Half-year Report

       3M COMPANY

    Form 10-Q for the Quarterly Period Ended June 30, 2016

	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 and Divestitures		12
	Note 3. Goodwill and Intangible Assets		14
	Note 4. Restructuring Actions		15
	Note 5. Supplemental Equity and Comprehensive Income Information		16
	Note 6. Income Taxes		20
	Note 7. Marketable Securities		21
	Note 8. Long-Term Debt and Short-Term Borrowings		22
	Note 9. Pension and Postretirement Benefit Plans		23
	Note 10. Derivatives		25
	Note 11. Fair Value Measurements		33
	Note 12. Commitments and Contingencies		37
	Note 13. Stock-Based Compensation		47
	Note 14. Business Segments		50
	Report of Independent Registered Public Accounting Firm		52
ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations
	Index to Management's Discussion and Analysis:
	Overview		53
	Results of Operations		59
	Performance by Business Segment		63
	Financial Condition and Liquidity		70
	Cautionary Note Concerning Factors That May Affect Future Results		76
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk		76
ITEM 4.	Controls and Procedures		77
PART II	OTHER INFORMATION
ITEM 1.	Legal Proceedings		78
ITEM 1A.	Risk Factors		78
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds		81
ITEM 3.	Defaults Upon Senior Securities		81
ITEM 4.	Mine Safety Disclosures		81
ITEM 5.	Other Information		81
ITEM 6.	Exhibits		81

 

 

3M COMPANY

FORM 10-Q

For the Quarterly Period Ended June 30, 2016

PART I.  Financial Information

 

Item 1.  Financial Statements.

 

3M Company and Subsidiaries

Consolidated Statement of Income

(Unaudited)

 

		Three months ended						Six months ended
		June 30,						June 30,
(Millions, except per share amounts)		2016			2015			2016			2015
Net sales		$	7,662		$	7,686		$	15,071		$	15,264
Operating expenses
Cost of sales			3,799			3,858			7,477			7,679
Selling, general and administrative expenses			1,560			1,550			3,053			3,114
Research, development and related expenses			437			438			887			901
Total operating expenses			5,796			5,846			11,417			11,694
Operating income			1,866			1,840			3,654			3,570
Interest expense and income
Interest expense			38			35			85			66
Interest income			(7)			(7)			(12)			(11)
Total interest expense - net			31			28			73			55
Income before income taxes			1,835			1,812			3,581			3,515
Provision for income taxes			542			509			1,010			1,011
Net income including noncontrolling interest		$	1,293		$	1,303		$	2,571		$	2,504
Less: Net income attributable to noncontrolling interest			2			3			5			5
Net income attributable to 3M		$	1,291		$	1,300		$	2,566		$	2,499
Weighted average 3M common shares outstanding - basic			606.9			631.3			607.2			633.8
Earnings per share attributable to 3M common shareholders - basic		$	2.13		$	2.06		$	4.23		$	3.94
Weighted average 3M common shares outstanding - diluted			620.9			643.0			621.1			646.1
Earnings per share attributable to 3M common shareholders - diluted		$	2.08		$	2.02		$	4.13		$	3.87
Cash dividends paid per 3M common share		$	1.11		$	1.025		$	2.22		$	2.05

 

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						Six months ended
		June 30,						June 30,
(Millions)		2016			2015			2016			2015
Net income including noncontrolling interest		$	1,293		$	1,303		$	2,571		$	2,504
Other comprehensive income (loss), net of tax:
Cumulative translation adjustment			37			23			175			(170)
Defined benefit pension and postretirement plans adjustment			67			96			136			187
Debt and equity securities, unrealized gain (loss)			-			-			-			-
Cash flow hedging instruments, unrealized gain (loss)			(27)			(32)			(137)			38
Total other comprehensive income (loss), net of tax			77			87			174			55
Comprehensive income (loss) including noncontrolling interest			1,370			1,390			2,745			2,559
Comprehensive (income) loss attributable to noncontrolling interest			(2)			(2)			(4)			(4)
Comprehensive income (loss) attributable to 3M		$	1,368		$	1,388		$	2,741		$	2,555

 

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

 

 

3M Company and Subsidiaries

Consolidated Balance Sheet

(Unaudited)

 

		June 30,			December 31,
(Dollars in millions, except per share amount)		2016			2015
Assets
Current assets
Cash and cash equivalents		$	1,688		$	1,798
Marketable securities - current			177			118
Accounts receivable - net			4,667			4,154
Inventories
Finished goods			1,676			1,655
Work in process			1,165			1,008
Raw materials and supplies			772			855
Total inventories			3,613			3,518
Other current assets			1,291			1,398
Total current assets			11,436			10,986
Marketable securities - non-current			14			9
Investments			121			117
Property, plant and equipment			23,793			23,098
Less: Accumulated depreciation			(15,189)			(14,583)
Property, plant and equipment - net			8,604			8,515
Goodwill			9,356			9,249
Intangible assets - net			2,477			2,601
Prepaid pension benefits			242			188
Other assets			985			1,053
Total assets		$	33,235		$	32,718
Liabilities
Current liabilities
Short-term borrowings and current portion of long-term debt		$	2,450		$	2,044
Accounts payable			1,650			1,694
Accrued payroll			580			644
Accrued income taxes			169			332
Other current liabilities			2,405			2,404
Total current liabilities			7,254			7,118
Long-term debt			9,299			8,753
Pension and postretirement benefits			3,418			3,520
Other liabilities			1,327			1,580
Total liabilities		$	21,298		$	20,971
Commitments and contingencies (Note 12)
Equity
3M Company shareholders' equity:
Common stock par value, $.01 par value, 944,033,056 shares issued		$	9		$	9
Additional paid-in capital			4,963			4,791
Retained earnings			37,194			36,575
Treasury stock, at cost: 339,632,765 shares at June 30, 2016; 334,702,932 shares at December 31, 2015			(24,088)			(23,308)
Accumulated other comprehensive income (loss)			(6,184)			(6,359)
Total 3M Company shareholders' equity			11,894			11,708
Noncontrolling interest			43			39
Total equity		$	11,937		$	11,747
Total liabilities and equity		$	33,235		$	32,718

 

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

 

3M Company and Subsidiaries

Consolidated Statement of Cash Flows

(Unaudited)

 

		Six months ended
		June 30,
(Millions)		2016			2015
Cash Flows from Operating Activities
Net income including noncontrolling interest		$	2,571		$	2,504
Adjustments to reconcile net income including noncontrolling interest to net cash provided by operating activities
Depreciation and amortization			722			683
Company pension and postretirement contributions			(97)			(185)
Company pension and postretirement expense			118			283
Stock-based compensation expense			193			187
Deferred income taxes			(134)			295
Excess tax benefits from stock-based compensation			-			(129)
Changes in assets and liabilities
Accounts receivable			(419)			(446)
Inventories			(42)			(269)
Accounts payable			(57)			(34)
Accrued income taxes (current and long-term)			(102)			(421)
Other - net			(208)			(50)
Net cash provided by operating activities			2,545			2,418
Cash Flows from Investing Activities
Purchases of property, plant and equipment (PP&E)			(637)			(661)
Proceeds from sale of PP&E and other assets			18			14
Acquisitions, net of cash acquired			(4)			(153)
Purchases of marketable securities and investments			(510)			(341)
Proceeds from maturities and sale of marketable securities and investments			449			1,269
Proceeds from sale of businesses			56			19
Other investing			(2)			19
Net cash provided by (used in) investing activities			(630)			166
Cash Flows from Financing Activities
Change in short-term debt - net			(337)			(39)
Repayment of debt (maturities greater than 90 days)			-			(10)
Proceeds from debt (maturities greater than 90 days)			1,112			1,925
Purchases of treasury stock			(2,055)			(2,581)
Proceeds from issuance of treasury stock pursuant to stock option and benefit plans			612			450
Dividends paid to shareholders			(1,344)			(1,298)
Excess tax benefits from stock-based compensation			-			129
Other - net			(16)			(50)
Net cash used in financing activities			(2,028)			(1,474)
Effect of exchange rate changes on cash and cash equivalents			3			(24)
Net increase (decrease) in cash and cash equivalents			(110)			1,086
Cash and cash equivalents at beginning of year			1,798			1,897
Cash and cash equivalents at end of period		$	1,688		$	2,983

 

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.

 

As described in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K) and 3M's Quarterly Report on Form 10-Q for the period ended March 31, 2016, effective in the first quarter of 2016, the Company made a product line reporting change involving two of its business segments. Segment information presented herein reflects the impact of this change for all periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's consolidated financial statements and notes included in its Current Report on Form 8-K dated May 17, 2016.

 

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 each applicable month. 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 2015. Since January 1, 2010, the financial statements of the Venezuelan subsidiary have been remeasured as if its functional currency were that of its parent.

 

The Venezuelan government sets official rates of exchange and conditions precedent to purchase foreign currency at these rates with local currency. Such rates and conditions have been and continue to be subject to change. In January 2014, the Venezuelan government announced that the National Center for Foreign Commerce (CENCOEX), had assumed the role with respect to the continuation of the existing official exchange rate, significantly expanded the use of a second currency auction exchange mechanism called the Complementary System for Foreign Currency Acquirement (or SICAD1), and issued exchange regulations indicating the SICAD1 rate of exchange would be used for payments related to international investments. In late March 2014, the Venezuelan government launched a third foreign exchange mechanism, SICAD2, which it later replaced with another foreign currency exchange platform in February 2015 called the Marginal System of Foreign Currency (SIMADI). The SIMADI rate was described as being derived from daily private bidders and buyers exchanging offers through authorized agents. This rate was approved and published by the Venezuelan Central Bank. In March 2016, the Venezuelan government effected a replacement of its preferential CENCOEX rate with Tipo de Cambio Protegido (DIPRO), described as available largely for essential imports; eliminated its SICAD exchange mechanism; and replaced its SIMADI rate with Tipo de Cambio Complementario (DICOM), published by the Venezuelan Central Bank and described as fluctuating in rate based on supply and demand.

 

The financial statements of 3M's Venezuelan subsidiary were remeasured utilizing the official CENCOEX (or its predecessor) rate into March 2014, the SICAD1 rate beginning in late March 2014, the SICAD2 rate beginning in June 2014, and the DICOM rate (or its SIMADI predecessor) beginning in February 2015. 3M's uses of these rates were based upon evaluation of a number of factors including, but not limited to, the exchange rate the Company's Venezuelan subsidiary may legally use to convert currency, settle transactions or pay dividends; the probability of accessing and obtaining currency by use of a particular rate or mechanism; and the Company's intent and ability to use a particular exchange mechanism. Other factors notwithstanding, remeasurement impacts of the changes in use of these exchange rates did not have material impacts on 3M's consolidated results of operations or financial condition.

 

The Company continues to monitor circumstances relative to its Venezuelan subsidiary. Changes in applicable exchange rates or exchange mechanisms may continue in the future. These changes could impact the rate of exchange applicable to remeasure the Company's net monetary assets (liabilities) denominated in Venezuelan Bolivars (VEF). As of June 30, 2016, the Company had a balance of net monetary assets denominated in VEF of less than 1.5 billion VEF and the DIPRO and DICOM exchange rates were approximately 10 VEF and 625 VEF per U.S. dollar, respectively.

 

A need to deconsolidate the Company's Venezuelan subsidiary's operations may result from a lack of exchangeability of VEF-denominated cash coupled with an acute degradation in the ability to make key operational decisions due to government regulations in Venezuela. 3M monitors factors such as its ability to access various exchange mechanisms; the impact of government regulations on the Company's ability to manage its Venezuelan subsidiary's capital structure, purchasing, product pricing, and labor relations; and the current political and economic situation within Venezuela. Based upon such factors as of June 30, 2016, the Company continues to consolidate its Venezuelan subsidiary. As of June 30, 2016, the balance of intercompany receivables due from this subsidiary and its equity balance were not significant.

 

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 (2.9 million average options for the three months ended June 30, 2016; 5.9 million average options for the six months ended June 30, 2016; 5.5 million average options for the three months ended June 30, 2015; and 4.5 million average options for the six months ended June 30, 2015). The computations for basic and diluted earnings per share follow:

 

Earnings Per Share Computations

 

		Three months ended						Six months ended
		June 30,						June 30,
(Amounts in millions, except per share amounts)		2016			2015			2016			2015
Numerator:
Net income attributable to 3M		$	1,291		$	1,300		$	2,566		$	2,499
Denominator:
Denominator for weighted average 3M common shares outstanding - basic			606.9			631.3			607.2			633.8
Dilution associated with the Company's stock-based compensation plans			14.0			11.7			13.9			12.3
Denominator for weighted average 3M common shares outstanding - diluted			620.9			643.0			621.1			646.1
Earnings per share attributable to 3M common shareholders - basic		$	2.13		$	2.06		$	4.23		$	3.94
Earnings per share attributable to 3M common shareholders - diluted		$	2.08		$	2.02		$	4.13		$	3.87

 

New Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-09, Revenue from Contracts with Customers, and in August 2015 issued ASU No. 2015-14, which amended ASU No. 2014-09 as to effective date. The ASU, as amended, provides a single comprehensive model to be used in the accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The standard's stated core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle the ASU includes provisions within a five step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when (or as) an entity satisfies a performance obligation. The standard also specifies the accounting for some costs to obtain or fulfill a contract with a customer and requires expanded disclosures about revenue recognition. The standard provides for either full retrospective adoption or a modified retrospective adoption by which it is applied only to the most current period presented. For 3M, the ASU, as amended, is effective January 1, 2018. The Company is currently assessing this standard's impact on 3M's consolidated results of operations and financial condition.

 

In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis, which changes guidance related to both the variable interest entity (VIE) and voting interest entity (VOE) consolidation models. With respect to the VIE model, the standard changes, among other things, the identification of variable interests associated with fees paid to a decision maker or service provider, the VIE characteristics for a limited partner or similar entity, and the primary beneficiary determination. With respect to the VOE model, the ASU eliminates the presumption that a general partner controls a limited partnership or similar entity unless the presumption can otherwise be overcome. Under the new guidance, a general partner would largely not consolidate a partnership or similar entity under the VOE model. The Company adopted this ASU effective January 1, 2016. Because 3M did not have significant involvement with entities subject to consolidation considerations impacted by the VIE model changes or with limited partnerships potentially impacted by the VOE model changes, the adoption did not have a material impact on the Company's consolidated results of operations and financial condition.

 

In April 2015, the FASB issued ASU No. 2015-05, Customer's Accounting for Fees Paid in a Cloud Arrangement, which requires a customer to determine whether a cloud computing arrangement contains a software license. If the arrangement contains a software license, the customer would account for fees related to the software license element in a manner consistent with accounting for the acquisition of other acquired software licenses. If the arrangement does not contain a software license, the customer would account for the arrangement as a service contract. An arrangement would contain a software license element if both (1) the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and (2) it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software. 3M adopted this ASU prospectively to arrangements entered into, or materially modified beginning January 1, 2016. The adoption did not have a material impact on 3M's consolidated results of operations and financial condition.

 

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, which modifies existing requirements regarding measuring inventory at the lower of cost or market. Under existing standards, the market amount requires consideration of replacement cost, net realizable value (NRV), and NRV less an approximately normal profit margin. The new ASU replaces market with NRV, defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This eliminates the need to determine and consider replacement cost or NRV less an approximately normal profit margin when measuring inventory. For 3M, this standard is effective prospectively beginning January 1, 2017, with early adoption permitted. The Company is currently assessing this ASU's impact on 3M's consolidated results of operations and financial condition.

 

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which revises the accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. The new guidance requires the fair value measurement of investments in equity securities and other ownership interests in an entity, including investments in partnerships, unincorporated joint ventures and limited liability companies (collectively, equity securities) that do not result in consolidation and are not accounted for under the equity method. Entities will need to measure these investments and recognize changes in fair value in net income. Entities will no longer be able to recognize unrealized holding gains and losses on equity securities they classify under current guidance as available for sale in other comprehensive income (OCI). They also will no longer be able to use the cost method of accounting for equity securities that do not have readily determinable fair values. Instead, for these types of equity investments that do not otherwise qualify for the net asset value practical expedient, entities will be permitted to elect a practicability exception and measure the investment at cost less impairment plus or minus observable price changes (in orderly transactions). The ASU also establishes an incremental recognition and disclosure requirement related to the presentation of fair value changes of financial liabilities for which the fair value option (FVO) has been elected. Under this guidance, an entity would be required to separately present in OCI the portion of the total fair value change attributable to instrument-specific credit risk as opposed to reflecting the entire amount in earnings. For derivative liabilities for which the FVO has been elected, however, any changes in fair value attributable to instrument-specific credit risk would continue to be presented in net income, which is consistent with current guidance. For 3M, this standard is effective beginning January 1, 2018 via a cumulative-effect adjustment to beginning retained earnings, except for guidance relative to equity securities without readily determinable fair values which is applied prospectively. The Company is currently assessing this ASU's impact on 3M's consolidated results of operations and financial condition.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases, replacing existing lease accounting guidance. The new standard introduces a lessee model that would require entities to recognize assets and liabilities for most leases, but recognize expenses on their income statements in a manner similar to current accounting. The ASU does not make fundamental changes to existing lessor accounting. However, it modifies what qualifies as a sales-type and direct financing lease and related accounting and aligns a number of the underlying principles with those of the new revenue standard, ASU No. 2014-09, such as evaluating how collectability should be considered and determining when profit can be recognized. The guidance eliminates existing real estate-specific provisions and requires expanded qualitative and quantitative disclosures. The standard requires modified retrospective transition by which it is applied at the beginning of the earliest comparative period presented in the year of adoption. For 3M, the ASU is effective January 1, 2019. The Company is currently assessing this standard's impact on 3M's consolidated results of operations and financial condition.

 

In March 2016, the FASB issued ASU No. 2016-06, Contingent Put and Call Options in Debt Instruments. This ASU clarifies guidance used to determine if debt instruments that contain contingent put or call options would require separation of the embedded put or call feature from the debt instrument and trigger accounting for the feature as a derivative with changes in fair value recorded through income. Under the new guidance, fewer put or call options embedded in debt instruments would require derivative accounting. For 3M, this ASU is effective January 1, 2017. The Company's outstanding debt with embedded put provisions does not require separate derivative accounting under existing guidance. As a result, 3M does not expect this ASU to have a material impact on the Company's consolidated results of operations and financial condition.

 

In March 2016, the FASB issued ASU No. 2016-07, Simplifying the Transition to the Equity Method of Accounting, which eliminates the existing requirement to apply the equity method of accounting retrospectively (revising prior periods as if the equity method had always been applied) when an entity obtains significant influence over a previously held investment. The new guidance would require the investor to apply the equity method prospectively from the date the investment qualifies for the equity method. The investor would add the carrying value of the existing investment to the cost of any additional investment to determine the initial cost basis of the equity method investment. For 3M, this ASU is effective January 1, 2017 on a prospective basis, with early adoption permitted. 3M would apply this guidance to investments that transition to the equity method after the adoption date.

 

In March 2016, the FASB issued ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which amends ASU No. 2014-09, Revenue from Contracts with Customers, to clarify principal versus agent guidance in situations in which a revenue transaction involves a third party in providing goods or services to a customer. In such circumstances, an entity must determine whether the nature of its promise to the customer is to provide the underlying goods or services (i.e., the entity is the principal in the transaction) or to arrange for the third party to provide the underlying goods or services (i.e., the entity is the agent in the transaction). To determine the nature of its promise to the customer, the entity must first identify each specified good or service to be provided to the customer and then (before transferring it) assess whether it controls each specified good or service. The new ASU clarifies how an entity should identify the unit of accounting (the specified good or service) for the principal versus agent evaluation, and how it should apply the control principle to certain types of arrangements, such as service transactions, by explaining what a principal controls before the specified good or service is transferred to the customer. This ASU has the same effective date and transition requirements as ASU No. 2014-09, as amended by ASU No. 2015-14, which for 3M is effective January 1, 2018. The Company is currently assessing this standard's impact on 3M's consolidated results of operations and financial condition.

 

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which modifies certain accounting aspects for share-based payments to employees including, among other elements, the accounting for income taxes and forfeitures, as well as classifications in the statement of cash flows. With respect to income taxes, under current guidance, when a share-based payment award such as a stock option or restricted stock unit (RSU) is granted to an employee, the fair value of the award is generally recognized over the vesting period. However, the related deduction from taxes payable is based on the award's intrinsic value at the time of exercise (for an option) or on the fair value upon vesting of the award (for RSUs), which can be either greater (creating an excess tax benefit) or less (creating a tax deficiency) than the compensation cost recognized in the financial statements. Excess tax benefits are recognized in additional paid-in capital (APIC) within equity, and tax deficiencies are similarly recognized in APIC to the extent there is a sufficient APIC amount (APIC pool) related to previously recognized excess tax benefits. Under the new guidance, all excess tax benefits/deficiencies would be recognized as income tax benefit/expense in the statement of income. The new ASU's income tax aspects also impact the calculation of diluted earnings per share by excluding excess tax benefits/deficiencies from the calculation of assumed proceeds available to repurchase shares under the treasury stock method. Relative to forfeitures, the new standard allows an entity-wide accounting policy election either to continue to estimate the number of awards that will be forfeited or to account for forfeitures as they occur. The new guidance also impacts classifications within the statement of cash flows by no longer requiring inclusion of excess tax benefits as both a hypothetical cash outflow within cash flows from operating activities and hypothetical cash inflow within cash flows from financing activities. Instead, excess tax benefits would be classified in operating activities in the same manner as other cash flows related to income taxes. Additionally, the new ASU requires cash payments to tax authorities when an employer uses a net-settlement feature to withhold shares to meet statutory tax withholding provisions to be presented as financing activity (eliminating previous diversity in practice). For 3M, this standard is required effective January 1, 2017, with early adoption permitted. The Company early adopted ASU No. 2016-09 as of January 1, 2016. Prospectively beginning January 1, 2016, excess tax benefits/deficiencies have been reflected as income tax benefit/expense in the statement of income resulting in a $59 million and $140 million tax benefit in the three and six months ended June 30, 2016, respectively. 3M typically experiences the largest volume of stock option exercises and RSU vestings in the first quarter of its fiscal year. The extent of excess tax benefits/deficiencies is subject to variation in 3M stock price and timing/extent of RSU vestings and employee stock option exercises. 3M's adoption of this ASU also resulted in associated excess tax benefits being classified as operating activity in the same manner as other cash flows related to income taxes in the statement of cash flows prospectively beginning January 1, 2016. Based on the adoption methodology applied, the statement of cash flows classification of prior periods has not been adjusted. In addition, 3M did not change its accounting principles relative to elements of this standard and continued its existing practice of estimating the number of awards that will be forfeited.

 

In April 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing, which amends ASU No. 2014-09, Revenue from Contracts with Customers. In terms of identifying performance obligations in a revenue arrangement, the amendments clarify how entities would determine whether promised goods or services are separately identifiable from other promises in a contract and, therefore, would be accounted for separately. The guidance would also allow entities to disregard goods or services that are immaterial in the context of a contract and provides an accounting policy election to account for shipping and handling activities as fulfillment costs rather than as additional promised services. With regard to the licensing, the amendments clarify how an entity would evaluate the nature of its promise in granting a license of intellectual property, which determines whether the entity recognizes revenue over time or at a point in time. The standard also clarifies certain other aspects relative to licensing. This ASU has the same effective date and transition requirements as ASU No. 2014-09, as amended by ASU No. 2015-14, which for 3M is effective January 1, 2018. The Company is currently assessing this standard's impact on 3M's consolidated results of operations and financial condition.

 

In May 2016, the FASB issued ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients, which amends ASU No. 2014-09, Revenue from Contracts with Customers, to address implementation issues relative to transition (adding a practical expedient for contract modifications and clarifying what constitutes a completed contract when employing ASU No. 2014-09's full or modified retrospective transition methods), collectability, noncash consideration, and the presentation of sales and other similar-type taxes (allowing entities to exclude sales-type taxes collected from transaction price). This ASU has the same effective date and transition requirements as ASU No. 2014-09, as amended by ASU No. 2015-14, which for 3M is effective January 1, 2018. The Company is currently assessing this standard's impact on 3M's consolidated results of operations and financial condition.

 

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which revises guidance for the accounting for credit losses on financial instruments within its scope. The new standard introduces an approach, based on expected losses, to estimate credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. The new approach to estimating credit losses (referred to as the current expected credit losses model) applies to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases and off-balance-sheet credit exposures. With respect to available-for-sale (AFS) debt securities, the ASU amends the current other-than-temporary impairment model. For such securities with unrealized losses, entities will still consider if a portion of any impairment is related only to credit losses and therefore recognized as a reduction in income. However, rather than also reflecting that credit loss amount as a permanent reduction in cost (amortized cost) basis of that AFS debt security, the ASU requires that credit losses be reflected as an allowance. As a result, under certain circumstances, a recovery in value could result in previous allowances, or portions thereof, reversing back into income. For 3M, this ASU is effective January 1, 2020, with early adoption permitted. Entities are required to apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently assessing this ASU's impact on 3M's consolidated result of operations and financial condition.

 

NOTE 2.  Acquisitions and Divestitures

 

Acquisitions:

 

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

 

There were no material business combinations that closed during the six months ended June 30, 2016. Adjustments in the first six months of 2016 to the preliminary purchase price allocations of other acquisitions within the allocation period were not material. The allocation of purchase price related to the acquisition of Capital Safety Group S.A.R.L. in August 2015 is considered preliminary, primarily with respect to contingent liabilities and certain tax-related assets and liabilities. 3M expects to finalize the allocation of purchase price within the one year measurement-period following this acquisition.

 

Divestitures:

 

3M may divest certain businesses from time to time based upon review of the Company's portfolio considering, among other items, factors relative to the extent of strategic and technological alignment and optimization of capital deployment, in addition to considering if selling the businesses results in the greatest value creation for the Company and for shareholders.

 

In the first quarter of 2016, 3M (Safety and Graphics Business) completed the sale of the remainder of the assets of 3M's library systems business to One Equity Partners Capital Advisors L.P. (OEP). 3M had previously sold the North American business and the majority of the business outside of North America to OEP in the fourth quarter of 2015. The library systems business delivers circulation management solutions to library customers with on-premise hardware and software, maintenance and service, and an emerging cloud-based digital lending platform.

 

In the first quarter of 2016, 3M (Industrial Business) sold to Innovative Chemical Products Group, a portfolio company of Audax Private Equity, the assets of 3M's pressurized polyurethane foam adhesives business (formerly known as Polyfoam). This business is a provider of pressurized polyurethane foam adhesive formulations and systems into the residential roofing, commercial roofing and insulation and industrial foam segments in the United States with annual sales of approximately $20 million.

 

The Company recorded a pre-tax gain of $40 million in the first quarter of 2016 as a result of the sales of these businesses (recorded in selling, general and administrative expenses). The aggregate operating income of these businesses included in the Company's operating results for the periods presented and the amounts of major assets and liabilities of any associated disposal groups classified as held-for-sale as of the respective balance sheet dates presented were not material.

 

Refer to Note 2 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K) for more information on 3M's acquisitions and divestitures.

 

NOTE 3.  Goodwill and Intangible Assets

 

There were no material acquisitions that closed during the first six months of 2016. 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, 2015 and June 30, 2016, follow:

 

Goodwill

 

		December 31, 2015			Acquisition			Translation				June 30, 2016
(Millions)		Balance			activity			and other				Balance
Industrial		$	2,573		$	1		$	49		$		2,623
Safety and Graphics			3,342			2			19				3,363
Health Care			1,624			-			14				1,638
Electronics and Energy			1,510			-			13				1,523
Consumer			200			-			9				209
Total Company		$	9,249		$	3		$	104		$		9,356

 

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 described in Note 14, effective in the first quarter of 2016, the Company changed its business segment reporting in its continuing effort to improve the alignment of its businesses around markets and customers. For any product changes 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 2016, 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

 

The carrying amount and accumulated amortization of acquired finite-lived intangible assets, in addition to the balance of non-amortizable intangible assets, as of June 30, 2016, and December 31, 2015, follow:

 

		June 30,			December 31,
(Millions)		2016			2015
Customer related intangible assets		$	1,974		$	1,973
Patents			607			616
Other technology-based intangible assets			525			525
Definite-lived tradenames			424			421
Other amortizable intangible assets			214			216
Total gross carrying amount		$	3,744		$	3,751
Accumulated amortization - customer related			(737)			(668)
Accumulated amortization - patents			(489)			(481)
Accumulated amortization - other technology based			(279)			(252)
Accumulated amortization - definite-lived tradenames			(228)			(215)
Accumulated amortization - other			(171)			(169)
Total accumulated amortization		$	(1,904)		$	(1,785)
Total finite-lived intangible assets - net		$	1,840		$	1,966
Non-amortizable intangible assets (primarily tradenames)			637			635
Total intangible assets - net		$	2,477		$	2,601

 

Certain tradenames acquired by 3M are not amortized because they have been in existence for over 55 years, have a history of leading-market share positions, have been and are intended to be continuously renewed, and the associated products of which are expected to generate cash flows for 3M for an indefinite period of time.

 

Amortization expense for acquired intangible assets for the three and six months ended June 30, 2016 and 2015 follows:

 

		Three months ended						Six months ended
		June 30,						June 30,
(Millions)		2016			2015			2016			2015
Amortization expense		$	66		$	50		$	132		$	103

 

Expected amortization expense for acquired amortizable intangible assets recorded as of June 30, 2016:

 

		Remainder
		of																		After
(Millions)		2016			2017			2018			2019			2020			2021			2021
Amortization expense		$	125		$	226		$	204		$	192		$	182		$	166		$	745

 

The preceding 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.  Restructuring Actions

 

During the fourth quarter of 2015, management approved and committed to undertake certain restructuring actions primarily focused on structural overhead, largely in the U.S. and slower-growing markets, with particular emphasis on Europe, Middle East, and Africa (EMEA) and Latin America. This impacted approximately 1,700 positions worldwide and resulted in a fourth quarter 2015 pre-tax charge of $114 million.

 

Components of these restructuring actions, including cash and non-cash impacts, follow:

(Millions)		Employee-Related			Asset-Related			Total
Expense incurred		$	98		$	16		$	114
Non-cash changes			(8)			(16)			(24)
Cash payments			(27)			-			(27)
Accrued restructuring action balances as of December 31, 2015		$	63		$	-		$	63
Cash payments			(35)			-			(35)
Accrued restructuring action balances as of June 30, 2016		$	28		$	-		$	28

 

Non-cash changes include certain pension settlements and special termination benefits recorded in accrued pension and postretirement benefits and accelerated depreciation resulting from the cessation of use of certain long-lived assets. Remaining activities related to the restructuring are expected to be completed in 2016.

 

NOTE 5.  Supplemental Equity and Comprehensive Income Information

 

Consolidated Statement of Changes in Equity

 

Three months ended June 30, 2016

 

					3M Company Shareholders
					Common									Accumulated
					Stock and									Other
					Additional									Comprehensive			Non-
					Paid-in			Retained			Treasury			Income			controlling
(Millions)		Total			Capital			Earnings			Stock			(Loss)			Interest
Balance at March 31, 2016		$	11,774		$	4,925		$	36,785		$	(23,716)		$	(6,261)		$	41
Net income			1,293						1,291									2
Other comprehensive income (loss), net of tax:
Cumulative translation adjustment			37												37			-
Defined benefit pension and post-retirement plans adjustment			67												67			-
Debt and equity securities - unrealized gain (loss)			-												-			-
Cash flow hedging instruments - unrealized gain (loss)			(27)												(27)			-
Total other comprehensive income (loss), net of tax			77
Dividends declared			(672)						(672)
Stock-based compensation			47			47
Reacquired stock			(837)									(837)
Issuances pursuant to stock option and benefit plans			255						(210)			465
Balance at June 30, 2016		$	11,937		$	4,972		$	37,194		$	(24,088)		$	(6,184)		$	43

 

Six months ended June 30, 2016

					3M Company Shareholders
					Common									Accumulated
					Stock and									Other
					Additional									Comprehensive			Non-
					Paid-in			Retained			Treasury			Income			controlling
(Millions)		Total			Capital			Earnings			Stock			(Loss)			Interest
Balance at December 31, 2015		$	11,747		$	4,800		$	36,575		$	(23,308)		$	(6,359)		$	39
Net income			2,571						2,566									5
Other comprehensive income (loss), net of tax:
Cumulative translation adjustment			175												176			(1)
Defined benefit pension and post-retirement plans adjustment			136												136			-
Debt and equity securities - unrealized gain (loss)			-												-			-
Cash flow hedging instruments - unrealized gain (loss)			(137)												(137)			-
Total other comprehensive income (loss), net of tax			174
Dividends declared			(1,344)						(1,344)
Stock-based compensation			172			172
Reacquired stock			(2,000)									(2,000)
Issuances pursuant to stock option and benefit plans			617						(603)			1,220
Balance at June 30, 2016		$	11,937		$	4,972		$	37,194		$	(24,088)		$	(6,184)		$	43

 

Three months ended June 30, 2015

 

					3M Company Shareholders
					Common									Accumulated
					Stock and									Other
					Additional									Comprehensive			Non-
					Paid-in			Retained			Treasury			Income			controlling
(Millions)		Total			Capital			Earnings			Stock			(Loss)			Interest
Balance at March 31, 2015		$	13,952		$	4,616		$	35,080		$	(19,458)		$	(6,321)		$	35
Net income			1,303						1,300									3
Other comprehensive income (loss), net of tax:
Cumulative translation adjustment			23												24			(1)
Defined benefit pension and post-retirement plans adjustment			96												96			-
Debt and equity securities - unrealized gain (loss)			-												-			-
Cash flow hedging instruments - unrealized gain (loss)			(32)												(32)			-
Total other comprehensive income (loss), net of tax			87
Dividends declared			(646)						(646)
Stock-based compensation, net of tax impacts			78			78
Reacquired stock			(1,787)									(1,787)
Issuances pursuant to stock option and benefit plans			143						(119)			262
Balance at June 30, 2015		$	13,130		$	4,694		$	35,615		$	(20,983)		$	(6,233)		$	37

 

Six months ended June 30, 2015

					3M Company Shareholders
					Common									Accumulated
					Stock and									Other
					Additional									Comprehensive			Non-
					Paid-in			Retained			Treasury			Income			controlling
(Millions)		Total			Capital			Earnings			Stock			(Loss)			Interest
Balance at December 31, 2014		$	13,142		$	4,388		$	34,317		$	(19,307)		$	(6,289)		$	33
Net income			2,504						2,499									5
Other comprehensive income (loss), net of tax:
Cumulative translation adjustment			(170)												(169)			(1)
Defined benefit pension and post-retirement plans adjustment			187												187			-
Debt and equity securities - unrealized gain (loss)			-												-			-
Cash flow hedging instruments - unrealized gain (loss)			38												38			-
Total other comprehensive income (loss), net of tax			55
Dividends declared			(649)						(649)
Stock-based compensation, net of tax impacts			306			306
Reacquired stock			(2,683)									(2,683)
Issuances pursuant to stock option and benefit plans			455						(552)			1,007
Balance at June 30, 2015		$	13,130		$	4,694		$	35,615		$	(20,983)		$	(6,233)		$	37

 

In December 2014, 3M's Board of Directors declared a first quarter 2015 dividend of $1.025 per share (paid in March 2015). This reduced 3M's stockholder equity and increased other current liabilities as of December 31, 2014, by approximately $0.6 billion.

 

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

 

Three months ended June 30, 2016

 

														Total
					Defined Benefit			Debt and			Cash Flow			Accumulated
					Pension and			Equity			Hedging			Other
		Cumulative			Postretirement			Securities,			Instruments,			Comprehensive
		Translation			Plans			Unrealized			Unrealized			Income
(Millions)		Adjustment			Adjustment			Gain (Loss)			Gain (Loss)			(Loss)
Balance at March 31, 2016, net of tax:		$	(1,540)		$	(4,735)		$	-		$	14		$	(6,261)
Other comprehensive income (loss), before tax:
Amounts before reclassifications			59			-			-			(15)			44
Amounts reclassified out			-			101			-			(28)			73
Total other comprehensive income (loss), before tax			59			101			-			(43)			117
Tax effect			(22)			(34)			-			16			(40)
Total other comprehensive income (loss), net of tax			37			67			-			(27)			77
Balance at June 30, 2016, net of tax:		$	(1,503)		$	(4,668)		$	-		$	(13)		$	(6,184)

 

Six months ended June 30, 2016

 

														Total
					Defined Benefit			Debt and			Cash Flow			Accumulated
					Pension and			Equity			Hedging			Other
		Cumulative			Postretirement			Securities,			Instruments,			Comprehensive
		Translation			Plans			Unrealized			Unrealized			Income
(Millions)		Adjustment			Adjustment			Gain (Loss)			Gain (Loss)			(Loss)
Balance at December 31, 2015, net of tax:		$	(1,679)		$	(4,804)		$	-		$	124		$	(6,359)
Other comprehensive income (loss), before tax:
Amounts before reclassifications			119			-			-			(136)			(17)
Amounts reclassified out			-			204			-			(80)			124
Total other comprehensive income (loss), before tax			119			204			-			(216)			107
Tax effect			57			(68)			-			79			68
Total other comprehensive income (loss), net of tax			176			136			-			(137)			175
Balance at June 30, 2016, net of tax:		$	(1,503)		$	(4,668)		$	-		$	(13)		$	(6,184)

 

Three months ended June 30, 2015

 

 

														Total
					Defined Benefit			Debt and			Cash Flow			Accumulated
					Pension and			Equity			Hedging			Other
		Cumulative			Postretirement			Securities,			Instruments,			Comprehensive
		Translation			Plans			Unrealized			Unrealized			Income
(Millions)		Adjustment			Adjustment			Gain (Loss)			Gain (Loss)			(Loss)
Balance at March 31, 2015, net of tax:		$	(1,288)		$	(5,202)		$	-		$	169		$	(6,321)
Other comprehensive income (loss), before tax:
Amounts before reclassifications			(12)			-			-			(16)			(28)
Amounts reclassified out			-			141			-			(34)			107
Total other comprehensive income (loss), before tax			(12)			141			-			(50)			79
Tax effect			36			(45)			-			18			9
Total other comprehensive income (loss), net of tax			24			96			-			(32)			88
Balance at June 30, 2015, net of tax:		$	(1,264)		$	(5,106)		$	-		$	137		$	(6,233)

 

Six months ended June 30, 2015

 

														Total
					Defined Benefit			Debt and			Cash Flow			Accumulated
					Pension and			Equity			Hedging			Other
		Cumulative			Postretirement			Securities,			Instruments,			Comprehensive
		Translation			Plans			Unrealized			Unrealized			Income
(Millions)		Adjustment			Adjustment			Gain (Loss)			Gain (Loss)			(Loss)
Balance at December 31, 2014, net of tax:		$	(1,095)		$	(5,293)		$	-		$	99		$	(6,289)
Other comprehensive income (loss), before tax:
Amounts before reclassifications			(56)			24			-			120			88
Amounts reclassified out			-			265			-			(61)			204
Total other comprehensive income (loss), before tax			(56)			289			-			59			292
Tax effect			(113)			(102)			-			(21)			(236)
Total other comprehensive income (loss), net of tax			(169)			187			-			38			56
Balance at June 30, 2015, net of tax		$	(1,264)		$	(5,106)		$	-		$	137		$	(6,233)

 

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
Details about Accumulated Other		Accumulated Other Comprehensive Income
Comprehensive Income Components		Three months ended June 30,						Six months ended June 30,						Location on Income
(Millions)		2016			2015			2016			2015			Statement
Gains (losses) associated with, defined benefit pension and postretirement plans amortization
Transition asset		$	1		$	1		$	1		$	1		See Note 9
Prior service benefit			24			17			47			35		See Note 9
Net actuarial loss			(126)			(159)			(252)			(318)		See Note 9
Curtailments/Settlements			-			-			-			17		See Note 9
Total before tax			(101)			(141)			(204)			(265)
Tax effect			34			45			68			91		Provision for income taxes
Net of tax		$	(67)		$	(96)		$	(136)		$	(174)
Debt and equity security gains (losses)
Sales or impairments of securities		$	-		$	-		$	-		$	-		Selling, general and administrative expenses
Total before tax			-			-			-			-
Tax effect			-			-			-			-		Provision for income taxes
Net of tax		$	-		$	-		$	-		$	-
Cash flow hedging instruments gains (losses)
Foreign currency forward/option contracts		$	28		$	35		$	81		$	65		Cost of sales
Commodity price swap contracts			-			-			-			(2)		Cost of sales
Interest rate swap contracts			-			(1)			(1)			(2)		Interest expense
Total before tax			28			34			80			61
Tax effect			(11)			(12)			(29)			(22)		Provision for income taxes
Net of tax		$	17		$	22		$	51		$	39
Total reclassifications for the period, net of tax		$	(50)		$	(74)		$	(85)		$	(135)

 

 

 

 

NOTE 6.  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 2005.

 

The IRS has completed its field examination of the Company's U.S. federal income tax returns for the years 2005 through 2014. The Company protested certain IRS positions within these tax years and entered into the administrative appeals process with the IRS. 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 2015 and 2016. It is anticipated that the IRS will complete its examination of the Company for 2015 by the end of the first quarter of 2017 and for 2016 by the end of the first quarter of 2018. As of June 30, 2016, the IRS has not proposed any significant adjustments to the Company's tax positions for which the Company is not adequately reserved.

 

Payments relating to other proposed assessments arising from the 2005 through 2016 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 audit activity in several U.S. state and foreign jurisdictions.

 

3M anticipates changes to the Company's uncertain tax positions due to the closing and resolution of audit issues for various audit years mentioned above and closure of statutes. The Company is not currently 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 June 30, 2016 and December 31, 2015 are $383 million and $369 million, respectively.

 

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 $1 million of expense and $4 million of benefit for the three months ended June 30, 2016 and June 30, 2015, respectively, and approximately $3 million of benefit and $2 million of benefit for the six months ended June 30, 2016 and June 30, 2015, respectively. At June 30, 2016 and December 31, 2015, accrued interest and penalties in the consolidated balance sheet on a gross basis were $39 million and $45 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 second quarter of 2016 was 29.6 percent, compared to 28.1 percent in the second quarter of 2015, an increase of 1.5 percentage points. Primary factors that increased the Company's effective tax rate on a combined basis by 5.3 percentage points year-on-year included international taxes that were impacted by changes to both the geographic mix of income before taxes and additional tax expense related to global cash optimization actions, plus remeasurements of 3M's uncertain tax positions. This increase was partially offset by a 3.8 percentage points year-on-year decrease to the Company's effective tax rate. Primary factors that decreased the effective tax rate included the recognition of excess tax benefits beginning in 2016 related to employee share-based payments (resulting from the adoption of ASU No. 2016-09, as discussed in Note 1), the reinstatement of the R&D tax credit, and other items.

 

The effective tax rate for the first six months of 2016 was 28.2 percent, compared to 28.8 percent in the first six months of 2015, a decrease of 0.6 percentage points. Primary factors that decreased the Company's effective tax rate on a combined basis by 4.5 percentage points for the first six months of 2016 when compared to the same period for 2015 included the recognition of excess tax benefits beginning in 2016 related to employee share-based payments (resulting from the adoption of ASU No. 2016-09, as discussed in Note 1), the reinstatement of the R&D tax credit, and other items. This decrease was partially offset by a 3.9 percentage point year-on-year increase, which included international taxes that were impacted by changes to both the geographic mix of income before taxes and additional tax expense related to global cash optimization actions, plus remeasurements of 3M's uncertain tax positions.

 

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 June 30, 2016 and December 31, 2015, the Company had valuation allowances of $39 million and $31 million on its deferred tax assets, respectively.

 

NOTE 7.  Marketable Securities

 

The Company invests in asset-backed securities, certificates of deposit/time deposits, commercial paper, and other securities. The following is a summary of amounts recorded on the Consolidated Balance Sheet for marketable securities (current and non-current).

 

		June 30,			December 31,
(Millions)		2016			2015
Foreign government agency securities		$	10		$	10
Corporate debt securities			10			10
Commercial paper			36			12
Certificates of deposit/time deposits			55			26
U.S. municipal securities			4			3
Asset-backed securities:
Automobile loan related			36			26
Credit card related			19			10
Other			7			21
Asset-backed securities total			62			57
Current marketable securities		$	177		$	118
U.S. municipal securities		$	14		$	9
Non-current marketable securities		$	14		$	9
Total marketable securities		$	191		$	127

 

Classification of marketable securities as current or non-current is based on the nature of the securities and availability for use in current operations. At June 30, 2016 and December 31, 2015, gross unrealized gains and/or losses (pre-tax) were not material. Refer to Note 5 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 June 30, 2016 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)		June 30, 2016
Due in one year or less		$	104
Due after one year through five years			87
Total marketable securities		$	191

 

3M has a diversified marketable securities portfolio. Within this portfolio, asset-backed securities primarily include interests in automobile loans, credit cards and other asset-backed securities. 3M's investment policy allows investments in asset-backed securities with minimum credit ratings of Aa2 by Moody's Investors Service or AA by Standard & Poor's or Fitch Ratings or DBRS. Asset-backed securities must be rated by at least two of the aforementioned rating agencies, one of which must be Moody's Investors Service or Standard & Poor's. At June 30, 2016, all asset-backed security investments were in compliance with this policy. Approximately 78.4 percent of all asset-backed security investments were rated AAA or A-1+ by Standard & Poor's and/or Aaa or P-1 by Moody's Investors Service and/or AAA or F1+ by Fitch Ratings. Interest rate risk and credit risk related to the underlying collateral may impact the value of investments in asset-backed securities, while factors such as general conditions in the overall credit market and the nature of the underlying collateral may affect the liquidity of investments in asset-backed securities. 3M does not currently expect risk related to its holding in asset-backed securities to materially impact its financial condition or liquidity.

 

NOTE 8.  Long-Term Debt and Short-Term Borrowings

 

In May 2016, 3M issued 500 million Euro aggregate principal amount of 5.75-year fixed rate medium-term notes due February 2022 with a coupon rate of 0.375% and 500 million Euro aggregate principal amount of 15-year fixed rate medium-term notes due 2031 with a coupon rate of 1.50%.

 

In March 2016, 3M amended and restated its existing $2.25 billion five-year revolving credit facility expiring in August 2019 to a $3.75 billion five-year revolving credit facility expiring in March 2021. This credit agreement includes a provision under which 3M may request an increase of up to $1.25 billion (at lender's discretion), bringing the total facility up to $5.0 billion. This revolving credit facility is undrawn at June 30, 2016. Under the $3.75 billion credit agreement, the Company is required to maintain its EBITDA to Interest Ratio as of the end of each fiscal quarter at not less than 3.0 to 1. This is calculated (as defined in the agreement) as the ratio of consolidated total EBITDA for the four consecutive quarters then ended to a total interest expense on all funded debt for the same period. At June 30, 2016, this ratio was approximately 51 to 1. Debt covenants do not restrict the payment of dividends.

 

NOTE 9.  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 and six months ended June 30, 2016 and 2015 follow:

 

Benefit Plan Information

 

		Three months ended June 30,
		Qualified and Non-qualified
		Pension Benefits												Postretirement
		United States						International						Benefits
(Millions)		2016			2015			2016			2015			2016			2015
Net periodic benefit cost (benefit)
Service cost		$	65		$	73		$	34		$	40		$	14		$	22
Interest cost			144			164			43			55			19			25
Expected return on plan assets			(261)			(267)			(78)			(81)			(22)			(23)
Amortization of transition (asset) obligation			-			-			(1)			(1)			-			-
Amortization of prior service cost (benefit)			(6)			(6)			(4)			(3)			(14)			(8)
Amortization of net actuarial (gain) loss			88			102			23			38			15			19
Settlements, curtailments, special termination benefits and other			-			-			-			-			-			-
Net periodic benefit cost (benefit) after settlements, curtailments, special termination benefits and other		$	30		$	66		$	17		$	48		$	12		$	35

 

 

		Six months ended June 30,
		Qualified and Non-qualified
		Pension Benefits												Postretirement
		United States						International						Benefits
(Millions)		2016			2015			2016			2015			2016			2015
Net periodic benefit cost (benefit)
Service cost		$	130		$	146		$	67		$	82		$	27		$	43
Interest cost			287			328			86			110			39			50
Expected return on plan assets			(521)			(534)			(156)			(162)			(45)			(45)
Amortization of transition (asset) obligation			-			-			(1)			(1)			-			-
Amortization of prior service cost (benefit)			(12)			(12)			(7)			(7)			(28)			(16)
Amortization of net actuarial (gain) loss			176			204			45			76			31			38
Settlements, curtailments, special termination benefits and other			-			-			-			(17)			-			-
Net periodic benefit cost (benefit) after settlements, curtailments, special termination benefits and other		$	60		$	132		$	34		$	81		$	24		$	70

 

For the six months ended June 30, 2016, contributions totaling $95 million were made to the Company's U.S. and international pension plans and $2 million to its postretirement plans. For total year 2016, the Company expects to contribute between approximately $200 million to $400 million of cash to its global defined benefit pension and postretirement plans. The Company does not have a required minimum cash pension contribution obligation for its U.S. plans in 2016. Future contributions will 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.

 

Beginning in 2016, 3M changed the method used to estimate the service and interest cost components of the net periodic pension and other postretirement benefit costs. The new method measures service cost and interest cost separately using the spot yield curve approach applied to each corresponding obligation. Service costs are determined based on duration-specific spot rates applied to the service cost cash flows. The interest cost calculation is determined by applying duration-specific spot rates to the year-by-year projected benefit payments. The spot yield curve approach does not affect the measurement of the total benefit obligations as the change in service and interest costs offset in the actuarial gains and losses recorded in other comprehensive income. The Company changed to the new method to provide a more precise measure of service and interest costs by improving the correlation between the projected benefit cash flows and the discrete spot yield curve rates. The Company accounted for this change as a change in estimate prospectively beginning in the first quarter of 2016. As a result of the change to the spot yield curve approach, 2016 annual defined benefit pension and postretirement net periodic benefit cost has decreased approximately $180 million.

 

Using this methodology, the Company determined discount rates for its plans as follows:

 

		U.S. Qualified Pension		International Pension (weighted average)		U.S. Postretirement Medical
December 31, 2015 Liability:
Benefit obligation		4.47	%	3.12	%	4.32	%
2016 Net Periodic Benefit Cost Components:
Service cost		4.72	%	2.84	%	4.60	%
Interest cost		3.77	%	2.72	%	3.44	%

 

The Company also sponsors employee savings plans under Section 401(k) of the Internal Revenue Code, as discussed in Note 11 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K). Beginning on January 1, 2016, for U.S. employees, the Company reduced its match on employee 401(k) contributions. For eligible employees hired prior to January 1, 2009, employee 401(k) contributions of up to 5% of eligible compensation are matched in cash at rates of 45% or 60%, depending on the plan in which the employee participates. Employees hired on or after January 1, 2009, receive a cash match of 100% for employee 401(k) contributions of up to 5% of eligible compensation and also continue to receive an employer retirement income account cash contribution of 3% of the participant's total eligible compensation.

 

In August 2015, 3M modified the 3M Retiree Welfare Benefit Plan postretirement medical benefit reducing the future benefit for participants not retired as of January 1, 2016. Current retirees and employees who retired on or before January 1, 2016, were not impacted by these changes. The Retiree Medical Savings Account (RMSA) is no longer credited with interest, and the indexation on both the RMSA and the Medicare Health Reimbursement Arrangement was reduced from 3 percent to 1.5 percent per year (for those employees who are eligible for these accounts). Also effective January 1, 2016, 3M no longer offered 3M Retiree Health Care Accounts to new hires. Due to these changes the plan was re-measured in the third quarter of 2015, resulting in a decrease to the projected benefit obligation liability of approximately $233 million, and a related increase to shareholders' equity, specifically accumulated other comprehensive income.

 

In March 2015, 3M Japan modified the Japan Limited Defined Benefit Corporate Pension Plan (DBCPP). Beginning July 1, 2015, eligible employees receive a company provided contribution match of 6.12% of their eligible salary to their defined contribution plan. Employees no longer earn additional service towards their defined benefit pension plans after July 1, 2015, except for eligible salaries above the statutory defined contribution limits. As a result of this plan modification, the Company re-measured the DBCPP, which resulted in a $17 million pre-tax curtailment gain for the six months ended June 30, 2015.

 

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 probable recovery of a portion of the decrease in original asset value. In the first quarter of 2014, 3M and certain 3M benefit plans filed a lawsuit in the U.S. District Court for the District of Minnesota against five insurers seeking insurance coverage for the WG Trading Company claim. In September 2015, the court ruled in favor of the defendant insurance companies on a motion for summary judgment and dismissed the lawsuit. In October 2015, 3M and the 3M benefit plans filed a notice of appeal to the United States Court of Appeals for the Eighth Circuit. As of the 2015 measurement date, these holdings represented less than one half of 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 10.  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 5. Additional information with respect to the fair value of derivative instruments is included in Note 11. References to information regarding derivatives and/or hedging instruments associated with the Company's long-term debt are also made in Note 10 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 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. 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. 3M may dedesignate 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. Beginning in the second quarter of 2014, 3M began extending the maximum length of time over which it hedges its exposure to the variability in future cash flows of the forecasted transactions from a previous term of 12 months to a longer term of 24 months, with certain currencies being extended further to 36 months starting in the first quarter of 2015.

 

Cash Flow Hedging - Commodity Price Management: The Company manages commodity price risks through negotiated supply contracts, price protection agreements and forward contracts. 3M discontinued the use of commodity price swaps as cash flow hedges of forecasted commodity transactions in the first quarter of 2015. The Company used commodity price swaps as cash flow hedges of forecasted commodity transactions to manage price volatility. The related mark-to-market gain or loss on qualifying hedges was included in other comprehensive income to the extent effective, and reclassified into cost of sales in the period during which the hedged transaction affected earnings.

 

Cash Flow Hedging - Interest Rate Contracts: The Company may use forward starting interest rate contracts to hedge exposure to variability in cash flows from forecasted debt issuances. The amortization of gains and losses on forward starting interest rate swaps is included in the tables below as part of the gain/(loss) recognized in income on the effective portion of derivatives as a result of reclassification from accumulated other comprehensive income. Additional information regarding previously issued and terminated interest rate contracts can be found in Note 12 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K).

 

 

In the first six months of 2016, the Company entered into forward starting interest rate swaps expiring in December 2016 with an aggregate notional amount of $300 million as a hedge against interest rate volatility associated with a forecasted issuance of fixed rate debt.

 

As of June 30, 2016, the Company had a balance of $13 million associated with the after-tax net unrealized loss associated with cash flow hedging instruments recorded in accumulated other comprehensive income. This includes a remaining balance of $5 million (after tax loss) related to the forward starting interest rate swaps, which will be amortized over the respective lives of the debt. Based on exchange rates as of June 30, 2016, 3M expects to reclassify approximately $20 million of the after-tax net unrealized foreign exchange cash flow hedging gains to earnings over the remainder of 2016, approximately $12 million of the after-tax net unrealized foreign exchange cash flow hedging losses to earnings in 2017, and approximately $21 million of the after-tax net unrealized foreign exchange cash flow hedging losses to earnings after 2017 (with the impact offset by earnings/losses from underlying hedged items). 3M expects to reclassify approximately $12 million of the after-tax net unrealized foreign exchange cash flow hedging gains to earnings over the next 12 months.

 

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.

 

Three months ended June 30, 2016

 

Pretax Gain (Loss) Recognized in

Pretax Gain (Loss)

Income on Effective Portion of

Ineffective Portion of Gain

Recognized in Other

Derivative as a Result of

(Loss) on Derivative and

Comprehensive

Reclassification from

Amount Excluded from

Income on Effective

Accumulated Other

Effectiveness Testing

Derivatives in Cash Flow Hedging Relationships

Portion of Derivative

Comprehensive Income

Recognized in Income

(Millions)

Amount

Location

Amount

Location

Amount

Foreign currency forward/option contracts

$

(11)

Cost of sales

$

28

Cost of sales

$

-

Interest rate swap contracts

(4)

Interest expense

-

Interest expense

-

Total

$

(15)

$

28

$

-

 

Six months ended June 30, 2016

 

Pretax Gain (Loss) Recognized in

Pretax Gain (Loss)

Income on Effective Portion of

Ineffective Portion of Gain

Recognized in Other

Derivative as a Result of

(Loss) on Derivative and

Comprehensive

Reclassification from

Amount Excluded from

Income on Effective

Accumulated Other

Effectiveness Testing

Derivatives in Cash Flow Hedging Relationships

Portion of Derivative

Comprehensive Income

Recognized in Income

(Millions)

Amount

Location

Amount

Location

Amount

Foreign currency forward/option contracts

$

(131)

Cost of sales

$

81

Cost of sales

$

-

Interest rate swap contracts

(5)

Interest expense

(1)

Interest expense

-

Total

$

(136)

$

80

$

-

 

Three months ended June 30, 2015

 

Pretax Gain (Loss) Recognized in

Pretax Gain (Loss)

Income on Effective Portion of

Ineffective Portion of Gain

Recognized in Other

Derivative as a Result of

(Loss) on Derivative and

Comprehensive

Reclassification from

Amount Excluded from

Income on Effective

Accumulated Other

Effectiveness Testing

Derivatives in Cash Flow Hedging Relationships

Portion of Derivative

Comprehensive Income

Recognized in Income

(Millions)

Amount

Location

Amount

Location

Amount

Foreign currency forward/option contracts

$

(16)

Cost of sales

$

35

Cost of sales

$

-

Interest rate swap contracts

-

Interest expense

(1)

Interest expense

-

Total

$

(16)

$

34

$

-

 

Six months ended June 30, 2015

 

Pretax Gain (Loss) Recognized in

Pretax Gain (Loss)

Income on Effective Portion of

Ineffective Portion of Gain

Recognized in Other

Derivative as a Result of

(Loss) on Derivative and

Comprehensive

Reclassification from

Amount Excluded from

Income on Effective

Accumulated Other

Effectiveness Testing

Derivatives in Cash Flow Hedging Relationships

Portion of Derivative

Comprehensive Income

Recognized in Income

(Millions)

Amount

Location

Amount

Location

Amount

Foreign currency forward/option contracts

$

120

Cost of sales

$

65

Cost of sales

$

-

Commodity price swap contracts

-

Cost of sales

(2)

Cost of sales

-

Interest rate swap contracts

-

Interest expense

(2)

Interest expense

-

Total

$

120

$

61

$

-

 

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. Additional information regarding designated interest rate swaps can be found in Note 12 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K).

 

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 June 30, 2016

 

		Gain (Loss) on Derivative					Gain (Loss) on Hedged Item
Derivatives in Fair Value Hedging Relationships		Recognized in Income					Recognized in Income
(Millions)		Location		Amount			Location		Amount
Interest rate swap contracts		Interest expense		$	5		Interest expense		$	(5)
Total				$	5				$	(5)

 

Six months ended June 30, 2016

		Gain (Loss) on Derivative					Gain (Loss) on Hedged Item
Derivatives in Fair Value Hedging Relationships		Recognized in Income					Recognized in Income
(Millions)		Location		Amount			Location		Amount
Interest rate swap contracts		Interest expense		$	34		Interest expense		$	(34)
Total				$	34				$	(34)

 

Three months ended June 30, 2015

 

		Gain (Loss) on Derivative					Gain (Loss) on Hedged Item
Derivatives in Fair Value Hedging Relationships		Recognized in Income					Recognized in Income
(Millions)		Location		Amount			Location		Amount
Interest rate swap contracts		Interest expense		$	(11)		Interest expense		$	11
Total				$	(11)				$	11

 

Six months ended June 30, 2015

 

		Gain (Loss) on Derivative					Gain (Loss) on Hedged Item
Derivatives in Fair Value Hedging Relationships		Recognized in Income					Recognized in Income
(Millions)		Location		Amount			Location		Amount
Interest rate swap contracts		Interest expense		$	(5)		Interest expense		$	5
Total				$	(5)				$	5

 

Net Investment Hedges:

 

The Company may use non-derivative (foreign currency denominated debt) and derivative (foreign exchange forward contracts) instruments to hedge portions of the Company's investment in foreign subsidiaries and manage foreign exchange risk. For instruments that are designated and qualify as hedges of net investments in foreign operations and 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. To the extent foreign currency denominated debt is not designated in or is dedesignated from a net investment hedge relationship, changes in value of that portion of foreign currency denominated debt due to exchange rate changes are recorded in earnings through their maturity date.

 

3M's use of foreign exchange forward contracts designated in hedges of the Company's net investment in foreign subsidiaries can vary by time period depending on when foreign currency denominated debt balances designated in such relationships are dedesignated, matured, or are newly issued and designated. Additionally, variation can occur in connection with the extent of the Company's desired foreign exchange risk coverage.

 

At June 30, 2016, the total notional amount of foreign exchange forward contracts designated in net investment hedges was approximately 150 million Euros and approximately 248 billion South Korean Won, along with a principal amount of long-term debt instruments designated in net investment hedges totaling 4.4 billion Euros. The maturity dates of these derivative and nonderivative instruments designated in net investment hedges range from 2016 to 2031.

 

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 June 30, 2016

 

		Pretax Gain (Loss)
		Recognized as
		Cumulative Translation
		within Other			Ineffective Portion of Gain (Loss) on
		Comprehensive Income			Instrument and Amount Excluded
Derivative and Nonderivative Instruments in Net Investment Hedging		on Effective Portion of			from Effectiveness Testing
Relationships		Instrument			Recognized in Income
(Millions)		Amount			Location		Amount
Foreign currency denominated debt		$	94		N/A		$	-
Foreign currency forward contracts			16		Cost of sales			3
Total		$	110				$	3

 

Six months ended June 30, 2016

 

		Pretax Gain (Loss)
		Recognized as
		Cumulative Translation
		within Other			Ineffective Portion of Gain (Loss) on
		Comprehensive Income			Instrument and Amount Excluded
Derivative and Nonderivative Instruments in Net Investment Hedging		on Effective Portion of			from Effectiveness Testing
Relationships		Instrument			Recognized in Income
(Millions)		Amount			Location		Amount
Foreign currency denominated debt		$	(50)		N/A		$	-
Foreign currency forward contracts			(27)		Cost of sales			1
Total		$	(77)				$	1

 

Three months ended June 30, 2015

 

		Pretax Gain (Loss)
		Recognized as
		Cumulative Translation
		within Other			Ineffective Portion of Gain (Loss) on
		Comprehensive Income			Instrument and Amount Excluded
Derivative and Nonderivative Instruments in Net Investment Hedging		on Effective Portion of			from Effectiveness Testing
Relationships		Instrument			Recognized in Income
(Millions)		Amount			Location		Amount
Foreign currency denominated debt		$	(55)		N/A		$	-
Foreign currency forward contracts			(55)		Cost of sales			4
Total		$	(110)				$	4

 

Six months ended June 30, 2015

 

		Pretax Gain (Loss)
		Recognized as
		Cumulative Translation
		within Other			Ineffective Portion of Gain (Loss) on
		Comprehensive Income			Instrument and Amount Excluded
Derivative and Nonderivative Instruments in Net Investment Hedging		on Effective Portion of			from Effectiveness Testing
Relationships		Instrument			Recognized in Income
(Millions)		Amount			Location		Amount
Foreign currency denominated debt		$	185		N/A		$	-
Foreign currency forward contracts			102		Cost of sales			4
Total		$	287				$	4

 

Derivatives Not Designated as Hedging Instruments:

 

3M enters into foreign exchange forward contracts that are not designated in hedge relationships to offset, in part, the impacts of certain intercompany transactions and to further mitigate short-term currency impacts. In addition, the Company enters into commodity price swaps to offset, in part, fluctuations in costs associated with the use of certain precious metals. These derivative instruments are not designated in hedging relationships; therefore, fair value gains and losses on these contracts are recorded in earnings. 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 June 30, 2016

Six months ended June 30, 2016

Gain (Loss) on Derivative Recognized in

Gain (Loss) on Derivative Recognized in

Derivatives Not Designated as Hedging Instruments

Income

Income

(Millions)

Location

Amount

Location

Amount

Foreign currency forward/option contracts

Cost of sales

$

(1)

Cost of sales

$

(6)

Foreign currency forward contracts

Interest expense

49

Interest expense

42

Total

$

48

$

36

 

 

 

Three months ended June 30, 2015

Six months ended June 30, 2015

Gain (Loss) on Derivative Recognized in

Gain (Loss) on Derivative Recognized in

Derivatives Not Designated as Hedging Instruments

Income

Income

(Millions)

Location

Amount

Location

Amount

Foreign currency forward/option contracts

Cost of sales

$

1

Cost of sales

$

5

Foreign currency forward contracts

Interest expense

(61)

Interest expense

28

Commodity price swap contracts

Cost of sales

-

Cost of sales

(4)

Total

$

(60)

$

29

 

 

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. Notional amounts below are presented at period end foreign exchange rates, except interest rate swaps, which are presented using the contract inception date's foreign exchange rate. Additional information with respect to the fair value of derivative instruments is included in Note 11.

 

		Gross			Assets					Liabilities
June 30, 2016		Notional					Fair					Fair
(Millions)		Amount			Location		Value Amount			Location		Value Amount
Derivatives designated as
hedging instruments
Foreign currency forward/option contracts		$	2,371		Other current assets		$	56		Other current liabilities		$	54
Foreign currency forward/option contracts			1,187		Other assets			35		Other liabilities			35
Interest rate swap contracts			2,053		Other assets			58		Other current liabilities			5
Total derivatives designated as hedging instruments							$	149				$	94
Derivatives not designated as
hedging instruments
Foreign currency forward/option contracts		$	5,365		Other current assets		$	94		Other current liabilities		$	97
Total derivatives not designated as hedging instruments							$	94				$	97
Total derivative instruments							$	243				$	191

 

 

		Gross			Assets					Liabilities
December 31, 2015		Notional					Fair					Fair
(Millions)		Amount			Location		Value Amount			Location		Value Amount
Derivatives designated as
hedging instruments
Foreign currency forward/option contracts		$	2,815		Other current assets		$	148		Other current liabilities		$	14
Foreign currency forward/option contracts			1,240		Other assets			61		Other liabilities			3
Interest rate swap contracts			1,753		Other assets			24		Other liabilities			1
Total derivatives designated as hedging instruments							$	233				$	18
Derivatives not designated as
hedging instruments
Foreign currency forward/option contracts		$	5,359		Other current assets		$	63		Other current liabilities		$	51
Total derivatives not designated as hedging instruments							$	63				$	51
Total derivative instruments							$	296				$	69

 

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 June 30, 2016, 3M has International Swaps and Derivatives Association (ISDA) agreements with 16 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 15 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 collateral had been received or pledged related to these derivative instruments.

 

Offsetting of Financial Assets under Master Netting Agreements with Derivative Counterparties

 

June 30, 2016					Gross Amounts not Offset in the
					Consolidated Balance Sheet that are Subject
		Gross Amount of			to Master Netting Agreements
		Derivative Assets			Gross Amount of
		Presented in the			Eligible Offsetting
		Consolidated			Recognized			Cash Collateral			Net Amount of
(Millions)		Balance Sheet			Derivative Liabilities			Received			Derivative Assets
Derivatives subject to master netting agreements		$	243		$	74		$	-		$	169
Derivatives not subject to master netting agreements			-									-
Total		$	243								$	169

 

December 31, 2015					Gross Amounts not Offset in the
					Consolidated Balance Sheet that are Subject
		Gross Amount of			to Master Netting Agreements
		Derivative Assets			Gross Amount of
		Presented in the			Eligible Offsetting
		Consolidated			Recognized			Cash Collateral			Net Amount of
(Millions)		Balance Sheet			Derivative Liabilities			Received			Derivative Assets
Derivatives subject to master netting agreements		$	296		$	37		$	-		$	259
Derivatives not subject to master netting agreements			-									-
Total		$	296								$	259

 

Offsetting of Financial Liabilities under Master Netting Agreements with Derivative Counterparties

 

June 30, 2016					Gross Amounts not Offset in the
					Consolidated Balance Sheet that are Subject
		Gross Amount of			to Master Netting Agreements
		Derivative Liabilities			Gross Amount of
		Presented in the			Eligible Offsetting
		Consolidated			Recognized			Cash Collateral			Net Amount of
(Millions)		Balance Sheet			Derivative Assets			Pledged			Derivative Liabilities
Derivatives subject to master netting agreements		$	180		$	74		$	-		$	106
Derivatives not subject to master netting agreements			11									11
Total		$	191								$	117

 

December 31, 2015					Gross Amounts not Offset in the
					Consolidated Balance Sheet that are Subject
		Gross Amount of			to Master Netting Agreements
		Derivative Liabilities			Gross Amount of
		Presented in the			Eligible Offsetting
		Consolidated			Recognized			Cash Collateral			Net Amount of
(Millions)		Balance Sheet			Derivative Assets			Pledged			Derivative Liabilities
Derivatives subject to master netting agreements		$	64		$	37		$	-		$	27
Derivatives not subject to master netting agreements			5									5
Total		$	69								$	32

 

Currency Effects

 

3M estimates that year-on-year foreign currency transactions effects, including hedging impacts, decreased pre-tax income by approximately $10 million for the three months ended June 30, 2016, which resulted in a minimal impact for the six months ended June 30, 2016. These estimates include transaction gains and losses, including derivative instruments designed to reduce foreign currency exchange rate risks and any impacts from swapping Venezuelan bolivars into U.S. dollars.

 

NOTE 11.  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 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 and six months ended June 30, 2016 and 2015.

 

 

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 certain U.S. municipal securities:

 

Marketable securities, except certain U.S. municipal securities, are valued utilizing multiple sources. A weighted average market 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 certain U.S. municipal securities) are classified as level 2. Marketable securities are discussed further in Note 7.

 

Available-for-sale marketable securities - certain U.S. municipal securities only:

 

In the fourth quarter of 2014 and first quarter of 2016, 3M obtained municipal bonds from the City of Nevada, Missouri, which represent 3M's only U.S. municipal securities holding as of June 30, 2016 and December 31, 2015. Due to the nature of this security, the valuation method utilized will include the financial health of the City of Nevada, any recent municipal bond issuances by Nevada, and macroeconomic considerations related to the direction of interest rates and the health of the overall municipal bond market, and as such has been classified as a level 3 security.

 

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, commodity price swaps, currency swaps, foreign currency options, interest rate swaps and cross-currency swaps will be considered level 2 measurements. 3M uses inputs other than quoted prices that are observable for the asset. These inputs include foreign currency exchange rates, volatilities, and interest rates. 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
Description		Fair Value at			Using Inputs Considered as
(Millions)		June 30, 2016			Level 1			Level 2			Level 3
Assets:
Available-for-sale:
Marketable securities:
Foreign government agency securities		$	10		$	-		$	10		$	-
Corporate debt securities			10			-			10			-
Commercial paper			36			-			36			-
Certificates of deposit/time deposits			55			-			55			-
Asset-backed securities:
Automobile loan related			36			-			36			-
Credit card related			19			-			19			-
Other			7			-			7			-
U.S. municipal securities			18			-			-			18
Derivative instruments - assets:
Foreign currency forward/option contracts			185			-			185			-
Interest rate swap contracts			58			-			58			-
Liabilities:
Derivative instruments - liabilities:
Foreign currency forward/option contracts			186			-			186			-
Interest rate swap contracts			5			-			5			-

 

 

					Fair Value Measurements
Description		Fair Value at			Using Inputs Considered as
(Millions)		December 31, 2015			Level 1			Level 2			Level 3
Assets:
Available-for-sale:
Marketable securities:
Foreign government agency securities		$	10		$	-		$	10		$	-
Corporate debt securities			10			-			10			-
Commercial paper			12			-			12			-
Certificates of deposit/time deposits			26			-			26			-
Asset-backed securities:
Automobile loan related			26			-			26			-
Credit card related			10			-			10			-
Other			21			-			21			-
U.S. municipal securities			12			-			-			12
Derivative instruments - assets:
Foreign currency forward/option contracts			272			-			272			-
Interest rate swap contracts			24			-			24			-
Liabilities:
Derivative instruments - liabilities:
Foreign currency forward/option contracts			68			-			68			-
Interest rate 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						Six months ended
Marketable securities - certain U.S. municipal securities only		June 30,						June 30,
(Millions)		2016			2015			2016			2015
Beginning balance		$	18		$	15		$	12		$	15
Total gains or losses:
Included in earnings			-			-			-			-
Included in other comprehensive income			-			-			-			-
Purchases and issuances			-			-			6			-
Sales and settlements			-			-			-			-
Transfers in and/or out of level 3			-			-			-			-
Ending balance		$	18		$	15		$	18		$	15
Change in unrealized gains or losses for the period included in earnings for securities held at the end of the reporting period			-			-			-			-

 

In addition, the plan assets of 3M's pension and postretirement benefit plans are measured at fair value on a recurring basis (at least annually). Refer to Note 11 in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 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 and six months ended June 30, 2016 and 2015.

 

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:

 

		June 30, 2016						December 31, 2015
		Carrying			Fair			Carrying			Fair
(Millions)		Value			Value			Value			Value
Long-term debt, excluding current portion		$	9,299		$	10,115		$	8,753		$	9,101

 

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. Many of 3M's fixed-rate bonds were trading at a premium at June 30, 2016 and December 31, 2015 due to the low interest rates and tightening of 3M's credit spreads.

 

NOTE 12.  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 about the Company's process for disclosure and recording of liabilities and insurance receivables related to legal proceedings can be found in Note 14 "Commitments and Contingencies" in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 as updated by the Company's Current Report on Form 8-K dated May 17, 2016.

 

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 June 30, 2016, the Company is a named defendant, with multiple co-defendants, in numerous lawsuits in various courts that purport to represent approximately 2,325 individual claimants, compared to approximately 2,130 individual claimants with actions pending at December 31, 2015.

 

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 it experienced at the peak of filings in 2003. 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 ten cases taken to trial, including eight of the nine cases tried to verdict (such trials occurred in 1999, 2000, 2001, 2003, 2004, 2007, and 2015), and an appellate reversal in 2005 of the 2001 jury verdict adverse to the Company. The remaining 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 plaintiff in the 2015 trial filed an appeal to the Missouri Court of Appeals for the Eastern District. In June 2016, the Missouri Court of Appeals affirmed the trial court's judgment and jury verdict in favor of 3M, a decision that is final as the Plaintiff did not file an appeal to the Missouri Supreme Court.

 

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 medically unimpaired claimants.

 

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. The case was inactive from the fourth quarter of 2007 until late 2013, other than a case management conference in March 2011. In November 2013, the State filed a motion to bifurcate the lawsuit into separate liability and damages proceedings. At the hearing on the motion, the court declined to bifurcate the lawsuit. 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 lack of any meaningful discovery responses by the State of West Virginia, the otherwise 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, if any, a jury might allocate to each defendant if the 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 Company's cost of resolving claims of persons who claim more serious injuries, including mesothelioma and other malignancies, the Company increased its accruals in the first six months of 2016 for respirator mask/asbestos liabilities by $29 million, $18 million of which occurred in the second quarter of 2016. In the first six months of 2016, the Company made payments for legal fees and settlements of $26 million related to the respirator mask/asbestos litigation, $12 million of which occurred in the second quarter of 2016. As of June 30, 2016, the Company had accruals for respirator mask/asbestos liabilities of $147 million (excluding Aearo accruals). This accrual represents the low end in a range of loss.

 

The Company cannot estimate the amount or upper end of the 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 or the time period in which future claims may be asserted, (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 June 30, 2016, the Company's receivable for insurance recoveries related to the respirator mask/asbestos litigation was $4 million. The Company estimates insurance receivables based on an analysis of its policies, including their exclusions, pertinent case law interpreting comparable policies, its experience with similar claims, and an assessment of the nature of each claim and remaining coverage. The Company then 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.

 

As a result of a final arbitration decision in June 2016 regarding insurance coverage under two policies, 3M reversed its receivable for insurance recoveries related to respirator mask/asbestos litigation by $35 million. The Company is seeking coverage under the policies of certain insolvent insurers. Once those claims for coverage are resolved, the Company will have collected substantially all of its remaining insurance coverage for respirator mask/asbestos claims.

 

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 June 30, 2016, 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 June 30, 2016, the Company, through its Aearo subsidiary, had accruals of $20 million 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 respective 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. In 2014, the court granted Aearo's motion for summary judgment on two claims, but declined to rule on two issues: the specific liability for certain known coal mine dust lawsuits; and Cabot's claim for allocation of liability between injuries allegedly caused by exposure to coal mine dust and injuries allegedly caused by exposure to silica dust. Following additional discovery, the parties filed new motions for summary judgment. In February 2016, the court ruled in favor of Aearo on these two remaining issues, and ordered that Cabot, and not Aearo, is solely responsible for all liability for the coal mine dust lawsuits under the 1995 agreement. Cabot has appealed.

 

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 insurance coverage limits, and/or (ix) 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 section 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, federal (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 the end of 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 received from suppliers that may ultimately degrade to PFOA, PFOS, or similar compounds. Upon such identification, the Company works to find alternatives for such materials.

 

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. As the database of studies of both chemicals has expanded, the EPA has developed human health effects documents summarizing the available data from these studies. In February 2014, the EPA initiated external peer review of its draft human health effects documents for PFOA and PFOS. The peer review panel met in August 2014. In May 2016, the EPA announced lifetime health advisory levels for PFOA and PFOS at 70 parts per trillion (superseding the provisional levels established by the EPA in 2009 of 400 parts per trillion for PFOA and 200 parts per trillion for PFOS). Where PFOA and PFOS are found together, EPA recommends that the concentrations be added together, and the lifetime health advisory for PFOA and PFOS combined is also 70 parts per trillion. Lifetime health advisories, while not enforceable, serve as guidance and are benchmarks for determining if concentrations of chemicals in tap water from public utilities are safe for public consumption. In an effort to collect exposure information 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 EPA is reporting results from this exercise on a rolling basis that will continue in 2016. Through April 2016, the EPA has reported results for 4,864 public water supplies nationwide. Based on the 2016 lifetime health advisory, 13 public water supplies exceed the level for PFOA, 46 exceed the level for PFOS, and 72 exceed the combined level for PFOA and PFOS. These results are based on one or more samples collected during the period 2012-2015 and do not necessarily reflect current conditions of these public water supplies. EPA reporting does not identify the sources of the PFOA and PFOS in the public water supplies.

 

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 Decatur, Alabama, Cottage Grove, Minnesota, and Cordova, Illinois 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. Pursuant to a permit issued by ADEM, for approximately twenty years, the Company incorporated its wastewater treatment plant sludge containing PFCs in fields at its Decatur facility. 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 plan continues and is expected to be completed in 2018.

 

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 and Woodbury sites, and they are in an operational maintenance mode. Remediation will continue at the Cottage Grove site during 2016.

 

In August 2014, the Illinois EPA approved a request by the Company to establish a groundwater management zone at its manufacturing facility in Cordova, Illinois, which includes ongoing pumping of impacted site groundwater, groundwater monitoring, and routine reporting of results.

 

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 (the St. John case), 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 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. In June 2015, the plaintiffs filed an amended complaint adding additional defendants, including BFI Waste Management Systems of Alabama, LLC; BFI Waste Management of North America, LLC; the City of Decatur, Alabama; Morgan County, Alabama; Municipal Utilities Board of Decatur; and Morgan County, Alabama, d/b/a Decatur Utilities. In September 2015, the court issued a scheduling order staying discovery pending mediation which occurred in January 2016, but did not resolve the case and the parties continue their negotiations. A hearing on class certification is scheduled for November 2016.

 

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 (the Chandler case) granted the Company's motion to abate the case, effectively putting the case on hold pending the resolution of class certification issues in the St. John case. 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 (the Stover case) 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 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 St. John case.

 

In October 2015, West Morgan-East Lawrence Water & Sewer Authority (Water Authority) filed an individual complaint against 3M Company, Dyneon, L.L.C, and Daikin America, Inc., in the U.S. District Court for the Northern District of Alabama. The complaint also includes representative plaintiffs who brought the complaint on behalf of themselves, and a class of all owners and possessors of property who use water provided by the Water Authority and five local water works to which the Water Authority supplies water (collectively, the "Water Utilities"). The complaint seeks compensatory and punitive damages and injunctive relief based on allegations that the defendants' chemicals, including PFOA and PFOS from their manufacturing processes in Decatur, have contaminated the water in the Tennessee River at the water intake, and that the chemicals cannot be removed by the water treatment processes utilized by the Water Authority. 3M has moved to dismiss the case on legal grounds. That motion is pending.

 

In June 2016, the Tennessee Riverkeeper, Inc. (Riverkeeper), a non-profit corporation, filed a lawsuit in the U.S. District Court for the Northern District of Alabama against 3M; BFI Waste Systems of Alabama; the City of Decatur, Alabama; and the Municipal Utilities Board of Decatur, Morgan County, Alabama. The complaint alleges that the defendants violated the Resource Conservation and Recovery Act in connection with the disposal of certain PFCs through their ownership and operation of their respective sites.  The complaint further alleges such practices may present an imminent and substantial endangerment to health and/or the environment and that Riverkeeper has suffered and will continue to suffer irreparable harm caused by defendants' failure to abate the endangerment unless the court grants the requested relief, including declaratory and injunctive relief.  The Company believes that the complaint lacks merit.

 

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 "NRD Lawsuit"). 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 November 2011, the Metropolitan Council filed a motion to intervene and a complaint in the NRD Lawsuit seeking compensatory damages 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, including the installation and maintenance of a water treatment system. The 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 bio solids from one or more of its wastewater treatment plants onto agricultural lands and local area landfills. Accordingly, 3M's complaint against the Metropolitan Council asks that if the court finds that the State is entitled to any of the damages it seeks, 3M be awarded 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 April 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 the State and Covington appealed the court's disqualification to the Minnesota Court of Appeals. In July 2013, the Minnesota Court of Appeals affirmed the district court's disqualification order. In October 2013, the Minnesota Supreme Court granted both the State's and Covington's petition for review of the decision of the Minnesota Court of Appeals. In April 2014, the Minnesota Supreme Court affirmed in part, reversed in part, and remanded the case to the district court for further proceedings. The district court took evidence on the disqualification issues at a hearing in October 2015. In February 2016, the district court ruled that Covington violated the professional ethics rule against representing a client (here the State of Minnesota) in the same or substantially related matter where that person's interests are materially adverse to the interests of a former client (3M). The district court, however, denied 3M's motion to disqualify Covington because it further found that 3M impliedly waived by delaying to assert the conflict. Other activity in the case, which had been stayed pending the outcome of the disqualification issue, has resumed. A trial date has not yet been set. In a separate but related action, the Company filed suit against Covington for breach of its fiduciary duties to the Company and for breach of contract arising out of Covington's representation of the State of Minnesota in the NRD Lawsuit.

 

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 any 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.

 

Environmental Liabilities and Insurance Receivables

 

As of June 30, 2016, the Company had recorded liabilities of $47 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 June 30, 2016, the Company had recorded liabilities of $33 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 June 30, 2016, 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 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 filed a declaratory judgment action in and successfully moved the litigation to the U.S. 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 constituted 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 was 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. In April, 2014, the court issued an order denying 3M's motions to set aside the jury's verdict. In addition, the court found two 3M patents unenforceable due to inequitable conduct. The court accepted the special master's recommendation as to the amount of attorneys' fees to be awarded as damages, and entered judgment against 3M in the amount of approximately $26 million. In July 2014, 3M filed a notice of appeal of the judgment to the U.S. Court of Appeals for the Federal Circuit. In February, 2016, the U.S. Court of Appeals for the Federal Circuit issued its decision affirming the lower court's judgment. In March 2016, 3M paid TransWeb $27 million in full satisfaction of the judgment.

 

Andover Healthcare filed an infringement suit against 3M in May 2013 in the U.S. District Court for the District of Delaware. Andover also filed a related infringement action against 3M and 3M Deutschland GmbH in December 2013 in Mannheim, Germany. In both cases, Andover alleges that certain of 3M's self-adherent wraps, including Coban™ Latex Free and Nexcare™ No Hurt Latex Free wraps, infringe Andover's U.S. and German patents. 3M denies that it infringes Andover's patents, asserts that the patents are invalid, and claims that Andover should be precluded from any recovery, in part because of its long delay in bringing this action. 3M and Andover have each filed motions for summary judgment. A hearing on the motions is scheduled in August 2016. Trial in the U.S. matter is scheduled for November 2016. A hearing in the German infringement case occurred in September 2014. In November 2014, the German trial court issued a decision ordering the appointment of an expert to assist with analysis of whether 3M's products infringe Andover's German patent. Separately, 3M filed a nullity action in Germany, challenging the validity of Andover's German patent. At a hearing in July 2015, the German patent court revoked Andover's German patents. Andover has appealed that decision and, in April 2016, the German trial court stayed the infringement proceedings during the pendency of Andover's appeal. No liability has been recorded in the Andover litigation, as the Company believes that any such liability is not probable and estimable.

 

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 claims were caused by allegedly 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 and that EDF thoroughly analyzed and tested the splices 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 submitted his report to the commercial court in May 2014. The expert found potential defects in 3M's product and found that EDF incurred damages in excess of 100 million euros. The expert's opinion was not dispositive of liability or damages and subject to numerous factual and legal challenges that could be raised with the court. In June 2016, the parties reached an agreement to resolve this dispute; the agreement includes confidential terms that, when taking into account 3M's insurance coverage, were not material to the Company's consolidated results of operations or financial condition.

 

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 allegedly 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. Those two cases are still pending. 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 the same 3M filters used in that customer's manufacturing process; the Company has resolved the claims in the German litigation. The Company has also settled without litigation the claims of two other customers arising out of the same issue. The amounts paid are not material to the Company's consolidated results of operations or financial condition.

 

As of June 30, 2016, the Company is a named defendant in approximately 437 lawsuits (compared to approximately 122 lawsuits at December 31, 2015), most of which are pending in federal or state court in Minnesota, in which the plaintiffs claim they underwent various joint arthroplasty, cardiovascular, and other surgeries and later developed surgical site infections due to the use of the Bair Hugger™ patient warming system. The complaints seek damages and other relief based on theories of strict liability, negligence, breach of express and implied warranties, failure to warn, design and manufacturing defect, fraudulent and/or negligent misrepresentation/concealment, unjust enrichment, and violations of various state consumer fraud, deceptive or unlawful trade practices and/or false advertising acts. One case, from the U.S. District Court for the Western District of Tennessee is a putative nationwide class action. The U.S. Judicial Panel on Multidistrict Litigation (MDL) granted the plaintiffs' motion to transfer and consolidate all cases pending in federal courts to the U.S. District Court for the District of Minnesota to be managed in a multi-district proceeding during the pre-trial phase of the litigation. In June 2016, the Company was served with a putative class action filed in the Ontario Superior Court of Justice for all Canadian residents who underwent various joint arthroplasty, cardiovascular, and other surgeries and later developed surgical site infections due to the use of the Bair Hugger™ patient warming system. The representative plaintiff seeks relief (including punitive damages) under Canadian law based on theories similar to those asserted in the MDL The Bair Hugger™ product line was acquired by 3M as part of the 2010 acquisition of Arizant, Inc., a leading manufacturer of patient warming solutions designed to prevent hypothermia and maintain normal body temperature in surgical settings. No liability has been recorded for this matter because the Company believes that any such liability is not probable and estimable at this time.

 

In September 2011, 3M Oral Care launched Lava Ultimate CAD/CAM dental restorative material. The product was originally indicated for inlay, onlay, veneer, and crown applications. In June 2015, 3M Oral Care voluntarily removed crown applications from the product's instructions for use, following reports from dentists of patients' crowns debonding, requiring additional treatment. The product remains on the market for other applications. 3M communicated with the U.S. Food and Drug Administration, as well as regulators outside the United States. 3M also informed customers and distributors of its action, offered to accept return of unused materials and provide refunds. In the second quarter of 2016 and in July, six complaints were filed in the U.S. District Court for the District of Minnesota and one complaint was filed in the U.S. District Court for the Southern District of Florida each seeking certification of a class action of dentists in the United States and its territories related to the Lava Ultimate dental crowns. The complaints allege 3M marketed and sold defective Lava Ultimate dental crowns to dentists throughout the country and, under various theories, seek monetary damages (replacement costs and business reputation loss), disgorgement of profits, injunction from marketing and selling Lava Ultimate for use in dental crowns, statutory penalties, and attorneys' fees. The plaintiffs in one of the cases filed in the District of Minnesota have moved the MDL to transfer and consolidate all pending cases to the District of Minnesota to be managed in an MDL proceeding during the pre-trial phase of the litigation.  3M opposed that motion and filed a motion instead to transfer the one case pending in the Southern District of Florida to the District of Minnesota where it can be consolidated with the other six pending cases for both pretrial and trial. Oral argument on the MDL motion occurred in July 2016. No liability has been recorded for this matter because the Company believes that any such liability is not probable and estimable at this time.

 

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 13. Stock-Based Compensation

 

The 3M 2008 Long-Term Incentive Plan (LTIP), as discussed in 3M's Current Report on Form 8-K dated May 17, 2016 (which updated 3M's 2015 Annual Report on Form 10-K), provides for the issuance or delivery of up to 100 million shares of 3M common stock (including additional shareholder approvals subsequent to 2008) pursuant to awards granted under the plan. In May 2016, shareholders approved the 2016 LTIP, providing an additional 23,965,000 shares, increasing the number of approved shares to 123,965,000 shares. The 2016 LTIP succeeds the 3M 2008 LTIP. Awards may be issued in the form of incentive stock options, nonqualified stock options, progressive stock options, stock appreciation rights, restricted stock, restricted stock units, other stock awards, and performance units and performance shares. Awards denominated in shares of common stock other than options and Stock Appreciation Rights, count against the 123,965,000 million share limit as 3.38 shares for every one share covered by such award (for full value awards with grant dates prior to May 11, 2010), as 2.87 shares for every one share covered by such award (for full value awards with grant dates on or after May 11, 2010 and prior to May 8, 2012), as 3.50 shares for every one share covered by such award (for full value awards with grant dates on or after of May 8, 2012 and prior to May 10, 2016), or as 2.50 shares for every one share covered by such award (for full value awards with grant dates of May 10, 2016 or later). The remaining total shares available for grant under the LTIP Program are 35,753,024 as of June 30, 2016.

 

The Company's annual stock option and restricted stock unit grant is made in February to provide a strong and immediate link between the performance of individuals during the preceding year and the size of their annual stock compensation grants. The grant to eligible employees uses the closing stock price on the grant date. Accounting rules require recognition of expense under a non-substantive vesting period approach, requiring compensation expense recognition when an employee is eligible to retire. Employees are considered eligible to retire at age 55 and after having completed ten years of service. This retiree-eligible population represents 35 percent of the 2016 annual grant stock-based compensation award expense dollars; therefore, higher stock-based compensation expense is recognized in the first quarter.

 

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

 

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

 

During the first quarter of 2016, the Company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The adoption is required to be implemented prospectively and resulted in income tax benefits of $59 million and $140 million in the second quarter and first six months of 2016, respectively. See Note 1 for additional information regarding ASU No. 2016-09.

 

Stock-Based Compensation Expense

 

		Three months ended						Six months ended
		June 30,						June 30,
(Millions)		2016			2015			2016			2015
Cost of sales		$	8		$	8		$	31		$	31
Selling, general and administrative expenses			34			35			130			123
Research, development and related expenses			7			6			32			33
Stock-based compensation expenses		$	49		$	49		$	193		$	187
Income tax benefits		$	(72)		$	(14)		$	(199)		$	(61)
Stock-based compensation expenses (benefits), net of tax		$	(23)		$	35		$	(6)		$	126

 

Stock Option Program

 

The following table summarizes stock option activity during the six months ended June 30, 2016:

 

							Weighted
				Weighted			Remaining		Aggregate
		Number of		Average			Contractual		Intrinsic Value
		Options		Exercise Price			Life (months)		(millions)
Under option -
January 1		38,552,445		$	102.01
Granted:
Annual		5,591,727			147.99
Exercised		(6,201,880)			86.81
Canceled		(136,887)			147.97
June 30		37,805,405		$	111.14		74		$	2,419
Options exercisable
June 30		26,739,297		$	95.14		61		$	2,139

 

Stock options vest over a period from one year to three years with the expiration date at 10 years from date of grant. As of June 30, 2016, there was $105 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 24 months. The total intrinsic values of stock options exercised were $469 million and $366 million during the six months ended June 30, 2016 and 2015, respectively. Cash received from options exercised was $534 million and $376 million for the June 30, 2016 and 2015, respectively. The Company's actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $173 million and $136 million for the six months ended June 30, 2016 and 2015, respectively.

 

For the primary 2016 annual stock option grant, the weighted average fair value at the date of grant was calculated using the Black-Scholes option-pricing model and the assumptions that follow.

 

Stock Option Assumptions

 

 

		Annual
		2016
Exercise price		$	147.87
Risk-free interest rate			1.5	%
Dividend yield			2.5	%
Expected volatility			20.8	%
Expected life (months)			77
Black-Scholes fair value		$	22.47

 

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2016 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.

 

Restricted Stock and Restricted Stock Units

 

The following table summarizes restricted stock and restricted stock unit activity during the six months ended June 30, 2016:

				Weighted
				Average
		Number of		Grant Date
		Awards		Fair Value
Nonvested balance -
As of January 1		2,441,088		$	127.47
Granted
Annual		749,068			148.20
Other		7,278			167.80
Vested		(882,421)			102.20
Forfeited		(30,014)			142.64
As of June 30		2,284,999		$	143.95

 

As of June 30, 2016, there was $120 million of compensation expense that has yet to be recognized related to non-vested restricted stock units and restricted stock. This expense is expected to be recognized over the remaining weighted-average vesting period of 26 months. The total fair value of restricted stock units and restricted stock that vested during the six months ended June 30, 2016 and 2015 was $136 million and $157 million, respectively. The Company's actual tax benefits realized for the tax deductions related to the vesting of restricted stock units and restricted stock was $51 million and $58 million for the six months ended June 30, 2016 and 2015, respectively.

 

Restricted stock units granted generally vest three years following the grant date assuming continued employment. Dividend equivalents equal to the dividends payable on the same number of shares of 3M common stock accrue on these restricted stock units during the vesting period, although no dividend equivalents are paid on any of these restricted stock units that are forfeited prior to the vesting date. Dividends are paid out in cash at the vest date on restricted stock units. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average restricted stock unit shares outstanding are included in the computation of diluted earnings per share.

 

Performance Shares

 

Instead of restricted stock units, the Company makes annual grants of performance shares to members of its executive management. The 2016 performance criteria for these performance shares (organic volume growth, return on invested capital, free cash flow conversion, and earning per share growth) were selected because the Company believes that they are important drivers of long-term stockholder value. The number of shares of 3M common stock that could actually be delivered at the end of the three-year performance period may be anywhere from 0% to 200% of each performance share granted, depending on the performance of the Company during such performance period. Non-substantive vesting requires that expense for the performance shares be recognized over one or three years depending on when each individual became a 3M executive. Prior to the 2016 performance share grant, performance shares did not accrue dividends during the performance period. Therefore, the grant date fair value was determined by reducing the closing stock price on the date of grant by the net present value of dividends during the performance period. The 2016 performance share grant accrues dividends, therefore the grant date fair value is equal to the closing stock price on the date of grant. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average performance shares whose performance period is complete are included in computation of diluted earnings per share.

 

The following table summarizes performance share activity during the six months ended June 30, 2016:

 

				Weighted
				Average
		Number of		Grant Date
		Awards		Fair Value
Undistributed balance -
As of January 1		871,192		$	120.89
Granted		211,021			159.50
Distributed		(367,428)			99.06
Performance change		(69,743)			161.40
Forfeited		(17,488)			146.65
As of June 30		627,554		$	141.44

 

As of June 30, 2016, there was $27 million of compensation expense that has yet to be recognized related to performance shares. This expense is expected to be recognized over the remaining weighted-average earnings period of 10 months. The total fair values of performance shares that were distributed were $54 million for both the six months ended June 30, 2016 and 2015. The Company's actual tax benefits realized for the tax deductions related to the distribution of performance shares were $15 million for both the six months ended June 30, 2016 and 2015.

 

NOTE 14. Business Segments

 

3M's businesses are organized, managed and internally grouped into segments based on differences in markets, products, technologies and services. 3M manages its operations in five business segments: Industrial; Safety and Graphics; Health Care; Electronics and Energy; 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. 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 2016, 3M made a product line reporting change involving two of its business segments in its continuing effort to improve the alignment of its businesses around markets and customers.

 

The change between business segments was as follows:

·      Elements of the electronic bonding product lines were previously separately reflected in the Electronics Materials Solutions Division (Electronics and Energy business segment) and the Industrial Adhesives and Tapes Division (Industrial business segment). Effective in the first quarter of 2016, certain sales and operating income results for these electronic bonding product lines in aggregate were equally divided between the Electronics and Energy business segment and Industrial business segment. This change resulted in a decrease in net sales and operating income for total year 2015 of $33 million and $7 million, respectively, in the Industrial business segment offset by a corresponding increase in the Electronics and Energy business segment.

 

The financial information presented herein reflects the impact of the preceding product line reporting change between business segments for all periods presented.

 

Business Segment Information

 

		Three months ended						Six months ended
		June 30,						June 30,
(Millions)		2016			2015			2016			2015
Net Sales
Industrial		$	2,631		$	2,632		$	5,207		$	5,288
Safety and Graphics			1,499			1,432			2,911			2,804
Health Care			1,404			1,364			2,787			2,693
Electronics and Energy			1,181			1,312			2,325			2,636
Consumer			1,130			1,111			2,179			2,159
Corporate and Unallocated			4			(4)			5			(2)
Elimination of Dual Credit			(187)			(161)			(343)			(314)
Total Company		$	7,662		$	7,686		$	15,071		$	15,264
Operating Income
Industrial		$	615		$	608		$	1,232		$	1,204
Safety and Graphics			411			364			756			699
Health Care			460			440			915			848
Electronics and Energy			229			278			437			563
Consumer			281			259			519			499
Corporate and Unallocated			(88)			(74)			(129)			(174)
Elimination of Dual Credit			(42)			(35)			(76)			(69)
Total Company		$	1,866		$	1,840		$	3,654		$	3,570

 

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 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 with such sales. The offset to the dual credit business segment reporting is reflected as a reconciling item entitled "Elimination of Dual Credit," such that sales and operating income for the U.S. in total are unchanged.