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3M Company (96OI)

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Tuesday 07 May, 2013

3M Company

1st Quarter Results

RNS Number : 0393E
3M Company
03 May 2013
 



 

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, 2013

 

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, 2013

Common Stock, $0.01 par value per share


690,194,620 shares

 

This document (excluding exhibits) contains 70 pages.

The table of contents is set forth on page 2.

The exhibit index begins on page 67.


3M COMPANY

Form 10-Q for the Quarterly Period Ended March 31, 2013

TABLE OF CONTENTS




BEGINNING
PAGE


PART I

FINANCIAL INFORMATION




ITEM 1.

Financial Statements





Index to Financial Statements:





Consolidated Statement of Income


3



Consolidated Statement of Comprehensive Income


4



Consolidated Balance Sheet


5



Consolidated Statement of Cash Flows


6



Notes to Consolidated Financial Statements





Note 1.   Significant Accounting Policies


7



Note 2.   Acquisitions


9



Note 3.   Goodwill and Intangible Assets


10



Note 4.   Supplemental Equity and Comprehensive Income Information


12



Note 5.   Income Taxes


15



Note 6.   Marketable Securities


16



Note 7.   Pension and Postretirement Benefit Plans


18



Note 8.   Derivatives


19



Note 9.   Fair Value Measurements


26



Note 10. Commitments and Contingencies


30



Note 11. Stock-Based Compensation


39



Note 12. Business Segments


43



Report of Independent Registered Public Accounting Firm


45


ITEM 2.

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





Index to Management's Discussion and Analysis:





Overview


46



Results of Operations


49



Performance by Business Segment


51



Financial Condition and Liquidity


57



Cautionary Note Concerning Factors That May Affect Future Results


62


ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk


62


ITEM 4.

Controls and Procedures


63


PART II

OTHER INFORMATION




ITEM 1.

Legal Proceedings


64


ITEM 1A.

Risk Factors


64


ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds


66


ITEM 3.

Defaults Upon Senior Securities


66


ITEM 4.

Mine Safety Disclosures


66


ITEM 5.

Other Information


66


ITEM 6.

Exhibits


67


 


3M COMPANY

FORM 10-Q

For the Quarterly Period Ended March 31, 2013

PART I.  Financial Information








Item 1.  Financial Statements.














3M Company and Subsidiaries







Consolidated Statement of Income







(Unaudited)










Three months ended




March 31,

(Millions, except per share amounts)


2013 


2012 

Net sales


$

 7,634 


$

 7,486 

Operating expenses








Cost of sales



 3,969 



 3,889 


Selling, general and administrative expenses



 1,589 



 1,552 


Research, development and related expenses



 430 



 411 


Total operating expenses



 5,988 



 5,852 

Operating income



 1,646 



 1,634 









Interest expense and income








Interest expense



 39 



 40 


Interest income



 (10)



 (9)



Total interest expense - net



 29 



 31 









Income before income taxes



 1,617 



 1,603 

Provision for income taxes



 470 



 462 

Net income including noncontrolling interest


$

 1,147 


$

 1,141 









Less: Net income attributable to noncontrolling interest



 18 



 16 









Net income attributable to 3M


$

 1,129 


$

 1,125 









Weighted average 3M common shares outstanding - basic



 691.1 



 696.8 

Earnings per share attributable to 3M common








shareholders - basic


$

 1.63 


$

 1.61 









Weighted average 3M common shares outstanding - diluted



 702.1 



 706.1 

Earnings per share attributable to 3M common








shareholders - diluted


$

 1.61 


$

 1.59 









Cash dividends paid per 3M common share


$

 0.635 


$

 0.59 










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


3M Company and Subsidiaries







Consolidated Statement of Comprehensive Income







(Unaudited)






















Three months ended


March 31,

(Millions)


2013 


2012 

Net income including noncontrolling interest


$

 1,147 


$

 1,141 

Other comprehensive income (loss), net of tax:








Cumulative translation adjustment



 (398)



 134 


Defined benefit pension and postretirement plans adjustment



 85 



 97 


Debt and equity securities, unrealized gain (loss)



           ―



 3 


Cash flow hedging instruments, unrealized gain (loss)



 24 



 (15)

Total other comprehensive income (loss), net of tax



 (289)



 219 

Comprehensive income (loss) including noncontrolling interest



 858 



 1,360 

Comprehensive (income) loss attributable to noncontrolling interest



 20 



 5 

Comprehensive income (loss) attributable to 3M


$

 878 


$

 1,365 









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


3M Company and Subsidiaries







Consolidated Balance Sheet







(Unaudited)




















March 31,


December 31,

(Dollars in millions, except per share amount)

2013 

2012 

Assets





Current assets






Cash and cash equivalents


$

 2,928 


$

 2,883 


Marketable securities - current



 1,448 



 1,648 


Accounts receivable - net



 4,418 



 4,061 


Inventories









Finished goods



 1,775 



 1,754 



Work in process



 1,179 



 1,186 



Raw materials and supplies



 865 



 897 

Total inventories



 3,819 



 3,837 

Other current assets



 1,242 



 1,201 


Total current assets



 13,855 



 13,630 










Marketable securities - non-current



 1,452 



 1,162 

Investments



 161 



 163 

Property, plant and equipment



 22,468 



 22,525 


Less: Accumulated depreciation



 (14,150)



 (14,147)



Property, plant and equipment - net



 8,318 



 8,378 

Goodwill



 7,247 



 7,385 

Intangible assets - net



 1,840 



 1,925 

Prepaid pension benefits



 19 



 16 

Other assets



 1,137 



 1,217 



Total assets


$

 34,029 


$

 33,876 









Liabilities





Current liabilities






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


$

 1,072 


$

 1,085 


Accounts payable



 1,820 



 1,762 


Accrued payroll



 466 



 701 


Accrued income taxes



 392 



 371 


Other current liabilities



 2,187 



 2,281 



Total current liabilities



 5,937 



 6,200 










Long-term debt



 4,864 



 4,916 

Pension and postretirement benefits



 3,014 



 3,086 

Other liabilities



 1,686 



 1,634 



Total liabilities


$

 15,501 


$

 15,836 










Commitments and contingencies (Note 10)
















Equity







3M Company shareholders' equity:








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


$

 9 


$

 9 


Additional paid-in capital



 4,179 



 4,044 


Retained earnings



 31,073 



 30,679 


Treasury stock, at cost: 253,838,436 shares at March 31, 2013;









256,941,406 shares at December 31, 2012



 (12,178)



 (12,407)


Accumulated other comprehensive income (loss)



 (5,001)



 (4,750)



Total 3M Company shareholders' equity



 18,082 



 17,575 

Noncontrolling interest



 446 



 465 



Total equity


$

 18,528 


$

 18,040 












Total liabilities and equity


$

 34,029 


$

 33,876 










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


3M Company and Subsidiaries







Consolidated Statement of Cash Flows







(Unaudited)




















Three months ended



March 31,

(Millions)


2013 


2012 

Cash Flows from Operating Activities





Net income including noncontrolling interest


$

 1,147 


$

 1,141 

Adjustments to reconcile net income including noncontrolling interest to net cash








provided by operating activities








Depreciation and amortization



 336 



 313 


Company pension and postretirement contributions



 (68)



 (337)


Company pension and postretirement expense



 138 



 180 


Stock-based compensation expense



 103 



 103 


Deferred income taxes



 61 



 44 


Excess tax benefits from stock-based compensation



 (34)



 (28)


Changes in assets and liabilities









Accounts receivable



 (447)



 (431)



Inventories



 (28)



 (96)



Accounts payable



 97 



 118 



Accrued income taxes (current and long-term)



 99 



 221 



Product and other insurance receivables and claims



 (8)



 (74)


Other - net



 (402)



 (326)

Net cash provided by operating activities



 994 



 828 










Cash Flows from Investing Activities







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



 (324)



 (261)

Proceeds from sale of PP&E and other assets



 10 



 4 

Purchases of marketable securities and investments



 (1,767)



 (900)

Proceeds from sale of marketable securities and investments



 786 



 539 

Proceeds from maturities of marketable securities



 885 



 574 

Other investing



 5 



 1 

Net cash used in investing activities



 (405)



 (43)










Cash Flows from Financing Activities







Change in short-term debt - net



 (13)



 (18)

Repayment of debt (maturities greater than 90 days)



 (5)



 (15)

Proceeds from debt (maturities greater than 90 days)



 9 



 6 

Purchases of treasury stock



 (805)



 (524)

Proceeds from issuance of treasury stock pursuant to stock option and benefit plans



 738 



 213 

Dividends paid to shareholders



 (440)



 (410)

Excess tax benefits from stock-based compensation



 34 



 28 

Other - net



 (4)



 (2)

Net cash used in financing activities



 (486)



 (722)










Effect of exchange rate changes on cash and cash equivalents



 (58)



 50 










Net increase (decrease) in cash and cash equivalents



 45 



 113 

Cash and cash equivalents at beginning of year



 2,883 



 2,219 

Cash and cash equivalents at end of period


$

 2,928 


$

 2,332 










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


3M Company and Subsidiaries

Notes to Consolidated Financial Statements

(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 2012 Annual Report on Form 10-K. However, as described in Note 12, effective in the first quarter of 2013, the Company completed a realignment of its business segments to better serve global markets and customers. In addition, during the first quarter of 2013, 3M realigned its geographic area reporting to include Puerto Rico in the United States rather than in the Latin America/Canada region. The Company has begun to report comparative results under the new business segment and geographic area structure with the filing of this Quarterly Report on Form 10-Q. In the second quarter of 2013, the Company plans to revise its business segment and geographic area disclosures in its 2012 Annual Report on Form 10-K via a Current Report on Form 8-K to reflect these realignments.

 

Foreign Currency Translation

 

Local currencies generally are considered the functional currencies outside the United States. Assets and liabilities for operations in local-currency environments are translated at month-end exchange rates of the period reported. Income and expense items are translated at month-end exchange rates of the period reported. Cumulative translation adjustments are recorded as a component of accumulated other comprehensive income (loss) in shareholders' equity.

 

Although local currencies are typically considered as the functional currencies outside the United States, under Accounting Standards Codification (ASC) 830, Foreign Currency Matters, the reporting currency of a foreign entity's parent is assumed to be that entity's functional currency when the economic environment of a foreign entity is highly inflationary-generally when its cumulative inflation is approximately 100 percent or more for the three years that precede the beginning of a reporting period. 3M has a subsidiary in Venezuela with operating income representing less than 1.0 percent of 3M's consolidated operating income for 2012. 3M has determined that the cumulative inflation rate of Venezuela has exceeded, and continues to exceed, 100 percent since November 2009. Accordingly, since January 1, 2010, the financial statements of the Venezuelan subsidiary have been remeasured as if its functional currency were that of its parent.

 

Regulations in Venezuela require the purchase and sale of foreign currency to be made at official rates of exchange that are fixed from time to time by the Venezuelan government. Certain laws in the country had, however, provided an exemption for the purchase and sale of certain securities that resulted in an indirect "parallel" market through which companies obtained foreign currency without having to purchase it from Venezuela's Commission for the Administration of Foreign Exchange (CADIVI). However, in 2010, the Venezuelan government took control of the previously freely-traded parallel market and created a government-controlled rate under the Transaction System for Foreign Currency Denominated Securities (SITME). In February 2013, the Venezuelan government announced a devaluation of its currency, the elimination of the SITME market, and the creation of the Superior Body for the Optimization of the Exchange System to oversee its foreign currency exchange policies. As a result, the new official exchange rate changed to a rate less favorable than the previous SITME rate. Since January 1, 2010, as discussed above, the financial statements of 3M's Venezuelan subsidiary have been remeasured as if its functional currency were that of its parent. This remeasurement utilized the parallel rate through May 2010, the SITME rate through January 2013, and the new official rate discussed above thereafter.

 

The Company continues to monitor circumstances relative to its Venezuelan subsidiary. Other factors notwithstanding, the elimination of the SITME rate and use of the new official exchange rate beginning in February 2013 did not have a material impact on 3M's consolidated results of operations or financial condition.

 

 

 

 

 

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 (4.1 million average options for the three months ended March 31, 2013 and 19.2 million average options for the three months ended March 31, 2012). 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)


2013 


2012 

Numerator:






Net income attributable to 3M


$

 1,129 


$

 1,125 










Denominator:








Denominator for weighted average 3M common shares outstanding - basic



 691.1 



 696.8 











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



 11.0 



 9.3 











Denominator for weighted average 3M common shares outstanding - diluted



 702.1 



 706.1 










Earnings per share attributable to 3M common shareholders - basic


$

 1.63 


$

 1.61 

Earnings per share attributable to 3M common shareholders - diluted


$

 1.61 


$

 1.59 










 

New Accounting Pronouncements

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures About Offsetting Assets and Liabilities, and in January 2013 issued ASU No. 2013-01, Clarifying the Scope of Disclosures About Offsetting Assets and Liabilities. These standards created new disclosure requirements regarding the nature of an entity's rights of setoff and related arrangements associated with its derivative instruments, repurchase agreements, and securities lending transactions. Certain disclosures of the amounts of certain instruments subject to enforceable master netting arrangements are required, irrespective of whether the entity has elected to offset those instruments in the statement of financial position. For 3M, these ASUs were effective January 1, 2013 with retrospective application required. The additional disclosures required by these ASUs are included in Note 8. Since these standards impact disclosure requirements only, their adoption did not have a material impact on 3M's consolidated results of operations or financial condition.

 

In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. Under this standard, entities testing long-lived intangible assets for impairment now have an option of performing a qualitative assessment to determine whether further impairment testing is necessary. If an entity determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more-likely-than-not less than the carrying amount, the existing quantitative impairment test is required. Otherwise, no further impairment testing is required. For 3M, this ASU was effective beginning January 1, 2013. The adoption of this standard did not have a material impact on 3M's consolidated results of operations or financial condition

 

In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under this standard, entities are required to disclose additional information with respect to changes in accumulated other comprehensive income (AOCI) balances by component and significant items reclassified out of AOCI. Expanded disclosures for presentation of changes in AOCI involve disaggregating the total change of each component of other comprehensive income (for example, unrealized gains or losses on available for sale marketable securities) as well as presenting separately for each such component the portion of change in AOCI related to (1) amounts reclassified into income and (2) current-period other comprehensive income. Additionally, for amounts reclassified into income, disclosure in one location is required, based upon each specific AOCI component, of the amounts impacting individual income statement line items. Disclosure of the income statement line item impacts is required only for components of AOCI reclassified into income in their entirety. Therefore, disclosure of the income statement line items affected by AOCI components such as net periodic benefit costs is not included. The disclosures required with respect to income statement line item impacts are to be made in either the notes to the consolidated financial statements or parenthetically on the face of the financial statements. For 3M, this ASU was effective beginning January 1, 2013. The additional disclosures required by this ASU are included in Note 4. Because this standard only impacts presentation and disclosure requirements, its adoption did not have a material impact on 3M's consolidated results of operations or financial condition.

 

In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters. This standard provides additional guidance with respect to the reclassification into income of the cumulative translation adjustment (CTA) recorded in accumulated other comprehensive income associated with a foreign entity of a parent company. The ASU differentiates between transactions occurring within a foreign entity and transactions/events affecting an investment in a foreign entity. For transactions within a foreign entity, the full CTA associated with the foreign entity would be reclassified into income only when the sale of a subsidiary or group of net assets within the foreign entity represents the substantially complete liquidation of that foreign entity. For transactions/events affecting an investment in a foreign entity (for example, control or ownership of shares in a foreign entity), the full CTA associated with the foreign entity would be reclassified into income only if the parent no longer has a controlling interest in that foreign entity as a result of the transaction/event. In addition, acquisitions of a foreign entity completed in stages will trigger release of the CTA associated with an equity method investment in that entity at the point a controlling interest in the foreign entity is obtained. For 3M, this ASU is effective prospectively beginning January 1, 2014, with early adoption permitted. This ASU would impact 3M's consolidated results of operations and financial condition only in the instance of an event/transaction as described above.


 

NOTE 2.  Acquisitions

 

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. 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 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.

 

There were no business combinations that closed during the three months ended March 31, 2013. Adjustments in the first quarter of 2013 to the preliminary purchase price allocations of other acquisitions within the allocation period were not material and primarily related to the 2012 acquisition of Ceradyne, Inc. The allocations of purchase price related to the acquisitions of the business purchased from Federal Signal Corp. in September 2012 and Ceradyne, Inc. in November 2012 are considered preliminary, largely with respect to certain acquired property, plant and equipment; intangible assets; and tax-related assets and liabilities. Refer to Note 2 in 3M's 2012 Annual Report on Form 10-K for more information on 3M's 2012 acquisitions.


NOTE 3.  Goodwill and Intangible Assets

 

There were no acquisitions that closed during the first three monthsof 2013. The acquisition activity in the following table includes the net impacts of adjustments to the preliminary allocation of purchase price for prior year acquisitions, which decreased goodwill by $6 million. The amounts in the "Translation and other" column in the following table primarily relate to changes in foreign currency exchange rates. The goodwill balances by business segment as of December 31, 2012 and March 31, 2013, follow:

 

Goodwill

 



December 31, 2012


Acquisition


Translation


March 31, 2013

(Millions)

Balance

activity

and other

Balance

Industrial


$

 2,174 


$

 (6)


$

 (47)


$

 2,121 

Safety and Graphics



 1,751 



             ―



 (29)



 1,722 

Electronics and Energy



 1,622 



             ―



 (22)



 1,600 

Health Care



 1,598 



             ―



 (26)



 1,572 

Consumer



 240 



             ―



 (8)



 232 

Total Company


$

 7,385 


$

 (6)


$

 (132)


$

 7,247 

 

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 12, effective in the first quarter of 2013, 3M completed a realignment of its business segments. Concurrent with this business segment realignment, certain products were also moved between 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 on goodwill of the associated reporting units. During the first quarter of 2013, 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

 

3M did not complete any business combinations during the three months ended March 31, 2013. As a result, balances of acquired intangible assets were primarily 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, 2013, and December 31, 2012, follow:

 




March 31,


December 31,

(Millions)

2013 

2012 

Patents


$

 591 


$

 596 

Other amortizable intangible assets (primarily tradenames and customer related








intangibles)



 2,423 



 2,456 

Total gross carrying amount


$

 3,014 


$

 3,052 









Accumulated amortization - patents



 (425)



 (421)

Accumulated amortization - other



 (874)



 (833)

Total accumulated amortization


$

 (1,299)


$

 (1,254)










Total finite-lived intangible assets - net


$

 1,715 


$

 1,798 









Non-amortizable intangible assets (tradenames)



 125 



 127 


Total intangible assets - net


$

 1,840 


$

 1,925 



 

Amortization expense for acquired intangible assets for the three months ended March 31, 2013 and 2012 follows:










Three months ended



March 31,

(Millions)


2013 


2012 

Amortization expense


$

 60 


$

 58 

 

The table below shows expected amortization expense for acquired amortizable intangible assets recorded as of March 31, 2013:

(Millions)


Remainder


















of












  After

2013 

2014 

2015 

2016 

2017 

2018 

2018 

Amortization expense


$

 178 


$

 211 


$

 197 


$

 184 


$

 168 


$

 152 


$

 625 

 

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.


NOTE 4.  Supplemental Equity and Comprehensive Income Information

Consolidated Statement of Changes in Equity

 

Three months ended March 31, 2013




3M Company Shareholders



(Millions)


Total


Common Stock and Additional Paid-in Capital


Retained Earnings


Treasury Stock


Accumulated Other Comprehen-sive Income (Loss)


Non-controlling Interest

Balance at December 31, 2012


$

 18,040 


$

 4,053 


$

 30,679 


$

 (12,407)


$

 (4,750)


$

 465 





















Net income



 1,147 






 1,129 









 18 

Other comprehensive income (loss), net of tax:



















Cumulative translation adjustment



 (398)












 (360)



 (38)

Defined benefit pension and post-retirement




















plans adjustment



 85 












 85 



         ―

Debt and equity securities - unrealized gain (loss)



          ―












               ―



         ―

Cash flow hedging instruments - unrealized




















gain (loss)



 24 












 24 



         ―

Total other comprehensive income (loss), net




















of tax



 (289)
















Dividends paid



 (440)






 (440)










Sale of subsidiary shares



 8 



 7 












 1 

Stock-based compensation, net of tax impacts



 128 



 128 













Reacquired stock



 (807)









 (807)







Issuances pursuant to stock option and




















benefit plans



 741 






 (295)



 1,036 







Balance at March 31, 2013


$

 18,528 


$

 4,188 


$

 31,073 


$

 (12,178)


$

 (5,001)


$

 446 

 

Three months ended March 31, 2012




3M Company Shareholders



(Millions)


Total


Common Stock and Additional Paid-in Capital


Retained Earnings


Treasury Stock


Accumulated Other Comprehen-sive Income (Loss)


Non-controlling Interest

Balance at December 31, 2011


$

 15,862 


$

 3,776 


$

 28,348 


$

 (11,679)


$

 (5,025)


$

 442 





















Net income



 1,141 






 1,125 









 16 

Other comprehensive income (loss), net of tax:



















Cumulative translation adjustment



 134 












 155 



 (21)

Defined benefit pension and post-retirement




















plans adjustment



 97 












 97 



        ―

Debt and equity securities - unrealized gain (loss)



 3 












 3 



        ―

Cash flow hedging instruments - unrealized




















gain (loss)



 (15)












 (15)



        ―

Total other comprehensive income (loss), net




















of tax



 219 
















Dividends paid



 (410)






 (410)










Stock-based compensation, net of tax impacts



 127 



 127 













Reacquired stock



 (534)









 (534)







Issuances pursuant to stock option and




















benefit plans



 214 






 (205)



 419 







Balance at March 31, 2012


$

 16,619 


$

 3,903 


$

 28,858 


$

 (11,794)


$

 (4,785)


$

 437 



 

Changes in Accumulated Other Comprehensive Income (Loss) Attributable to 3M by Component























Three months ended March 31, 2013
















(Millions)


Cumulative Translation Adjustment


Defined Benefit Pension and Postretirement Plans Adjustment


Debt and Equity Securities, Unrealized Gain (Loss)


Cash Flow Hedging Instruments, Unrealized Gain (Loss)


Total Accumulated Other Comprehen-sive Income (Loss)

Balance at December 31, 2012, net of tax


$

 230 


$

 (4,955)


$

 (2)


$

 (23)


$

 (4,750)

Other comprehensive income (loss),

















before tax:

















Amounts before reclassifications



 (324)



           ―



             ―



 (70)



 (394)


Amounts reclassified out



             ―



 143 



             ―



 108 



 251 

Total other comprehensive income (loss),

















before tax



 (324)



 143 



             ―



 38 



 (143)

Tax effect



 (36)



 (58)



             ―



 (14)



 (108)

Total other comprehensive income (loss),

















net of tax



 (360)



 85 



             ―



 24 



 (251)

Balance at March 31, 2013, net of tax


$

 (130)


$

 (4,870)


$

 (2)


$

 1 


$

 (5,001)


















Three months ended March 31, 2012
















(Millions)


Cumulative Translation Adjustment


Defined Benefit Pension and Postretirement Plans Adjustment


Debt and Equity Securities, Unrealized Gain (Loss)


Cash Flow Hedging Instruments, Unrealized Gain (Loss)


Total Accumulated Other Comprehen-sive Income (Loss)

Balance at December 31, 2011, net of tax


$

 114 


$

 (5,155)


$

 (6)


$

 22 


$

 (5,025)

Other comprehensive income (loss),

















before tax:

















Amounts before reclassifications



 155 



            ―



 4 



 (28)



 131 


Amounts reclassified out



            ―



 153 



 1 



 4 



 158 

Total other comprehensive income (loss),

















before tax



 155 



 153 



 5 



 (24)



 289 

Tax effect



            ―



 (56)



 (2)



 9 



 (49)

Total other comprehensive income (loss),

















net of tax



 155 



 97 



 3 



 (15)



 240 

Balance at March 31, 2012, net of tax


$

 269 


$

 (5,058)


$

 (3)


$

 7 


$

 (4,785)

 

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. Reclassification adjustments are made to avoid double counting in comprehensive income items that are also recorded as part of net income.



 

Reclassifications out of Accumulated Other Comprehensive Income Attributable to 3M














Amount Reclassified from



(Millions)



Accumulated Other Comprehensive Income


Location on Income Statement

Details about Accumulated Other Comprehensive Income Components


Three months ended   March 31, 2013


Three months ended   March 31, 2012


Gains (losses) associated with, defined benefit pension and postretirement plans amortization










Transition asset


$

 1 


$

 1 


See Note 7


Prior service benefit



 20 



 20 


See Note 7


Net actuarial loss



 (164)



 (174)


See Note 7

Total before tax



 (143)



 (153)



Tax effect



 58 



 56 


Provision for income taxes

Net of tax


$

 (85)


$

 (97)













Debt and equity security gains (losses)










Sales or impairments                                of securities


$

                            ―


$

 (1)


Selling, general and administrative expenses

Total before tax



                            ―



 (1)



Tax effect



                            ―



                             ―


Provision for income taxes

Net of tax


$

                            ―


$

 (1)













Cash flow hedging instruments gains (losses)










Foreign currency forward/option contracts


$

 (6)


$

                             ―


Cost of sales


Foreign currency forward contracts



 (101)



                             ―


Interest expense


Commodity price swap contracts



 (1)



 (4)


Cost of sales

Total before tax



 (108)



 (4)



Tax effect



 39 



 1 


Provision for income taxes

Net of tax


$

 (69)


$

 (3)



Total reclassifications for the period,               net of tax


$

 (154)


$

 (101)



 

Sale of Subsidiary Shares

 

In March 2013, 3M sold shares in 3M India Limited, a subsidiary of the Company, in return for $8 million. The noncontrolling interest shares of this subsidiary trade on a public exchange in India. This sale of shares complied with an amendment to Indian securities regulations that required 3M India Limited, as a listed company, to achieve a minimum public shareholding of at least 25 percent. As a result of this transaction, 3M's ownership in 3M India Limited was reduced from 76 percent to 75 percent. The $8 million received in the first quarter of 2013 was classified as other financing activity in the consolidated statement of cash flows. Because the Company retained its controlling interest, the sale resulted in an increase in 3M Company shareholders' equity of $7 million and an increase in noncontrolling interest of $1 million.


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 2004.

 

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. During the first quarter of 2012, the IRS completed its field examination of the Company's U.S. federal income tax return for the 2010 year. The Company protested certain IRS positions for 2010 and entered into the administrative appeals process with the IRS during the second quarter of 2012. In December 2012, the Company received a statutory notice of deficiency for the 2006 year. The Company filed a petition in Tax Court in the first quarter of 2013 relating to the 2006 tax year.

 

Currently, the Company is under examination by the IRS for its U.S. federal income tax returns for the years 2011, 2012, and 2013. It is anticipated that the IRS will complete its examination of the Company for 2011 by the end of the third quarter of 2013, for 2012 by the end of the first quarter of 2014, and for 2013 by the end of the first quarter of 2015. As of March 31, 2013, the IRS has not proposed any significant adjustments to any of the Company's tax positions for which the Company is not adequately reserved.

 

During the second quarter of 2011, the Company received a refund from the IRS for the 2004 tax year. During the first quarter of 2012, the Company paid the agreed upon assessments for the 2010 tax year. Payments relating to other proposed assessments arising from the 2005 through 2013 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 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, 2013 and December 31, 2012, respectively, are $198 million and $185 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 $4 million of expense and $3 million of benefit for the three months ended March 31, 2013 and March 31, 2012, respectively. At March 31, 2013 and December 31, 2012, accrued interest and penalties in the consolidated balance sheet on a gross basis were $46 million and $44 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 2013 was 29.1 percent, compared to 28.8 percent in the first quarter of 2012, an increase of 0.3 percentage points. This included an increase in the effective tax rate of 3.6 percentage points year-on-year, which largely related to adjustments to 3M's income tax reserves in the first quarter of 2012. This increase was partially offset by factors which decreased the Company's effective tax rate by 3.3 percentage points year-on-year, which included the combination of the reinstatement of the U.S. research and development credit in 2013, and international taxes. The international tax benefit was largely due to the estimated current year geographic mix of income before taxes.

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 March 31, 2013 and December 31, 2012, the Company had valuation allowances of $28 million and $29 million on its deferred tax assets, respectively.


 

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).

 




March 31,


December 31,

(Millions)


2013 


2012 







U.S. government agency securities


$

 336 


$

 162 

Foreign government agency securities



 21 



 16 

Corporate debt securities



 301 



 471 

Commercial paper



 95 



 116 

Certificates of deposit/time deposits



 42 



 41 

U.S. treasury securities



 54 



 54 

U.S. municipal securities



 15 



 13 

Asset-backed securities:








Automobile loan related



 479 



 567 


Credit card related



 61 



 123 


Equipment lease related



 43 



 54 


Other



 1 



 31 

Asset-backed securities total



 584 



 775 









Current marketable securities


$

 1,448 


$

 1,648 









U.S. government agency securities


$

 196 


$

 125 

Foreign government agency securities



 71 



 51 

Corporate debt securities



 475 



 494 

Certificates of deposit/time deposits



 20 



                   ―

U.S. treasury securities



 2 



 18 

U.S. municipal securities



 13 



 14 

Auction rate securities



 7 



 7 

Asset-backed securities:








Automobile loan related



 506 



 375 


Credit card related



 82 



 34 


Equipment lease related



 54 



 36 


Other



 26 



 8 

Asset-backed securities total



 668 



 453 









Non-current marketable securities


$

 1,452 


$

 1,162 









Total marketable securities


$

 2,900 


$

 2,810 

 

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, 2013, gross unrealized losses totaled approximately $6 million (pre-tax), while gross unrealized gains totaled approximately $2 million (pre-tax). At December 31, 2012, gross unrealized losses totaled approximately $6 million (pre-tax), while gross unrealized gains totaled approximately $3 million (pre-tax). Refer to Note 4 for a table that provides the net realized gains (losses) related to sales or impairments of debt and equity securities, which includes marketable securities. The gross amounts of the realized gains or losses 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, 2013 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.

 

(Millions)


March 31, 2013




Due in one year or less


$

 704 

Due after one year through three years



 1,526 

Due after three years through five years



 651 

Due after five years



 19 





Total marketable securities


$

 2,900 

 

3M has a diversified marketable securities portfolio of $2.900 billion as of March 31, 2013. Within this portfolio, current and long-term asset-backed securities (estimated fair value of $1.252 billion) primarily include interests in automobile loans and credit cards. At March 31, 2013, one asset-backed security with a fair market value of approximately $4 million was rated Aa2 by Moody's and AA by Fitch. All remaining asset-backed securities were rated AAA or A-1+ by Standard & Poor's and/or Aaa or P-1 by Moody's and/or AAA or F1+ by Fitch.

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 was $7 million at both March 31, 2013 and December 31, 2012. Gross unrealized losses within accumulated other comprehensive income related to auction rate securities totaled $6 million (pre-tax) at both March 31, 2013 and December 31, 2012. As of March 31, 2013, 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 9 for a table that reconciles the beginning and ending balances of auction rate securities.


NOTE 7.  Pension and Postretirement Benefit Plans

 

Net periodic benefit cost is recorded in cost of sales, selling, general and administrative expenses, and research, development and related expenses. Components of net periodic benefit cost and other supplemental information for the three months ended March 31, 2013 and 2012 follow:

 

Benefit Plan Information

 




Three months ended March 31,




Qualified and Non-qualified








Pension Benefits

Postretirement




United States


International


Benefits

(Millions)


2013 


2012 


2013 


2012 


2013 


2012 

Net periodic benefit cost (benefit)













Service cost


$

 64 


$

 63 


$

 36 


$

 31 


$

 20 


$

 19 

Interest cost



 150 



 147 



 61 



 61 



 22 



 22 

Expected return on plan assets



 (261)



 (248)



 (75)



 (73)



 (22)



 (21)

Amortization of transition (asset) obligation



    ―



     ―



 (1)



 (1)



     ―



     ―

Amortization of prior service cost (benefit)



 1 



 2 



 (4)



 (4)



 (17)



 (18)

Amortization of net actuarial (gain) loss



 100 



 117 



 40 



 30 



 24 



 27 

Net periodic benefit cost (benefit)


$

 54 


$

 81 


$

 57 


$

 44 


$

 27 


$

 29 

Settlements, curtailments, special termination benefits and other



    ―



 26 



    ―



    ―



    ―



    ―

Net periodic benefit cost (benefit) after settlements, curtailments,




















special termination benefits and other


$

 54 


$

 107 


$

 57 


$

 44 


$

 27 


$

 29 

 

For the three months ended March 31, 2013, contributions totaling $67 million were made to the Company's U.S. and international pension plans and $1 million to its postretirement plans. For total year 2013, the Company expects to contribute approximately $400 million to $600 million of cash to its U.S. and international pension and postretirement plans. The Company does not have a required minimum cash pension contribution obligation for its U.S. plans in 2013. Therefore, the amount of future discretionary pension contributions could vary significantly depending on the U.S. plans' funded status and the anticipated tax deductibility of the contributions. 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.

In December 2011, the Company began offering a voluntary early retirement incentive program to certain eligible participants of its U.S. pension plans who met age and years of pension service requirements. The eligible participants who accepted the offer and retired on February 1, 2012 received an enhanced pension benefit. Pension benefits were enhanced by adding one additional year of pension service and one additional year of age for certain benefit calculations. 616 participants accepted the offer and retired on February 1, 2012. As a result, the Company incurred a $26 million charge related to these special termination benefits in the first quarter of 2012.

 

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 (and in April 2013, the United States Court of Appeals for the Second Circuit affirmed the district court's ruling). 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 2012 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.


NOTE 8.  Derivatives

 

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 9. References to information regarding derivatives and/or hedging instruments associated with the Company's long-term debt are also made in Note 9 to the Consolidated Financial Statements in 3M's 2012 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 months ended March 31, 2013 and 2012. 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, 2013, 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, 2013 was approximately $5.9 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 months ended March 31, 2013 and 2012. The dollar equivalent gross notional amount of the Company's natural gas commodity price swaps designated as cash flow hedges at March 31, 2013 was $14 million.

 

Cash Flow Hedging - Forecasted Debt Issuance: In August 2011, in anticipation of the September 2011 issuance of $1 billion in five-year fixed rate notes, 3M executed a pre-issuance cash flow hedge on a notional amount of $400 million by entering into a forward-starting five-year floating-to-fixed interest rate swap. Upon debt issuance in September 2011, 3M terminated the floating-to-fixed interest rate swap. The termination of the swap resulted in a $7 million pre-tax loss ($4 million after-tax) that is amortized over the five-year life of the note and, when material, is included in the tables below as part of the loss recognized in income on the effective portion of derivatives as a result of reclassification from accumulated other comprehensive income.

 

As of March 31, 2013, the Company had a balance of $1 million associated with the after-tax net unrealized gain associated with cash flow hedging instruments recorded in accumulated other comprehensive income. This net gain includes a $3 million balance(loss) related to a floating-to-fixed interest rate swap (discussed in the preceding paragraph), which is being amortized over the five-year life of the note. 3M expects to reclassify a majority of the remaining balance to earnings over the next 12 months (with the impact offset by cash flows from underlying hedged items).

 

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, 2013







(Millions)

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

Derivatives in Cash Flow Hedging Relationships


Amount


Location


Amount


Location


Amount

Foreign currency forward/option contracts


$

 31 


Cost of sales


$

 (6)


Cost of sales


$

Foreign currency forward contracts



 (103)


Interest expense



 (101)


Interest expense



Commodity price swap contracts



 2 


Cost of sales



 (1)


Cost of sales



  Total


$

 (70)




$

 (108)




$















Three months ended March 31, 2012







(Millions)


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

Derivatives in Cash Flow Hedging Relationships


Amount


Location


Amount


Location


Amount

Foreign currency forward/option contracts


$

 (24)


Cost of sales


$

        ―


Cost of sales


$

Foreign currency forward contracts



 1 


Interest expense



        ―


Interest expense



Commodity price swap contracts



 (5)


Cost of sales



 (4)


Cost of sales



  Total


$

 (28)




$

 (4)




$

 

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, 2013 was $342 million.

 

At March 31, 2013, 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, is amortized over this debt's remaining life. Prior to termination of the applicable portion of the interest rate swap, the mark-to-market of the hedge instrument was recorded as gains or losses in interest expense and was offset by the gain or loss on carrying value of the underlying debt instrument. Consequently, the subsequent amortization of the 18 million Euros recorded as part of the underlying debt balance is not part of gain on hedged items recognized in income in the tables below.

 



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, 2013


Gain (Loss) on Derivative


Gain (Loss) on Hedged Item

(Millions)

Recognized in Income

Recognized in Income

Derivatives in Fair Value Hedging Relationships


Location


Amount


Location


Amount

Interest rate swap contracts


Interest expense


$

 (5)


Interest expense


$

 5 

  Total




$

 (5)




$

 5 












Three months ended March 31, 2012


Gain (Loss) on Derivative


Gain (Loss) on Hedged Item

(Millions)

Recognized in Income

Recognized in Income

Derivatives in Fair Value Hedging Relationships


Location


Amount


Location


Amount

Interest rate swap contracts


Interest expense


$

 (1)


Interest expense


$

 1 

  Total




$

 (1)




$

 1 

 

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, 2013, 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, 2013









(Millions)


Amount


Location


Amount

Foreign currency denominated debt


$

 (41)


N/A


$

  Total


$

 (41)




$










Three months ended March 31, 2012





(Millions)


Amount


Location


Amount

Foreign currency denominated debt


$

 (40)


N/A


$

  Total


$

 (40)




$



 

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 $1.1 billion as of March 31, 2013. 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 March 31, 2013

Derivatives Not Designated as Hedging Instruments

Gain (Loss) on Derivative Recognized in Income

(Millions)


Location


Amount

Foreign currency forward/option contracts


Cost of sales


$

 10 

Foreign currency forward contracts


Interest expense



 21 

  Total




$

 31 









Three months ended March 31, 2012

Derivatives Not Designated as Hedging Instruments

Gain (Loss) on Derivative Recognized in Income

(Millions)


Location


Amount

Foreign currency forward/option contracts


Cost of sales


$

 (15)

Foreign currency forward contracts


Interest expense



 27 

Commodity price swap contracts


Cost of sales



 1 

  Total




$

 13 



 

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. Additional information with respect to the fair value of derivative instruments is included in Note 9.

 

March 31, 2013











(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


$

 58 


Other current liabilities


$

 61 

Commodity price swap contracts


Other current assets



 2 


Other current liabilities



     ―

Interest rate swap contracts


Other assets



 18 


Other liabilities



     ―

  Total derivatives designated as












hedging instruments




$

 78 




$

 61 













Derivatives not designated as hedging instruments









Foreign currency forward/option contracts


Other current assets


$

 15 


Other current liabilities


$

 25 

  Total derivatives not designated as












hedging instruments




$

 15 




$

 25 













Total derivative instruments




$

 93 




$

 86 













December 31, 2012











(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


$

 39 


Other current liabilities


$

 85 

Commodity price swap contracts


Other current assets



     ―


Other current liabilities



 1 

Interest rate swap contracts


Other assets



 23 


Other liabilities



      ―

  Total derivatives designated as












hedging instruments




$

 62 




$

 86 













Derivatives not designated as hedging instruments









Foreign currency forward/option contracts


Other current assets


$

 10 


Other current liabilities


$

 20 

  Total derivatives not designated as












hedging instruments




$

 10 




$

 20 













Total derivative instruments




$

 72 




$

 106 



 

Credit Risk and Offsetting of Assets and Liabilities of Derivative Instruments

 

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. 3M enters into master netting arrangements with counterparties when possible to mitigate credit risk in derivative transactions. A master netting arrangement may allow each counterparty to net settle amounts owed between a 3M entity and the counterparty as a result of multiple, separate derivative transactions. As of March 31, 2013, 3M has International Swaps and Derivatives Association (ISDA) agreements with eight applicable banks and financial institutions which contain netting provisions. In addition to a master agreement with 3M supported by a primary counterparty's parent guarantee, 3M also has associated credit support agreements in place with six of its primary derivative counterparties which, among other things, provide the circumstances under which either party is required to post eligible collateral (when the market value of transactions covered by these agreements exceeds specified thresholds or if a counterparty's credit rating has been downgraded to a predetermined rating). The Company does not anticipate nonperformance by any of these counterparties.

 

3M has elected to present the fair value of derivative assets and liabilities within the Company's consolidated balance sheet on a gross basis even when derivative transactions are subject to master netting arrangements and may otherwise qualify for net presentation. However, the following tables provide information as if the Company had elected to offset the asset and liability balances of derivative instruments, netted in accordance with various criteria in the event of default or termination as stipulated by the terms of netting arrangements with each of the counterparties. For each counterparty, if netted, the Company would offset the asset and liability balances of all derivatives at the end of the reporting period based on the 3M entity that is a party to the transactions. Derivatives not subject to master netting agreements are not eligible for net presentation. As of the applicable dates presented below, no cash collateral had been received or pledged related to these derivative instruments.

 

Offsetting of Financial Assets/Liabilities under Master Netting Agreements with Derivative Counterparties

March 31, 2013



















Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements




(Millions)



Gross Amount of Derivative Assets Presented in the Consolidated Balance Sheet



Gross Amount of Eligible Offsetting Recognized Derivative Liabilities



Cash Collateral Received



Net Amount of Derivative Assets

Derivatives subject to master netting agreements


$

 91 


$

 26 


$

 ―   


$

 65 

Derivatives not subject to master netting agreements



 2 









 2 

Total


$

 93 








$

 67 

 

March 31, 2013



















Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements




(Millions)



Gross Amount of Derivative Liabilities Presented in the Consolidated Balance Sheet



Gross Amount of Eligible Offsetting Recognized Derivative Assets



Cash Collateral Pledged



Net Amount of Derivative Liabilities

Derivatives subject to master netting agreements


$

 80 


$

 26 


$

 ―   


$

 54 

Derivatives not subject to master netting agreements



 6 









 6 

Total


$

 86 








$

 60 



 

December 31, 2012



















Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements




(Millions)



Gross Amount of Derivative Assets Presented in the Consolidated Balance Sheet



Gross Amount of Eligible Offsetting Recognized Derivative Liabilities



Cash Collateral Received



Net Amount of Derivative Assets

Derivatives subject to master netting agreements


$

 67 


$

 25 


$

 ―   


$

 42 

Derivatives not subject to master netting agreements



 5 









 5 

Total


$

 72 








$

 47 

 

December 31, 2012



















Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements




(Millions)



Gross Amount of Derivative Liabilities Presented in the Consolidated Balance Sheet



Gross Amount of Eligible Offsetting Recognized Derivative Assets



Cash Collateral Pledged



Net Amount of Derivative Liabilities

Derivatives subject to master netting agreements


$

 106 


$

 25 


$

 ―   


$

 81 

Derivatives not subject to master netting agreements



                     ―









 ―   

Total


$

 106 








$

 81 

 

Currency Effects

 

3M estimates that year-on-year currency effects, including hedging impacts, decreased net income attributable to 3M by approximately $6 million for the three months ended March 31, 2013. 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 risksand the negative impact of swapping Venezuelan bolivars into U.S. dollars, which 3M estimates increased net income attributable to 3M by approximately $13 million for three months ended March 31, 2013.


NOTE 9.  Fair Value Measurements

 

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, 2013 and 2012.

 

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 Measurements

(Millions)

Fair Value at

Using Inputs Considered as

Description


March 31, 2013


Level 1


Level 2


Level 3

Assets:









Available-for-sale:










Marketable securities:











U.S. government agency securities


$

 532 


$


$

532


$



Foreign government agency securities



 92 





92





Corporate debt securities



 776 





776





Certificates of deposit/time deposits



 62 





62





Commercial paper



 95 





95





Asset-backed securities:
















Automobile loan related



 985 





985






Credit card related



 143 





143






Equipment lease related



 97 





97






Other



 27 





27





U.S. treasury securities



 56 



56







U.S. municipal securities



 28 





28





Auction rate securities



 7 







7


Investments



 3 



3





Derivative instruments - assets:














Foreign currency forward/option contracts



 73 



73






Commodity price swap contracts



 2 



2






Interest rate swap contracts



 18 





18



















Liabilities:













Derivative instruments - liabilities:














Foreign currency forward/option contracts



 86 



86







 






Fair Value at


Fair Value Measurements

(Millions)

December 31, 2012

Using Inputs Considered as

Description



Level 1


Level 2


Level 3

Assets:









Available-for-sale:










Marketable securities:











U.S. government agency securities


$

 287 


$


$

287


$



Foreign government agency securities



 67 





67





Corporate debt securities



 965 





965





Certificates of deposit/time deposits



 41 





41





Commercial paper



 116 





116





Asset-backed securities:
















Automobile loan related



 942 





942






Credit card related



 157 





157






Equipment lease related



 90 





90






Other



 39 





39





U.S. treasury securities



 72 



72







U.S. municipal securities



 27 





27





Auction rate securities



 7 







7


Investments



 3 



3





Derivative instruments - assets:














Foreign currency forward/option contracts



 49 



49






Interest rate swap contracts



 23 





23



















Liabilities:













Derivative instruments - liabilities:














Foreign currency forward/option contracts



 105 



104



1




Commodity price swap contracts



 1 



1





 

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

(Millions)

March 31,

Marketable securities - auction rate securities only


2013 


2012 

Beginning balance


$

7


$

4

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



5









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 10 in 3M's 2012 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, 2013 and 2012.

 

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. For its long-term debt the Company utilized third-party quotes to estimate fair values (classified as level 2). Information with respect to the carrying amounts and estimated fair values of these financial instruments follow:

 



March 31, 2013



December 31, 2012



Carrying


Fair


Carrying


Fair

(Millions)

Value

Value

Value


Value

Long-term debt, excluding current portion


$

 4,864 


$

 5,282 


$

 4,916 


$

 5,363 

 

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, 2013 and December 31, 2012 due to the low interest rates and tightening of 3M's credit spreads.


NOTE 10.  Commitments and Contingencies

 

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 13 "Commitments and Contingencies" in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, 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 - described below), 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 accruals and the related insurance receivables:

 

Liability and Receivable Balances







(Millions)



March 31, 2013



December 31, 2012






Respirator mask/asbestos liabilities


$

 160 


$

 154 

Respirator mask/asbestos insurance receivables



 80 



 87 








Environmental remediation liabilities


$

 31 


$

 29 

Environmental remediation insurance receivables



 11 



 11 








Other environmental liabilities


$

 55 


$

 57 

Other environmental insurance receivables



 15 



 15 

 

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, 2013, the Company is a named defendant, with multiple co-defendants, in numerous lawsuits in various courts that purport to represent approximately 2,095 individual claimants compared to approximately 2,060 individual claimants, with actions pending at December 31, 2012.

 

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 the lawsuits and claims resolved by and currently pending against the Company 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, 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. The plaintiffs appealed, but in February 2012 the California Court of Appeals granted the plaintiff's voluntary dismissal of the appeal.

 

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 court held a case management conference in March 2011, but no further activity has occurred in the case since that conference. 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 greater cost of resolving claims of persons with more serious injuries, including mesothelioma and other malignancies, the Company increased its accruals in the first quarter of 2013 for respirator mask/asbestos liabilities by $13 million. In the first quarter of 2013, the Company made payments for fees and settlements of $7 million related to the respirator mask/asbestos litigation. As of March 31, 2013, the Company had accruals for respirator mask/asbestos liabilitiesof $132 million (excluding Aearo accruals). The Company cannot estimate the amount or range of amounts by which the liability may exceed the accrual 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, 2013, the Company's receivable for insurance recoveries related to the respirator mask/asbestos litigation was $80 million. The Company estimates insurance receivables based on an analysis of its numerous policies, including their exclusions, pertinent case law interpreting comparable policies, its experience with similar claims, and assessment of the nature of the claim and remaining coverage, and records an amount it has concluded is likely to be recovered.

 

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. 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. The plaintiffs, Continental Casualty and Continental Insurance Co., as well as 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. Trial is scheduled to begin in the summer of 2013. During the first quarter of 2013, the Company received payments of $8 million from settlements with insurers.

 

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 manufactured and sold various products, including personal protection equipment, such as eye, ear, head, face, fall and certain respiratory protection products.

 

As of March 31, 2013, 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, 2013, the Company, through its Aearo subsidiary, has recorded $28 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 a quarterly fee of $100,000, Cabot will retain responsibility and liability for, and indemnify Aearo against, any product liability claims involving exposure to asbestos, silica, or  silica products for respirators sold prior to July 11, 1995. Because of the difficulty in determining how long a particular respirator remains in the stream of commerce after being sold,  Aearo and Cabot have applied the agreement to claims arising out of the alleged use of respirators involving exposure to asbestos, silica or silica products 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 involving exposure to asbestos, silica, or silica products on or after January 1, 1997. To date, Aearo has elected to pay the quarterly 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.

 

In March 2012, Cabot CSC Corporation and Cabot Corporation filed a lawsuit against Aearo in the Superior Court of Suffolk County, Massachusetts seeking declaratory relief as to the scope of Cabot's indemnity obligations under the July 11, 1995 agreement, including whether Cabot has retained liability for coal workers' pneumoconiosis claims, and seeking damages for breach of contract. Fact discovery in the first phase of the case is scheduled to conclude in May 2013.

 

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 amount accrued.

 

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 cannot estimate the amount or range of amounts by which Aearo's liability may exceed the accrual 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 accrual.

 

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 perfluorooctanyl compounds such as perfluorooctanoate  ("PFOA") and perfluorooctane sulfonate ("PFOS"). As a result of its phase-out decision in May 2000, the Company no longer manufactures perfluorooctanyl compounds. The company ceased manufacturing and using the vast majority of these compounds within approximately two years of the phase-out announcement, and ceased all manufacturing and the last significant use of this chemistry by 2008. Through its ongoing life cycle management and its raw material composition identification processes associated with the Company's policies covering the use of all persistent and bio-accumulative materials, the Company has on occasion identified the presence of precursor chemicals in materials purchased from suppliers that may ultimately degrade to PFOA, PFOS or similar compounds. Upon such identification, the Company works to find alternatives for such chemicals.

 

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 2013. 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 published on May 2, 2012 a list of unregulated substances, including six PFCs, required to be monitored during the period 2013-2015 by public water system suppliers to determine the extent of their occurrence.

 

The Agency for Toxic Substances and Disease Registry (ATSDR) has completed a bio-monitoring study evaluating PFC blood levels in volunteers living near fields where wastewater treatment sludge was applied from the municipal wastewater treatment plant in Decatur, Alabama that received wastewater from numerous sources, including sanitary wastewater from 3M. ATSDR released the results of its exposure investigation in April 2013. The exposure study found that drinking well or public water with detectable levels of PFC's may contribute to an increase of PFC levels in blood, but did not find a link between living near a biosolids-treated field and the PFC levels in blood.

 

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 3M Decatur facility as well as at three local landfills used by the facility. The Company shared results from this final phase of sampling work with the EPA in September 2012 and will submit updated analysis of the sampling work in 2013.

 

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 the balance of 2013 and is expected to be completed in 2016.

 

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 certain PFCs 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 certain PFCs 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 (MDH) to be safe for human consumption over a lifetime) for certain PFCs for which a HBV and/or HRL exists as a result of contamination from these sites; (iii) remediating identified sources of other PFCs at these sites that are not controlled by actions to remediate PFOA and PFOS; and (iv) sharing information with the MPCA about certain 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 agreed upon 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 recommended by the Company and approved by the MPCA. Remediation work has been completed at the Oakdale site, and it is in an operational maintenance mode. Remediation will continue at the other two sites during 2013.

 

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 certain 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 certain 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 utility's 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, its subsidiary 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 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 December 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 common law claims of trespass, nuisance, and negligence with respect to the presence of PFCs 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.

 

In January 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 granted the City of Lake Elmo's motion to intervene in this lawsuit.

 

In November 2011, the Metropolitan Council filed a motion to intervene and a complaint in the State of Minnesota lawsuit seeking damages in excess of $50,000 and other legal, declaratory and equitable relief, including reasonable attorneys' fees, for costs and fees that the Metropolitan Council alleges it will be required to assess at some time in the future if the MPCA imposes restrictions on Metropolitan Council's PFOS discharges to the Mississippi River. Metropolitan Council's intervention motion was based on several theories, including common law negligence, and statutory claims under MERLA for response costs and under the Minnesota Environmental Rights Act (MERA) for declaratory and equitable relief against 3M for PFOS and other PFC pollution of the waters and sediments of the Mississippi River. 3M did not object to the motion to intervene. In January 2012, 3M answered the Metropolitan Council's complaint and filed a counterclaim alleging that the Metropolitan Council discharges PFCs to the Mississippi River and discharges PFC-containing sludge and biosolids from one or more of its wastewater treatment plants onto agricultural lands and local area landfills. Accordingly, 3M requested that if the Court finds that the State is entitled to any of the damages the State seeks, 3M seeks contribution and apportionment from the Metropolitan Council, including attorneys' fees, under MERLA, and contribution from and liability for the Metropolitan Council's proportional share of damages awarded to the State under the MWPCA, as well as under statutory nuisance and common law theories of trespass, nuisance and negligence. 3M also seeks declaratory relief under MERA. 

 

In May 2012, 3M filed a motion to disqualify the State of Minnesota's counsel, Covington & Burling, LLP (Covington). In October 2012, the court granted 3M's motion to disqualify Covington as counsel to the State and stayed the case for up to 180 days to give the State time to secure new counsel. In October 2012, the State and Covington appealed the court's disqualification to the Minnesota Court of Appeals. In April 2013, the Court of Appeals heard arguments on the appeal.

 

The State of New Jersey filed suit in 2005 against Occidental Chemical Corporation, Tierra Solutions Inc., Maxus Energy Corporation and five other companies seeking cleanup and removal costs and other damages associated with the presence of dioxin and other hazardous substances in the sediment of a 17-mile stretch of the Passaic River in New Jersey. In June 2009, the Company, along with more than 250 other companies, was served with a third-party complaint by Tierra Solutions Inc. and Maxus Energy Corporation seeking contribution towards the cost and damages asserted or incurred for investigation and remediation of discharges to the Passaic River. The third-party complaint seeks to spread those costs among the third-party defendants, including 3M. Allegations asserted against 3M relate to its use of two commercial drum conditioning facilities in New Jersey. In March 2013, 3M and other third party defendants entered into a settlement agreement with the state of New Jersey for an amount that is not material to 3M. The settlement is subject to public notice and Court approval. The proposed settlement resolves claims or potential claims by the State of New Jersey regarding discharges or alleged discharges into the Passaic River by the settling parties, and precludes certain cost recovery actions by the third-party plaintiffs. The proposed settlement with the State of New Jersey does not include release from potential federal claims, yet to be asserted. Total costs for the remedy currently proposed by EPA could easily exceed $1 billion. While the Company does not yet have a basis for estimating its potential exposure in the yet to be asserted EPA claim, the Company currently believes its allocable share of the possible loss, if any, is likely to be a fraction of one percent of the total costs because of the Company's limited potential involvement at this site.

 

For environmental litigation matters described in this section for which a liability, if any, has been recorded, the Company believes the amount recorded, as well as the possible loss or range of loss in excess of the established accrual is not material to the Company's consolidated results of operations or financial condition. For those matters for which a liability has not been recorded, the Company believes such liability is not probable and estimable and the Company is not able to estimate a possible loss or range of loss at this time, with the exception of the Passaic River litigation, where the Company's 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, 2013, the Company had recorded liabilities of $31 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 $11 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, 2013, the Company had recorded liabilities of $55 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, 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 four years. As of March 31, 2013, the Company's receivable for insurance recoveries related to "other environmental liabilities" was $15 million.

 

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 ongoing, the Company cannot estimate a possible loss or range of loss in excess of the associated established accruals for the reasons described above.

 

Other Matters

 

Commercial Litigation

 

3M completed its acquisition of Cogent, Inc. in December 2010. Several purported holders of Cogent shares, representing a total of approximately 5.8 million shares, have asserted appraisal rights under Delaware law. Trial in Delaware occurred in November 2012 and the parties are awaiting the court's decision.

 

In October 2012, four plaintiffs filed purported class actions against Ceradyne, Inc., its directors, 3M and Cyborg Acquisition Corporation (a direct wholly owned subsidiary of 3M) in connection with 3M's proposed acquisition of Ceradyne. Two suits were filed in California Superior Court for Orange County and two were filed in the Delaware Chancery Court. The suits alleged that the defendants breached and/or aided and abetted the breach of their fiduciary duties to Ceradyne by seeking to sell Ceradyne through an allegedly unfair process and for an unfair price and on unfair terms, and/or by allegedly failing to make adequate disclosures to Ceradyne stockholders regarding the acquisition of Ceradyne. 3M completed its acquisition of Ceradyne in November 2012. In November 2012, the parties reached a settlement with the California plaintiffs for an amount that is not material to the Company, while the Delaware plaintiffs dismissed their complaints without prejudice. The settlement will bind all former Ceradyne shareholders and has received preliminary approval from the California court. A final approval hearing is scheduled for July 2013.

 

Separately, one Ceradyne shareholder, who purports to hold 16,656 shares, filed a petition for appraisal rights under Delaware law. The parties reached a settlement of this matter for an amount that is not material to the Company.

 

The previously disclosed patent infringement litigation against Avery Dennison Corporation in the United States District Court for the District of Minnesota relating toretroreflective sheeting products used on traffic signs, pavement markings and other traffic control products has been resolved with the court entering a consent judgment in favor of 3M. Avery's separate claims of patent infringement and antitrust violations against 3M have been dismissed by the court with prejudice.

 

3M sued TransWeb Corporation in Minnesota in 2010 for infringement of several 3M patents covering fluorination and hydrocharging of filter media used in 3M's respirators and furnace filters. TransWeb does not make finished goods, but sells media to competitors of 3M's respirator and furnace filter businesses. TransWeb filed a declaratory judgment action in and successfully moved the litigation to the United States District Court for the District of New Jersey, seeking a declaration of invalidity and non-infringement of 3M's patents, and further alleging that 3M waited too long to enforce its rights. TransWeb also alleged 3M obtained the patents through inequitable conduct and that 3M's attempt to enforce the patents constitutes a violation of the antitrust laws. In November 2012, a jury returned a verdict in favor of TransWeb on all but one count, including findings that 3M's patents were invalid and not infringed, and that 3M had committed an antitrust violation by seeking to enforce a patent it had obtained fraudulently. The jury also recommended that the court find 3M had committed inequitable conduct in obtaining the patents, and that the patents were therefore unenforceable. Since the vast majority of TransWeb's claim for treble antitrust damages is in the form of its attorneys' fees and expenses in connection with the defense of the patent case, the parties agreed that the measure of damages would not go to the jury, but rather would be submitted to a special master after the trial. This process is ongoing. The special master's recommendations will be forwarded to the court for review and entry of a final judgment. 3M intends to appeal if the court enters judgment against 3M.

 

In December 2010, Meda AB, the Swedish-based acquirer of 3M's European pharmaceutical business, filed a lawsuit against 3M, 3M Innovative Properties Company, and Riker Laboratories, Inc. (collectively, "3M"). Meda initially asserted claims against 3M for breach of contract and breach of the implied covenant of good faith and fair dealing. In October 2011, Meda amended its pleading to assert a claim for fraud. All three claims are based on allegations that 3M did not inform Meda about certain information relating to the pricing of a particular drug in France prior to the acquisition. Meda seeks to recover compensatory damages in excess of $300 million (including prejudgment interest), punitive damages, and attorneys' fees. In September 2012, 3M filed a motion for summary judgment on the grounds that Meda cannot establish a breach of any duty owed by 3M. A non-jury trial occurred in the United States District Court for the Southern District of New York in January 2013. The court is expected to issue its decision in 2013.

 

Shurtape Technologies, LLC sued 3M in the United States District Court for the Western District of North Carolina, alleging that 3M's ScotchBlue™ Painter's Masking Tape with Edge-Lock™ Paint Line Protector, which was introduced in late 2009, infringes Shurtape's U.S. patent describing masking tape having an absorbent coating applied to the edge of the tape and several of Shurtape's trademarks. 3M is challenging both Shurtape's allegations of infringement and the validity of the patent. Trial is anticipated in late 2013 or early 2014. 3M has also requested reexamination of the Shurtape patent, and in November 2012, the US PTO issued an office action adopting many of 3M's invalidity arguments and rejecting all claims in the Shurtape patent. The reexamination is ongoing.

 

For commercial litigation matters described in this section for which a liability, if any, has been recorded, the Company believes the amount recorded, as well as the possible loss or range of loss in excess of the established accrual is not material to the Company's consolidated results of operations or financial condition. For those matters for which a liability has not been recorded, the Company believes that such liability is not probable and estimable and the Company is not able to estimate a possible loss or range of loss at this time.

 

Product Liability Litigation

 

Électricité de France (EDF) filed a lawsuit against 3M France in the French courts in 2006 claiming commercial loss and property damage after experiencing electrical network failures which EDF alleges were caused by so-called defective 3M transition splices. The French Court of Appeals at Versailles affirmed the commercial trial court's decision that the transition splices conformed to contract specifications which were thoroughly analyzed and tested by EDF before purchase and installation. The Court of Appeals, however, ordered a court-appointed expert to study the problem and issue a technical opinion on the cause of the network failures. The court-appointed expert is expected to submit his preliminary report to the commercial court by June 30, 2013. Thereafter, the commercial court may take from six months to one year to render its decision.

 

One customer obtained an order in the French courts against 3M Purification SAS (a French subsidiary) in October 2011 appointing an expert to determine the amount of commercial loss and property damage allegedly caused by so-called defective 3M filters used in the customer's manufacturing process. An Austrian subsidiary of this same customer also filed a claim against 3M Austria GmbH (an Austrian subsidiary) and 3M Purification SAS in the Austrian courts in September 2012 seeking damages for the same issue. Another customer filed a lawsuit against 3M Deutschland GmbH (a German subsidiary) in the German courts in March 2012 seeking commercial loss and property damage allegedly caused by so-called defective 3M filters used in that customer's manufacturing process. The Company has resolved on an amicable basis claims of two other customers arising out of the same issue.

 

For product liability litigation matters described in this section for which a liability has been recorded, the Company believes the amount recorded is not material to the Company's consolidated results of operations or financial condition. In addition, the Company is not able to estimate a possible loss or range of loss in excess of the established accruals at this time.


NOTE 11. Stock-Based Compensation

 

The 3M 2008 Long-Term Incentive Plan, as discussed in the 2012 Annual Report on Form 10-K, provides for the issuance or delivery of up to 100 million shares of 3M common stock pursuant to awards granted under the plan. Awards under this plan may be issued in the form of Incentive Stock Options, Nonqualified Stock Options, Progressive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Other Stock Awards, and Performance Units and Performance Shares. The remaining total shares available for grant under the 2008 Long Term Incentive Plan Program are 38,205,266 as of March 31, 2013.

 

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 32 percent of the 2013 annual grant stock-based compensation award expense dollars; therefore, higher stock-based compensation expense is recognized in the first quarter. 3M also has granted progressive (reload) options. These options are nonqualified stock options that were granted to certain participants under the 1997 or 2002 MSOP, but for which the reload feature was eliminated in 2005 (on a prospective basis only). Participants who had options granted prior to this effective date may still qualify to receive new progressive (reload) stock options.

 

In addition to the annual grants, the Company makes other minor grants of stock options, restricted stock units and other stock-based grants. The Company issues cash settled Restricted Stock Units and Stock Appreciation Rights in certain countries. These grants do not result in the issuance of Common Stock and are considered immaterial by the Company.

 

Amounts recognized in the financial statements with respect to stock-based compensation programs, which include stock options, restricted stock, restricted stock units, performance shares and the General Employees' Stock Purchase Plan (GESPP), are provided in the following table. Capitalized stock-based compensation amounts were not material for the three months ended March 31, 2013 and 2012.

 

Stock-Based Compensation Expense
















Three months ended



March 31,

(Millions)


2013 


2012 

Cost of sales


$

 12 


$

 12 

Selling, general and administrative expenses



 77 



 78 

Research, development and related expenses



 14 



 13 








Stock-based compensation expenses


$

 103 


$

 103 








Income tax benefits


$

 (32)


$

 (32)








Stock-based compensation expenses, net of tax


$

 71 


$

 71 



 

The following table summarizes stock option activity during the three months ended March 31, 2013:














Stock Option Program













Number of

Options


Weighted Average Exercise

Price


Weighted Average Remaining

Contractual

Life (months)


Aggregate

Intrinsic Value

(millions)

Under option -












January 1


 56,565,030 


$

 80.33 







Granted:













Annual


 6,220,810 



 101.55 








Progressive (Reload)


 91,690 



 102.45 







Exercised


 (9,059,296)



 77.46 







Canceled


 (40,064)



 87.37 







March 31


53,778,170 


$

 83.29 


64 


$

 1,238 

Options exercisable












March 31


41,708,894 


$

 79.83 


51 


$

 1,105 

 

As of March 31, 2013, there was $94 million of compensation expense that has yet to be recognized related to non-vested stock option based awards. This expense is expected to be recognized over the remaining weighted-average vesting period of 25 months. The total intrinsic values of stock options exercised were $215 million and $67 million during the three months ended March 31, 2013 and 2012, respectively. Cash received from options exercised was $702 million and $179 million for the three months ended March 31, 2013 and 2012, respectively. The Company's actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $80 million and $25 million for the three months ended March 31, 2013 and 2012, respectively.

 

For the primary 2013 annual stock option grant, the weighted average fair value at the date of grant was calculated using the Black-Scholes option-pricing model and the assumptions that follow.

 



Annual


Stock Option Assumptions


2013 


Exercise price


$

101.49 


Risk-free interest rate



1.2 

%

Dividend yield



2.7 

%

Expected volatility



20.0 

%

Expected life (months)



75 


Black-Scholes fair value


$

13.46 


 

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2013 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, 2013:

 

Restricted Stock and Restricted Stock Units













Weighted Average

Restricted Stock and


Number of


Grant Date

Restricted Stock Units

Awards

Fair Value

Nonvested balance -






As of January 1


 3,261,562 


$

           85.17



Granted:









Annual


 946,774 



 101.57 




Other


 4,553 



 103.95 



Vested


 (1,020,901)



 79.74 



Forfeited


 (10,315)



 89.85 


As of March 31


 3,181,673 


$

 91.81 

 

As of March 31, 2013, there was $128 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 28 months. The total fair value of restricted stock and restricted stock units that vested during the three months ended March 31, 2013 and 2012 was $105 million and $102 million, respectively. The Company's actual tax benefits realized for the tax deductions related to the vesting of restricted stock and restricted stock units was $39 million and $58 million for the three months ended March 31, 2013 and 2012, respectively.

 

Restricted stock units granted under the 3M 2008 Long-Term Incentive Plan generally vest three years following the grant date assuming continued employment. Dividend equivalents equal to the dividends payable on the same number of shares of 3M common stock accrue on these restricted stock units during the vesting period, although no dividend equivalents are paid on any of these restricted stock units that are forfeited prior to the vesting date. Dividends are paid out in cash at the vest date on restricted stock units, except for performance shares which do not earn dividends. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average restricted stock unit shares outstanding are included in the computation of diluted earnings per share.

 

Performance Shares

 

Beginning in 2008, the Company grants certain members of executive management performance shares on an annual basis. The performance criteria, which were modified in 2010, are designed to focus management attention on three key factors that create long-term stockholder value: Organic Sales Growth, Return on Invested Capital and sales from new products. The number of shares of 3M common stock that could actually be delivered at the end of the three-year performance period may be anywhere from 0% to 200% of each performance share granted, depending on the performance of the Company during such performance period. Non-substantive vesting requires that expense for the performance shares be recognized over one or three years depending on when each individual became a 3M executive. The first performance shares, which were granted in 2008, were distributed in 2011. Performance shares do not accrue dividends during the performance period. Therefore, the grant date fair value is determined by reducing the closing stock price on the date of grant by the net present value of dividends during the performance period. As a result of the significant uncertainty due to the economic crisis of 2008-2009, the Company granted restricted stock units instead of performance shares in 2009. Therefore, since there were no performance shares in 2009, there were also no related distributions in 2012. Performance share grants resumed in 2010 and continued thereafter.

 



The following table summarizes performance share activity during the three months ended March 31, 2013:

 








Weighted Average






Number of


Grant Date

Performance Shares

Awards

Fair Value

Undistributed balance -






As of January 1


 1,089,084 


$

 79.27 



Granted


 335,031 



 95.79 



Distributed


 (506,725)



 75.16 



Performance change


 (50,908)



 85.54 



Forfeited


 (11,276)



 91.27 


As of March 31


 855,206 


$

 87.65 

 

As of March 31, 2013, there was $33 million of compensation expense that has yet to be recognized related to performance shares. This expense is expected to be recognized over the remaining weighted-average earnings period of 11 months. The total fair value of performance shares that were distributed during the three months ended March 31, 2013 was $52 million and actual tax benefits realized for the tax deductions related to the distribution of performance shares was $16 million. There were no performance shares distributed or related tax benefits realized during the three months ended March 31, 2012. 


NOTE 12. Business Segments

 

3M's businesses are organized, managed and internally grouped into segments based on differences in markets, products, technologies and services. Effective in the first quarter of 2013 (as discussed below), 3M now manages its operations in five operating business segments: Industrial; Safety and Graphics; Electronics and Energy; Health Care; and Consumer. 3M's five 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.

 

Effective in the first quarter of 2013, 3M completed a realignment of its business groups (segments) to better serve global markets and customers. This realignment included:

·      The alignment of divisions into five business groups (segments) as further described below.

·      The combination of certain existing divisions into new divisions.  These included Traffic Safety and Security Division (reflecting the combination of the former Traffic Safety Systems Division and Security Systems Division) and the Optical Systems Division (reflecting the combination of the former Optical Systems Division and Mobile Interactive Solutions Division).

·      The movement of certain product lines between various divisions.

 

In addition to the above, there were also adjustments for dual credit reporting to reflect the realigned structure. The new structure is comprised of five business segments: Industrial, Safety and Graphics, Electronics and Energy, Health Care, and Consumer.

 

Industrial: This business segment, previously referred to as Industrial and Transportation, is largely unchanged, except for the transfer of the Renewable Energy Division to the Electronics and Energy business segment.

Safety and Graphics: This business segment includes Architectural Markets, Building and Commercial Services, Commercial Graphics, Industrial Mineral Products, Personal Safety, and Traffic Safety and Security. This new business segment also reflects movement of certain product lines between various divisions.

Electronics and Energy: This business segment includes Communication Markets, Electrical Markets, Electronics Markets Materials, Electronic Solutions, Infrastructure Protection, Optical Systems, Renewable Energy, and 3M Touch Systems. This new business segment also reflects the movement of certain product lines between various divisions.

Health Care: This business segment is largely unchanged, except for the movement of certain product lines between various divisions.

Consumer: This business segment, previously referred to as Consumer and Office, is largely unchanged, except for the movement of certain product lines between various divisions.

 

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)


2013 


2012 






Net Sales







Industrial


$

 2,675 


$

 2,558 

Safety and Graphics



 1,417 



 1,387 

Electronics and Energy



 1,277 



 1,320 

Health Care



 1,311 



 1,275 

Consumer



 1,081 



 1,060 

Corporate and Unallocated



 2 



 2 

Elimination of Dual Credit



 (129)



 (116)

Total Company


$

 7,634 


$

 7,486 








Operating Income







Industrial


$

 576 


$

 591 

Safety and Graphics



 335 



 334 

Electronics and Energy



 196 



 234 

Health Care



 404 



 401 

Consumer



 237 



 237 

Corporate and Unallocated



 (74)



 (138)

Elimination of Dual Credit



 (28)



 (25)

Total Company


$

 1,646 


$

 1,634 

 

Corporate and unallocated operating income includes a variety of miscellaneous items, such as corporate investment gains and losses, certain derivative gains and losses, certain 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 five 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 Personal Safety Division within the Safety and Graphics business segment; however, the Industrial business segment also sells this product to certain customers in its U.S. markets. In this example, the non-primary selling segment (Industrial) 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