentiate between temporary and other-than-temporary include the projected future cash flows, credit ratings actions, and assessment of the credit quality of the underlying collateral, as well as other factors.

The balances at March 31, 2011 for marketable securities by contractual maturity are shown below. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

 


Mar. 31, 2011


 





 

Due in one year or less...................................................................................................................


$

762


 

Due after one year through three years.............................................................................................


825


 

 

Due after three years through five years............................................................................................


39


Due after five years.........................................................................................................................


19


 





 

Total marketable securities.............................................................................................................


$

1,645


 

 

3M has a diversified marketable securities portfolio of $1.645 billion as of March 31, 2011. Within this portfolio, current and long-term asset-backed securities (estimated fair value of $758 million) are primarily comprised of interests in automobile loans and credit cards. At March 31, 2011, the asset-backed securities credit ratings were AAA or A-1+, with the exception of two securities rated AA+ with a fair market value of less than $1 million.

 

3M's marketable securities portfolio includes auction rate securities that represent interests in investment grade credit default swaps; however, currently these holdings comprise less than one percent of this portfolio. The estimated fair value of auction rate securities is $7 million at both March 31, 2011 and December 31, 2010. Gross unrealized losses within accumulated other comprehensive income related to auction rate securities totaled $6 million (pre-tax) at both March 31, 2011 and December 31, 2010. As of March 31, 2011, auction rate securities associated with these balances have been in a loss position for more than 12 months. Since the second half of 2007, these auction rate securities failed to auction due to sell orders exceeding buy orders. Liquidity for these auction-rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals, usually every 7, 28, 35, or 90 days. The funds associated with failed auctions will not be accessible until a successful auction occurs or a buyer is found outside of the auction process. Refer to Note 10 for a table that reconciles the beginning and ending balances of auction rate securities.

 

 

As disclosed in 3M's 2010 Annual Report on Form 10-K, in the fourth quarter of 2010, the Company entered into a 100.5 million Canadian Dollar loan, with four equal installments due in April 2011, July 2011, October 2011 and January 2012. At December 31, 2010, the floating interest rate on this loan was 1.8%. During March 2011, this loan agreement was amended to increase the loan amount to 201 million Canadian Dollars and to allow for repayment of the total loan in July 2012, instead of in four equal installments. However, 3M has the option to repay the principal amount of this loan before July 2012. All other terms and conditions of the loan agreement remain in full force.

 

As also disclosed in 3M's 2010 Annual Report on Form 10-K, during the first quarter of 2010, the Company entered into a floating rate note payable of 17.4 billion Japanese Yen (approximately $188 million based on exchange rates at that time) in connection with the purchase of additional interest in the Company's Sumitomo 3M Limited subsidiary as discussed in Note 4. This note is due in three equal installments of 5.8 billion Japanese Yen, with one installment paid on September 30, 2010, one installment paid on March 30, 2011, and the remaining installment due on September 30, 2011. Interest accrues on the note based on the three-month Tokyo Interbank Offered Rate (TIBOR) plus 40 basis points.

 



NOTE 8.  Pension and Postretirement Benefit Plans

 

Components of net periodic benefit cost and other supplemental information for the three months ended March 31, 2011 and 2010 follows:

 

Benefit Plan Information

 



Three months ended March 31,


 



Qualified and Non-qualified

Pension Benefits


Postretirement


 



United States


International


Benefits


 

(Millions)


2011


2010


2011


2010


2011


2010


 

Net periodic benefit cost (benefit)














 

Service cost..................................................


$

51


$

50


$

28


$

28


$

15


$

14


 

Interest cost..................................................


158


160


62


62


23


22


 

 

Expected return on plan assets.......................


(232

)

(232

)

(70

)

(71

)

(19

)

(21

)

 

Amortization of transition (asset) obligation......


-


-


-


-


-


-


 

Amortization of prior service cost (benefit)........


3


3


(3

)

(1

)

(18

)

(23

)

Amortization of net actuarial (gain) loss...........


83


55


28


21


26


21


 

Net periodic benefit cost (benefit)........................


$

63


$

36


$

45


$

39


$

27


$

13


 

Settlements, curtailments, special termination benefits and other.........................


-


-


-


-


-


-


 

Net periodic benefit cost (benefit) after settlements, curtailments, special termination benefits and other..........................................

63


$

36

45


$

39

27


$

13


 

 

For the three months ended March 31, 2011, contributions totaling $39 million were made to the Company's U.S. and international pension plans and $22 million to its postretirement plans. In 2011, the Company expects to contribute in the range of $400 million to $600 million to its U.S. and international pension and postretirement plans. The Company does not have a required minimum pension contribution obligation for its U.S. plans in 2011. Therefore, the amount of the anticipated discretionary pension contribution could vary significantly depending on the U.S. plans' funded status and the anticipated tax deductibility of the contribution. Future contributions will also depend on market conditions, interest rates and other factors. 3M's annual measurement date for pension and postretirement assets and liabilities is December 31 each year, which is also the date used for the related annual measurement assumptions.

 

3M was informed during the first quarter of 2009 that the general partners of WG Trading Company, in which 3M's benefit plans hold limited partnership interests, are the subject of a criminal investigation as well as civil proceedings by the SEC and CFTC (Commodity Futures Trading Commission). In March 2011, over the objections of 3M and six other limited partners of WG Trading Company, the district court judge ruled in favor of the court appointed receiver's proposed distribution plan. In April 2011, the 3M benefit plans received their share under the court-ordered distribution plan. 3M and six other limited partners of WG Trading Company have appealed the court's order to the United States Court of Appeals for the Second Circuit. The benefit plan trustee holdings of WG Trading Company interests were adjusted to reflect the decreased estimated fair market value, inclusive of estimated insurance proceeds, as of the annual measurement dates. The Company has insurance that it believes, based on what is currently known, will result in the recovery of a portion of the decrease in original asset value. As of the 2010 measurement date these holdings represented less than one percent of 3M's fair value of total plan assets. 3M currently believes that the resolution of these events will not have a material adverse effect on the consolidated financial position of the Company.

 

The Company uses interest rate swaps, currency swaps, commodity price swaps, and forward and option contracts to manage risks generally associated with foreign exchange rate, interest rate and commodity price fluctuations. The information that follows explains the various types of derivatives and financial instruments used by 3M, how and why 3M uses such instruments, how such instruments are accounted for, and how such instruments impact 3M's financial position and performance.

 

Additional information with respect to the impacts on other comprehensive income of nonderivative hedging and derivative instruments is included in Note 4. Additional information with respect to the fair value of derivative instruments is included in Note 10. References to information regarding derivatives and/or hedging instruments associated with the Company's long-term debt are also made in Note 10 to the Consolidated Financial Statements in 3M's 2010 Annual Report on Form 10-K.

 

Types of Derivatives/Hedging Instruments and Inclusion in Income/Other Comprehensive Income

 

Cash Flow Hedges:

 

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

 

Cash Flow Hedging - Foreign Currency Forward and Option Contracts: The Company enters into foreign exchange forward and option contracts to hedge against the effect of exchange rate fluctuations on cash flows denominated in foreign currencies and certain intercompany financing transactions. These transactions are designated as cash flow hedges. The settlement or extension of these derivatives will result in reclassifications (from accumulated other comprehensive income) to earnings in the period during which the hedged transactions affect earnings. Generally, 3M dedesignates these cash flow hedge relationships in advance of the occurrence of the forecasted transaction. The portion of gains or losses on the derivative instrument previously accumulated in other comprehensive income for dedesignated hedges remains in accumulated other comprehensive income until the forecasted transaction occurs. Changes in the value of derivative instruments after dedesignation are recorded in earnings and are included in the Derivatives Not Designated as Hedging Instruments section below. Hedge ineffectiveness and the amount excluded from effectiveness testing recognized in income on cash flow hedges were not material for the three month periods ended March 31, 2011 and 2010. The maximum length of time over which 3M hedges its exposure to the variability in future cash flows for a majority of the forecasted transactions is 12 months and, accordingly, at March 31, 2011, the majority of the Company's open foreign exchange forward and option contracts had maturities of one year or less. The dollar equivalent gross notional amount of the Company's foreign exchange forward and option contracts designated as cash flow hedges at March 31, 2011 was approximately $3.5 billion.

 

Cash Flow Hedging - Commodity Price Management: The Company manages commodity price risks through negotiated supply contracts, price protection agreements and forward physical contracts. The Company uses commodity price swaps relative to natural gas as cash flow hedges of forecasted transactions to manage price volatility. The related mark-to-market gain or loss on qualifying hedges is included in other comprehensive income to the extent effective, and reclassified into cost of sales in the period during which the hedged transaction affects earnings. Generally, the length of time over which 3M hedges its exposure to the variability in future cash flows for its forecasted natural gas transactions is 12 months. No significant commodity cash flow hedges were discontinued and hedge ineffectiveness was not material for the three month periods ended March 31, 2011 and 2010. The dollar equivalent gross notional amount of the Company's natural gas commodity price swaps designated as cash flow hedges at March 31, 2011 was $34 million.

 

The location in the consolidated statements of income and comprehensive income and amounts of gains and losses related to derivative instruments designated as cash flow hedges are provided in the following table. Reclassifications of amounts from accumulated other comprehensive income into income include accumulated gains (losses) on dedesignated hedges at the time earnings are impacted by the forecasted transaction.

 

Three months ended March 31, 2011


Pretax Gain (Loss)

Recognized in Other

Comprehensive Income on

Effective Portion of

Derivative


Pretax Gain (Loss) Recognized

in Income on Effective Portion

of Derivative as a Result of

Reclassification from

Accumulated Other

Comprehensive Income


Ineffective Portion of Gain

(Loss) on Derivative and

Amount Excluded from

Effectiveness Testing Recognized in Income



Amount


Location


Amount


Location


Amount


Foreign currency forward/option contracts.........................................


$

(34

)

Cost of sales


$

(6

)

Cost of sales


$

-


Foreign currency forward contracts........


8


Interest expense


10


Interest expense


-


Commodity price swap contracts...........


(1

)

Cost of sales


(4

)

Cost of sales


-


Total................................................


$

(27

)



$

-




$

-


 



 

Three months ended March 31, 2010


Pretax Gain (Loss)
Recognized in Other
Comprehensive Income on
Effective Portion of
Derivative


Pretax Gain (Loss) Recognized
in Income on Effective Portion
of Derivative as a Result of
Reclassification from
Accumulated Other
Comprehensive Income


Ineffective Portion of Gain
(Loss) on Derivative and
Amount Excluded from
Effectiveness Testing
Recognized in Income



Amount


Location


Amount


Location


Amount


Foreign currency forward/option
contracts.........................................


$

3


Cost of sales


$

(40

)

Cost of sales


$

-


Foreign currency forward contracts........


(5

)

Interest expense


(5

)

Interest expense


-


Commodity price swap contracts...........


(9

)

Cost of sales


(2

)

Cost of sales


-


Total............................................


$

(11

)



$

(47

)



$

-


 

As of March 31, 2011, the Company had a balance of $49 million associated with the after tax net unrealized loss associated with cash flow hedging instruments recorded in accumulated other comprehensive income. 3M expects to reclassify to earnings over the next 12 months a majority of this balance (with the impact offset by cash flows from underlying hedged items).

 

Fair Value Hedges:

 

For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivatives as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings.

 

Fair Value Hedging - Interest Rate Swaps: The Company manages interest expense using a mix of fixed and floating rate debt. To help manage borrowing costs, the Company may enter into interest rate swaps. Under these arrangements, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. The mark-to-market of these fair value hedges is recorded as gains or losses in interest expense and is offset by the gain or loss of the underlying debt instrument, which also is recorded in interest expense. These fair value hedges are highly effective and, thus, there is no impact on earnings due to hedge ineffectiveness. The dollar equivalent (based on inception date foreign currency exchange rates) gross notional amount of the Company's interest rate swaps at March 31, 2011 was $1.1 billion.

 

At March 31, 2011, the Company had interest rate swaps designated as fair value hedges of underlying fixed rate obligations. In July 2007, in connection with the issuance of a seven-year Eurobond for an amount of 750 million Euros, the Company completed a fixed-to-floating interest rate swap on a notional amount of 400 million Euros as a fair value hedge of a portion of the fixed interest rate Eurobond obligation. In August 2010, the Company terminated 150 million Euros of the notional amount of this swap. As a result, a gain of 18 million Euros, recorded as part of the balance of the underlying debt, will be amortized over this debt's remaining life. The Company also has two fixed-to-floating interest rate swaps with an aggregate notional amount of $800 million designated as fair value hedges of the fixed interest rate obligation under its $800 million, three-year, 4.50% notes issued in October 2008.

 

The location in the consolidated statements of income and amounts of gains and losses related to derivative instruments designated as fair value hedges and similar information relative to the hedged items are as follows:

 

Three months ended March 31, 2011

(Millions)


Gain (Loss) on Derivative

Recognized in Income


Gain (Loss) on Hedged Item

Recognized in Income


Derivatives in Fair Value Hedging Relationships


Location


Amount


Location


Amount


Interest rate swap contracts..............................


Interest expense


$

(10

)

Interest expense


$

10


Total............................................................




$

(10

)



$

10


 

Three months ended March 31, 2010
(Millions)


Gain (Loss) on Derivative
Recognized in Income


Gain (Loss) on Hedged Item
Recognized in Income


Derivatives in Fair Value Hedging Relationships


Location


Amount


Location


Amount


Interest rate swap contracts..............................


Interest expense


$

8


Interest expense


$

(8

)

Total............................................................




$

8




$

(8

)

 



Net Investment Hedges:

 

As circumstances warrant, the Company uses cross currency swaps, forwards and foreign currency denominated debt to hedge portions of the Company's net investments in foreign operations. For hedges that meet the effectiveness requirements, the net gains or losses attributable to changes in spot exchange rates are recorded in cumulative translation within other comprehensive income. The remainder of the change in value of such instruments is recorded in earnings. Recognition in earnings of amounts previously recorded in cumulative translation is limited to circumstances such as complete or substantially complete liquidation of the net investment in the hedged foreign operation. At March 31, 2011, there were no cross currency swaps and foreign currency forward contracts designated as net investment hedges.

 

In addition to the derivative instruments used as hedging instruments in net investment hedges, 3M also uses foreign currency denominated debt as nonderivative hedging instruments in certain net investment hedges. In July and December 2007, the Company issued seven-year fixed rate Eurobond securities for amounts of 750 million Euros and 275 million Euros, respectively. 3M designated each of these Eurobond issuances as hedging instruments of the Company's net investment in its European subsidiaries.

 

The location in the consolidated statements of income and comprehensive income and amounts of gains and losses related to derivative and nonderivative instruments designated as net investment hedges are as follows. There were no reclassifications of the effective portion of net investment hedges out of accumulated other comprehensive income into income for the periods presented in the table below.

 

Three months ended March 31, 2011

(Millions)


Pretax Gain (Loss) Recognized as
Cumulative Translation within Other
Comprehensive Income on Effective
Portion of Instrument


Ineffective Portion of Gain (Loss) on
Instrument and Amount Excluded from
Effectiveness Testing Recognized in Income



Amount


Location


Amount


Foreign currency denominated debt...................


$

(85

)

N/A


$

-


Total............................................................


$

(85

)



$

-


 

Three months ended March 31, 2010

(Millions)


Pretax Gain (Loss) Recognized as
Cumulative Translation within Other
Comprehensive Income on Effective
Portion of Instrument


Ineffective Portion of Gain (Loss) on
Instrument and Amount Excluded from
Effectiveness Testing Recognized in Income



Amount


Location


Amount


Foreign currency denominated debt...................


90


N/A


-


    Total...........................................................


$

90




$

-


 

Derivatives Not Designated as Hedging Instruments:

 

Derivatives not designated as hedging instruments include dedesignated foreign currency forward and option contracts that formerly were designated in cash flow hedging relationships (as referenced in the preceding Cash Flow Hedges section). In addition, 3M enters into foreign currency forward contracts and commodity price swaps to offset, in part, the impacts of certain intercompany activities (primarily associated with intercompany licensing arrangements) and fluctuations in costs associated with the use of certain precious metals, respectively. These derivative instruments are not designated in hedging relationships; therefore, fair value gains and losses on these contracts are recorded in earnings. The dollar equivalent gross notional amount of these forward, option and swap contracts not designated as hedging instruments totaled $975 million as of March 31, 2011. The Company does not hold or issue derivative financial instruments for trading purposes.

 

The location in the consolidated statements of income and amounts of gains and losses related to derivative instruments not designated as hedging instruments are as follows:

 


Three months ended Mar. 31, 2011
Gain (Loss) on Derivative
Recognized in Income


Three months ended Mar. 31, 2010
Gain (Loss) on Derivative
Recognized in Income



Location


Amount


Location


Amount


Foreign currency forward/option contracts..........


Cost of sales


$

(12

)

Cost of sales


$

(1

)

Foreign currency forward contract......................


Interest expense


16


Interest expense


7


Total........................................................




$

4




$

6


 



Location and Fair Value Amount of Derivative Instruments

 

The following tables summarize the fair value of 3M's derivative instruments, excluding nonderivative instruments used as hedging instruments, and their location in the consolidated balance sheet.

 

March 31, 2011
(Millions)


Assets


Liabilities


Fair Value of Derivative Instruments


Location

Amount


Location


Amount











Derivatives designated as hedging instruments









Foreign currency forward/option contracts.......


Other current assets

$

29


Other current liabilities


$

57


Commodity price swap contracts...................


Other current assets

-


Other current liabilities


2


Interest rate swap contracts...........................


Other assets

28


Other liabilities


-


Total derivatives designated as hedging instruments..........................................



$

57




$

59











Derivatives not designated as hedging
instruments









Foreign currency forward/option contracts.......


Other current assets

$

4


Other current liabilities


$

44


Total derivatives not designated as hedging instruments............................



$

4




$

44











Total derivative instruments..........................



$

61




$

103


 

December 31, 2010
(Millions)


Assets


Liabilities


Fair Value of Derivative Instruments


Location

Amount


Location


Amount











Derivatives designated as hedging instruments.................................................









Foreign currency forward/option contracts.......


Other current assets

$

26


Other current liabilities


$

48


Commodity price swap contracts...................


Other current assets

-


Other current liabilities


5


Interest rate swap contracts...........................


Other assets

39


Other liabilities


-


Total derivatives designated as hedging instruments..........................................



$

65




$

53











Derivatives not designated as hedging
instruments
.................................................









Foreign currency forward/option contracts.......


Other current assets

$

12


Other current liabilities


$

34


Total derivatives not designated as hedging instruments............................



$

12




$

34











Total derivative instruments..........................



$

77




$

87


 

Additional information with respect to the fair value of derivative instruments is included in Note 10.

 

Currency Effects and Credit Risk

 

Currency Effects: 3M estimates that year-on-year currency effects, including hedging impacts, increased net income attributable to 3M by approximately $47 million for the for the three months ended March 31, 2011. This estimate includes the effect of translating profits from local currencies into U.S. dollars and the impact of currency fluctuations on the transfer of goods between 3M operations in the United States and abroad. This estimate also includes year-on-year currency effects from transaction gains and losses, including derivative instruments designed to reduce foreign currency exchange rate risks, which 3M estimates increased net income attributable to 3M by approximately $16 million for the three months ended March 31, 2011.

 

Credit risk: The Company is exposed to credit loss in the event of nonperformance by counterparties in interest rate swaps, currency swaps, commodity price swaps, and forward and option contracts. However, the Company's risk is limited to the fair value of the instruments. The Company actively monitors its exposure to credit risk through the use of credit approvals and credit limits, and by selecting major international banks and financial institutions as counterparties. The Company does not anticipate nonperformance by any of these counterparties. 3M has credit support agreements in place with two of its primary derivatives counterparties. Under these agreements, either party is required to post eligible collateral when the market value of transactions covered by these agreements exceeds specified thresholds, thus limiting credit exposure for both parties.

 

 

3M follows ASC 820, Fair Value Measurements and Disclosures, with respect to assets and liabilities that are measured at fair value on a recurring basis and nonrecurring basis. Under the standard, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The standard also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company's assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances. The hierarchy is broken down into three levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis:

 

For 3M, assets and liabilities that are measured at fair value on a recurring basis primarily relate to available-for-sale marketable securities, available-for-sale investments (included as part of investments in the Consolidated Balance Sheet) and certain derivative instruments. Derivatives include cash flow hedges, interest rate swaps and most net investment hedges. The information in the following paragraphs and tables primarily addresses matters relative to these financial assets and liabilities. Separately, there were no material fair value measurements with respect to nonfinancial assets or liabilities that are recognized or disclosed at fair value in the Company's financial statements on a recurring basis for the three month periods ended March 31, 2011 and 2010.

 

3M uses various valuation techniques, which are primarily based upon the market and income approaches, with respect to financial assets and liabilities. Following is a description of the valuation methodologies used for the respective financial assets and liabilities measured at fair value.

 

Available-for-sale marketable securities - except auction rate securities:

 

Marketable securities, except auction rate securities, are valued utilizing multiple sources. A weighted average price is used for these securities. Market prices are obtained for these securities from a variety of industry standard data providers, security master files from large financial institutions, and other third-party sources. These multiple prices are used as inputs into a distribution-curve-based algorithm to determine the daily fair value to be used. 3M classifies U.S. treasury securities as level 1, while all other marketable securities (excluding auction rate securities) are classified as level 2. Marketable securities are discussed further in Note 6.

 

Available-for-sale marketable securities - auction rate securities only:

 

As discussed in Note 6, auction rate securities held by 3M failed to auction since the second half of 2007. As a result, investments in auction rate securities are valued utilizing third-party indicative bid levels in markets that are not active and broker-dealer valuation models that utilize inputs such as current/forward interest rates, current market conditions and credit default swap spreads. 3M classifies these securities as level 3.

 



Available-for-sale investments:

 

Investments include equity securities that are traded in an active market. Closing stock prices are readily available from active markets and are used as being representative of fair value. 3M classifies these securities as level 1.

 

Derivative instruments:

 

The Company's derivative assets and liabilities within the scope of ASC 815, Derivatives and Hedging, are required to be recorded at fair value. The Company's derivatives that are recorded at fair value include foreign currency forward and option contracts, commodity price swaps, interest rate swaps, and net investment hedges where the hedging instrument is recorded at fair value. Net investment hedges that use foreign currency denominated debt to hedge 3M's net investment are not impacted by the fair value measurement standard under ASC 820, as the debt used as the hedging instrument is marked to a value with respect to changes in spot foreign currency exchange rates and not with respect to other factors that may impact fair value.

 

3M has determined that foreign currency forwards and commodity price swaps will be considered level 1 measurements as these are traded in active markets which have identical asset or liabilities, while currency swaps, foreign currency options, interest rate swaps and cross-currency swaps will be considered level 2. For level 2 derivatives, 3M uses inputs other than quoted prices that are observable for the asset. These inputs include foreign currency exchange rates, volatilities, and interest rates. The level 2 derivative positions are primarily valued using standard calculations/models that use as their basis readily observable market parameters. Industry standard data providers are 3M's primary source for forward and spot rate information for both interest rates and currency rates, with resulting valuations periodically validated through third-party or counterparty quotes and a net present value stream of cash flows model.

 

The following tables provide information by level for assets and liabilities that are measured at fair value on a recurring basis.

 



Fair Value








 

(Millions)


at
Mar. 31,


Fair Value Measurements
Using Inputs Considered as


 

Description


2011


Level 1


Level 2


Level 3


 

Assets:










 

Available-for-sale:










 

 

Marketable securities:










U.S. government agency securities..........................


$

280


$

-


$

280


$

-


 

Foreign government agency securities.....................


40


-


40


-


 

 

Corporate debt securities........................................


382


-


382


-


 

Certificates of deposit.............................................


15


-


15


-


 

Commercial paper..................................................


30


-


30


-


 

Asset-backed securities:










 

Automobile loan related.......................................


514


-


514


-


 

Credit card related..............................................


180


-


180


-


 

Equipment lease related......................................


25


-


25


-


 

Other.................................................................


39


-


39


-


 

U.S. treasury securities..........................................


94


94


-


-


 

U.S. municipal securities........................................


16


-


16


-


 

Auction rate securities............................................


7


-


-


7


 

Other securities.....................................................


23


-


23


-


 

Investments..............................................................


9


9


-


-


 

Derivative instruments - assets:










 

Foreign currency forward/option contracts....................


33


33


-


-


 

Interest rate swap contracts.......................................


28


-


28


-


 











 

Liabilities:










 

Derivative instruments - liabilities:










 

Foreign currency forward/option contracts....................


101


101


-


-


 

Commodity price swap contracts................................


2


2


-


-


 



 

 


Fair Value









at
Dec. 31,


Fair Value Measurements
Using Inputs Considered as


 


2010


Level 1


Level 2


Level 3


 

Assets:










 

Available-for-sale:










 

 

Marketable securities:










U.S. government agency securities..........................


$

309


$

-


$

309


$

-


 

Foreign government agency securities.....................


55


-


55


-


 

 

Corporate debt securities........................................


472


-


472


-


 

Commercial paper..................................................


55


-


55


-


 

Asset-backed securities:










 

Automobile loan related.......................................


397


-


397


-


 

Credit card related..............................................


149


-


149


-


 

Equipment lease related......................................


38


-


38


-


 

Other.................................................................


8


-


8


-


 

U.S. treasury securities..........................................


99


99


-


-


 

U.S. municipal securities........................................


23


-


23


-


 

Auction rate securities............................................


7


-


-


7


 

Other securities.....................................................


29


-


29


-


 

Investments..............................................................


21


21


-


-


 

Derivative instruments - assets:










 

Foreign currency forward/option contracts....................


38


36


2


-


 

Interest rate swap contracts.......................................


39


-


39


-


 











 

Liabilities:










 

Derivative instruments - liabilities:










 

Foreign currency forward/option contracts....................


82


82


-


-


 

Commodity price swap contracts................................


5


5


-


-


 

The following table provides a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis in the table above that used significant unobservable inputs (Level 3).

 


Three months ended Mar. 31,


 


2011


2010


 

Beginning balance..................................................................

7


$

5


 

Total gains or (losses):





 

 

Included in earnings.............................................................

-


-


 

Included in other comprehensive income................................

-


1


 

Purchases, issuances, and settlements...................................

-


-


Transfers in and/or out of Level 3..............................................

-


-


 

Ending balance (March 31)......................................................

7


6


 






 

Additional losses included in earnings due to reclassifications from other comprehensive income for:





 

 

Securities sold during the period ended March 31...................

-


-


 

Securities still held at March 31............................................

-


-


 

In addition, the plan assets of 3M's pension and postretirement benefit plans are measured at fair value on a recurring basis (at least annually). Refer to Note 11 in 3M's 2010 Annual Report on Form 10-K.

 

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis:

 

Disclosures are required for certain assets and liabilities that are measured at fair value, but are recognized and disclosed at fair value on a nonrecurring basis in periods subsequent to initial recognition. For 3M, such measurements of fair value relate primarily to long-lived asset impairments. There were no material long-lived asset impairments for the three months ended March 31, 2011 and 2010.

Fair Value of Financial Instruments:

 

The Company's financial instruments include cash and cash equivalents, marketable securities, accounts receivable, certain investments, accounts payable, borrowings, and derivative contracts. The fair values of cash and cash equivalents, accounts receivable, accounts payable, and short-term borrowings and current portion of long-term debt approximated carrying values because of the short-term nature of these instruments. Available-for-sale marketable securities and investments, in addition to certain derivative instruments, are recorded at fair values as indicated in the preceding disclosures. The Company utilized third-party quotes to estimate fair values for its long-term debt. Information with respect to the carrying amounts and estimated fair values of these financial instruments follow:

 


Mar. 31, 2011


Dec. 31, 2010



Carrying
Amount


Fair
Value


Carrying
Amount


Fair
Value


Long-term debt, excluding current portion

$       4,486

$       4,736


$       4,183


$       4,466


 

The fair values reflected above consider the terms of the related debt absent the impacts of derivative/hedging activity. The carrying amount of long-term debt referenced above is impacted by certain fixed-to-floating interest rate swaps that are designated as fair value hedges and by the designation of fixed rate Eurobond securities issued by the Company as hedging instruments of the Company's net investment in its European subsidiaries. 3M's fixed-rate bonds were trading at a premium at March 31, 2011 and December 31, 2010 due to the low interest rates and tightening of 3M's credit spreads.

 



 

Legal Proceedings:

 

The Company and some of its subsidiaries are involved in numerous claims and lawsuits, principally in the United States, and regulatory proceedings worldwide. These include various products liability (involving products that the Company now or formerly manufactured and sold), intellectual property, and commercial claims and lawsuits, including those brought under the antitrust laws, and environmental proceedings. Unless otherwise stated, the Company is vigorously defending all such litigation. Additional information can be found in Note 14 "Commitments and Contingencies" in the Company's Annual Report on Form 10-K for the year ended December 31, 2010, including information about the Company's process for disclosure and recording of liabilities and insurance receivables related to legal proceedings.

The following table shows the major categories of significant legal matters - respirator mask/asbestos litigation (including Aearo), environmental remediation and other environmental liabilities -- for which the Company has been able to estimate its probable liability and for which the Company has taken reserves and the related insurance receivables:

 

Liability and Receivable Balances


Mar. 31,


Dec. 31,


 

(Millions)


2011


2010


 







 

Respirator mask/asbestos liabilities.....................................................


$

123


$

126


 

Respirator mask/asbestos insurance receivables...................................


121


122


 

 







Environmental remediation liabilities.....................................................


$

30


$

24


 

Environmental remediation insurance receivables...................................


15


15


 

 







Other environmental liabilities..............................................................


$

85


$

90


 

 

The following sections first describe the significant legal proceedings in which the Company is involved, and then describe the liabilities and associated insurance receivables the Company has accrued relating to its significant legal proceedings.

Respirator Mask/Asbestos Litigation

As of March 31, 2011, the Company is a named defendant, with multiple co-defendants, in numerous lawsuits in various courts that purport to represent approximately 2,200 individual claimants compared to approximately 2,148 individual claimants with actions pending at December 31, 2010.

The vast majority of the lawsuits and claims resolved by and currently pending against the Company allege use of some of the Company's mask and respirator products and seek damages from the Company and other defendants for alleged personal injury from workplace exposures to asbestos, silica, coal mine dust or other occupational dusts found in products manufactured by other defendants or generally in the workplace. A minority of claimants generally allege personal injury from occupational exposure to asbestos from products previously manufactured by the Company, which are often unspecified, as well as products manufactured by other defendants, or occasionally at Company premises.

The Company's current volume of new and pending matters is substantially lower than its historical experience. The Company expects that filing of claims by unimpaired claimants in the future will continue to be at much lower levels than in the past. Accordingly, the number of claims alleging more serious injuries, including mesothelioma and other malignancies, while remaining relatively constant and consistent with historical experience, will represent a greater percentage of total claims than in the past. The Company has prevailed in all nine cases taken to trial, including seven of the eight cases tried to verdict (such trials occurred in 1999, 2000, 2001, 2003, 2004, and 2007), and an appellate reversal in 2005 of the 2001 jury verdict adverse to the Company. The ninth case, tried in 2009, was dismissed by the Court at the close of plaintiff's evidence, based on the Court's legal finding that the plaintiff had not presented sufficient evidence to support a jury verdict. This case is being appealed by the plaintiffs and briefing is complete and the parties are waiting for the court to set a hearing date for oral argument.

The Company has demonstrated in these past trial proceedings that its respiratory protection products are effective as claimed when used in the intended manner and in the intended circumstances. Consequently the Company believes that claimants are unable to establish that their medical conditions, even if significant, are attributable to the Company's respiratory protection products. Nonetheless the Company's litigation experience indicates that claims of persons with malignant conditions are costlier to resolve than the claims of unimpaired persons, and it therefore believes the average cost of resolving pending and future claims on a per-claim basis will continue to be higher than it experienced in prior periods when the vast majority of claims were asserted by the unimpaired.

As previously reported, the State of West Virginia, through its Attorney General, filed a complaint in 2003 against the Company and two other manufacturers of respiratory protection products in the Circuit Court of Lincoln County, West Virginia and amended its complaint in 2005. The amended complaint seeks substantial, but unspecified, compensatory damages primarily for reimbursement of the costs allegedly incurred by the State for worker's compensation and healthcare benefits provided to all workers with occupational pneumoconiosis and unspecified punitive damages. While the case has been inactive since the fourth quarter of 2007, the State of West Virginia has recently asked the Court to set a case management conference in the near future. No liability has been recorded for this matter because the Company believes that liability is not probable and estimable at this time. In addition, the Company is not able to estimate a possible loss or range of loss given the minimal activity in this case and the fact that the complaint asserts claims against two other manufacturers where a defendant's share of liability may turn on the law of joint and several liability and by the amount of fault a jury allocates to each defendant if a case is ultimately tried.

Respirator Mask/Asbestos Liabilities and Insurance Receivables: The Company estimates its respirator mask/asbestos liabilities, including the cost to resolve the claims and defense costs, by examining: (i) the Company's experience in resolving claims, (ii) apparent trends, (iii) the apparent quality of claims (e.g., whether the claim has been asserted on behalf of asymptomatic claimants), (iv) changes in the nature and mix of claims (e.g., the proportion of claims asserting usage of the Company's mask or respirator products and alleging exposure to each of asbestos, silica, coal or other occupational dusts, and claims pleading use of asbestos-containing products allegedly manufactured by the Company), (v) the number of current claims and a projection of the number of future asbestos and other claims that may be filed against the Company, (vi) the cost to resolve recently settled claims, and (vii) an estimate of the cost to resolve and defend against current and future claims.

Developments may occur that could affect the Company's estimate of its liabilities. These developments include, but are not limited to, significant changes in (i) the number of future claims, (ii) the average cost of resolving claims, (iii) the legal costs of defending these claims and in maintaining trial readiness, (iv) changes in the mix and nature of claims received, (v) trial and appellate outcomes, (vi) changes in the law and procedure applicable to these claims, and (vii) the financial viability of other co-defendants and insurers.

As a result of the costs of aggressively defending itself and the greater cost of resolving claims of persons with malignant conditions, the Company increased its reserves in the first quarter of 2011 for respirator mask/asbestos liabilities by $4 million. As of March 31, 2011, the Company had reserves for respirator mask/asbestos liabilities of $92 million (excluding Aearo reserves). The Company can not estimate the amount or range of amounts by which the liability may exceed the reserve the Company has established because of the (i) inherent difficulty in projecting the number of claims that have not yet been asserted, particularly with respect to the Company's respiratory products that themselves did not contain any harmful materials, (ii) the complaints nearly always assert claims against multiple defendants where the damages alleged are typically not attributed to individual defendants so that a defendant's share of liability may turn on the law of joint and several liability, which can vary by state, (iii) the multiple factors described above that the Company considers in estimating its liabilities, and (iv) the several possible developments described above that may occur that could affect the Company's estimate of liabilities.

As of March 31, 2011, the Company's receivable for insurance recoveries related to the respirator mask/asbestos litigation was $121 million. The Company increased its receivables for insurance recoveries by $1 million in the first quarter of 2011 related to this litigation.

Various factors could affect the timing and amount of recovery of this receivable, including (i) delays in or avoidance of payment by insurers; (ii) the extent to which insurers may become insolvent in the future, and (iii) the outcome of negotiations with insurers and legal proceedings with respect to respirator mask/asbestos liability insurance coverage. The difference between the accrued liability and insurance receivable represents in part the time delay between payment of claims on the one hand and receipt of insurance reimbursements on the other hand. Because of the lag time between settlement and payment of a claim, no meaningful conclusions may be drawn from quarterly or annual changes in the amount of receivables for expected insurance recoveries or changes in the number of claimants.

As previously reported, on January 5, 2007 the Company was served with a declaratory judgment action filed on behalf of two of its insurers (Continental Casualty and Continental Insurance Co. - both part of the Continental Casualty Group) disclaiming coverage for respirator mask/asbestos claims. These insurers represent approximately $14 million of the $121 million insurance recovery receivable referenced in the above table. The action, pending in the District Court in Ramsey County, Minnesota, seeks declaratory judgment regarding coverage provided by the policies and the allocation of covered costs among the policies issued by the various insurers. The action named, in addition to the Company, over 60 of the Company's insurers. This action is similar in nature to an action filed in 1994 with respect to breast implant coverage, which ultimately resulted in the Minnesota Supreme Court's ruling of 2003 that was largely in the Company's favor. The plaintiff insurers have served an amended complaint that names some additional insurers and deletes others. A significant number of the insurer defendants named in the amended complaint have been dismissed because of settlements they have reached with 3M regarding the matters at issue in the lawsuit. The case is currently in the discovery phase. Trial is scheduled to begin in June, 2012.

Respirator Mask/Asbestos Litigation - Aearo Technologies

On April 1, 2008, a subsidiary of the Company purchased the stock of Aearo Holding Corp., the parent of Aearo Technologies ("Aearo"). Aearo manufactures and sells various products, including personal protection equipment, such as eye, ear, head, face, fall and certain respiratory protection products.

As of March 31, 2011, Aearo and/or other companies that previously owned and operated Aearo's respirator business (American Optical Corporation, Warner-Lambert LLC, AO Corp. and Cabot Corporation ("Cabot")) are named defendants, with multiple co-defendants, including the Company, in numerous lawsuits in various courts in which plaintiffs allege use of mask and respirator products and seek damages from Aearo and other defendants for alleged personal injury from workplace exposures to asbestos, silica-related, or other occupational dusts found in products manufactured by other defendants or generally in the workplace.

As of March 31, 2011, the Company, through its Aearo subsidiary, has recorded $31 million as the best estimate of the probable liabilities for product liabilities and defense costs related to current and future Aearo-related asbestos and silica-related claims. Responsibility for legal costs, as well as for settlements and judgments, is currently shared in an informal arrangement among Aearo, Cabot, American Optical Corporation and a subsidiary of Warner Lambert and their insurers (the "Payor Group"). Liability is allocated among the parties based on the number of years each company sold respiratory products under the "AO Safety" brand and/or owned the AO Safety Division of American Optical Corporation and the alleged years of exposure of the individual plaintiff. Aearo's share of the contingent liability is further limited by an agreement entered into between Aearo and Cabot on July 11, 1995. This agreement provides that, so long as Aearo pays to Cabot an annual fee of $400,000, Cabot will retain responsibility and liability for, and indemnify Aearo against, asbestos and silica-related product liability claims for respirators manufactured prior to July 11, 1995. Because the date of manufacture for a particular respirator allegedly used in the past is often difficult to determine, Aearo and Cabot have applied the agreement to claims arising out of the alleged use of respirators while exposed to asbestos or silica or products containing asbestos or silica prior to January 1, 1997. With these arrangements in place, Aearo's potential liability is limited to exposures alleged to have arisen from the use of respirators while exposed to asbestos, silica or other occupational dusts on or after January 1, 1997.

To date, Aearo has elected to pay the annual fee. Aearo could potentially be exposed to additional claims for some part of the pre-July 11, 1995 period covered by its agreement with Cabot if Aearo elects to discontinue its participation in this arrangement, or if Cabot is no longer able to meet its obligations in these matters.

Developments may occur that could affect the estimate of Aearo's liabilities. These developments include, but are not limited to: (i) significant changes in the number of future claims, (ii) significant changes in the average cost of resolving claims, (iii) significant changes in the legal costs of defending these claims, (iv) significant changes in the mix and nature of claims received, (v) trial and appellate outcomes, (vi) significant changes in the law and procedure applicable to these claims, (vii) significant changes in the liability allocation among the co-defendants, (viii) the financial viability of members of the Payor Group including exhaustion of available coverage limits, (ix) the outcome of pending insurance coverage litigation among certain other members of the Payor Group and their respective insurers, and/or (x) a determination that the interpretation of the contractual obligations on which Aearo has estimated its share of liability is inaccurate. The Company cannot determine the impact of these potential developments on its current estimate of Aearo's share of liability for these existing and future claims. If any of the developments described above were to occur, the actual amount of these liabilities for existing and future claims could be significantly larger than the reserved amount.

Because of the inherent difficulty in projecting the number of claims that have not yet been asserted, the complexity of allocating responsibility for future claims among the Payor Group, and the several possible developments that may occur that could affect the estimate of Aearo's liabilities, the Company can not estimate the amount or range of amounts by which Aearo's liability may exceed the reserve the Company has established.

Environmental Matters and Litigation

The Company's operations are subject to environmental laws and regulations including those pertaining to air emissions, wastewater discharges, toxic substances, and the handling and disposal of solid and hazardous wastes enforceable by national, state, and local authorities around the world, and private parties in the United States and abroad. These laws and regulations provide, under certain circumstances, a basis for the remediation of contamination, for restoration of or compensation for damages to natural resources, and for personal injury and property damage claims. The Company has incurred, and will continue to incur, costs and capital expenditures in complying with these laws and regulations, defending personal injury and property damage claims, and modifying its business operations in light of its environmental responsibilities. In its effort to satisfy its environmental responsibilities and comply with environmental laws and regulations, the Company has established, and periodically updates, policies relating to environmental standards of performance for its operations worldwide.

Under certain environmental laws, including the United States Comprehensive Environmental Response, Compensation and Liability Act of 1980 and similar state laws, the Company may be jointly and severally liable, typically with other companies, for the costs of remediation of environmental contamination at current or former facilities and at off-site locations. The Company has identified numerous locations, most of which are in the United States, at which it may have some liability. Please refer to the paragraph entitled "Environmental Liabilities and Insurance Receivables" that follows for information on the amount of the reserve.

Environmental Matters

As previously reported, the Company has been voluntarily cooperating with ongoing reviews by local, state, national (primarily the U.S. Environmental Protection Agency (EPA)), and international agencies of possible environmental and health effects of various perfluorinated compounds ("PFCs"), including perfluorooctanoic acid or "PFOA" and perfluorooctane sulfonate or "PFOS" and other perfluorooctanyl compounds. As a result of its phase-out decision in May 2000, the Company no longer manufactures perfluorooctanyl compounds, and through changes to its manufacturing process at the end of 2008, no longer uses such compounds in its manufacturing process.

Regulatory activities concerning PFOA and/or PFOS continue in the United States, Europe and elsewhere, and before certain international bodies. These activities include gathering of exposure and use information, risk assessment, and consideration of regulatory approaches. The EPA continues to develop Drinking Water Health Advisories for PFOS and PFOA, which are expected to be released in 2011. Those advisory levels will supersede the current provisional advisory levels. In an effort to move toward developing standards under the Safe Drinking Water Act, the EPA has proposed to have public water suppliers monitor for six PFCs to determine the extent of their occurrence.

In late 2008 and early 2009, the EPA undertook testing of private wells and soils at certain agricultural sites in Alabama where wastewater treatment sludge was applied from the municipal wastewater treatment plant in Decatur, Alabama that received wastewater from numerous industrial sources. In this same timeframe, the EPA also issued provisional health advisory values for drinking water for PFOA of 0.4 parts per billion ("ppb") and PFOS of 0.2 ppb. The EPA has been working with local industry, including 3M, and the Decatur utility to identify and test private wells in the area, and to connect to municipal water any private wells used for drinking water that exceed the EPA's provisional health advisory levels. EPA's and the industry's testing of public drinking water supplies in the area indicate that the levels of PFOA and PFOS in municipal water supplies are well below the provisional health advisories. 3M and other companies have completed a survey of properties near the sites where wastewater treatment sludge was applied to identify any additional private drinking water wells not already identified by the EPA, and have connected a small number of wells that exceeded the provisional health advisory levels for PFOS and PFOA to municipal water. 3M and the other companies have continued to monitor those few wells that showed levels of PFOS or PFOA above detection levels but below the EPA's provisional health advisory levels.

The Agency for Toxic Substances and Disease Registry (ATSDR) has completed a bio-monitoring study evaluating PFC blood levels in volunteers living near the sludge application fields. The Company expects ATSDR to release its report in 2011.

3M continues its third and final phase of work pursuant to a Memorandum of Understanding with the EPA regarding an environmental assessment program at the Company's Decatur manufacturing site. That work includes groundwater sampling off-site from the Decatur facility (unrelated to the work described above involving the wastewater treatment sludge) as well as at three local landfills used by the facility.

The Company is continuing to make progress in its work, under the supervision of state regulators, to address its historic disposal of PFC-containing waste associated with manufacturing operations at the Cottage Grove, Minnesota and Decatur, Alabama plants.

As previously reported, the Company entered into a voluntary remedial action agreement with the Alabama Department of Environmental Management (ADEM) to address the presence of PFCs in the soil at the Company's manufacturing facility in Decatur, Alabama. For approximately twenty years, the Company incorporated its wastewater treatment plant sludge containing PFCs in fields at its Decatur facility pursuant to a permit issued by ADEM. After a review of the available options to address the presence of PFCs in the soil, ADEM agreed that the preferred remediation option is to use a multilayer cap over the former sludge incorporation areas on the manufacturing site with subsequent groundwater migration controls and treatment. Implementation of that option will continue throughout 2011 and is expected to be completed in 2015.

The Company continues to work with the Minnesota Pollution Control Agency (MPCA) pursuant to the terms of the previously disclosed May 2007 Settlement Agreement and Consent Order to address the presence of perfluorinated compounds in the soil and groundwater at former disposal sites in Washington County, Minnesota (Oakdale and Woodbury) and at the Company's manufacturing facility at Cottage Grove, Minnesota. Under this agreement, the Company's principal obligations include (i) evaluating releases of perfluorinated compounds from these sites and proposing response actions; (ii) providing treatment or alternative drinking water upon identifying any level exceeding a Health Based Value ("HBV") or Health Risk Limit ("HRL") (i.e., the amount of a chemical in drinking water determined by the Minnesota Department of Health to be safe for people to drink for a lifetime) for any perfluorinated compounds as a result of contamination from these sites; (iii) remediating any source of other PFCs at these sites that is not controlled by actions to remediate PFOA and PFOS; and (iv) sharing information with the MPCA about perfluorinated compounds. During 2008, the MPCA issued formal decisions adopting remedial options for the former disposal sites in Washington County, Minnesota (Oakdale and Woodbury). In August 2009, the MPCA issued a formal decision adopting remedial options for the Company's Cottage Grove manufacturing facility. During the spring and summer of 2010, 3M began implementing the remedial options at the Cottage Grove and Woodbury sites. 3M commenced the remedial option at the Oakdale site in late 2010. At each location the remedial options were among those recommended by the Company. Remediation work will continue at all three sites in 2011.

The Company cannot predict what additional regulatory actions arising from the foregoing proceedings and activities, if any, may be taken regarding such compounds or the consequences of any such actions.

Environmental Litigation

As previously reported, a former employee filed a purported class action lawsuit in 2002 in the Circuit Court of Morgan County, Alabama seeking unstated damages and alleging that the plaintiffs suffered fear, increased risk, subclinical injuries, and property damage from exposure to perfluorochemicals at or near the Company's Decatur, Alabama, manufacturing facility. The Circuit Court in 2005 granted the Company's motion to dismiss the named plaintiff's personal injury-related claims on the basis that such claims are barred by the exclusivity provisions of the state's Workers Compensation Act. The plaintiffs' counsel filed an amended complaint in November 2006, limiting the case to property damage claims on behalf of a purported class of residents and property owners in the vicinity of the Decatur plant. Also, in 2005, the judge in a second purported class action lawsuit (filed by three residents of Morgan County, Alabama, seeking unstated compensatory and punitive damages involving alleged damage to their property from emissions of perfluorochemical compounds from the Company's Decatur, Alabama, manufacturing facility that formerly manufactured those compounds) granted the Company's motion to abate the case, effectively putting the case on hold pending the resolution of class certification issues in the first action described above filed in the same court in 2002. Despite the stay, plaintiffs filed an amended complaint seeking damages for alleged personal injuries and property damage on behalf of the named plaintiffs and the members of a purported class. No further action in the case is expected unless and until the stay is lifted.

In February 2009, a resident of Franklin County, Alabama, filed a purported class action lawsuit in the Circuit Court of Franklin County seeking compensatory damages and injunctive relief based on the application by the Decatur wastewater treatment plant of wastewater treatment sludge to farmland and grasslands in the state that allegedly contain PFOA, PFOS and other perfluorochemicals. The named defendants in the case include 3M, Dyneon LLC, Daikin America, Inc., Synagro-WWT, Inc., Synagro South, LLC and Biological Processors of America. The named plaintiff seeks to represent a class of all persons within the State of Alabama, Inc. who have had PFOA, PFOS and other perfluorochemicals released or deposited on their property. In March 2010, the Alabama Supreme Court ordered the case transferred from Franklin County to Morgan County. In May, 2010, consistent with its handling of the other matters, the Morgan County Circuit Court abated this case, putting it on hold pending the resolution of the class certification issues in the first case filed there.

In March 2011, several residents of Lawrence County, Alabama, filed a lawsuit in the Circuit Court of Lawrence County seeking unspecified compensatory and punitive damages and other relief for alleged personal injuries due to the exposure to PFCs. The named defendants in the case include the City of Decatur, Alabama, 3M, Dyneon LLC, Daikin America, Inc., Toray Industries, Inc. and two of its US subsidiaries, Synagro-WWT, Inc., Synagro South, LLC and Biological Processors of America. According to the complaint, Synagro acquired wastewater treatment sludge that allegedly contained PFOA, PFOS and other perfluorochemicals from the Decatur utilities wastewater treatment plant, and made it into a fertilizer that it sold to farmers who applied it to their farmland in Morgan, Limestone and Lawrence counties, including land adjacent to the plaintiffs' residence.

On December 30, 2010, the State of Minnesota, by its Attorney General Lori Swanson, acting in its capacity as trustee of the natural resources of the State of Minnesota, filed a lawsuit in Hennepin County District Court against 3M to recover damages (including unspecified assessment costs and reasonable attorney's fees) for alleged injury to, destruction of, and loss of use of certain of the State's natural resources under the Minnesota Environmental Response and Liability Act (MERLA) and the Minnesota Water Pollution Control Act (MWPCA), as well as statutory nuisance and under common law claims of trespass, nuisance, and negligence with respect to the presence of PFC's in the groundwater, surface water, fish or other aquatic life and sediments. The State also seeks declarations under MERLA that 3M is responsible for all damages the State may suffer in the future for injuries to natural resources from releases of PFCs into the environment, and under MWPCA that 3M is responsible for compensation for future loss or destruction of fish, aquatic life and other damages. On January 14, 2011, the City of Lake Elmo filed a motion to intervene in the State of Minnesota lawsuit and seeks damages in excess of $50,000 and other legal and equitable relief, including reasonable attorneys' fees, for alleged contamination of city property, wells, groundwater and water contained in the wells with PFCs under several theories, including common law and statutory nuisance, strict liability, trespass, negligence, and conversion. The court has not yet ruled on whether the City of Lake Elmo will be a party to this lawsuit.

In June 2009, the Company, along with more than 250 other companies, was served with a third-party complaint seeking contribution towards the cost of cleaning up a 17-mile stretch of the Passaic River in New Jersey. After commencing an enforcement action in 1990, the State of New Jersey filed suit against Maxus Energy, Tierra Solutions, Occidental Chemical and two other companies seeking cleanup and removal costs and other damages associated with the presence of dioxin and other hazardous substances in the sediment of the Passaic. The third-party complaint seeks to spread those costs among the third-party defendants, including the Company. Based on the cleanup remedy currently proposed by the EPA, the total costs at issue could easily exceed $1 billion. The Company's recent involvement in the case appears to relate to its past disposal of industrial waste at two commercial waste disposal facilities in New Jersey. Whether, and to what extent, the Company may be required to contribute to the costs at issue in the case remains to be determined. The Company does not yet have a basis for estimating its potential exposure in this case, although the Company currently believes its allocable share, if any, is likely to be a fraction of one percent of the total costs.

The Company has not recorded any liabilities for the Company's environmental litigation described in this section because the Company believes that liability is not probable and estimable at this time. Because of the limited activity in these cases, the Company is not able to estimate a possible loss or range of loss, with the exception of the Passaic River litigation, where the Company indicated that its potential exposure, if any, is likely to be a fraction of one percent of the total costs.

Environmental Liabilities and Insurance Receivables

As of March 31, 2011, the Company had recorded liabilities of $30 million for estimated "environmental remediation" costs based upon an evaluation of currently available facts with respect to each individual site and also recorded related insurance receivables of $15 million. The Company records liabilities for remediation costs on an undiscounted basis when they are probable and reasonably estimable, generally no later than the completion of feasibility studies or the Company's commitment to a plan of action. Liabilities for estimated costs of environmental remediation, depending on the site, are based primarily upon internal or third-party environmental studies, and estimates as to the number, participation level and financial viability of any other potentially responsible parties, the extent of the contamination and the nature of required remedial actions. The Company adjusts recorded liabilities as further information develops or circumstances change. The Company expects that it will pay the amounts recorded over the periods of remediation for the applicable sites, currently ranging up to 20 years.

As of March 31, 2011, the Company had recorded liabilities of $85 million for "other environmental liabilities" based upon an evaluation of currently available facts to implement the Settlement Agreement and Consent Order with the MPCA, the remedial action agreement with ADEM, and to address trace amounts of perfluorinated compounds in drinking water sources in the City of Oakdale and Lake Elmo, Minnesota, as well as presence in the soil and groundwater at the Company's manufacturing facilities in Decatur, Alabama, and Cottage Grove, Minnesota, and at two former disposal sites in Washington County, Minnesota (Oakdale and Woodbury). The Company expects that most of the spending will occur over the next five years.

It is difficult to estimate the cost of environmental compliance and remediation given the uncertainties regarding the interpretation and enforcement of applicable environmental laws and regulations, the extent of environmental contamination and the existence of alternative cleanup methods. Developments may occur that could affect the Company's current assessment, including, but not limited to: (i) changes in the information available regarding the environmental impact of the Company's operations and products; (ii) changes in environmental regulations, changes in permissible levels of specific compounds in drinking water sources, or changes in enforcement theories and policies, including efforts to recover natural resource damages; (iii) new and evolving analytical and remediation techniques; (iv) success in allocating liability to other potentially responsible parties; and (v) the financial viability of other potentially responsible parties and third-party indemnitors. For sites included in both "environmental remediation liabilities" and "other environmental liabilities," at which remediation activity is largely complete and remaining activity relates primarily to operation and maintenance of the remedy, including required post-remediation monitoring, the Company believes the exposure to loss in excess of the amount accrued would not be material to the Company's consolidated results of operations or financial condition. However, for locations at which remediation activity is largely on-going, the Company cannot estimate a possible loss or range of loss in excess of the associated established reserves for the reasons described above.

Employment Litigation

In January 2011, 3M reached an agreement in principle with plaintiffs' counsel to resolve the Whitaker and Garcia lawsuits.  The Whitaker settlement agreement was signed by all parties in March 2011. The court granted preliminary approval of the settlement on April 6, 2011 and provisionally certified a class for settlement purposes only. The final approval hearing is scheduled in December 2011. The Garcia settlement agreement is in the process of being signed by the parties and is not subject to further court review or approval. 3M is currently in discussions with the Equal Employment Opportunity Commission to resolve related charges described below. If finalized and approved by the court, administration of the settlement agreements will take several months to complete. The amount of the proposed settlements is not material to the Company's consolidated results of operations or financial condition. The background of this litigation is set forth below.

Whitaker Lawsuit:

As previously reported, in December, 2004, one current and one former employee of the Company filed a purported class action in the District Court of Ramsey County, Minnesota, seeking to represent a class of all current and certain former salaried employees employed by the Company in Minnesota below a certain salary grade who were age 46 or older at any time during the applicable period to be determined by the Court (the "Whitaker" lawsuit). The complaint alleges the plaintiffs suffered various forms of employment discrimination on the basis of age in violation of the Minnesota Human Rights Act and seeks injunctive relief, unspecified compensatory damages (which they seek to treble under the statute), including back and front pay, punitive damages (limited by statute to $8,500 per claimant) and attorneys' fees. In January 2006, the plaintiffs filed a motion to join four additional named plaintiffs. This motion was unopposed by the Company and the four plaintiffs were joined in the case, although one plaintiff's claim was dismissed following an individual settlement. On April 11, 2008, the Court granted the plaintiffs' motion to certify the case as a class action. On April 28, 2009, the Minnesota Court of Appeals reversed the District Court's class certification decision, finding that the District Court had not required plaintiffs to meet the proper legal standards for certification of a class under Minnesota law and incorrectly had deferred resolving certain factual disputes that were relevant to the class certification requirements. The Court of Appeals remanded the case to the District Court for further proceedings in line with the evidentiary standards defined in its opinion. The trial court took expert testimony and held a hearing on the class certification question and had the matter under advisement when the parties reached a tentative settlement which rendered the certification issues moot.

Garcia Lawsuit

The Company was served on May 7, 2009 with a purported class action/collective action age discrimination lawsuit, which was filed in United States District Court for the Northern District of California, San Jose Division (the "Garcia lawsuit"). The case was subsequently transferred to the U.S. District Court for the District of Minnesota.

In this case, five former and one current employee of the Company are seeking to represent all current and former salaried employees employed by the Company in the United States during the liability period, which plaintiffs define as 2001 to the present. In addition to the six named plaintiffs, there are approximately 86 other current or former employees who have signed "opt-in" forms, seeking to join the action. The Garcia lawsuit expressly excludes those persons encompassed within the proposed class in the Whitaker lawsuit. The same firm, joined by additional California counsel and local Minnesota counsel for the Garcia lawsuit, represents the plaintiffs in both cases.

The allegations of the complaint in the Garcia lawsuit are similar to those in the Whitaker lawsuit. Plaintiffs claim that they and other similarly situated employees suffered various forms of employment discrimination on the basis of age in violation of the federal Age Discrimination in Employment Act. In regard to these claims, plaintiffs seek to represent "all persons who were 46 or older when employed by 3M in the United States in a salaried position below the level of director, or salary grade 18, during the liability period."  Because federal law protects persons age 40 and older from age discrimination, with respect to their claim of disparate impact only, plaintiffs also propose an alternative definition of similarly situated persons that would begin at age 40. On behalf of this group, plaintiffs seek injunctive relief, unspecified compensatory damages including back and front pay, benefits, liquidated damages and attorneys' fees.

Certain of the plaintiffs' and putative class members' employment terminated under circumstances in which they were eligible for group severance plan benefits and in connection with those plans they signed waivers of claims, including age discrimination claims. Plaintiffs claim the waivers of age discrimination claims were invalid in various respects. This subset of release-signing plaintiffs seeks a declaration that the waivers of age discrimination claims are invalid, other injunctive, but non-monetary, remedies, and attorneys' fees.

EEOC Age-Discrimination Charges

Six former employees and one current employee, all but one of whom are plaintiffs in the Garcia lawsuit, have also filed age discrimination charges against the Company with the U.S. Equal Employment Opportunity Commission and various pertinent state agencies, alleging age discrimination similar to the Whitaker and Garcia lawsuits and claiming that a class of similarly situated persons exists. Of these, three former employees filed charges in 2005 in Minnesota, Texas, and California. These filings include allegations that the release of claims signed by certain former employees in the purported class defined in the charges is invalid for various reasons and assert age discrimination claims on behalf of certain current and former salaried employees in states other than Minnesota and New Jersey. In 2006, a current employee filed an age discrimination charge against the Company with the U.S. Equal Employment Opportunity Commission and the pertinent state agency in Missouri, asserting claims on behalf of a class of all current and certain former salaried employees who worked in Missouri and other states other than Minnesota and New Jersey. In 2007, a former employee filed an age discrimination charge against the Company with the U.S. Equal Employment Opportunity Commission and the pertinent state agency in California, asserting claims on behalf of a class of all current and certain former salaried employees who worked in California. In January 2009, two former employees filed age discrimination charges against the Company with the U.S. Equal Employment Opportunity Commission and the pertinent state agency in Minnesota. The filings include allegations that the release of claims signed by certain former employees in the purported class defined in the charges is invalid for various reasons and assert age discrimination claims on behalf of certain current and former salaried employees in states other than Minnesota. The same law firm represents the plaintiffs in the Whitaker lawsuit as well as the claimants in each of these EEOC proceedings.

Compliance Matters

On November 12, 2009, the Company contacted the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) to voluntarily disclose that the Company was conducting an internal investigation as a result of reports it received about its subsidiary in Turkey, alleging bid rigging and bribery and other inappropriate conduct in connection with the supply of certain reflective and other materials and related services to Turkish government entities. The Company also contacted certain affected government agencies in Turkey. The Company continues to cooperate with the DOJ and SEC in the Company's ongoing investigation of this matter. The Company retained outside counsel to conduct an assessment of its policies, practices, and controls and to evaluate its overall compliance with the Foreign Corrupt Practices Act, including an ongoing review of our practices in certain other countries. The Company cannot predict at this time the outcome of its investigation or what regulatory actions may be taken or what other consequences may result.

Other Matters

Commercial Litigation

In September 2010, various parties, on behalf of a purported class of shareholders of Cogent, Inc. ("Cogent"), commenced three lawsuits against the Company, Cogent, and its directors in the Delaware Court of Chancery. Plaintiffs allege that 3M, in connection with its tender offer for Cogent shares, aided and abetted the breach of fiduciary duties by Cogent directors and seek an unspecified amount of damages. The three cases were consolidated, expedited discovery was conducted, and Plaintiffs' motion for a preliminary injunction to enjoin the transaction was denied on October 1, 2010. On November 15, 2010, plaintiffs filed an amended complaint that added directors of Cogent, Inc. appointed by 3M, as named defendants, and asserted additional claims of breach of fiduciary duties in connection with the transaction and a subsequent offering period. 3M has moved to dismiss all claims, which motion is scheduled to be heard by the Court in late April. The transaction closed on December 1, 2010.

In September 2010, various parties, again on behalf of a purported class of Cogent shareholders, commenced six lawsuits against the Company, Cogent and its directors in the Los Angeles Superior Court for the State of California that contained similar claims that 3M had aided and abetted the breach of fiduciary duties by Cogent directors. The parties have reached a resolution of these matters. A separate lawsuit was commenced in September 2010 by an individual, again on behalf of a purported class of Cogent shareholders, against Cogent and its directors in the United States District Court for the Central District of California that raised similar claims; plaintiff later filed an amended complaint that also named the Company. The plaintiff has voluntarily dismissed that lawsuit.

Separately, several purported holders of Cogent shares, representing a total of approximately 5.8 million shares, have asserted appraisal rights under Delaware law. The Company has answered the appraisal petition and is defending this matter vigorously.

3M filed suit against Avery Dennison Corporation in the United States District Court for the District of Minnesota in June 2010, alleging that Avery's OmniCube™ full cube retroreflective sheeting products, which are used for highway signage, infringe a number of 3M patents. 3M also sought a declaratory judgment from the District Court in Minnesota that 3M's Diamond Grade DG3 full cube retroreflective sheeting does not infringe two Avery patents. In October 2010, Avery Dennison filed a lawsuit against the Company in the United States District Court for the Central District of California, alleging that 3M monopolized or attempted to monopolize the markets for Type XI retroreflective sheeting and for broad high performance sheeting in violation of the Sherman Act, as well as other claims. Avery alleges that 3M manipulated the standards-setting process of the American Society for Testing and Materials (ASTM), a private organization responsible for creating standards for, among other things, retroreflective sheeting used for highway signage; entered into illegal and anticompetitive contracts; and engaged in other anticompetitive acts including false advertising and disparagement. 3M moved to transfer the antitrust case to the United States District Court for the District of Minnesota, which motion was granted in February 2011. In the patent case, 3M's motion to preliminarily enjoin the sales of Avery's OmniCube retroreflective sheeting was denied in December 2010. The District Court also granted Avery's motion to dismiss 3M's declaratory judgment suit in March 2011.  3M has appealed the dismissal of the declaratory judgment lawsuit. In the meantime, 3M's patent infringement lawsuit against Avery and Avery's antitrust suit against 3M are moving forward in the Minnesota Court. 

In December 2010, Meda AB filed a lawsuit in the Supreme Court of the State of New York, County of New York, alleging breach of certain representations and warranties contained in the October 2006 acquisition agreement pursuant to which Meda AB acquired the Company's European pharmaceutical business. The lawsuit seeks to recover an amount to be determined at trial, but not less than $200 million, in compensatory damages alleging that 3M failed to disclose, during the due diligence period, certain pricing arrangements between 3M's French subsidiary and the French government agency that determines the eligible levels of reimbursement for prescription pharmaceuticals. As previously stated, the damage amounts specified in complaints are not a meaningful factor in any assessment of the Company's potential liability. The Company believes it has a number of legal and factual defenses to this claim and will vigorously defend it.

In December 2008, the investors that sold Acolyte Biomedica, Ltd. to the Company's subsidiary in the United Kingdom filed suit in London's High Court seeking damages for breach of the acquisition agreement, including damages of 40 million pounds sterling for loss of potential earnout payments under the acquisition agreement. Notwithstanding significant investments and efforts by the Company to support the sales of BacLite,™ a methicillin-resistant staphlococcus aureus (MRSA) screening device, the product was not a commercial success. A five week trial in London's High Court is scheduled to start June 13, 2011.

No liability has been recorded for the Company's commercial litigation described in this section because the Company believes that liability is not probable and estimable and the Company is not able to estimate a possible loss or range of loss at this time.

 

 

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 28 percent of the 2011 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 22,050,326 as of March 31, 2011.

 

Amounts recognized in the financial statements with respect to stock-based compensation programs, which include stock options, restricted stock, restricted stock units and the General Employees' Stock Purchase Plan (GESPP), are provided in the following table. 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.

 

 


Three months ended



March 31,



2011


2010


Cost of sales................................................................................

14


$

14


Selling, general and administrative expenses..................................

87


82


Research, development and related expenses.................................

15


16





Stock-based compensation expenses............................................

116


$

112








Income tax benefits......................................................................

(41

$

(36

)







Stock-based compensation expenses, net of tax.............................

75


$

76


The following table summarizes stock option activity during the three months ended March 31, 2011:

 

Stock Option Program

 







Remaining


Aggregate


 

 



Number of


Exercise


Contractual


Intrinsic Value




Options


Price*


Life* (months)


(millions)


 

Under option -










 

January 1.....................................................


70,335,044


$

74.80






 

Granted.......................................................










 

 

Annual.....................................................


5,514,500


89.46






 

Progressive (Reload)..................................


108,782


91.44






 

Other.......................................................


2,251


90.46






 

Exercised....................................................


(5,374,873

)

66.09






Canceled.....................................................


(28,401

)

73.66






 

March 31.....................................................


70,557,303


$

76.64


61


$

1,210


 

Options exercisable.........................................










 

March 31.....................................................


56,960,468


$

76.09


50


$

992


 

 

*Weighted average

 

As of March 31, 2011, there was $111 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 $135 million and $67 million during the three month periods ended March 31, 2011 and 2010, respectively. Cash received from options exercised was $355 million and $122 million for the three months ended March 31, 2011 and 2010, respectively. The Company's actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $42 million and $17 million for the three months ended March 31, 2011 and 2010, respectively. Capitalized stock-based compensation amounts were not material at March 31, 2011.

 

For the primary 2011 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


 


2011


 

Exercise price............................................

89.47

 

Risk-free interest rate..................................

2.8

 

 

Dividend yield.............................................

2.6

 

Expected volatility.......................................

22.0

Expected life (months)................................

72

 

Black-Scholes fair value..............................

16.10

 

 

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2011 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, 2011:

 

Restricted Stock and
Restricted Stock Units


Number of
Awards


Grant Date
Fair Value*


 

Nonvested balance -...............................






 

As of January 1.....................................


5,573,302


$

70.43


 

Granted................................................






 

 

Annual..............................................


889,448


89.46


 

Performance shares...........................


384,148


84.00


 

Other................................................


196,712


89.54


 

Vested.................................................


(393,802

)

73.62


Forfeited...............................................


(21,420

)

68.95


 

As of March 31.........................................


6,628,388


$

74.15


 

 

*Weighted average

 

As of March 31, 2011, there was $172 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 2.0 years. The total fair value of restricted stock and restricted stock units that vested during the three months ended March 31, 2011 was $32 million and was not material for the three months ended March 31, 2010. The Company's actual tax benefits realized for the tax deductions related to the vesting of restricted stock and restricted stock units was $10 million for the three months ended March 31, 2011 and not material for the three months ended March 31, 2010.

 

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.

 

In addition, 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.

 



 

Effective in the first quarter of 2011, 3M made certain product moves between its business segments in its continuing effort to drive growth by aligning businesses around markets and customers. There were no changes impacting business segments related to product moves for the Display and Graphics segment or the Consumer and Office segment. The product moves between business segments are summarized as follows:

 

·      Certain pressure sensitive adhesives products within the Industrial Adhesives and Tapes Division and shock absorption and vibration dampening products within the Aerospace and Aircraft Maintenance Department (both within the Industrial and Transportation business segment) were transferred to the Electronic Markets Materials Division (part of the Electro and Communications business segment). In addition, certain medical respirator products within the Infection Prevention Division (part of the Health Care business segment) were transferred to the Occupational Health and Environmental Safety Division (within the Safety, Security and Protection Services business segment). The preceding product moves resulted in decreases in net sales for the total year 2010 of $152 million in the Industrial and Transportation business segment and $8 million in the Health Care business segment. These decreases were offset by increases in net sales for the total year 2010 of $121 million for the Electro and Communications business segment and $8 million for the Safety, Security and Protection Services business segment along with a $31 million change in the elimination of dual credit sales and corporate and unallocated.

 

3M's businesses are organized, managed and internally grouped into segments based on differences in products, technologies and services. 3M continues to manage its operations in six operating business segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security and Protection Services; and Electro and Communications. 3M's six business segments bring together common or related 3M technologies, enhancing the development of innovative products and services and providing for efficient sharing of business resources. These segments have worldwide responsibility for virtually all 3M product lines. 3M is not dependent on any single product/service or market. Transactions among reportable segments are recorded at cost. 3M is an integrated enterprise characterized by substantial intersegment cooperation, cost allocations and inventory transfers. Therefore, management does not represent that these segments, if operated independently, would report the operating income information shown. The difference between operating income and pre-tax income relates to interest income and interest expense, which are not allocated to business segments.

 

The financial information presented herein reflects the impact of all of the preceding segment structure changes for all periods presented.

 

Business Segment Information

 



Three months ended


 



March 31,


 

(Millions)


2011


2010


 







 

Net Sales






 

Industrial and Transportation...................................................................


$

2,450


$

2,036


 

Health Care...........................................................................................


1,255


1,114


 

 

Display and Graphics.............................................................................


943


869


 

Consumer and Office..............................................................................


1,000


912


 

Safety, Security and Protection Services.................................................


929


813


 

Electro and Communications..................................................................


836


694


 

Corporate and Unallocated......................................................................


5


4


Elimination of Dual Credit.......................................................................


(107

)

(94

)

 

Total Company......................................................................................


$

7,311


$

6,348


 







 

Operating Income






 

Industrial and Transportation...................................................................


$

516


$

443


 

Health Care...........................................................................................


369


346


 

 

Display and Graphics.............................................................................


230


212


 

Consumer and Office..............................................................................


215


219


 

Safety, Security and Protection Services.................................................


199


182


 

Electro and Communications..................................................................


178


147


 

Corporate and Unallocated......................................................................


(105

)

(83

)

Elimination of Dual Credit.......................................................................


(24

)

(21

)

 

Total Company......................................................................................


$

1,578


$

1,445


 

 

Corporate and unallocated operating income includes a variety of miscellaneous items, such as corporate investment gains and losses, certain derivative gains and losses, insurance-related gains and losses, certain litigation and environmental expenses, corporate restructuring charges and certain under- or over-absorbed costs (e.g. pension, stock-based compensation) that the Company may choose not to allocate directly to its business segments. Because this category includes a variety of miscellaneous items, it is subject to fluctuation on a quarterly and annual basis.

 

3M business segment reporting measures include dual credit to business segments for certain U.S. sales and related operating income. Management evaluates each of its six operating business segments based on net sales and operating income performance, including dual credit U.S. reporting to further incentivize U.S. sales growth. As a result, 3M provides additional ("dual") credit to those business segments selling products in the U.S. to an external customer when that segment is not the primary seller of the product. For example, certain respirators are primarily sold by the Occupational Health and Environmental Safety Division within the Safety, Security and Protection Services business segment; however, the Industrial and Transportation business segment also sells this product to certain customers in its U.S. markets. In this example, the non-primary selling segment (Industrial and Transportation) would also receive credit for the associated net sales it initiated and the related approximate operating income. The assigned operating income related to dual credit activity may differ from operating income that would result from actual costs associated with such sales. The offset to the dual credit business segment reporting is reflected as a reconciling item entitled "Elimination of Dual Credit," such that sales and operating income for the U.S. in total are unchanged.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM*

 

To the Stockholders and Board of Directors of 3M Company:

 

We have reviewed the accompanying consolidated balance sheet of 3M Company and its subsidiaries as of March 31, 2011, and the related consolidated statements of income and of cash flows for the three-month periods ended March 31, 2011 and 2010. These interim financial statements are the responsibility of the Company's management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2010, and the related consolidated statements of income, of changes in equity and comprehensive income, and of cash flows for the year then ended (not presented herein), and in our report dated February 16, 2011, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2010, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

 

 

/s/ PricewaterhouseCoopers LLP

 

PricewaterhouseCoopers LLP

Minneapolis, Minnesota

May 5, 2011

___________

Pursuant to Rule 436(c) of the Securities Act of 1933 ("Act") this should not be considered a "report" within the meaning of Sections 7 and 11 of the Act and the independent registered public accounting firm liability under Section 11 does not extend to it.

 

 

 



 

Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of 3M's financial statements with a narrative from the perspective of management. 3M's MD&A is presented in the following sections:

 

·      Overview

·      Results of Operations

·      Performance by Business Segment

·      Financial Condition and Liquidity

·      Cautionary Note Concerning Factors That May Affect Future Results 

 

 

3M is a diversified global manufacturer, technology innovator and marketer of a wide variety of products and services. 3M manages its operations in six operating business segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security and Protection Services; and Electro and Communications. As discussed in Note 13 to the Consolidated Financial Statements, effective in the first quarter of 2011, 3M made certain product moves between its business segments in its continuing effort to drive growth by aligning businesses around markets and customers. The financial information presented herein reflects the impact of these business segment changes for all periods presented.

 

First-quarter 2011 sales totaled $7.3 billion, an increase of 15.2 percent from the first quarter of 2010, with all business segments showing improvement. First-quarter 2011 sales also increased in every major geographic region, with Asia Pacific up 21 percent, Latin America/Canada up 19.5 percent, Europe up 13.1 percent, and the U.S up 10.2 percent. Of the 15.2 percent sales growth, approximately 9 points were from higher organic volumes, 3 points from acquisitions and another 3 points from favorable currency effects. From the second quarter of 2009 through the third quarter of 2010, 3M recorded H1N1-related sales in 3M's personal protection business within the Safety, Security and Protection Services business segment. The absence of H1N1-related sales in the first quarter of 2011 reduced first-quarter 2011 sales growth by approximately 0.80 percentage points. Adjusting for Japan (discussed below) and H1N1-related impacts, organic volumes increased approximately 10.4 percent. Net income attributable to 3M in the first quarter of 2011 was $1.081 billion, or $1.49 per diluted share. Including special items (discussed below), net income attributable to 3M in the first quarter of 2010 was $930 million, or $1.29 per diluted share.

 

3M estimates that combined direct and indirect business disruption resulting from the recent Japan natural disaster reduced first-quarter 2011 sales growth by 0.70 percentage points, operating margins by 0.40 percentage points, and earnings by approximately 3 cents per diluted share. Japan represented approximately 9 percent of total 3M sales for total year 2010. 3M's facilities in Japan are fully operational, and the Company plans to install backup power for contingency purposes. Distribution channels are also returning to normal and 3M is leveraging alternative supply chains to meet demand. 3M expects additional Japan-related impacts in the second quarter of 2011, but these impacts should begin to wane in the second half of 2011. Automobile and electronic manufacturers are most impacted, which largely impacts 3M's automotive OEM and consumer electronics-related businesses. Based on 3M's current assessment, no material asset or investment impairments have been recorded. In addition, 3M is not aware of any significant issues related to this natural disaster concerning inventory, customer receivables, lease terminations, environmental exposures, guarantees, indemnifications, debt covenant compliance, or significant tax issues. 3M does have certain insurance coverage which could limit its exposure if any material issues do develop.

 

The first quarter of 2010 includes a one-time, non-cash income tax charge of $84 million, or 11 cents per diluted share, resulting from the March 2010 enactment of the Patient Protection and Affordable Care Act, including modifications made in the Health Care and Education Reconciliation Act of 2010. Refer to the special items discussion at the end of this overview section for more detail.

 

In the first quarter of 2011, all six of 3M's business segments posted strong sales growth, ranging from 8.5 to 20.5 percent, in addition to having operating income margins of greater than 21 percent. The following table contains sales and operating income results by business segment for the three months ended March 31, 2011 and 2010.

 



Three months ended March 31,






 



2011


2010


% change


 



Net


Operating


Net


Operating


Net


Operating


 

(Dollars in millions)


Sales


Income


Sales


Income


Sales


Income


 

Business Segments














 

Industrial and Transportation....


$

2,450


$

516


$

2,036


$

443


20.3

%

16.6

%

 

Health Care............................


1,255


369


1,114


346


12.7


6.5


 

 

Display and Graphics..............


943


230


869


212


8.5


8.9


 

Consumer and Office...............


1,000


215


912


219


9.6


(1.9

)

 

Safety, Security and Protection Services..............................


929


199


813


182


14.4


9.1


 

Electro and Communications...


836


178


694


147


20.5


21.4


 

Corporate and Unallocated.......


5


(105

)

4


(83

)





Elimination of Dual Credit.........


(107

)

(24

)

(94

)

(21

)





 

Total Company.......................


$

7,311


$

1,578


$

6,348


$

1,445


15.2

%

9.2

%

 

 

Sales in the first quarter of 2010 increased 15.2 percent, as every business segment experienced solid growth, led by Electro and Communications at 20.5 percent, Industrial and Transportation at 20.3 percent, Safety, Security and Protection Services at 14.4 percent and Health Care at 12.7 percent. Organic sales volumes grew 8.9 percent, led by sales in emerging markets. Sales grew by 30 percent in India, 27 percent in China/Hong Kong and 25 percent in Brazil. Local-currency sales (which includes volume, selling price and acquisition impacts, but excludes divestiture and translation impacts) increased 12.2 percent and foreign currency impacts added 3 percent. Operating income margins for the three months ended March 31, 2011 were 21.6 percent, compared to 22.8 percent in the first three months of 2010. Refer to the section entitled "Performance by Business Segment" later in MD&A for a more detailed discussion of the results of the respective segments. Refer to Note 13 for discussion of Corporate and Unallocated and Elimination of Dual Credit.

 

3M generated $733 million of operating cash flows for the three months ended March 31, 2011, compared to $1.082 billion for the three months ended March 31, 2010. Refer to the section entitled "Cash Flows from Operating Activities" later in the MD&A for a discussion of items impacting cash flows. In February 2011, 3M's Board of Directors authorized the repurchase of up to $7.0 billion of 3M's outstanding common stock, which replaced the Company's previous repurchase program. This authorization has no pre-established end date. In the first three months of 2011, the Company purchased $680 million of treasury stock, of which a portion was under the previous authorization, compared to $20 million of treasury stock in the first three months of 2010. As of March 31, 2011, approximately $6.6 billion remained available for repurchase. In February 2011, 3M's Board of Directors authorized a dividend increase of 4.8 percent for 2011, marking the 53rd consecutive year of dividend increases for 3M. 3M's debt to total capital ratio (total capital defined as debt plus equity) at both March 31, 2011 and December 31, 2010 was 25 percent. 3M has an AA- credit rating with a stable outlook from Standard & Poor's and an Aa2 credit rating with a stable outlook from Moody's Investors Service. In addition to cash on hand, the Company has sufficient access to capital markets to meet currently anticipated growth and acquisition investment funding needs.

 

For total year 2011, 3M estimates that combined direct and indirect business disruption resulting from events in Japan will reduce full year 2011 sales growth by approximately 1 percentage point, operating income margins by 0.30 percentage points, and earnings by approximately 10 to 13 cents per diluted share. In 2011, including the impacts of the natural disaster in Japan, 3M expects sales growth of 12 percent or more. This includes organic sales volume growing at a rate of 6 to 7.5 percent, currency effects adding 2 to 3 percent (assuming March 31, 2011 exchange rates), and acquisitions adding 4 to 6 percent for the year. This expected sales growth and related incremental operating income, including a benefit from currency effects (assuming March 31, 2011 exchange rates), should more than offset the items that will negatively impact earnings, as summarized below.

 

There are a few major items that will negatively impact earnings in 2011. First, as discussed further below, 3M expects that pension and postretirement expense will decrease 2011 earnings, when compared to 2010, by approximately 22 cents per diluted share. A banked vacation policy change made in 2009 will also negatively impact earnings in 2011. Prior to 2009, 3M allowed employees to bank a certain amount of unused vacation. Effective January 1, 2009, 3M employees were given two years to use their previously banked vacation, with the resulting reduction in 3M's liability benefiting both 2009 and 2010 operating results. This change resulted in an estimated 8 cent per diluted share benefit in 2010 results, which will not carry-over into 2011, and thus, will negatively impact 2011 versus 2010 comparisons. Finally, 3M's assessment of the income tax rate indicates an expected 2011 effective tax rate of approximately 29.5 percent compared to 27.7 percent for 2010.

 

On a worldwide basis, 3M's pension and postretirement plans were 90 percent funded at year-end 2010. The U.S. qualified plan, which is approximately 71 percent of the worldwide pension obligation, was 97 percent funded, the non-qualified pension plan was not funded, and the international pension plans were 89 percent funded. Asset returns in 2010 for the U.S. qualified plan were 14.4% while the year-end 2010 discount rate was 5.23%, down 0.54 percentage points from the 2009 discount rate of 5.77%. 3M expects to contribute $400 million to $600 million of cash to its global pension and postretirement plans in 2011. The Company does not have a required minimum pension contribution obligation for its U.S. plans in 2011. 3M expects pension and postretirement benefit expense in 2011 to increase by approximately $215 million pre-tax, or 22 cents per diluted share, when compared to 2010.

 

Forward-looking statements in Part I, Item 2 may involve risks and uncertainties that could cause results to differ materially from those projected (refer to the section entitled "Cautionary Note Concerning Factors That May Affect Future Results" in Part I, Item 2 and the risk factors provided in Part II, Item 1A for discussion of these risks and uncertainties).

 

Special Items:

 

Special items represent significant charges or credits that are important to understanding changes in the Company's underlying operations.

 

First quarter 2010 special items:

 

The first quarter of 2010 includes a one-time, non-cash income tax charge of $84 million, or 11 cents per diluted share, resulting from the March 2010 enactment of the Patient Protection and Affordable Care Act, including modifications made in the Health Care and Education Reconciliation Act of 2010 (collectively, the "Act"). The charge is due to a reduction in the value of the company's deferred tax asset as a result of the Act's change to the tax treatment of Medicare Part D reimbursements. This item is discussed in more detail in Note 5 (Income Taxes).

 

 

Percent change information compares the first quarter of 2011 with the same period last year, unless otherwise indicated.

 

Net Sales:


Three months ended March 31, 2011



United
States


Asia Pacific


Europe,
Middle East
and Africa


Latin
America/
Canada


Other
Unallocated


Worldwide


Net sales (millions) .......

2,406

2,341

1,764

802

(2

7,311

% of worldwide sales ....

32.9

32.0

24.1

11.0

-

100.0

Components of net sales change:







Volume - organic ........

6.1

14.2

6.4

8.4

-

8.9

Price ...................

0.7

(1.7

0.6

2.3

-

0.1

Organic local-currency sales

6.8

12.5

7.0

10.7

-

9.0

Acquisitions .............

3.4

3.1

3.5

1.6

-

3.2

Local-currency sales ......

10.2

15.6

10.5

12.3

-

12.2

Divestitures ..............

-

-

-

-

-

-

Translation ..............

-

5.4

2.6

7.2

-

3.0

Total sales change ........

10.2

21.0

13.1

19.5

-

15.2

 

Sales in the first quarter of 2010 increased 15.2 percent, with broad-based geographic area growth across all major geographic regions led by Asia Pacific and the combined Latin America/Canada region. 3M's organic volume growth of 8.9 percent, or 10.4 percent adjusted for H1N1 and Japan, was significantly higher than first-quarter 2011 estimated worldwide IPI (Industrial Production Index) of approximately 6 percent. Acquisitions added 3.2 percent to growth and currency impacts benefited first quarter 2011 sales growth by 3 percent. Selling prices rose just slightly in the first quarter, impacted significantly by optical systems, where price-down is a normal part of business, as selling prices in 3M's other businesses increased by nearly one percentage point.

 

 



Operating Expenses:

 


Three months ended



March 31,



2011


2010


Change


Cost of sales..........................................

52.0

51.0

%

1.0

%

Selling, general and administrative expenses.......................

21.0


20.8


0.2


Research, development and related expenses.................................

5.4


5.4


-


Operating income....................................

21.6

22.8

%

(1.2

)%

 

As discussed in the overview section, 3M expects pension and postretirement expense (excluding any possible settlement, curtailment or other special termination benefits in 2011) to increase approximately $215 million for total year 2011 when compared to 2010. The first-quarter 2011 versus 2010 year-on-year increase was $47 million, which negatively impacted cost of sales; selling, general and administrative expenses (SG&A); and research, development and related expenses (R&D) in the aggregate by approximately 0.7 percentage points.

 

Cost of sales includes manufacturing, engineering and freight costs. Cost of sales as a percent of net sales was 52.0 percent in the first quarter of 2011, an increase of one percentage point from the same quarter last year. While an 8.9 percent growth in organic sales volume helped first-quarter 2011 operating income margins, this benefit was essentially offset by higher raw material costs. 3M expects price increases to largely offset total year 2011 raw material inflation. In addition, higher pension and postretirement expense, and the impact of the natural disaster in Japan, increased cost of sales as a percent of net sales.

 

SG&A and R&D expenses in dollars increased 16 percent and 17 percent, respectively, with the increases primarily attributable to continued high levels of growth-oriented investment, currency translation, acquisitions, and higher pension and postretirement expense. SG&A as a percent of net sales increased 0.2 percentage points in the first quarter of 2011 compared to the first quarter of 2010, while R&D as a percent of sales remained unchanged.

 

Operating Income:

 

3M uses operating income as one of its primary business segment performance measurement tools. Operating income margins were 21.6 percent in the first three months of 2011 compared to 22.8 percent of sales in the first three months of 2010. From an operating income margin perspective, the benefits from organic sales volume leverage were more than offset by the impact of the natural disaster in Japan, H1N1-related impacts, increases in raw material prices, and increased pension and postretirement expense. Operating income dollars increased 9 percent to $1.6 billion, but would have increased an additional 8 percent if you were to adjust for the combined impacts of the Japan natural disaster, H1N1-related impacts and increased pension and postretirement expense.

 

Interest Expense and Income:

 


Three months ended



March 31,



2011


2010


Interest expense.....................

43


$

48


Interest income......................

(10

(6

)

Total..................................

33


$

42


 

Interest expense was lower when compared to the same period last year, primarily due to reductions in U.S. long-term average debt balances. Interest income increased, primarily due to higher U.S. and international rates.

 



Provision for Income Taxes:

 


Three months ended



March 31,



2011


2010


Effective tax rate.................

28.6

31.9

%

 

The effective tax rate for the first quarter of 2011 was 28.6 percent, compared to 31.9 percent in the first quarter of 2010, a decrease of 3.3 percent. The first quarter of 2010 includes a one-time income tax charge of $84 million as a result of the March 2010 enactment of the Patient Protection and Affordable Care Act, including modifications made in the Health Care and Education Reconciliation Act of 2010, which increased the first-quarter 2010 effective tax rate by approximately 6 percent. Other factors on a combined basis increased the effective tax rate for the first quarter of 2011 when compared to the first quarter of 2010 by 2.7 percent, with the most significant item related to international taxes. This was due primarily to the one-time 2010 tax benefits resulting from the corporate alignment transactions that allowed the Company to increase its ownership of a foreign subsidiary. In addition, the Company's effective tax rate benefited during the first quarter of 2011 from the reinstatement of the research and development credit and adjustments to its income tax reserves. Refer to Note 5 for further discussion of income taxes.

 

The company currently expects that its effective tax rate for total year 2011 will be approximately 29.5 percent. The rate will change from quarter to quarter due to discrete items, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors, such as the geographic mix of income before taxes.

 

Net Income Attributable to Noncontrolling Interest:

 


Three months ended



March 31,



2011


2010


Net income attributable to noncontrolling interest             

22


$

25


 

Net income attributable to noncontrolling interest represents the elimination of the income or loss attributable to non-3M ownership interests in 3M consolidated entities. The changes in noncontrolling interest amounts are primarily related to Sumitomo 3M Limited (Japan), which is 3M's most significant consolidated entity with non-3M ownership interests. As of March 31, 2011, 3M's effective ownership in Sumitomo 3M Limited is 75 percent.

 

Currency Effects:

 

3M estimates that year-on-year currency effects, including hedging impacts, increased net income attributable to 3M by approximately $47 million for the for the three months ended March 31, 2011. This estimate includes the effect of translating profits from local currencies into U.S. dollars and the impact of currency fluctuations on the transfer of goods between 3M operations in the United States and abroad. This estimate also includes year-on-year currency effects from transaction gains and losses, including derivative instruments designed to reduce foreign currency exchange rate risks, which 3M estimates increased net income attributable to 3M by approximately $16 million for the three months ended March 31, 2011.

 

Significant  Accounting Policies:

 

Information regarding new accounting standards is included in Note 1 to the Consolidated Financial Statements.

 

 

As discussed in Note 13 to the Consolidated Financial Statements, effective in the first quarter of 2011, 3M made certain product moves between its business segments. Segment information for all periods presented has been reclassified to reflect the new segment structure.

 

Information related to 3M's business segments for the first quarters of both 2011 and 2010 is presented in the tables that follow. Organic local-currency sales include both organic volume impacts plus selling price impacts. Acquisition impacts, a component of local currency sales growth, are measured separately for the first twelve months of the acquisition. The divestiture impact, if any, translation impact and total sales change are also provided for each business segment.



Industrial and Transportation Business:

 



Three months ended


 



March 31,


 



2011


2010


 

Sales (millions)....................................................................


$

2,450


$

2,036


 

Sales change analysis:






 

 

Organic local currency...................................................


13.3

%

22.9

%

Acquisitions..................................................................


3.6


0.1


 

Local currency..............................................................


16.9


23.0


 

 

Translation....................................................................


3.4


5.7


Total sales change............................................................


20.3

%

28.7

%

 







 

Operating income (millions)...................................................


$

516


$

443


 

Percent change................................................................


16.6

%

158.5

%

 

Percent of sales...............................................................


21.1

%

21.7

%

 

 

The Industrial and Transportation segment serves a broad range of markets, such as appliance, paper and packaging, food and beverage, electronics, automotive original equipment manufacturer (OEM) and automotive aftermarket (auto body shops and retail). Industrial and Transportation products include tapes, a wide variety of coated and non-woven abrasives, adhesives, specialty materials, filtration products, energy control products, closure systems for personal hygiene products, acoustic systems products, and components and products that are used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles.

 

Sales in Industrial and Transportation increased 20.3 percent to $2.45 billion. In local-currency terms, sales increased 16.9 percent, which included 3.6 percent from acquisitions, primarily Winterthur Technologie AG (Winterthur) and Alpha Beta Enterprise Co. Ltd. (Alpha Beta), which are discussed further below. Foreign currency impacts added 3.4 percent to first quarter sales growth. Sales growth was broad-based, as every business in this segment posted local-currency sales increases. Local-currency sales growth was led by renewable energy, aerospace and aircraft maintenance, abrasives and industrial adhesives and tapes. Geographically, sales increased in all major regions, led by a 28 percent increase in Asia Pacific, 22 percent in Latin America/Canada, 19 percent in Europe and 14 percent in the U.S.

 

Industrial and Transportation continues to invest aggressively to accelerate its growth capability. In March 2011, 3M acquired a controlling interest in Winterthur via completion of a public tender offer. Winterthur, based in Zug, Switzerland, is a leading global supplier of precision grinding technology serving customers in the area of hard-to-grind precision applications in industrial, automotive, aircraft, and cutting tools. In addition, in February 2011, 3M completed its acquisition of the tape-related assets of Alpha Beta, a leading manufacturer of box sealing tape and masking tape headquartered in Taipei, Taiwan.

 

Operating income was $516 million in the first quarter, 16.6 percent higher than the first quarter of last year, and increased in-line with 3M's local-currency sales growth of 16.9 percent. Strong revenue growth and operational excellence drove operating income growth. Considering 3M's continued investments, including purchase accounting impacts from the recent acquisitions discussed above, higher raw material costs, and higher pension/postretirement benefit costs, 3M was still able to maintain operating income margins above 21 percent.

 



Health Care Business:

 


Three months ended


 


March 31,


 


2011


2010


 

Sales (millions)....................................................................

1,255


$

1,114


 

Sales change analysis:






 

 

Organic local currency...................................................

4.6

7.5

%

Acquisitions..................................................................

5.1


-


 

Local currency..............................................................

9.7


7.5


 

Divestitures...................................................................

-


(0.2

)

 

Translation....................................................................

3.0


4.6


 

Total sales change............................................................

12.7

11.9

%

 







 

Operating income (millions)...................................................

369


$

346


 

Percent change................................................................

6.5

13.1

%

 

Percent of sales...............................................................

29.4

31.1

%

 

 

The Health Care segment serves markets that include medical clinics and hospitals, pharmaceuticals, dental and orthodontic practitioners, and health information systems. Products and services provided to these and other markets include medical and surgical supplies, skin health and infection prevention products, dental and orthodontic products (oral care), inhalation and transdermal drug delivery systems, health information systems, and food safety products.

 

Health Care local-currency sales increased 9.7 percent, including a benefit of 5.1 percent from acquisitions, primarily related to the Arizant Inc. acquisition in the fourth quarter of 2010. Arizant Inc. is a leading manufacturer of patient warming solutions designed to prevent hypothermia in surgical settings. Currency impacts increased sales by 3 percent. On a geographic basis, all regions posted positive sales growth, with Asia Pacific up 21 percent, Latin America/Canada up 19 percent, Europe up 11 percent and the U.S. up 10 percent. Local currency sales increased in all businesses, led by growth in both infection prevention and food safety.

 

Operating income increased 6.5 percent to $369 million. Operating income margins were 29.4 percent in the first quarter of 2011 compared to 31.1 percent in the first quarter of 2010. 3M's long-term expectation is that operating income margins will be in the high 20's, as 3M continues to invest to grow this business.

 



Display and Graphics Business:

 



Three months ended


 



March 31,


 



2011


2010


 

Sales (millions)....................................................................


$

943


$

869


 

Sales change analysis:






 

 

Organic local currency...................................................


6.4

%

38.4

%

Acquisitions..................................................................


-


-


 

Local currency..............................................................


6.4


38.4


 

 

Translation....................................................................


2.1


4.0


Total sales change............................................................


8.5

%

42.4

%

 







 

Operating income (millions)...................................................


$

230


$

212


 

Percent change................................................................


8.9

%

254.4

%

 

Percent of sales...............................................................


24.4

%

24.3

%

 

 

The Display and Graphics segment serves markets that include electronic display, traffic safety and commercial graphics. This segment includes optical film solutions for LCD electronic displays; computer screen filters; reflective sheeting for transportation safety; commercial graphics sheeting and systems; and mobile interactive solutions, including mobile display technology, visual systems products, and computer privacy films.

 

Sales in Display and Graphics were $943 million, up 8.5 percent year-on-year. Sales increased 6.4 percent in local currencies, which was all organic. Foreign currency impacts increased sales by 2.1 percent. Local-currency sales growth was led by 3M's commercial graphics and architectural markets businesses. The architectural markets business brings new solutions and technologies for surface and glass finishes and lighting into the architectural and design market. Optical systems sales grew, even though consumer TV demand was soft, while demand for 3M film used in smart phones and tablet PC's remained robust. Traffic safety systems also posted positive sales growth. Sales increased in all geographic regions, led by the U.S. at 18 percent and Latin America/Canada at 15 percent.

 

Concerning optical systems, 3M estimates that the TV channel still has a few weeks of excess inventory. 3M expects that this excess inventory will be quickly corrected via production cuts, plus the impact of model changes that will take place in the second quarter of 2011. For planning purposes, 3M has assumed some volume contraction from the loss of LCD TV attachment, which frequently happens in the ebb and flow of competition and pricing in that channel.

 

Operating income in the first quarter of 2011 totaled $230 million, or 24.4 percent of sales, slightly higher than the first quarter of 2010. Sales growth in commercial graphics, architectural markets, and optical systems helped 3M maintain its operating income margins in this business segment. Operating income increased 8.9 percent, in-line with sales growth.

 



Consumer and Office Business:

 


Three months ended


 


March 31,


 


2011


2010


 

Sales (millions)....................................................................

1,000


$

912


 

Sales change analysis:






 

 

Organic local currency...................................................

4.8

8.1

%

Acquisitions..................................................................

2.2


2.6


 

Local currency..............................................................

7.0


10.7


 

 

Translation....................................................................

2.6


4.0


Total sales change............................................................

9.6

14.7

%

 







 

Operating income (millions)...................................................

215


$

219


 

Percent change................................................................

(1.9

32.7

%

 

Percent of sales...............................................................

21.5

24.0

%

 

 

The Consumer and Office segment serves markets that include consumer retail, office retail, home improvement, building maintenance and other markets. Products in this segment include office supply products, stationery products, construction and home improvement products (do-it-yourself), home care products, protective material products, certain consumer retail personal safety products, and consumer health care products.

 

Sales in Consumer and Office increased 9.6 percent in the first quarter to $1 billion. Local-currency sales increased 7 percent, which included 4.8 percent from organic growth and 2.2 percent from acquisitions. Acquisition growth was largely due to the April 2010 acquisition of the A-One branded label business and related operations. A-One is the largest branded label business in Asia and the second largest worldwide. 3M acquired Hybrivet Systems Inc. in the first quarter of 2011, a provider of instant-read products to detect lead and other contaminants and toxins. The office supply business led local-currency sales growth, driven by both the A-One acquisition and organic growth. All other businesses also posted positive local-currency growth in the first quarter. Foreign currency impacts contributed 2.6 percent to sales growth. On a geographic basis, sales increased in all regions, led by Asia Pacific at 31 percent and Latin America/Canada at 15 percent.

 

Consumer and Office operating income decreased 1.9 percent to $215 million, with operating income margins of 21.5 percent. Increased strategic selling, advertising and merchandising investments are helping 3M achieve strong levels of sales growth, but in the short-term this is resulting in some operating income margin erosion. 3M is committed to investing in and driving this business for the longer term. In addition, like other businesses, raw material increases in the first quarter also impacted operating income margins.

 



Safety, Security and Protection Services Business:

 


Three months ended


 


March 31,


 


2011


2010


 

Sales (millions)....................................................................

929


$

813


 

Sales change analysis:






 

 

Organic local currency...................................................

5.0

14.8

%

Acquisitions..................................................................


6.3

-


 

Local currency..............................................................

11.3


14.8


 

Translation....................................................................

3.1


5.7


 

Total sales change............................................................

14.4

20.5

%

 







 

Operating income (millions)...................................................

199


$

182


 

Percent change................................................................

9.1

46.0

%

 

Percent of sales...............................................................

21.4

22.4

%

 

 

The Safety, Security and Protection Services segment serves a broad range of markets that increase the safety, security and productivity of workers, facilities and systems. Major product offerings include personal protection products, cleaning and protection products for commercial establishments, safety and security products (including border and civil security solutions), roofing granules for asphalt shingles, corrosion protection products used in the oil and gas pipeline markets, and track and trace solutions.

 

Safety, Security and Protection Services sales increased 14.4 percent in the first quarter of 2011. H1N1-related comparisons reduced first quarter 2011 sales growth by 6.5 percent. 3M had sales related to the H1N1 virus in 2010, all in the first three quarters of the year. Even with this difficult comparison, local-currency sales growth was 11.3 percent, which included 6.3 percent growth from acquisitions. The acquisition benefit primarily related to two fourth-quarter 2010 acquisitions, namely Attenti Holdings S.A. and Cogent Inc. Attenti Holdings S.A. is a supplier of remote people-monitoring technologies used for offender-monitoring applications and to assist eldercare facilities in monitoring and enhancing the safety of patients. Cogent Inc. is a provider of finger, palm, face and iris biometric systems for governments, law enforcement agencies, and commercial enterprises. Foreign currency effects added 3.1 percent to first-quarter sales. All geographic regions posted sales growth, led by Asia Pacific at 24 percent, and Latin America/Canada at 20 percent.

 

3M experienced local-currency sales growth in security systems, track and trace, and corrosion protection products. 3M also saw growth in its personal protection products, or more specifically, respiratory products, but this growth was hampered by H1N1-related comparisons.

 

Operating income for the first quarter of 2010 rose 9.1 percent to $199 million, with a 21.4 percent operating income margin. H1N1-related comparisons negatively impacted year-on-year sales and operating income growth.

 

 



Electro and Communications Business:

 


Three months ended


 


March 31,


 


2011


2010


 

Sales (millions)....................................................................

836


$

694


 

Sales change analysis:






 

 

Organic local currency...................................................

17.1

34.6

%

Acquisitions..................................................................


-


-


 

Local currency..............................................................

17.1


34.6


 

Divestitures ..................................................................

-


(1.0

)

 

Translation....................................................................

3.4


5.1


 

Total sales change............................................................

20.5

38.7

%

 







 

Operating income (millions)...................................................

178


$

147


 

Percent change................................................................

21.4

484.7

%

 

Percent of sales...............................................................

21.3

21.1

%

 

 

The Electro and Communications segment serves the electrical, electronics and communications industries, including electrical utilities; electrical construction, maintenance and repair; original equipment manufacturer (OEM) electrical and electronics; computers and peripherals; consumer electronics; telecommunications central office, outside plant and enterprise; as well as aerospace, military, automotive and medical markets; with products that enable the efficient transmission of electrical power and speed the delivery of information. Products include electronic and interconnect solutions, micro interconnect systems, high-performance fluids, high-temperature and display tapes, telecommunications products, electrical products, and touch screens and touch monitors.

 

Electro and Communications sales were $836 million in the first quarter, an increase of 20.5 percent in U.S. dollars and 17.1 percent in local currency. Foreign currency impacts added 3.4 percent to first-quarter growth. Sales expanded in all geographic regions, led by the Asia Pacific area at 25 percent and Latin America/Canada at 23 percent. Sales growth was led by businesses that supply the consumer electronics and semiconductor industries. 3M also saw strong growth in the electrical markets business, which supplies connectors and other such solutions to the power utility, MRO (maintenance, repair and overhaul) and appliance markets. The telecom infrastructure-related business and touch systems also showed sales growth.

 

Operating income increased 21.4 percent to $178 million in the first quarter of 2011, with operating income increasing at a slightly higher rate than sales. Operating income margins were 21.3 percent, slightly higher than the first quarter of 2010.

 



FINANCIAL CONDITION AND LIQUIDITY

 

As indicated in the following table, 3M's net debt at March 31, 2011 totaled $1.227 billion, compared to $434 million at December 31, 2010. At March 31, 2011, 3M had $4.4 billion of cash, cash equivalents, and marketable securities and $5.6 billion of debt. Debt included $4.5 billion of long-term debt and $1.1 billion related to the current portion of long-term debt and other borrowings. The current portion of long-term debt includes $800 million in medium-term notes due in November 2011. The strength of 3M's capital structure and consistency of its cash flows provide 3M reliable access to capital markets. Additionally, the Company's debt maturity profile is staggered to ensure refinancing needs in any given year are reasonable in proportion to the total portfolio.

 

The Company generates significant ongoing cash flow, which has been used, in part, to fund share repurchase activities, pay dividends on 3M common stock, and for acquisitions. As discussed in Note 2, in the first quarter of 2011, the Company acquired Winterthur Technologie AG and other businesses for an aggregate $471 million in cash. This is in addition to several significant fourth-quarter 2010 acquisitions, when the Company purchased Arizant Inc., Attenti Holdings S.A. and Cogent Inc. 3M was able to complete these acquisitions without incurring significant additional debt, while maintaining a strong cash, cash equivalents and marketable securities position.

 


Mar. 31,


Dec. 31,



2011


2010








Total Debt..............................................................................

5,619


$

5,452


Less: Cash and cash equivalents and marketable securities.......

4,392


5,018


Net Debt................................................................................

1,227


$

434


 

The Company defines net debt as total debt less cash, cash equivalents and marketable securities. 3M considers net debt to be an important measure of liquidity and its ability to meet ongoing obligations. This measure is not defined under U.S. generally accepted accounting principles and may not be computed the same as similarly titled measures used by other companies.

 

Cash, cash equivalents and marketable securities at March 31, 2011 decreased by $626 million when compared to year-end 2010. Operating cash flow of $733 million in the first three months of 2011 was more than offset by utilization of cash for acquisitions ($471 million), dividends paid to shareholders ($392 million), net treasury stock repurchases ($302 million), and capital spending ($231 million). The Company has sufficient liquidity to meet currently anticipated growth plans, including capital expenditures, working capital investments and acquisitions. The Company does not utilize derivative instruments linked to the Company's stock. However, the Company does have contingently convertible debt that, if conditions for conversion are met, is convertible into shares of 3M common stock (refer to Note 10 in 3M's 2010 Annual Report on Form 10-K).

 

The Company's financial condition and liquidity are strong. Various assets and liabilities, including cash and short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. Working capital (defined as current assets minus current liabilities) totaled $6.745 billion at March 31, 2011, compared with $6.126 billion at December 31, 2010. Working capital increases were primarily attributable to increases in accounts receivable and inventory, which was partially attributable to the strong increase in demand in the first quarter of 2011.

 

Primary short-term liquidity needs are met through U.S. commercial paper and euro commercial paper issuances. The Company maintains a commercial paper program that allows 3M to have a maximum of $3 billion outstanding with a maximum maturity of 397 days from date of issuance. As of March 31, 2011 and December 31, 2010, 3M had no outstanding commercial paper. The Company believes it is unlikely that its access to the commercial paper market will be restricted. Effective April 30, 2007, the Company has a $1.5-billion five-year credit facility, which has provisions for the Company to request an increase of the facility up to $2 billion (at the lenders' discretion), and providing for up to $150 million in letters of credit. As of March 31, 2011, approximately $148 million was utilized for letters of credit in connection with normal business activities. Debt covenants do not restrict the payment of dividends.

 

The Company has a "well-known seasoned issuer" shelf registration statement, effective February 17, 2009, which registers an indeterminate amount of debt or equity securities for future sales. No securities have been issued under this shelf. The Company intends to use the proceeds from future securities sales off this shelf for general corporate purposes. In connection with a prior "well-known seasoned issuer" shelf registration, in June 2007 the Company established a $3 billion medium-term notes program. Three debt securities have been issued under this medium-term notes program. First, in December 2007, 3M issued a five-year, $500 million, fixed rate note with a coupon rate of 4.65%. Second, in August 2008, 3M issued a five-year, $850 million, fixed rate note with a coupon rate of 4.375%. Third, in October 2008, the Company issued a three-year $800 million, fixed rate note with a coupon rate of 4.50%. The Company entered into an interest rate swap to convert this $800 million note to a floating rate.

 

The Company has an AA- credit rating, with a stable outlook, from Standard & Poor's and an Aa2 credit rating, with a stable outlook, from Moody's Investors Service. Under its $1.5-billion five-year credit facility agreement, 3M is required to maintain its EBITDA to Interest Ratio as of the end of each fiscal quarter at not less than 3.0 to 1. This is calculated (as defined in the agreement) as the ratio of consolidated total EBITDA for the four consecutive quarters then ended to total interest expense on all funded debt for the same period. At March 31, 2011, this ratio was approximately 36 to 1.

 

3M's strong balance sheet and liquidity provide the Company with significant flexibility to take advantage of numerous opportunities going forward. The Company will continue to invest in its operations to drive growth, including continual review of acquisition opportunities. 3M has a long history of dividend increases. In February 2011, the Board of Directors increased the quarterly dividend on 3M common stock by 4.8 percent to 55 cents per share, equivalent to an annual dividend of $2.20 per share. In February 2011, 3M's Board of Directors authorized the repurchase of up to $7.0 billion of 3M's outstanding common stock, which replaced the Company's previous repurchase program. This authorization has no pre-established end date. At March 31, 2011, the Company has $6.6 billion remaining under this authorization.

 

For the three months ended March 31, 2011, contributions totaling $39 million were made to the Company's U.S. and international pension plans and $22 million to its postretirement plans. In 2011, the Company expects to contribute in the range of $400 million to $600 million to its U.S. and international pension and postretirement plans. The Company does not have a required minimum pension contribution obligation for its U.S. plans in 2011. Therefore, the amount of the anticipated discretionary contribution could vary significantly depending on the U.S. qualified plans' funded status as of the 2011 measurement date and the anticipated tax deductibility of the contribution. Future contributions will also depend on market conditions, interest rates and other factors. 3M believes its strong cash flow and balance sheet will allow it to fund future pension needs without compromising growth opportunities.

 

The Company uses various working capital measures that place emphasis and focus on certain working capital assets and liabilities. These measures are not defined under U.S. generally accepted accounting principles and may not be computed the same as similarly titled measures used by other companies. One of the primary working capital measures 3M uses is a combined index, which includes accounts receivable, inventory and accounts payable. This combined index (defined as current quarterly net sales multiplied by four, divided by the sum of ending net accounts receivable plus inventory less accounts payable) was 5.0 at March 31, 2011, down from 5.3 at both December 31, 2010 and March 31, 2010. Receivables increased $594 million, or 16 percent, compared with December 31, 2010, with higher March 2011 sales compared to December 2010 sales contributing to this increase. In addition, acquisitions increased accounts receivable by $80 million and currency translation increased accounts receivable by $45 million, as the U.S. dollar weakened in aggregate against a multitude of currencies. Inventories increased $334 million, or 11 percent, compared with December 31, 2010. The inventory increases are partially attributable to the increase in demand in the first quarter of 2011. In addition, acquisitions increased inventory by $101 million and currency translation increased inventory by $52 million, as the U.S. dollar weakened in aggregate against a multitude of currencies. Accounts payable increased $153 million compared with December 31, 2010, with acquisitions accounting for $45 million of this increase and currency translation accounting for $25 million, with the balance primarily related to improvement in business activity.

 

Cash flows from operating, investing and financing activities are provided in the tables that follow. Individual amounts in the Consolidated Statement of Cash Flows exclude the effects of acquisitions, divestitures and exchange rate impacts on cash and cash equivalents, each of which are presented separately in the cash flows. Thus, the amounts presented in the following operating, investing and financing activities tables reflect changes in balances from period to period adjusted for these effects.

 



Cash Flows from Operating Activities:

 


Three months ended


 


March 31,


 


2011


2010


 







 

Net income including noncontrolling interest..............................

1,103


$

955


 

Depreciation and amortization..................................................

289


287


 

 

Company pension contributions...............................................

(39

(54

)

 

Company postretirement contributions......................................

(22

(28

)

 

Company pension expense.....................................................