10-K 1 a06-1861_110k.htm ANNUAL REPORT PURSUANT TO SECTION 13 AND 15(D)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

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

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2005

 

Commission file number 1-3285

 

3M COMPANY

 

State of Incorporation: Delaware

 

I.R.S. Employer Identification No. 41-0417775

Principal executive offices: 3M Center, St. Paul, Minnesota 55144

Telephone number: (651) 733-1110

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

Name of each exchange

Title of each class

 

on which registered

Common Stock, Par Value $.01 Per Share

 

New York Stock Exchange, Inc.

 

 

Pacific Exchange, Inc.

 

 

Chicago Stock Exchange, Inc.

 

Note: The common stock of the Registrant is also traded on the SWX Swiss Exchange.

Securities registered pursuant to section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ý.  No  o.

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o.  No  ý.

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ý      Accelerated filer  o      Non-accelerated filer  o

 

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

 

The aggregate market value of voting stock held by nonaffiliates of the Registrant, computed by reference to the closing price and shares outstanding, was approximately $54.9 billion as of January 31, 2006 (approximately

$55.3 billion as of June 30, 2005, the last business day of the Registrant’s most recently completed second quarter).

 

Shares of common stock outstanding at January 31, 2006: 754,988,840.

 

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Company’s definitive proxy statement (to be filed pursuant to Regulation 14A within 120 days after Registrant’s fiscal year end of December 31, 2005) for its annual meeting to be held on May 9, 2006, are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.

 

This document (excluding exhibits) contains 80 pages.

The table of contents is set forth on page 2.  The exhibit index begins on page 78.

 

 



 

3M COMPANY

FORM 10-K

For the Year Ended December 31, 2005

TABLE OF CONTENTS

 

 

PAGES

PART I

 

 

ITEM 1

Business

3-8

 

 

 

ITEM 1A

Risk Factors

9-10

 

 

 

ITEM 1B

Unresolved Staff Comments

10

 

 

 

ITEM 2

Properties

10

 

 

 

ITEM 3

Legal Proceedings

10

 

 

 

ITEM 4

Submission of Matters to a Vote of Security Holders

10

 

 

 

PART II

 

 

ITEM 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

10-11

 

 

 

ITEM 6

Selected Financial Data

12

 

 

 

ITEM 7

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

13-32

 

 

 

ITEM 7A

Quantitative and Qualitative Disclosures About Market Risk

32

 

 

 

ITEM 8

Financial Statements and Supplementary Data

33-76

 

 

 

 

Index to Financial Statements

33

 

 

 

ITEM 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

76

 

 

 

ITEM 9A

Controls and Procedures

76

 

 

 

ITEM 9B

Other Information

76

 

 

 

PART III

 

 

ITEM 10

Directors and Executive Officers of the Registrant

76-77

 

 

 

ITEM 11

Executive Compensation

77

 

 

 

ITEM 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

77

 

 

 

ITEM 13

Certain Relationships and Related Transactions

77

 

 

 

ITEM 14

Principal Accounting Fees and Services

77

 

 

 

PART IV

 

 

ITEM 15

Exhibits, Financial Statement Schedules

78-79

 

 

 

 

Index to Exhibits

78-79

 

2



 

3M COMPANY

FORM 10-K

For the Year Ended December 31, 2005

PART I

 

Item 1. Business.

 

3M Company, formerly known as Minnesota Mining and Manufacturing Company, was incorporated in 1929 under the laws of the State of Delaware to continue operations begun in 1902. The Company’s ticker symbol is MMM. As used herein, the term “3M” or “Company” includes 3M Company and its subsidiaries unless the context indicates otherwise.

 

Available Information

The Company files annual reports, quarterly reports, proxy statements and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov.

 

The corporation also makes available free of charge through its website (http://investor.3M.com) the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC.

 

General

3M is a diversified technology company with a global presence in the following businesses: health care; industrial; display and graphics; consumer and office; safety, security and protection services; electronics and telecommunications; and transportation. 3M is among the leading manufacturers of products for many of the markets it serves. Most 3M products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies.

 

At December 31, 2005, the Company employed 69,315 people, with 33,033 employed in the United States and 36,282 employed internationally.

 

Business Segments

In 2005, 3M managed its operations in seven operating business segments: Health Care; Industrial; Display and Graphics; Consumer and Office; Electro and Communications; Safety, Security and Protection Services; and Transportation. 3M’s seven business segments bring together common or related 3M technologies, enhancing the development of innovative products and services and providing for efficient sharing of business resources. These segments have worldwide responsibility for virtually all 3M product lines. Certain small businesses and staff-sponsored products, as well as various corporate assets and expenses, are not allocated to the business segments. Financial information and other disclosures relating to 3M’s business segments and operations in major geographic areas are provided in the Notes to Consolidated Financial Statements.

 

Effective January 1, 2006, 3M combined its Industrial and Transportation business segments. This new segment will leverage common markets, sales channels and customers, technologies, manufacturing facilities and selling processes. This combination will provide additional efficiencies that will be reinvested in growth. The results for the new Industrial and Transportation segment can be approximated by combining the existing Industrial and Transportation segments. In addition, during the first quarter of 2006, the Personal Care Division (2005 annual sales of approximately $600 million) within the Health Care segment transferred to the combined Industrial and Transportation segment. Segment information for all periods presented will be reclassified in 2006 to reflect the combined Industrial and Transportation segment in addition to the transfer of the Personal Care Division.

 

Health Care Business: The Health Care segment serves markets that include medical, surgical, pharmaceutical, dental and orthodontic, health information systems and personal care. Products provided to these markets include medical and surgical supplies, skin health and infection prevention products, pharmaceuticals, drug delivery systems, dental and orthodontic products, health information systems, microbiology products, and closures for disposable diapers.

 

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In the medical and surgical area, 3M is a supplier of medical tapes, dressings, wound closure products, orthopedic casting materials, electrodes and stethoscopes. In infection prevention, 3M markets a variety of surgical drapes, masks and preps, as well as sterilization assurance equipment. Pharmaceutical products include immune response modifiers, respiratory products and women’s health products. Other products include drug delivery systems, such as metered-dose inhalers, transdermal skin patches and related components. Dental and orthodontic products include restoratives, adhesives, finishing and polishing products, crowns, impression materials, preventive sealants, professional tooth whiteners, prophylaxis and orthodontic appliances.

 

In health information systems, 3M develops and markets computer software for hospital coding and data classification, as well as providing related consulting services. 3M provides microbiology products that make it faster and easier for food processors to test the microbiological quality of food. Tape closures for disposable diapers, and reclosable fastening systems and other diaper components, help disposable diapers fit better.

 

Industrial Business: The Industrial segment serves a broad range of industrial markets, from appliance and electronics to paper and packaging and food and beverage. Products include tapes, a wide variety of coated and nonwoven abrasives, adhesives, specialty materials and supply chain execution software solutions. The August 2005 acquisition of CUNO, Incorporated (“CUNO”) adds a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases.

 

Major product lines include vinyl, polyester, foil and specialty industrial tapes and adhesives; Scotch® Masking Tape, Scotch® Filament Tape and Scotch® Packaging Tape; packaging equipment; 3M™ VHB™ Bonding Tapes; conductive, low surface energy, hot melt, spray and structural adhesives; reclosable fasteners; label materials for durable goods; and coated, nonwoven and microstructured surface finishing and grinding abrasives for the industrial market. Other products include fluoroelastomers for seals, tubes and gaskets in engines; engineering fluids; and supply chain execution software and solutions.  3M acquired CUNO in August 2005. CUNO is engaged in the design, manufacture and marketing of a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases. 3M and CUNO have complementary sets of filtration technologies and the opportunity to bring an even wider range of filtration solutions to customers around the world.

 

Display and Graphics Business: The Display and Graphics segment serves markets that include electronic display, touch screen, traffic safety and commercial graphics. This segment includes optical film and lens solutions for electronic displays; touch screens and touch monitors; reflective sheeting for transportation safety; and commercial graphics systems.

 

The optical film business provides films that serve numerous market segments of the display lighting industry. 3M provides distinct products for five market segments, including products for: 1) LCD computer monitors 2) LCD televisions 3) handheld devices such as cellular phones 4) notebook PCs and 5) automotive displays. Additional optical products include touch screens, touch monitors and lens systems for projection televisions. In traffic safety systems, 3M provides reflective sheetings used on highway signs, vehicle license plates, construction workzone devices, trucks and other vehicles, and also provides pavement marking systems. 3M’s Intelligent Transportation Systems include emergency response and transit signal priority systems, traffic monitoring systems, and driver feedback signs. Major commercial graphic products include equipment, films, inks and related products used to produce graphics for vehicles and signs.

 

Consumer and Office Business: The Consumer and Office segment serves markets that include consumer retail, office retail, education, home improvement, building maintenance and other markets. Products in this segment include office supply products, stationery products, construction and home improvement products, home care products, protective material products (including consumer health care products such as bandages), and visual systems products.

 

Major consumer and office products include Scotch® brand products like Scotch® Magic Tape, Scotch® Glue Stick and Scotch® Cushioned Mailer; Post-it® Products, such as Post-it® Flags, Post-it® Memo Pads, Post-it® Labels, and Post-it® Pop-up Notes and Dispensers; construction and home improvement products, including surface-preparation and wood-finishing materials and Command Adhesive products; home care products, including Scotch-Brite® Scour Pads, Scotch-Brite® Scrub Sponges, Scotch-Brite® Microfiber Cloth products, O-Cel-O™ Sponges and Scotchgard™ Fabric Protectors; protective material products, including Filtrete™ Filters for furnaces and air conditioners, and 3M™ Nexcare™ Adhesive Bandages. Visual communication products serve the world’s office and education markets with overhead projectors and transparency films, plus equipment and materials for electronic and multimedia presentations.

 

4



 

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

 

Major electronic and electrical products include packaging and interconnection devices; high-performance fluids used in the manufacture of computer chips, and for electronics cooling and lubricating of computer hard disk drives; high- temperature and display tapes; insulating materials, including pressure-sensitive tapes and resins; and related items. 3M™ Flexible Circuits use electronic packaging and interconnection technology, providing more connections in less space, and are used in ink-jet print cartridges, cell phones and electronic devices. This segment serves the world’s telecommunications companies with a wide array of products for fiber-optic and copper-based telecommunications systems.

 

Safety, Security and Protection Services Business: The Safety, Security and Protection Services segment serves a broad range of markets that strive to increase the safety, security and productivity of workers, facilities and systems. Major product offerings include personal protection products, safety and security products, energy control products, cleaning and protection products for commercial establishments, and roofing granules for asphalt shingles.

 

This segment’s products include maintenance-free and reusable respirators, electronic surveillance products, films that protect against counterfeiting, and reflective materials that are widely used on apparel, footwear and accessories, enhancing visibility in low-light situations. Other products include theft protection systems for libraries and library patron self-checkout systems; spill-control sorbents; Thinsulate™ Insulation and Thinsulate™ Lite Loft™ Insulation; 3M ScotchtintWindow Film for buildings; 3M ScotchshieldUltra Safety and Security Film for property; nonwoven abrasive materials for floor maintenance and commercial cleaning; floor matting; and natural and color-coated mineral granules for asphalt shingles. In March 2004, 3M completed the acquisition of Hornell Holding AB, a global supplier of personal protective equipment.

 

Transportation Business: The Transportation segment serves markets that include automotive, automotive aftermarket, marine, aerospace and specialty vehicle markets. This segment provides components and products that are used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles.

 

Major product categories include insulation components, including components for catalytic converters; functional and decorative graphics; abrasion-resistant films; masking tapes; fasteners and tapes for attaching nameplates, trim, moldings, interior panels and carpeting; coated, nonwoven and microstructured finishing and grinding abrasives; structural adhesives; and other specialty materials. This segment also provides paint finishing and detailing products, including a complete system of cleaners, dressings, polishes, waxes and other products.

 

Distribution

3M products are sold through numerous distribution channels. Products are sold directly to users and through numerous wholesalers, retailers, jobbers, distributors and dealers in a wide variety of trades in many countries around the world. Management believes the confidence of wholesalers, retailers, jobbers, distributors and dealers in 3M and its products, developed through long association with skilled marketing and sales representatives, has contributed significantly to 3M’s position in the marketplace and to its growth. 3M has 188 sales offices worldwide, with 15 in the United States and 173 internationally.

 

Research and Patents

Research and product development constitute an important part of 3M’s activities. Products resulting from research and development have been a major driver of 3M’s growth. Research, development and related expenses totaled $1.242 billion in 2005, $1.194 billion in 2004 and $1.147 billion in 2003. Research and development, covering basic scientific research and the application of scientific advances to the development of new and improved products and their uses, totaled $798 million in 2005, $759 million in 2004 and $749 million in 2003.  Related expenses primarily include technical support provided to customers for existing products by 3M laboratories and costs of internally developed patents.

 

The Company’s products are sold around the world under various trademarks that are important to the Company. The Company also owns, or holds licenses to use, numerous U.S. and foreign patents. The Company’s research and development activities continuously generate inventions that are covered by new patents. Patents applicable to specific products extend for varying periods according to the date of patent application filing or patent grant and the

 

5



 

legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country.

 

The Company believes that its patents provide an important competitive advantage in many of its businesses. In general, no single patent or group of related patents is in itself essential to the Company as a whole or to any of the Company’s business segments. The importance of patents in the Health Care and Display and Graphics segments is described in “Performance by Business Segment” — “Health Care Business” and “Display and Graphics Business” in Part II, Item 7, of this Form 10-K.

 

Raw Materials

In 2005, the Company experienced both price increases and supply limitations affecting several oil-derived raw materials, but to date the Company is receiving sufficient quantities of such materials to meet its reasonably foreseeable production requirements. It is impossible to predict future shortages of raw materials or the impact any such shortages would have. Hurricanes Katrina and Rita resulted in tight supply conditions and significant increases in energy costs, fuel surcharges and prices for certain natural gas and petroleum related raw materials. 3M has avoided disruption to its manufacturing operations through careful management of existing raw material inventories and development and qualification of additional supply sources. 3M manages commodity price risks through negotiated supply contracts, price protection agreements and forward physical contracts.

 

Environmental Law Compliance

3M’s manufacturing operations are affected by national, state and local environmental laws around the world. 3M has made, and plans to continue making, necessary expenditures for compliance with applicable laws. 3M is also involved in remediation actions relating to environmental matters from past operations at certain sites (refer to “Environmental Liabilities and Insurance Receivables” in Note 11 Commitments and Contingencies).

 

Environmental expenditures relating to existing conditions caused by past operations that do not contribute to current or future revenues are expensed. Liabilities for remediation costs are recorded 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. Environmental expenditures for capital projects that contribute to current or future operations generally are capitalized and depreciated over their estimated useful lives.

 

In 2005, 3M expended about $26 million for capital projects related to protecting the environment. The comparable amount in 2004 was about $67 million. These amounts exclude expenditures for remediation actions relating to existing matters caused by past operations. Capital expenditures for environmental purposes have included pollution control devices — such as wastewater treatment plant improvements, scrubbers, containment structures, solvent recovery units and thermal oxidizers — at new and existing facilities constructed or upgraded in the normal course of business. Consistent with the Company’s policies stressing environmental responsibility, capital expenditures (other than for remediation projects) for known projects are presently expected to be about $35 million over the next two years for new or expanded programs to build facilities or modify manufacturing processes to minimize waste and reduce emissions.

 

While the Company cannot predict with certainty the future costs of such cleanup activities, capital expenditures or operating costs for environmental compliance, the Company does not believe they will have a material effect on its capital expenditures, earnings or competitive position.

 

Executive Officers

Following is a list of the executive officers of 3M, their ages, present positions, the years elected to their present positions and other positions held during the past five years. No family relationships exist among any of the executive officers named, nor is there any undisclosed arrangement or understanding pursuant to which any person was selected as an officer. This information is presented as of the date of the 10-K filing (February 21, 2006).

 

6



 

Executive Officers

 

 

 

 

 

 

 

Year
Elected to

 

 

 

 

 

 

 

 

Present

 

Other Positions

Name

 

Age

 

Present Position

 

Position

 

Held During 2001-2006

 

 

 

 

 

 

 

 

 

George W. Buckley

 

58

 

Chairman of the Board, President and Chief Executive Officer

 

2005

 

Chairman and Chief Executive Officer, Brunswick Corporation, 2000-2005

 

 

 

 

 

 

 

 

 

Patrick D. Campbell

 

53

 

Senior Vice President and Chief Financial Officer

 

2002

 

Vice President, Finance, General Motors Europe, Zurich, Switzerland, 2001-2002

Executive Director, Investor Relations and Worldwide Benchmarking, General Motors, Detroit, Michigan, 2000-2001

 

 

 

 

 

 

 

 

 

Joe E. Harlan

 

46

 

Executive Vice President,
Electro and Communications Business

 

2004

 

President and Chairman of the Board, Sumitomo 3M Limited, 2003-2004

Executive Vice President, Sumitomo 3M Limited, 2002-2003

Staff Vice President, Financial Planning and Analysis, 2001-2002

Vice President and Chief Financial Officer, General Electric Lighting, 1999-2001

 

 

 

 

 

 

 

 

 

Jay V. Ihlenfeld

 

54

 

Senior Vice President,
Research and Development

 

2003

 

Vice President, Research and Development, 2002-2003

Executive Vice President, Sumitomo 3M Limited, 2001-2002

Division Vice President, Performance Materials Division, 1999-2001

 

 

 

 

 

 

 

 

 

Angela S. Lalor

 

40

 

Senior Vice President,
Human Resources

 

2006

 

Staff Vice President, Human Resources Operations, 2005

Executive Director, Human Resources Operations, 2004-2005

Director, Compensation and Employee Administration, 2002-2004

Master Black Belt, Human Resources 2001-2002

 

 

 

 

 

 

 

 

 

Jean Lobey

 

53

 

Executive Vice President,
Safety, Security and Protection Services Business

 

2005

 

Managing Director, 3M Brazil, 2003-2004

Executive Director, Six Sigma, Europe and Middle East, 2001-2003

Regional Managing Director, Central Europe Marketing Subsidiaries Region, 2000-2001

 

 

 

 

 

 

 

 

 

Robert D. MacDonald

 

55

 

Senior Vice President,
Marketing and Sales

 

2004

 

Division Vice President, Automotive Aftermarket Division, 2002-2004

Managing Director, 3M Italy, 1999-2002

 

 

 

 

 

 

 

 

 

James T. Mahan

 

59

 

Senior Vice President,
Corporate Supply Chain Operations

 

2005

 

Senior Vice President, Engineering, Manufacturing and Logistics, 2003-2005

Division Vice President, Industrial Adhesives and Tapes Division, 2002-2003

Division Vice President, Engineered Adhesives Division, 2001-2002

Division Vice President, Bonding Systems Division, 1999-2001

 

 

 

 

 

 

 

 

 

Moe S. Nozari

 

63

 

Executive Vice President,
Consumer and Office Business

 

2002

 

Executive Vice President, Consumer and Office Markets, 1999-2002

 

7



 

Executive Officers (continued)

 

 

 

 

 

 

 

Year

 

 

 

 

 

 

 

 

Elected to

 

 

 

 

 

 

 

 

Present

 

Other Positions

Name

 

Age

 

Present Position

 

Position

 

Held During 2001-2006

 

 

 

 

 

 

 

 

 

Frederick J. Palensky

 

56

 

Executive Vice President, Enterprise Services

 

2005

 

Executive Vice President, Safety, Security and Protection Services Business, 2002-2004

Executive Vice President, Specialty Material Markets and Corporate Services, 2001-2002

Vice President and General Manager 3M ESPE, 2001

Division Vice President, Dental Products Division, 1997-2001

 

 

 

 

 

 

 

 

 

Brad T. Sauer

 

46

 

Executive Vice President,
Health Care Business

 

2004

 

Executive Vice President, Electro and Communications Business, 2002-2004

Executive Director, Six Sigma, 2001-2002

Managing Director, 3M Korea Ltd., 1999-2001

 

 

 

 

 

 

 

 

 

Hak Cheol Shin

 

48

 

Executive Vice President, Industrial and Transportation Business

 

2006

 

Executive Vice President, Industrial Business, 2005

Division Vice President, Industrial Adhesives and Tapes Division, 2003-2005

Division Vice President, Electronics Markets Materials Division, 2002-2003

Division Vice President, Superabrasives and Microfinishing Systems Division, 2001-2002

General Manager, Superabrasives and Microfinishing Systems Division, 1999-2001

 

 

 

 

 

 

 

 

 

James B. Stake

 

53

 

Executive Vice President,
Display and Graphics Business

 

2002

 

Division Vice President, Industrial Tape and Specialties Division; and Vice President, Marketing, Industrial Markets, 2002

Division Vice President, Industrial Tape and Specialties Division, 2000-2002

 

 

 

 

 

 

 

 

 

Inge G. Thulin

 

52

 

Executive Vice President, International Operations

 

2004

 

Vice President, Asia Pacific; and Executive Vice President, International Operations, 2003-2004

Vice President, Europe and Middle East, 2002-2003

Division Vice President, Skin Health Division, 2000-2001

 

 

 

 

 

 

 

 

 

Richard F. Ziegler

 

56

 

Senior Vice President,
Legal Affairs and General Counsel

 

2003

 

Partner, Cleary, Gottlieb, Steen & Hamilton, 1983-2002

 

8



 

Item 1A. Risk Factors.

 

The most significant risk factors applicable to the Company are as follows:

 

Results are impacted by the effects of, and changes in, worldwide economic conditions. The Company operates in more than 60 countries and derives approximately 60% of its revenues from outside the United States. The Company’s business may be affected by factors in the United States and other countries that are beyond its control, such as downturns in economic activity in a specific country or region, or in the various industries in which the Company operates; social, political or labor conditions in a specific country or region; or potential adverse changes in tax in the jurisdictions in which the Company operates.

 

The Company’s results are affected by competitive conditions and customer preferences.  Demand for the Company’s products, which impacts revenue and profit margins, is affected by (i) the development and timing of introduction of competitive products; (ii) the Company’s response to downward pricing to stay competitive; (iii) changes in customer order patterns, such as changes in the levels of inventory maintained by customers and the timing of customer purchases which may be affected by announced price changes, changes in the Company’s incentive programs, or the customer’s ability to achieve incentive goals ; and (iv) changes in customers’ preferences for our products, including changes in customer designs for their products that can affect the demand for some of the Company’s products.

 

Foreign currency exchange rates and fluctuations in those rates may affect the Company’s ability to realize projected growth rates in its sales and earnings. Because the Company derives approximately 60% of its revenues from outside the United States, its ability to realize projected growth rates in sales and earnings could be adversely affected if the U.S. dollar strengthens significantly against foreign currencies.

 

The Company’s growth objectives are largely dependent on the timing and market acceptance of its new product offerings, including its ability to renew its pipeline of new products and to bring those products to market. This ability may be adversely affected by difficulties or delays in product development, such as the inability to: identify viable new products; obtain adequate intellectual property protection; gain market acceptance of new products; or successfully complete clinical trials and obtain regulatory approvals. For example, new 3M pharmaceutical products, like any pharmaceutical under development, face substantial risks and uncertainties in the process of development and regulatory review. There are no guarantees that new products will prove to be commercially successful.

 

The Company’s future results are subject to fluctuations in the costs and availability of purchased components, compounds, raw materials and energy, including oil and natural gas and their derivatives, due to shortages, increased demand, supply interruptions, currency exchange risks, natural disasters and other factors. The Company depends on various components, compounds, raw materials, and energy (including oil and natural gas and their derivatives) supplied by others for the manufacturing of its products and it is possible that any of its supplier relationships could be interrupted due to natural and other disasters and other events or terminated in the future. Any sustained interruption in the Company’s receipt of adequate supplies could have a material adverse effect on the Company. In addition, while the Company has a process to minimize volatility in component and material pricing, no assurance can be given that the Company will be able to successfully manage price fluctuations or that future price fluctuations or shortages will not have a material adverse effect on the Company.

 

Acquisitions, strategic alliances, divestitures, and other unusual events resulting from portfolio management actions and other evolving business strategies, and possible organizational restructuring could affect future results. The Company monitors its business portfolio and organizational structure and has made and may continue to make acquisitions, strategic alliances, divestitures and changes to its organizational structure. With respect to acquisitions, future results will be affected by the Company’s ability to quickly integrate an acquired business and obtain the anticipated synergies.

 

The Company’s future results may be affected if the Company generates less productivity improvements than estimated. The Company utilizes various tools, such as Six Sigma, to improve operational efficiency and productivity. There can be no assurance that all of the estimated productivity improvements will be realized.

 

The Company’s future results may be affected by various legal and regulatory proceedings, including those involving product liability, antitrust, environmental or other matters. The outcome of these legal proceedings may differ from the Company’s expectations because the outcomes of litigation, including regulatory matters, are often difficult to reliably predict. Various factors or developments can lead the Company to change current estimates of liabilities and related insurance receivables where applicable, or make such estimates for matters previously not

 

9



 

susceptible of reasonable estimates, such as a significant judicial ruling or judgment, significant settlement, significant regulatory development or changes in applicable law. A future adverse ruling, settlement or unfavorable development could result in future charges that could have a material adverse effect on the Company’s results of operations or cash flows in any particular period. A specific factor that could increase the Company’s estimate of its future asbestos-related liabilities is the pending Congressional consideration of legislation to reform asbestos-related litigation and pertinent information derived from that process. For a more detailed discussion of the legal proceedings involving the Company and associated accounting estimates, see the discussion in Note 11 to the Consolidated Financial Statements of this Annual Report on Form 10-K.

 

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

3M’s general offices, corporate research laboratories, and certain division laboratories are located in St. Paul, Minnesota. In the United States, 3M has 15 sales offices in 12 states and operates 59 manufacturing facilities in 23 states. Internationally, 3M has 173 sales offices. The Company operates 80 manufacturing and converting facilities in 29 countries outside the United States.

 

3M owns substantially all of its physical properties. 3M’s physical facilities are highly suitable for the purposes for which they were designed. Because 3M is a global enterprise characterized by substantial intersegment cooperation, properties are often used by multiple business segments.

 

Item 3. Legal Proceedings.

 

Discussion of legal matters is incorporated by reference from Part II, Item 8, Note 11, “Commitments and Contingencies”, of this document, and should be considered an integral part of Part I, Item 3, “Legal Proceedings”.

 

Item 4. Submission of Matters to a Vote of Security Holders.

 

None in the quarter ended December 31, 2005.

 

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Equity compensation plans’ information is incorporated by reference from Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management, of this document, and should be considered an integral part of Item 5. At January 31, 2006, there were approximately 125,823 shareholders of record. 3M’s stock is listed on the New York Stock Exchange, Inc. (NYSE), Pacific Exchange, Inc., Chicago Stock Exchange, Inc., and the SWX Swiss Exchange. Cash dividends declared and paid totaled $.42 per share for each quarter of 2005, and $.36 per share for each quarter of 2004. Stock price comparisons follow:

 

Stock price comparisons (NYSE composite transactions)

 

(Per share amounts)

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

Year

 

2005 High

 

$

87.45

 

$

86.21

 

$

76.74

 

$

79.84

 

$

87.45

 

2005 Low

 

80.73

 

$

72.25

 

70.41

 

69.71

 

69.71

 

2004 High

 

$

86.20

 

$

90.29

 

$

90.11

 

$

83.03

 

$

90.29

 

2004 Low

 

74.35

 

80.90

 

77.20

 

73.31

 

73.31

 

 

10



 

Issuer Purchases of Equity Securities

 

Repurchases of common stock are made to support the Company’s stock-based employee compensation plans and for other corporate purposes. On November 8, 2004, the Board of Directors authorized the purchase of $2.0 billion of the Company’s common stock between January 1, 2005 and January 31, 2006. In October 2005, 3M’s Board of Directors authorized the repurchase of an additional $300 million of the Company’s common stock through January 31, 2006. This increased the total repurchase authorization to $2.3 billion through January 31, 2006.

 

Issuer Purchases of Equity Securities (registered pursuant to Section 12 of the Exchange Act)

 

Period

 

Total Number of Shares
Purchased(1)

 

Average Price
Paid per Share

 

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

 

Maximum Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs

 

 

 

 

 

 

 

 

 

(Millions)

 

January 1-31, 2005

 

2,333,811

 

$

82.66

 

2,245,000

 

$

1,814

 

February 1-28, 2005

 

2,111,948

 

$

84.58

 

1,775,500

 

$

1,665

 

March 1-31, 2005

 

3,490,467

 

$

85.76

 

3,411,800

 

$

1,372

 

Total January 1 — March 31, 2005

 

7,936,226

 

$

84.53

 

7,432,300

 

$

1,372

 

April 1-30, 2005

 

879,751

 

$

84.67

 

863,000

 

$

1,299

 

May 1-31, 2005

 

2,572,923

 

$

77.22

 

2,439,000

 

$

1,111

 

June 1-30, 2005

 

3,146,737

 

$

76.47

 

3,115,000

 

$

872

 

Total April 1 — June 30, 2005

 

6,599,411

 

$

77.86

 

6,417,000

 

$

872

 

July 1-31, 2005

 

2,389,531

 

$

73.96

 

2,353,700

 

$

698

 

August 1-31, 2005

 

3,415,930

 

$

72.05

 

3,398,300

 

$

453

 

September 1-30, 2005

 

2,754,191

 

$

73.06

 

2,734,300

 

$

254

 

Total July 1 — September 30, 2005

 

8,559,652

 

$

72.91

 

8,486,300

 

$

254

 

October 1-31, 2005

 

1,725,380

 

$

73.78

 

1,658,700

 

$

431

 

November 1-30, 2005

 

2,283,087

 

$

77.24

 

2,237,400

 

$

259

 

December 1-31, 2005

 

3,406,831

 

$

77.74

 

3,271,400

 

$

4

 

Total October 1 — Dec. 31, 2005

 

7,415,298

 

$

76.67

 

7,167,500

 

$

4

 

 

 

 

 

 

 

 

 

 

 

Total January 1 — December 31, 2005

 

30,510,587

 

$

77.92

 

29,503,100

 

$

4

 


(1) The total number of shares purchased includes: (i) shares purchased under the Board’s $2.3 billion authorization described above, and (ii) shares purchased in connection with the exercise of stock options (which combined totaled 88,811 shares in January 2005, 336,448 shares in February 2005, 78,667 shares in March 2005, 16,751 shares in April 2005, 133,923 shares in May 2005, 31,737 shares in June 2005, 35,831 shares in July 2005, 17,630 shares in August 2005, 19,891 shares in September 2005, 66,680 shares in October 2005, 45,687 shares in November 2005, and 135,431 shares in December 2005).

 

11



 

Item 6. Selected Financial Data.

 

(Dollars in millions, except per share amounts)

 

2005

 

2004

 

2003

 

2002

 

2001

 

Years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

21,167

 

$

20,011

 

$

18,232

 

$

16,332

 

$

16,054

 

Income before cumulative effect of accounting change

 

3,234

 

2,990

 

2,403

 

1,974

 

1,430

 

Per share of common stock:

 

 

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change — basic

 

4.23

 

3.83

 

3.07

 

2.53

 

1.81

 

Income before cumulative effect of accounting change — diluted

 

4.16

 

3.75

 

3.02

 

2.50

 

1.79

 

Cash dividends declared and paid

 

1.68

 

1.44

 

1.32

 

1.24

 

1.20

 

At December 31:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

20,513

 

$

20,708

 

$

17,600

 

$

15,329

 

$

14,606

 

Long-term debt (excluding portion due within one year) and long-term capital lease obligations

 

1,368

 

798

 

1,805

 

2,142

 

1,520

 

 

The above income and earnings per share information exclude a cumulative effect of accounting change in 2005 ($35 million, or 4 cents per diluted share). Effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004) and will use the modified retrospective method to adjust all prior periods to give effect to the fair-value based method of accounting for stock options. Refer to Note 1 to the Consolidated Financial Statements for more detail on these two items.

 

As discussed in the Notes to Consolidated Financial Statements, 2005 results included charges that reduced net income by $75 million. This relates to a tax liability resulting from 3M’s reinvestment of approximately $1.8 billion of foreign earnings into the United States pursuant to the repatriation provisions of the American Jobs Creation Act of 2004. 2003 results included charges related to an adverse ruling in a lawsuit filed against 3M in 1997 by LePage’s Inc. that reduced operating income by $93 million ($58 million after tax).

 

2002 charges in connection with 3M’s 2001/2002 restructuring plan reduced operating income by $202 million ($108 million after tax and minority interest).  2001 includes net losses that reduced operating income by $504 million ($312 million after tax and minority interest), principally related to charges in connection with 3M’s 2001/2002 restructuring plan, acquisition-related charges, a reversal of a 1999 litigation accrual, and a net gain related to the sale of available-for-sale equity securities, partially offset by the write-down of available-for-sale equity securities.

 

12



 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

OVERVIEW

3M is a diversified global manufacturer, technology innovator and marketer of a wide variety of products. In 2005, 3M managed its operations in seven operating business segments: Health Care; Industrial; Display and Graphics; Consumer and Office; Electro and Communications; Safety, Security and Protection Services; and Transportation. Refer to the Performance by Business Segment section for discussion of segment changes effective in the first quarter of 2006.

 

3M’s 2005 performance demonstrated the operational strength of 3M and the value of the diversification of the 3M business portfolio. 3M’s sourcing organization and the businesses worked together to maintain customer service, while successfully managing the business to avoid supply disruptions in the face of hurricanes and shortages of key raw materials. 3M increased its dividend 16.7%, the 47th consecutive year of 3M dividend increases, and repurchased $2.3 billion of stock under its stock repurchase authorization. The combination of dividends and stock buy-backs returned a total of $3.6 billion to shareholders during 2005. 3M also acquired CUNO, a liquid filtration company.

 

In 2005, 3M reported record net sales of $21.167 billion and record net income of $3.199 billion, or $4.12 per diluted share, compared with net sales of $20.011 billion and net income of $2.990 billion, or $3.75 per diluted share, in 2004. The combination of a 5.8% increase in net sales, including core local-currency sales growth of 4.1% (which excludes the impact of businesses acquired in the last 12 months), and declining manufacturing costs as a percent of sales, resulted in a 23.7% operating income profit margin.

 

In 2005, income before cumulative effect of accounting change totaled $3.234 billion, or $4.16 per diluted share. As of December 31, 2005, 3M adopted Financial Accounting Standards Board Interpretation (FASB) No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). The adoption of FIN 47 resulted in an after tax charge of $35 million, which is reflected as a cumulative change in accounting principle (refer to Note 1 to the Consolidated Financial Statements for more detail). In addition, during 2005, 3M completed its evaluation of the repatriation provision of the American Jobs Creation Act of 2004 and repatriated approximately $1.8 billion of foreign earnings into the U.S. pursuant to its provisions. As a consequence, in the second quarter of 2005, 3M recorded a tax expense of $75 million, net of available foreign tax credits. Combined, these two items reduced net income by $110 million in 2005.

 

The following table contains sales and operating income results by business segment for the years ended December 31.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005 vs. 2004

 

 

 

2005

 

2004

 

% change

 

 

 

Net

 

% of

 

Oper.

 

Net

 

% of

 

Oper.

 

Net

 

Oper.

 

(Dollars in millions)

 

Sales

 

Total

 

Income

 

Sales

 

Total

 

Income

 

Sales

 

Income

 

Business Segments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Health Care

 

$

4,373

 

20.7

%

$

1,215

 

$

4,230

 

21.1

%

$

1,123

 

3.4

%

8.2

%

Industrial

 

3,806

 

18.0

%

735

 

3,444

 

17.2

%

610

 

10.5

%

20.5

%

Display and Graphics

 

3,558

 

16.8

%

1,159

 

3,416

 

17.1

%

1,133

 

4.2

%

2.3

%

Consumer and Office

 

2,986

 

14.1

%

576

 

2,861

 

14.3

%

542

 

4.4

%

6.3

%

Electro and Communications

 

2,333

 

11.0

%

463

 

2,224

 

11.1

%

342

 

4.9

%

35.4

%

Safety, Security and Protection Services

 

2,292

 

10.8

%

553

 

2,125

 

10.6

%

491

 

7.9

%

12.6

%

Transportation

 

1,772

 

8.4

%

461

 

1,674

 

8.4

%

426

 

5.8

%

8.1

%

Corporate and Unallocated

 

47

 

0.2

%

(153

)

37

 

0.2

%

(89

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Company

 

$

21,167

 

100

%

$

5,009

 

$

20,011

 

100

%

$

4,578

 

5.8

%

9.4

%

 

3M’s performance in 2005 was broad-based, with all seven business segments contributing to positive local-currency sales growth. Sales growth in Health Care was led by 3M’s core medical and dental businesses and strong growth in health information systems, which helped overcome the growth challenges of the pharmaceuticals and personal care businesses. Sales growth in the Industrial segment was led by industrial adhesives and tapes, as well as the abrasives businesses. The CUNO acquisition added 5.1% to Industrial sales growth.  Display and Graphics sales growth in display enhancement films used in flat-panel devices was partially offset by the continued decline in lens systems for

 

13



 

the CRT rear projection television market along with the phase out of the commercial videotape business. Sales growth in the Consumer and Office segment was broad-based across the many channels 3M serves, most notably in the mass-market consumer and home improvement retail channels. For the Electro and Communications segment, sales growth was led by demand for 3M electronic products for the semiconductor manufacturers, along with continued strong growth in electrical products for insulating, testing and sensing. Sales growth in the Safety, Security and Protection Services segment was driven by continued strong demand for personal protection products and solutions, particularly respiratory protection products, along with strong demand for cleaning and protection products for commercial buildings. Sales growth in the Transportation segment was led by both the automotive OEM and repair markets. Refer to the Performance by Business Segment section for a more detailed discussion of the results of the respective segments.

 

Geographically, U.S. sales revenue increased 4.9%, Asia Pacific local-currency sales (which exclude translation impacts) increased 10.6%, European local-currency sales increased 0.9%, and the combined Latin America and Canada area local-currency sales increased 1.3%. Refer to the Performance by Geographic Area section for a more detailed discussion of the results for the respective areas.

 

Operating income in 2005 increased by 9.4% versus 2004, as all seven business segments posted increases. The combination of solid sales growth and positive benefits from corporate initiatives helped drive the increase in operating income. The Company estimates that cost reduction projects related to initiatives provided a combined incremental benefit to operating income of approximately $400 million in 2005. These initiatives contributed more than $400 million to operating income in both 2004 and 2003.

 

3M generated $4.258 billion of operating cash flows in 2005, essentially flat when compared to 2004, and ended the year with $1.072 billion of cash and cash equivalents. In 2005, the Company utilized approximately $3.6 billion of cash to repurchase 3M common stock under its share repurchase authorization and to pay dividends, and contributed $788 million to its pension and postretirement plans. 3M’s debt to total capital ratio (total capital defined as debt plus equity) as of December 31, 2005, was approximately 19%. 3M has an AA credit rating from Standard & Poor’s and an Aa1 credit rating from Moody’s Investors Service.

 

The Company experienced both price increases and supply limitations affecting several oil-derived raw materials in 2005, which is expected to carry forward into 2006, but to date the Company is receiving sufficient quantities of such materials to meet its reasonably foreseeable production requirements. It is impossible to predict future shortages of raw materials or the impact any such shortages would have. Hurricanes Katrina and Rita resulted in tight supply conditions and significant increases in energy costs, fuel surcharges and prices for certain natural gas and petroleum-related raw materials and their derivatives. 3M has avoided disruption to its manufacturing operations through careful management of existing raw material inventories and development and qualification of additional supply sources. 3M manages commodity price risks through negotiated supply contracts, price protection agreements and forward physical contracts. Fluctuations in foreign currency exchange rates also impact results, although the Company minimizes this effect through hedging about half of this impact. 3M will also continue, as it has for many years, to incur expenses (insured and uninsured) in managing its litigation and environmental contingencies.

 

In 2006, 3M expects to drive profitable growth by investing in its most promising commercialization, geographic and technology opportunities, with part of this investment coming from savings generated through continuous operational improvements. The Company expects solid sales growth across the majority of its business portfolio. The Company’s long history and unique ability to match technological solutions with the needs of its customers has resulted in a steady flow of new products and solutions, with this trend expected to continue in 2006. In addition, the Company’s increasing focus on products and solutions for emerging economies, such as Asia and Eastern Europe, is expected to foster significant growth in 2006. The Company expects to increase both research and development and capital expenditures in 2006, led primarily by growth programs. Research, development and related expenses totaled $1.242 billion in 2005, or 5.9% of sales. The Company expects 2006 capital expenditures to total approximately $1.1 billion, compared with $943 million in 2005, providing the capacity to meet expected growth.

 

While 3M anticipates solid sales growth across the majority of its businesses, sales are expected to decline in a few of its businesses. In Health Care, 3M expects continued solid growth in its core medical and dental businesses as 3M continues to invest in fast growth areas such as the alternate care segment in medical, digital dentistry, and emerging markets. However, 3M expects declines in its personal care business (which will become part of the combined Industrial and Transportation segment in 2006) and in its branded pharmaceuticals business (Health Care) to persist throughout 2006. 3M experienced a sales decline in the fourth quarter of 2005 for Metrogel-Vaginal, a women’s health care product, due to a competitive product. 3M now expects that there will be a generic

 

14



 

substitute approved for Metrogel-Vaginal, which accounts for approximately 2% of total Health Care sales, in mid 2006. Health Care sales for 3M’s Aldara™ (imiquimod) pharmaceutical product for the actinic keratosis (a pre-cancerous skin condition) indication has and is expected to continue to fall short of expectations 3M had at the time of FDA approval and 3M is currently reassessing Aldara’s total market potential. In Display and Graphics, 3M expects the continued negative impact from the CRT rear projection lens business to continue into the first half of 2006, with sales in the second half of 2006 expected to be comparable to the second half of 2005. However, in Display and Graphics, 3M expects this decline in CRT rear projection lens sales to be more than offset by strong sales growth in display enhancement films used in flat-panel devices, such as LCD televisions.

 

The preceding forward-looking statements involve risks and uncertainties that could cause results to differ materially from those projected (refer to the forward-looking statements section in Item 7 and the risk factors provided in Item 1A for discussion of these risks and uncertainties).

 

 

INDEX TO MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:

 

 

 

 

Reference (pages)

Item 7

 

 

Results of operations

 

15-18

Performance by business segment

 

18-23

Performance by geographic area

 

23-24

Critical accounting estimates

 

24-26

New accounting pronouncements

 

26

Financial condition and liquidity

 

27-31

Financial instruments

 

31-32

Forward-looking statements

 

32

Item 7A

 

 

Quantitative and qualitative disclosures about market risk

 

32

 

 

 

RESULTS OF OPERATIONS

 

Net Sales:

 

 

 

2005

 

2004

 

 

 

Worldwide

 

U.S.

 

International

 

Worldwide

 

U.S.

 

International

 

Net sales (millions)

 

$

21,167

 

$

8,267

 

$

12,900

 

$

20,011

 

$

7,878

 

$

12,133

 

Components of net sales change:

 

 

 

 

 

 

 

 

 

 

 

 

 

Volume — core

 

3.5

%

1.0

%

5.1

%

6.2

%

3.2

%

8.2

%

Volume — acquisitions

 

1.0

 

1.4

 

0.7

 

0.5

 

0.8

 

0.3

 

Volume — total

 

4.5

 

2.4

 

5.8

 

6.7

 

4.0

 

8.5

 

Price

 

0.6

 

2.5

 

(0.7

)

(0.7

)

(0.1

)

(1.1

)

Local currency

 

5.1

 

4.9

 

5.1

 

6.0

 

3.9

 

7.4

 

Translation

 

0.7

 

 

1.2

 

3.8

 

 

6.5

 

Total

 

5.8

%

4.9

%

6.3

%

9.8

%

3.9

%

13.9

%

 

In 2005, local-currency sales growth was broad based, with selling prices increasing 0.6%.  Along with the benefits provided by 3M’s sourcing initiative, 3M’s pricing strategy has been key to maintaining margins in the face of significant raw material price pressure.  3M’s pricing strategy resulted in U.S. price growth of 2.5% in 2005. Internationally, selling prices declined 0.7% in 2005.  Adjusting for the price decreases in consumer electronics related businesses (LCD films and flex circuits), international pricing would have increased 0.3% in 2005. Acquisitions increased 2005 sales by 1.0%, driven by the 2005 acquisition of CUNO. Refer to both the “Performance by Business Segment” and “Performance by Geographic Area” sections for additional discussion of sales change.

 

15



 

In 2004, core volume growth (which excludes the impact of businesses acquired in the last 12 months) was broad-based, with all seven businesses posting worldwide local-currency sales growth. Local-currency growth was led by Display and Graphics; Industrial; Consumer and Office; Safety, Security and Protection Services; and the Transportation businesses. Health Care local-currency sales increased 1.7%, as results were negatively impacted by 2003 sales from pharmaceutical and drug delivery agreements that did not repeat in 2004. Electro and Communications local-currency sales increased 2.7%, the first year of positive local-currency sales growth since 2000. Acquisitions increased 2004 sales by 0.5%, driven by the 2004 acquisitions of HighJump Software, Inc. and Hornell Holding AB. Internationally, selling prices declined 1.1%, with most of the decline coming in certain businesses that serve the electronics industry, where it is important to look at the combined impact of volume and price. On a geographic basis, local-currency sales growth in 2004 was led by the Asia Pacific area.

 

Operating Expenses:

 

(Percent of net sales)

 

2005

 

2004

 

2003

 

2005
versus
2004

 

2004
versus
2003

 

Cost of sales

 

49.0

%

49.8

%

50.9

%

(0.8

)%

(1.1

)%

Selling, general and administrative expenses

 

21.4

 

21.4

 

21.9

 

 

(0.5

)

Research, development and related expenses

 

5.9

 

5.9

 

6.3

 

 

(0.4

)

Other expense

 

 

 

0.5

 

 

(0.5

)

Operating income

 

23.7

 

22.9

 

20.4

 

0.8

 

2.5

 

 

Cost of Sales:

Cost of sales decreased 0.8 percentage points in 2005. Cost of sales as a percent of net sales benefited from the combination of improved selling prices, favorable product mix, productivity gains, factory efficiency and sourcing, which helped offset the impact of higher raw material prices.  Raw material costs increased approximately 6.0% for 2005 when compared to 2004, with this impact mitigated through commodity hedging programs and negotiated supply contracts.  Cost of sales includes manufacturing, engineering and freight costs.

 

The 2004 decrease as a percent of net sales was driven by a combination of higher volumes, productivity gains, ongoing benefits of corporate initiatives and positive currency impacts (including hedging impacts). While 3M raw material costs increased during the year, 3M’s global sourcing initiative was important in enabling 3M to minimize raw material cost increases during a period of commodity price inflation.

 

Research, Development and Related Expenses:

Research, development and related expenses as a percent of sales were flat when comparing 2005 to 2004. However, spending in dollars increased approximately 4%, reflecting 3M’s continuing commitment to fund future growth for the Company.

 

Selling, General and Administrative Expenses:

Selling, general and administrative (SG&A) expenses as a percent of net sales were flat when comparing 2005 to 2004. 3M continues to invest in growth programs and brand building throughout the portfolio as a means of stimulating growth. SG&A in the fourth quarter of 2005 was impacted by a pre-tax charge of approximately $30 million in connection with settlement agreements of one pending LePage’s follow-on class actions and of two individual follow-on actions, all involving direct purchasers of transparent tape. For more detail, refer to the discussion in Note 11 to the Consolidated Financial Statements.

 

Selling, general and administrative expenses improved by 0.5 percentage points in 2004 compared to 2003. The improvement in 2004 as a percent of net sales was helped by leverage related to 3M’s strong growth in the Asia Pacific area. SG&A expenses in U.S. dollars increased in 2004, negatively impacted by currency translation and increased advertising and merchandising spending to support 3M’s strong brand portfolio. On an ongoing basis, the Company is shifting SG&A dollars toward faster-growth businesses and geographic areas.

 

Other Expense:

In 2003, 3M recorded pre-tax charges of $93 million ($58 million after-tax) related to an adverse ruling in a lawsuit filed against 3M in 1997 by LePage’s Inc. The pre-tax charge of $93 million is classified as “Other expense” within operating income.

 

16



 

Operating Income:

3M uses operating income as one of its primary business segment performance measurement tools. Operating income in 2005 was 23.7% of sales, up from 22.9% of sales in 2004 and 20.4% of sales in 2003. Operating income in 2005 grew by $431 million, or 9.4 percent, following 2004 operating income growth of $865 million, or 23.3 percent. The LePage’s Inc. lawsuit negatively impacted operating income in 2003 by $93 million, or 0.5% of sales.

 

Interest Expense and Income:

 

(Millions)

 

2005

 

2004

 

2003

 

Interest expense

 

$

82

 

$

69

 

$

84

 

Interest income

 

(56

)

(46

)

(28

)

Total

 

$

26

 

$

23

 

$

56

 

 

Interest Expense: Interest expense increased in 2005 compared to 2004, primarily due to higher interest rates. The decrease in 2004 interest expense was primarily the result of lower average debt balances, partially offset by higher interest rates in the United States.

Interest Income: Interest income was higher in 2005, benefiting primarily from higher interest rates. Interest income increased in 2004 due to substantially higher cash balances.

 

Provision for Income Taxes:

 

(Percent of pretax income)

 

2005

 

2004

 

2003

 

Effective tax rate

 

34.0

%

33.0

%

32.9

%

 

The tax rate for 2005 was 34.0%, compared with 33.0% in 2004. During 2005, 3M completed its evaluation of the repatriation provision of the American Jobs Creation Act of 2004 (Jobs Act) and repatriated approximately $1.8 billion of foreign earnings into the U.S. pursuant to its provisions. The Jobs Act provides 3M the opportunity to tax effectively repatriate foreign earnings for U.S. qualifying investments specified by 3M’s domestic reinvestment plan.  As a consequence, in the second quarter of 2005, 3M recorded a tax expense of $75 million, net of available foreign tax credits, which negatively impacted the 2005 effective worldwide tax rate by 1.5%. A half-point tax rate reduction compared to the same periods last year is primarily attributable to the combination of the effects of the Medicare Modernization Act and the domestic manufacturer’s deduction, which was a part of the Jobs Act.

 

The tax rate of 33.0% for 2004 was comparable to the 2003 rate of 32.9%. Income taxes associated with repatriating certain cash from outside the United States negatively impacted the 2004 and 2003 income tax rates.

 

Minority Interest:

 

(Millions)

 

2005

 

2004

 

2003

 

Minority interest

 

$

55

 

$

62

 

$

52

 

 

Minority interest expense eliminates the income or loss attributable to non-3M ownership interests in 3M consolidated entities. 3M’s most significant consolidated entity with non-3M ownership interests is Sumitomo 3M Limited in Japan (3M owns 75% of Sumitomo 3M Limited).  The decrease in 2005 related primarily to lower net income in Sumitomo 3M, while the increase in 2004 related primarily to higher net income in Sumitomo 3M.

 

Cumulative Effect of Accounting Change:

As of December 31, 2005, the Company adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). This accounting standard applies to the fair value of a liability for an asset retirement obligation associated with the retirement of tangible long-lived assets and where the liability can be reasonably estimated. Conditional asset retirement obligations exist for certain of the Company’s long-term assets. The fair value of these obligations is recorded as liabilities on a discounted basis.  Over time the liabilities are accreted for the change in the present value and the initial capitalized costs are depreciated over the useful lives of the related assets.  The adoption of FIN 47 resulted in the recognition of an asset retirement obligation liability of $59 million and an after tax charge of $35 million, which is reflected as a cumulative change in accounting principle in the Consolidated Statement of Income. The pro forma effect of applying this guidance in all prior periods presented was determined not to be material.

 

17



 

 

Currency Effects:

3M estimates that year-on-year currency effects, including hedging impacts, increased net income by approximately $115 million in 2005, $181 million in 2004 and $73 million in 2003. This estimate includes the effect of translating profits from local currencies into U.S. dollars; the impact of currency fluctuations on the transfer of goods between 3M operations in the United States and abroad; and transaction gains and losses, including derivative instruments designed to reduce foreign currency exchange rate risks.  3M estimates that year-on-year derivative and other transaction gains and losses increased net income by approximately $50 million for 2005 and $48 million in 2004. 3M estimates that year-on-year derivative and other transaction gains and losses decreased net income by $73 million in 2003.

 

PERFORMANCE BY BUSINESS SEGMENT

Effective January 1, 2006, 3M combined its Industrial and Transportation business segments. This new segment will leverage common markets, sales channels and customers, technologies, manufacturing facilities and selling processes. This combination will provide additional efficiencies that will be reinvested in growth. The results for the new Industrial and Transportation segment can be approximated by combining the existing Industrial and Transportation segments. In addition, during the first quarter of 2006, the Personal Care Division (2005 annual sales of approximately $600 million) within the Health Care segment transferred to the combined Industrial and Transportation segment. Segment information for all periods presented will be reclassified in 2006 to reflect the combined Industrial and Transportation segment in addition to the transfer of the Personal Care Division.

 

Disclosures relating to 3M’s business segments are provided in Item 1, Business Segments. Financial information and other disclosures are provided in the Notes to the Consolidated Financial Statements. In 2005, 3M managed its operations in seven operating business segments: Health Care; Industrial; Display and Graphics; Consumer and Office; Electro and Communications; Safety, Security and Protection Services; and Transportation. Information related to 3M’s business segments is presented in the tables that follow. Local-currency sales (which include both core and acquisition volume impacts, plus price impacts) are provided for each segment. The translation impact and total sales change are also provided for each segment.

 

Health Care Business (20.7% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

4,373

 

$

4,230

 

$

3,995

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

2.9

%

1.7

%

6.0

%

Translation

 

0.5

 

4.2

 

6.2

 

Total sales change

 

3.4

%

5.9

%

12.2

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,215

 

$

1,123

 

$

1,027

 

Percent change

 

8.2

%

9.3

%

14.1

%

Percent of sales

 

27.8

%

26.5

%

25.7

%

 

The Health Care segment serves markets that include medical, surgical, pharmaceutical, dental and orthodontic, health information systems and personal care. Products provided to these markets include medical and surgical supplies, skin health and infection prevention products, pharmaceuticals, drug delivery systems, dental and orthodontic products, health information systems, microbiology products, and closures for disposable diapers.

 

In 2005, Health Care reported local-currency sales growth of 2.9%. 3M’s core medical and dental businesses and health information systems businesses experienced local-currency sales growth of approximately 6%. The strength of these businesses helped overcome the sales growth challenges of the pharmaceutical and personal care businesses. Personal care, which is 3M’s diaper tape business, has experienced significant raw material price increases in some product lines over the past year, and 3M has elected to drive profits at the expense of volume in this business, which has the lowest margins in the Health Care segment. Sales of certain products within 3M’s pharmaceuticals business, primarily comprised of prescription drugs in inhalation, women’s health, and cardiovascular, are declining due to price pressure in Europe and decreased demand for some of these older products. 3M continues to generate growth in its Aldara™ pharmaceutical product, which accounts for approximately 6% of total Health Care sales. Aldara sales grew nearly 10% in 2005, and growth outside the U.S. was particularly strong. However, fourth quarter 2005 year-over-year local-currency sales declined for the first time since the product was launched in 1997. Health Care sales for 3M’s Aldara pharmaceutical product for the actinic keratois (a pre-cancerous skin condition) indication has and is expected to continue to fall short of expectations 3M had at the time of FDA approval and 3M is

 

18



 

currently reassessing Aldara’s total market potential. Health Care continued to focus on operational efficiency, which helped drive an 8.2% increase in operating income in 2005. The Company’s agreement with Takeda Pharmaceutical Co., Ltd., announced in early 2005 and described further below, is currently the focus of the Company’s efforts to develop its immune response modifier technology while the Company reviews its other development efforts.

 

3M received U.S. Food and Drug Administration (FDA) approval for Aldara™ (imiquimod) Cream, 5%, in 1996 for the treatment of external genital warts, in March 2004 for the treatment of certain types of actinic keratosis (a pre-cancerous skin condition), and in July 2004 for the treatment of superficial basal cell carcinoma (a common form of non-melanoma skin cancer). The patent and related rights for the imiquimod molecule are important to the Health Care Business. The original patent on the imiquimod molecule expired in August 2004, but the patent term extension runs through August 2009, with an anticipated pediatric exclusivity extension of a further six months to February 2010.

 

In the first quarter of 2005, 3M and Takeda Pharmaceutical Co. Ltd. entered into an agreement to collaborate on a potential breakthrough treatment utilizing an immune response modifier for cervical high-risk human papilloma virus (HPV) infection and cervical dysplasia, which are known risk factors for cervical cancer.  This immune response modifier currently is in early stage clinical trials, and 3M and Takeda will share further development costs. Upon successful clinical development and regulatory approvals, the parties will commercialize jointly in the United States and Europe. Takeda will hold commercial rights in certain countries in Asia, while 3M will retain the rights in other parts of the world.

 

In October 2003, IVAX Corporation agreed to assume exclusive rights to 3M’s branded health care respiratory products, together with related marketing and sales personnel, in nine European countries. The agreement covered QVAR™ (beclomethasone dipropionate HFA) Inhalation Aerosol, a “maintenance” medication used to prevent asthma attacks, and also covered Airomir™ (albuterol sulfate) Inhaler, a “rescue” medication used to relieve acute asthma symptoms. 3M will continue to manufacture and supply these products to IVAX. The total consideration due under the agreement, including minimum annual royalty payments, was $77 million, of which $24 million was paid in 2005, $24 million was paid in 2004 and $26 million was paid in 2003. 3M expects to receive $3 million in 2006. 3M may also receive additional royalty payments in 2010 (up to a maximum of approximately $7 million in total) if IVAX achieves certain annual sales levels. The Company recognizes the royalty revenue related to the IVAX agreement ratably over the term of the licensing arrangement.

 

In 2004, local-currency sales in Health Care increased 1.7%, with 2004 negatively impacted by 2003 pharmaceutical and drug delivery agreements that did not repeat. Fourth quarter 2004 local-currency sales grew 5.0%, as year-on-year comparisons became more favorable. Operating income increased 9.3% to $1.123 billion in 2004.

 

Industrial Business (18.0% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

3,806

 

$

3,444

 

$

3,070

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

9.3

%

8.2

%

(0.7

)%

Translation

 

1.2

 

4.0

 

5.0

 

Total sales change

 

10.5

%

12.2

%

4.3

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

735

 

$

610

 

$

425

 

Percent change

 

20.5

%

43.7

%

(11.1

)%

Percent of sales

 

19.3

%

17.7

%

13.8

%

 

The Industrial segment serves a broad range of industrial markets, from appliance and electronics to paper and packaging and food and beverage. Products include tapes, a wide variety of coated and nonwoven abrasives, adhesives, specialty materials and supply chain execution software solutions. The August 2005 CUNO acquisition adds a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases.

 

In 2005, Industrial local-currency sales grew 9.3%. The August 2005 CUNO acquisition, whose results are included in Industrial, added 5.1% of growth in 2005. In addition to CUNO, growth was led by industrial adhesives and tapes, as well as the abrasives businesses. 3M continues to selectively raise selling prices to offset commodity raw material

 

19



 

price pressures. Industrial continues to demonstrate strong operational discipline, as operating income grew 20.5% in 2005.

 

In 2004, Industrial local-currency sales growth of 8.2% for the year was broad-based across major geographic areas and Industrial businesses. Acquisitions increased sales by 1.4%, driven by the February 2004 acquisition of HighJump Software, Inc., a provider of supply chain execution software. Strong local-currency sales growth helped leverage operating income growth. Operating income increased 43.7% to $610 million in 2004.

 

Display and Graphics Business (16.8% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

3,558

 

$

3,416

 

$

2,970

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

4.0

%

10.5

%

26.7

%

Translation

 

0.2

 

4.5

 

6.0

 

Total sales change

 

4.2

%

15.0

%

32.7

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,159

 

$

1,133

 

$

886

 

Percent change

 

2.3

%

27.9

%

65.4

%

Percent of sales

 

32.6

%

33.2

%

29.8

%

 

The Display and Graphics segment serves markets that include electronic display, touch screen, traffic safety and commercial graphics. This segment includes optical film and lens solutions for electronic displays; touch screens and touch monitors; reflective sheeting for transportation safety; and commercial graphics systems. The optical film business provides films that serve numerous market segments of the display lighting industry. 3M provides distinct products for five market segments, including products for: 1) LCD computer monitors 2) LCD televisions 3) handheld devices such as cellular phones 4) notebook PCs and 5) automotive displays. The optical business includes a number of different products that are protected by various patents and groups of patents. The remaining lifetimes of such patents, as well as patents protecting future products, range from less than a few years to greater than 15 years. These patents provide varying measures of exclusivity to 3M for a number of such products. 3M’s proprietary manufacturing technology and know-how also provide a competitive advantage to 3M independent of such patents.

 

In 2005, Display and Graphics local-currency sales grew 4.0%, impacted by many factors. The first half of 2005 was tempered by tough year-on-year optical film comparisons, while 3M’s traffic safety systems business awaited a new highway funding bill in the U.S. and the sluggish economies in Western Europe and Japan held back growth in the commercial graphics business. Growth rebounded in the second half of 2005 as a new U.S. highway funding bill was passed in July, the economies in Western Europe and Japan started to experience some moderate growth and, as expected, 3M saw acceleration in demand for consumer electronics, especially flat-panel LCD televisions and a more normal LCD component inventory situation. This growth in the second half of 2005 drove record sales of 3M’s proprietary optical films and components despite growing pricing pressure. Display and Graphics sales growth was negatively impacted by approximately 4% in 2005 due to the continued decline in lens systems for the CRT rear projection television market along with the phase out of the commercial videotape business announced in the fourth quarter of 2004. Operating income increased 2.3% in 2005.  Operating income was impacted by the commercial videotape business phase out and decline in lens systems for the CRT rear projection television market, which negatively impacted 2005 operating income by approximately 8%.

 

In 2004, Display and Graphics’ local-currency sales growth was 10.5%. Strong demand for 3M films that brighten the displays on electronic products, such as flat-panel computer monitors, cellular phones, notebook PCs and LCD televisions, continued to drive results in 2004. Year-on-year local-currency sales growth in the Optical Systems business was slower in the last half of 2004, primarily due to inventory channel adjustments in the LCD market. This resulted in reduced demand for 3M’s proprietary optical films and components. While this business is subject to periodic customer inventory fluctuations, 3M believes that this business will continue to be a significant growth engine for 3M. In the fourth quarter of 2004, 3M announced the phase out of its commercial videotape business, and this action, combined with a continuing decline in lens systems for the CRT rear-projection television market, negatively impacted sales and operating income. Operating income increased 27.9% to $1.133 billion in 2004.

 

20



 

Consumer and Office Business (14.1% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

2,986

 

$

2,861

 

$

2,607

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

3.4

%

6.9

%

2.6

%

Translation

 

1.0

 

2.8

 

4.1

 

Total sales change

 

4.4

%

9.7

%

6.7

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

576

 

$

542

 

$

460

 

Percent change

 

6.3

%

17.9

%

2.5

%

Percent of sales

 

19.3

%

18.9

%

17.6

%

 

The Consumer and Office segment serves markets that include consumer retail, office retail, education, home improvement, building maintenance and other markets. Products in this segment include office supply products, stationery products, construction and home improvement products, home care products, protective material products (including consumer health care products such as bandages), and visual systems products.

 

In 2005, Consumer and Office local-currency sales increased 3.4%, with broad-based growth across the many channels 3M serves. Consumer and Office experienced solid local-currency sales growth in construction and home improvement, home care and in its protective materials businesses. In the fourth quarter of 2005, sales were up slightly in local-currency terms as compared to an exceptional fourth quarter of 2004, when sales increased 8.3%, as several large retailers apparently increased their purchase rate level to meet their objectives. The continuing decline in 3M’s Visual Systems business impacted sales by approximately 2% for the year. Consumer and Office continues to drive success by combining unique functionality along with customer inspired design into new and mature products such as Scotch® Tape, Post-It® Notes, Filtrete™ Filters and O-Cel-O™ sponges. Operating income increased 6.3% in 2005.

 

In 2004, local-currency sales growth in Consumer and Office was 6.9%. Sales growth was fairly broad-based across the many retail channels 3M serves, most notably in mass-market consumer retail and home improvement. This included strong sales growth in construction and home improvement/home care products, office supply products and stationery products. Sales increased 8.3% in the fourth quarter of 2004 as several large retailers apparently increased their purchase rate level to meet their objectives. Geographic area local-currency growth was led by the United States. Operating income increased 17.9% to $542 million in 2004.

 

Electro and Communications Business (11.0% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

2,333

 

$

2,224

 

$

2,101

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

4.2

%

2.7

%

(0.7

)%

Translation

 

0.7

 

3.1

 

4.0

 

Total sales change

 

4.9

%

5.8

%

3.3

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

463

 

$

342

 

$

288

 

Percent change

 

35.4

%

18.8

%

9.7

%

Percent of sales

 

19.8

%

15.4

%

13.7

%

 

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

 

21



 

In 2005, local-currency sales in Electro and Communications increased 4.2%, with improving end market conditions and success driving existing products into new applications helping the business post its best local-currency growth since 2000. Local-currency growth accelerated in the second half of 2005, with local-currency growth in the fourth quarter of 2005 up 10.9%. Local-currency growth was led by demand for 3M electronic products for semiconductor manufacturers, along with continued strong growth in electrical products used for insulating, testing and sensing. This strong sales growth helped offset weakness in the electronic solutions and communications markets. Operating margins were 19.8% in 2005, with operating income increasing 35.4% in 2005.

 

In 2004, local-currency sales in Electro and Communications increased 2.7%, led by electronic materials, along with electrical products for insulating, testing and sensing. Sales in the electronic solutions and telecommunications segments were negatively impacted by the general slowdown in the semiconductor industry and continued softness in the hard-line infrastructure segment of the telecommunications market. Geographically, local-currency growth in this business for 2004 was led by the Latin America and Canada area along with the Asia Pacific area. Operating income was up 18.8% to $342 million in 2004.

 

Safety, Security and Protection Services Business (10.8% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

2,292

 

$

2,125

 

$

1,928

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

6.9

%

6.6

%

9.5

%

Translation

 

1.0

 

3.6

 

4.9

 

Total sales change

 

7.9

%

10.2

%

14.4

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

553

 

$

491

 

$

437

 

Percent change

 

12.6

%

12.3

%

29.1

%

Percent of sales

 

24.1

%

23.1

%

22.7

%

 

The Safety, Security and Protection Services segment serves a broad range of markets that strive to increase the safety, security and productivity of workers, facilities and systems. Major product offerings include personal protection products, safety and security products, energy control products, cleaning and protection products for commercial establishments, and roofing granules for asphalt shingles.

 

In 2005, Safety, Security and Protection Services local-currency sales growth was 6.9%, driven by broad-based growth across the business portfolio and geographies. The continued global threat of events such as terrorism, natural disasters, SARS and Avian flu helped raise the awareness in the general public about the importance of personal protective equipment, especially respiratory protection for overall health. Sales growth was driven by continued strong global demand for personal protection products and solutions, particularly respiratory protection products, along with strong demand for cleaning and protection products for commercial buildings. Roofing granules for asphalt shingles also experienced solid sales growth. Operating income improved 12.6% in 2005.

 

In 2004, Safety, Security and Protection Services local-currency sales growth was 6.6%. Local-currency growth was driven by strong global demand for personal protective products and solutions, along with cleaning and protective products for commercial buildings. 3M’s acquisition of Hornell Holding AB, a European-based global supplier of personal safety equipment, added 2.3 percentage points of growth in 2004. Operating income increased 12.3% to $491 million in 2004.

 

22



Transportation Business (8.4% of consolidated sales):

 

 

 

2005

 

2004

 

2003

 

Sales (millions)

 

$

1,772

 

$

1,674

 

$

1,531

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

5.0

%

5.1

%

5.4

%

Translation

 

0.8

 

4.2

 

5.6

 

Total sales change

 

5.8

%

9.3

%

11.0

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

461

 

$

426

 

$

388

 

Percent change

 

8.1

%

9.8

%

17.2

%

Percent of sales

 

26.0

%

25.5

%

25.4

%

 

The Transportation segment serves markets that include automotive, automotive aftermarket, marine, aerospace and specialty vehicle markets. This segment provides components and products that are used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles.

 

In 2005, Transportation local-currency sales growth was 5.0%, with benefits from customer-focused new products and productivity solutions driving results. One of these new products is 3M™ Paint Replacement Film, which is an alternative to using paint around car and truck windows. In the automotive aftermarket area, the 3M™ Paint Preparation System shortens paint changeover and clean-up time while also reducing the use of solvents for cleaning paint guns. Sales growth was broad based in Transportation, led by businesses that serve the automotive OEMs and auto body repair shops, despite challenges in the U.S. OEM Big-3 automotive market along with lower levels of distribution buy-in due to cash flow trade-offs by customers in the automotive aftermarket business. Operating income increased 8.1% in 2005.

 

In March 2005, 3M’s automotive business completed the purchase from TI&M Beteiligungsgesellschaft mbH of 19 percent of I&T Innovation Technology (I&T), which was founded in Austria in 1999.  3M and I&T will collaborate to deliver flat flexible wiring systems for automotive interior applications to the global automotive market. The purchase price of approximately $55 million is reported as “Investments” in the Consolidated Balance Sheet and as “Purchases of Investments” in the Consolidated Statement of Cash Flows.  Due to its distribution involvement and voting rights, the Company is using equity method accounting for its investment in I&T. The Company has a purchase option to buy an additional 31% investment of I&T after certain conditions have been met.  This purchase option expires December 31, 2008.  The Company also has a put option, which provides the Company the right to sell back its entire ownership interest in I&T, exercisable between January 1, 2007 and March 31, 2009, unless the Company exercises its purchase option before then.

 

In 2004, local-currency sales growth was 5.1% in Transportation. Top-line growth in this business continued to benefit from new products and solutions for customers, along with a strategy of replicating successful 3M solutions across several distinct segments of the transportation industry. Operating income increased 9.8% to $426 million in 2004.

 

PERFORMANCE BY GEOGRAPHIC AREA

Financial information related to 3M operations in various geographic areas is provided in Note 16 to the Consolidated Financial Statements. A summary of key information and discussion related to 3M’s geographic areas follow:

 

Geographic Area

 

2005

 

2005 vs. 2004 % Change

 

Net Sales and

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

Operating Income

 

% of

 

 

 

Oper.

 

Local

 

 

 

Sales

 

Oper.

 

(Dollars in millions)

 

Sales

 

Total

 

Income

 

Currency

 

Translation

 

Change

 

Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

8,267

 

39.1

%

$

1,324

 

4.9

%

 

4.9

%

10.3

%

Asia Pacific

 

5,744

 

27.1

%

2,093

 

10.6

%

0.5

%

11.1

%

11.7

%

Europe, Middle East and Africa

 

5,219

 

24.7

%

1,073

 

0.9

%

(0.2

)%

0.7

%

5.8

%

Latin America and Canada

 

1,881

 

8.9

%

519

 

1.3

%

7.4

%

8.7

%

7.5

%

Other Unallocated

 

56

 

0.2

%

 

 

 

 

 

 

 

 

 

Total Company

 

$

21,167

 

100.0

%

$

5,009

 

5.1

%

0.7

%

5.8

%

9.4

%

 

23



 

While 3M manages its businesses globally and believes its business segment results are the most relevant measure of performance, the Company also utilizes geographic area data as a secondary performance measure. Export sales are reported within the geographic area where the final sales to 3M customers are made. A portion of the products or components sold by 3M’s operations to its customers are exported by these customers to different geographic areas. As customers move their operations from one geographic area to another, 3M’s results will follow. Thus, net sales in a particular geography is not indicative of end-user consumption in that geography.

 

U.S. sales revenue increased 4.9%, with growth led by Industrial; Consumer and Office; and Safety, Security and Protection Services. Asia Pacific local-currency sales (which exclude translation impacts) increased 10.6%. All seven business segments contributed to this increase in the Asia Pacific area, with optical film being the largest growth component. Japan sales totaled approximately $2.1 billion, with local-currency sales up 3.6% from 2004. European local-currency sales increased 0.9%, with good growth in Industrial; Safety, Security and Protection Services; and Transportation. In the combined Latin America and Canada area, local-currency sales increases of 1.3% were led by Consumer and Office; Industrial; Safety, Security and Protection Services; and Transportation. Growth in Latin America was impacted by the continued decline of 3M’s CRT rear projection lens business in Mexico and the move of a flex circuits customer from Puerto Rico to Singapore. Foreign currency translation positively impacted the combined Latin America and Canada area sales by 7.4%, and the Asia Pacific area sales by 0.5%, as the U.S. dollar weakened against these currencies. Foreign currency translation had a minimal impact on European sales. For 2005, international operations represented approximately 61% of 3M’s sales.

 

Geographic Area Supplemental Information

 

 

 

Employees as of
December 31, 2005

 

Capital
Spending

 

Property, Plant and
Equipment — net

 

(Millions, except employees)

 

2005

 

2004

 

2003

 

2005

 

2004

 

2003

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

33,033

 

32,648

 

33,329

 

$

532

 

$

565

 

$

425

 

$

3,291

 

$

3,290

 

$

3,342

 

Europe, Middle East and Africa

 

16,722

 

16,574

 

16,669

 

120

 

143

 

112

 

1,076

 

1,288

 

1,235

 

Asia Pacific

 

11,574

 

10,439

 

9,916

 

228

 

182

 

102

 

865

 

810

 

724

 

Latin America and Canada

 

7,986

 

7,410

 

7,158

 

63

 

47

 

38

 

361

 

323

 

308

 

Total Company

 

69,315

 

67,071

 

67,072

 

$

943

 

$

937

 

$

677

 

$

5,593

 

$

5,711

 

$

5,609

 

 

Employment:

Employment increased by 2,244 people since year-end 2004. The CUNO acquisition in August 2005 added approximately 2,300 employees. The Company continues to increase headcount in faster-growing areas of the world, such as Asia Pacific, primarily to support increasing local sales. Excluding the impact of CUNO, employment has been decreasing in the United States and combined Europe, Middle East and Africa area. Sales per employee in local currencies increased approximately 4% in 2005, approximately 7% in 2004 and 8.5% in 2003.

 

Capital Spending/Net Property, Plant and Equipment:

The bulk of 3M capital spending historically has been in the United States, resulting in higher net property, plant and equipment balances in the U.S. The Company is striving to more closely align its manufacturing and sourcing with geographic market sales, and because approximately 61% of sales are outside the United States, this would increase production outside the United States, helping to improve customer service and reduce working capital requirements.  The 2005 decrease in net property, plant and equipment in the Europe, Middle East and Africa area was primarily due to currency translation (due to the stronger U.S dollar at December 31, 2005 when compared to December 31, 2004). Capital spending in Asia has more than doubled since 2003 as we continue to grow our presence in this region.

 

CRITICAL ACCOUNTING ESTIMATES

Information regarding significant accounting policies is included in Note 1 to the Consolidated Financial Statements. As stated in Note 1, the preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

24



 

The Company believes its most critical accounting estimates relate to legal proceedings, the Company’s pension and postretirement obligations, and potential asset impairment issues. Senior management has discussed the development, selection and disclosure of its critical accounting estimates with the Audit Committee of 3M’s Board of Directors.

 

Legal Proceedings:

The categories of claims for which the Company has estimated its probable liability, the amount of its liability accruals, and the estimates of its related insurance receivables are critical accounting estimates related to legal proceedings. Please refer to the section entitled “Accrued Liabilities and Insurance Receivables Related to Legal Proceedings” (contained in “Legal Proceedings” in Note 11 to the Consolidated Financial Statements) for additional information about such estimates.

 

Pension and Postretirement Obligations:

3M has various company-sponsored retirement plans covering substantially all U.S. employees and many employees outside the United States. The Company accounts for its defined benefit pension and postretirement health care and life insurance benefit plans in accordance with Statement of Financial Accounting Standards (SFAS) No. 87, “Employers’ Accounting for Pensions” and SFAS No. 106, “Employer’s Accounting for Postretirement Benefits Other than Pensions”, which require that amounts recognized in financial statements be determined on an actuarial basis. Pension benefits associated with these plans are generally based primarily on each participant’s years of service, compensation, and age at retirement or termination. Two critical assumptions, the discount rate and the expected return on plan assets, are important elements of expense and liability measurement. The assumed health care trend rate is the most significant postretirement health care assumption. See Note 10 to the Consolidated Financial Statements for additional discussion of actuarial assumptions used in determining pension and postretirement health care liabilities and expenses.

 

The Company determines the discount rate used to measure plan liabilities as of the December 31 measurement date for the U.S. pension and postretirement benefit plans. The discount rate reflects the current rate at which the associated liabilities could be effectively settled at the end of the year. In estimating this rate, the Company looks at rates of return on fixed-income investments of similar duration to the liabilities in the plan that receive high, investment grade ratings by recognized ratings agencies. Using these methodologies, the Company determined a discount rate of 5.50% to be appropriate as of December 31, 2005, which is a reduction of 0.25 percentage points from the rate used as of December 31, 2004.

 

As of December 31, 2005, the Company converted to the RP (Retirement Plans) 2000 Mortality Table for calculating the year-end 2005 U.S. pension and postretirement obligations and 2006 expense. The impact of this change increased the year-end 2005 U.S. Projected Benefit Obligations for pension by $385 million, the year-end 2005 U.S. Accumulated Benefit Obligations for pension by $349 million and the 2005 U.S. Accumulated Postretirement Benefit Obligation by $93 million. This change will also increase pension expenses for 2006 by $64 million and postretirement expenses by $17 million.

 

A significant element in determining the Company’s pension expense in accordance with SFAS No. 87 is the expected return on plan assets, which is based on historical results for similar allocations among asset classes. For the U.S. pension plan, the Company’s assumption for the expected return on plan assets was 8.75% for 2005 and will remain at 8.75% for 2006. Refer to Note 10 to the Consolidated Financial Statements for information on how this rate is determined.

 

The difference between the expected return and the actual return on plan assets is deferred and, under certain circumstances, amortized over future years of service. Therefore, the net deferral of past asset gains (losses) ultimately affects future pension expense. This is also true of changes to actuarial assumptions. As of December 31, 2005, the Company had net unrecognized pension actuarial losses of $2.676 billion and $954 million for the U.S. and International pension benefit plans, respectively, and $1.005 billion for the postretirement health care and life insurance benefit plan. These amounts represent potential future pension and postretirement expenses that would be amortized over average future service periods. The average remaining service periods for U.S. and International pension plans and the postretirement plans are 10.2 years, 14.1 years and 10.0 years, respectively.

 

For the year ended December 31, 2005, the Company recognized total consolidated pre-tax pension expense (after settlements, curtailments and special termination benefits) of $331 million, up from $325 million in 2004. Pension expense (before settlements, curtailments and special termination benefits) is anticipated to decrease to approximately $300 million in 2006. For the pension plans, holding all other factors constant, an increase/decrease in the expected long-term rate of return on plan assets by 0.25 percentage points would decrease/increase U.S. 2006 pension expense by approximately $22 million for U.S. pension plans and approximately $7 million for

 

25



 

international pension plans. Also, holding all other factors constant, an increase/decrease in the discount rate used to measure plan liabilities by 0.25 percentage points would decrease/increase 2006 pension expense by approximately $31 million for U.S. pension plans and approximately $7 million for international pension plans. See Note 10 to the Consolidated Financial Statements for details of the impact of a one percentage point change in assumed health care trend rates on the postretirement health care benefit expense and obligation.

 

Potential Asset Impairment Issues:

3M net property, plant and equipment totaled approximately $5.6 billion at December 31, 2005. Management makes estimates and assumptions in preparing the consolidated financial statements for which actual results will emerge over long periods of time. This includes the recoverability of long-lived assets employed in the business, including assets of acquired businesses. These estimates and assumptions are closely monitored by management and periodically adjusted as circumstances warrant. For instance, expected asset lives may be shortened or an impairment recorded based on a change in the expected use of the asset or performance of the related business reporting unit.

 

3M goodwill totaled approximately $3.5 billion at December 31, 2005, which, based on impairment testing, is not impaired. Impairment testing for goodwill is done at a reporting unit level. Reporting units are one level below the business segment level, but can be combined when reporting units within the same segment have similar economic characteristics. 3M had 18 reporting units at December 31, 2005. The majority of goodwill relates to and is assigned directly to a specific reporting unit. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The estimated fair value of a reporting unit is determined using earnings for the reporting unit multiplied by a price/earnings ratio for comparable industry groups, or by using a discounted cash flow analysis.

 

NEW ACCOUNTING PRONOUNCEMENTS

As of December 31, 2005, the Company adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47).  This accounting standard applies to the fair value of a liability for an asset retirement obligation associated with the retirement of tangible long-lived assets and where the liability can be reasonably estimated. Conditional asset retirement obligations exist for certain of the Company’s long-term assets. The fair value of these obligations is recorded as liabilities on a discounted basis. Over time the liabilities are accreted for the change in the present value and the initial capitalized costs are depreciated over the useful lives of the related assets.  The adoption of FIN 47 resulted in the recognition of an asset retirement obligation liability of $59 million and an after tax charge of $35 million, which is reflected as a cumulative change in accounting principle in the Consolidated Statement of Income. The pro forma effect of applying this guidance in all prior periods presented was determined not to be material.

 

Effective January 1, 2006, 3M adopted SFAS No. 123 (revised 2004), “Share-Based Payment”, which requires 3M to expense stock-based compensation expense. The Company is adopting SFAS No. 123R using the modified retrospective method. All prior periods will be adjusted to give effect to the fair-value-based method of accounting for awards granted in fiscal years beginning on or after January 1, 1995. Stock-based compensation disclosures in Note 1 reflect pro forma expense of $.14 cents per diluted share in 2005. The 2006 impact of adopting SFAS No. 123R is estimated to be approximately $.16 per diluted share with an estimated $0.02 per diluted share cost in the first quarter, an estimated $0.08 per diluted share cost in the second quarter, and an estimated $0.03 per diluted share cost in both the third and fourth quarters. The pro forma impact of stock-based compensation on net income and earnings per share provided in Note 1 for the years ended December 31, 2005, 2004 and 2003, was recognized over the nominal vesting period, whereby if an employee retired before the end of the vesting period, the Company would recognize any remaining unrecognized compensation cost at the date of retirement. SFAS No. 123R requires recognition under a non-substantive vesting period approach, requiring compensation expense recognition when an employee is eligible to retire. 3M employees in the U.S. are eligible to retire beginning at age 55 and after having completed five years of service. Approximately 25 to 30% of the number of stock-based compensation awards are made to this population. The Company will change to the non-substantive vesting period approach for new stock compensation grants made after the Company’s adoption of SFAS No. 123R on January 1, 2006. Therefore, primarily beginning in May 2006 with the annual Management Stock Ownership Program grant, immediate expensing of those stock-based compensation awards granted to employees eligible to retire will result in a higher compensation expense than historically recognized in comparable prior periods. The total expense in 2006 and beyond will depend on several variables, including the number of share-based awards granted, the fair value of those awards, and the period the vesting of those awards is recognized over; therefore the actual expense may be different from this estimate.

 

Additional information regarding these and other accounting pronouncements is included in Note 1 to the Consolidated Financial Statements.

 

26



 

FINANCIAL CONDITION AND LIQUIDITY

The Company generates significant ongoing cash flow. Net debt decreased significantly in 2004, but increased in 2005, primarily related to the $1.36 billion CUNO acquisition.

 

At December 31

 

 

 

 

 

 

 

(Millions)

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Total Debt

 

$

2,381

 

$

2,821

 

$

2,937

 

Less: Cash & Cash Equiv.

 

1,072

 

2,757

 

1,836

 

Net Debt

 

$

1,309

 

$

64

 

$

1,101

 

 

3M believes its ongoing cash flows provide ample cash to fund expected investments and capital expenditures. The Company has an AA credit rating from Standard & Poor’s and an Aa1 credit rating from Moody’s Investors Service. The Company has sufficient access to capital markets to meet currently anticipated growth and acquisition investment funding needs. The Company does not utilize derivative instruments linked to the Company’s stock. However, the Company does have contingently convertible debt that, if conditions for conversion are met, is convertible into shares of 3M common stock (refer to Note 8 in this document).

 

The Company’s financial condition and liquidity at December 31, 2005, remained strong. Various assets and liabilities, including cash and short-term debt, can fluctuate significantly from month-to-month depending on short-term liquidity needs. Working capital (defined as current assets minus current liabilities) totaled $1.877 billion at December 31, 2005, compared with $2.649 billion at December 31, 2004. This decrease was primarily related to a decrease in cash and cash equivalents ($1.685 billion) partially offset by a decrease in debt classified as short-term borrowings and current portion of long-term debt ($1.022 billion). The cash and cash equivalents balance was impacted by the acquisition of CUNO and repayment of debt.

 

The Company uses various working capital measures that place emphasis and focus on certain working capital assets and liabilities. These measures are not defined under U.S. generally accepted accounting principles and may not be computed the same as similarly titled measures used by other companies.  One of the primary working capital measures 3M uses is a combined index, which includes accounts receivables, inventory and accounts payable. This combined index (defined as quarterly net sales — fourth quarter at year-end — multiplied by four, divided by ending net accounts receivable plus inventory less accounts payable) was 5.7 at December 31, 2005, down from 5.8 at December 31, 2004. Excluding CUNO, net working capital turns at December 31, 2005, were 5.8, the same as at December 31, 2004. Receivables increased $46 million, or 1.6%, compared with December 31, 2004. At December 31, 2005, the CUNO acquisition increased accounts receivable by $88 million. Currency translation (due to the stronger U.S dollar) reduced accounts receivable by $231 million year-on-year. Inventories increased $265 million, or 14.0%, compared with December 31, 2004. At December 31, 2005, the CUNO acquisition increased inventories by $56 million. Currency translation reduced inventories by $89 million year-on-year. Accounts payable increased $88 million compared with December 31, 2004, with CUNO accounting for $18 million of this increase.

 

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

 

27



 

Cash Flows from Operating Activities:

 

Years ended December 31

 

 

 

 

 

 

 

(Millions)

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Net income

 

$

3,199

 

$

2,990

 

$

2,403

 

Depreciation and amortization

 

986

 

999

 

964

 

Company pension contributions

 

(654

)

(591

)

(749

)

Company postretirement contributions

 

(134

)

(168

)

(194

)

Company pension expense

 

331

 

325

 

168

 

Company postretirement expense

 

106

 

110

 

88

 

Income taxes (deferred and accrued income taxes)

 

417

 

396

 

539

 

Accounts receivable

 

(184

)

56

 

38

 

Inventories

 

(294

)

7

 

281

 

Accounts payable

 

113

 

35

 

62

 

Product and other insurance receivables and claims

 

122

 

12

 

(35

)

Other — net

 

250

 

111

 

208

 

Net cash provided by operating activities

 

$

4,258

 

$

4,282

 

$

3,773

 

 

Cash flows from operating activities can fluctuate significantly from period to period, as pension funding decisions, tax timing differences and other items can significantly impact cash flows. In 2005, cash flow was essentially flat when compared to 2004. Higher net income, higher accounts payable and increased insurance receivable collections were offset by accounts receivable increases, inventory increases and other items. Product and other insurance receivables and claims increased cash flow by $122 million in 2005, benefiting from the $148 million in insurance recoveries for the breast implant matter in 2005. For a more detailed discussion of these and other legal proceedings, refer to Note 11 in the Consolidated Financial Statements of this Annual Report on Form 10-K. The category “Other — net” in the preceding table reflects changes in other asset and liability accounts. For example, in 2005, this category includes the non-cash impact of adopting FIN 47 ($35 million cumulative effect of accounting change), increases in accrued liabilities (such as the $30 million increase in liability related to legal settlement agreements), and other items.

 

In 2005, the Company made discretionary contributions totaling $500 million to its U.S. qualified pension plan, with $200 million contributed in the fourth quarter of 2005, and $300 million contributed in the third quarter of 2005. In the third quarter of 2004, the Company made a special pension contribution to 3M’s Japanese pension plan of $155 million and a discretionary contribution of $300 million to its U.S. qualified pension plan. In the third quarter of 2003, 3M made a discretionary contribution of $600 million to its U.S. qualified pension plan. Future contributions will depend on market conditions, interest rates and other factors. 3M believes its strong cash flow and balance sheet will allow it to fund future pension needs without compromising growth opportunities.

 

In 2004, cash flow improvements were primarily driven by higher net income. In all periods presented, significant Company pension contributions negatively impacted cash flows. In all years, with a larger amount in 2003, a portion of the tax timing benefit relates to the tax benefit received from Company pension contributions.

 

Cash Flows from Investing Activities:

 

Years ended December 31

 

 

 

 

 

 

 

(Millions)

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

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

 

$

(943

)

$

(937

)

$

(677

)

Proceeds from sale of PP&E and other assets

 

41

 

69

 

129

 

Acquisitions, net of cash acquired

 

(1,293

)

(73

)

(439

)

Purchases and proceeds from sale of investments — net

 

(46

)

3

 

18

 

Net cash used in investing activities

 

$

(2,241

)

$

(938

)

$

(969

)

 

28



 

Investments in property, plant and equipment are enabling growth in diverse markets, helping to meet product demand and increasing manufacturing efficiency. These investments will continue to be primarily capacity and growth focused. For example, in December 2005, 3M announced its intention to build an LCD optical film manufacturing facility in Poland to support the fast-growing LCD-TV market in Europe and to better serve its customers. The Company expects 2006 capital expenditures to total approximately $1.1 billion, compared with $943 million in 2005.

 

In the third quarter of 2005, 3M completed the acquisition of CUNO. 3M acquired CUNO for approximately $1.36 billion, including assumption of debt. This $1.36 billion included $1.27 billion of cash paid (net of cash acquired) and the assumption of $80 million of debt, most of which has been repaid. In 2005, the Company also entered into two additional business combinations for a total purchase price of $27 million. Refer to Note 2 to the Consolidated Financial Statements for more information on these 2005 business combinations, and for information concerning 2004 and 2003 business combinations.

 

Purchases of investments in 2005 include the purchase from TI&M Beteiligungsgesellschaft mbH of 19 percent of I&T Innovation Technology (discussed previously under the Transportation business segment). The purchase price of approximately $55 million is reported as “Investments” in the Consolidated Balance Sheet and as “Purchases of Investments” in the Consolidated Statement of Cash Flows. Other “Purchases of Investments” and “Proceeds from Sale of Investments” in 2005 are primarily attributable to auction rate securities, which are classified as available-for-sale. Prior to 2005, purchases of and proceeds from the sale of auction rate securities were classified as Cash and Cash Equivalents. At December 31, 2004, the amount of such securities taken as a whole was immaterial to Cash and Cash Equivalents, and accordingly were not reclassified for 2004 and prior. Proceeds from the sale of investments in 2003 include $26 million of cash received related to the sale of 3M’s 50% ownership in Durel Corporation to Rogers Corporation. Additional purchases of investments totaled $5 million in 2005, $10 million in 2004 and $16 million in 2003. These purchases include additional survivor benefit insurance and equity investments.

 

The Company is actively considering additional acquisitions, investments and strategic alliances.

 

Cash Flows from Financing Activities:

 

Years ended December 31

 

 

 

 

 

 

 

(Millions)

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Change in short-term debt — net

 

$

(258

)

$

399

 

$

(215

)

Repayment of debt (maturities greater than 90 days)

 

(656

)

(868

)

(719

)

Proceeds from debt (maturities greater than 90 days)

 

429

 

358

 

494

 

Total change in debt

 

$

(485

)

$

(111

)

$

(440

)

Purchases of treasury stock

 

(2,377

)

(1,791

)

(685

)

Reissuances of treasury stock

 

545

 

508

 

555

 

Dividends paid to stockholders

 

(1,286

)

(1,125

)

(1,034

)

Distributions to minority interests and other — net

 

(76

)

(15

)

(23

)

Net cash used in financing activities

 

$

(3,679

)

$

(2,534

)

$

(1,627

)

 

Total debt at December 31, 2005, was $2.381 billion, down from $2.821 billion at year-end 2004, with the decrease primarily attributable to the retirement of $400 million in medium-term notes. There were no new long-term debt issuances in 2005. In 2005, the cash flow decrease in net short-term debt of $258 million includes the portion of short-term debt with original maturities of 90 days or less. The repayment of debt of $656 million primarily related to the retirement of $400 million in medium-term notes and commercial paper retirements. Proceeds from debt of $429 million primarily related to commercial paper issuances. Total debt was 19% of total capital (total capital is defined as debt plus equity), compared with 21% at year-end 2004.

 

Debt securities, including the Company’s shelf registration, its medium-term notes program, dealer remarketable securities and Convertible Note, are all discussed in more detail in Note 8 to the Consolidated Financial Statements. 3M has a shelf registration and medium-term notes program through which $1.5 billion of medium-term notes may be offered. In 2004, the Company issued approximately $62 million in debt securities under its medium-term notes program. No debt was issued under this program in 2005. The medium-term notes program and shelf registration have remaining capacity of approximately $1.438 billion. The Company’s $350 million of dealer remarketable securities (classified as current portion of long-term debt) were remarketed for one year in December 2005. In addition, the Company has Convertible Notes with a book value of $539 million at December 31, 2005.

 

29



 

The next put option date for these Convertible Notes is November 2007, thus at year-end 2005 this debt is classified as long-term debt. At December 31, 2005, the dealer remarketable securities and $62 million of medium-term notes are classified as current portion of long-term debt as the result of put provisions associated with these debt instruments. For a discussion of accounting pronouncements that will affect accounting treatment for the Convertible Note, refer to Note 1 to the Consolidated Financial Statements for discussion of EITF Issue No. 04-08, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” and proposed SFAS No. 128R, “Earnings per Share”.

 

Repurchases of common stock are made to support the Company’s stock-based employee compensation plans and for other corporate purposes.  On November 8, 2004, the Board of Directors authorized the purchase of  $2.0 billion of the Company’s common stock between January 1, 2005 and January 31, 2006.  In October 2005, 3M’s Board of Directors authorized the repurchase of an additional $300 million of the Company’s stock through January 31, 2006.  This increased the total repurchase authorization to $2.3 billion for the period through January 31, 2006. As of December 31, 2005, substantially all of this repurchase authorization had been utilized. Refer to the table captioned “Issuer Purchases of Equity Securities” in Part II, Item 5, for more information.

 

Cash dividends paid to stockholders totaled $1.286 billion ($1.68 per share) in 2005, $1.125 billion ($1.44 per share) in 2004 and $1.034 billion ($1.32 per share) in 2003. 3M has paid dividends since 1916. Other cash flows from financing activities include distributions to minority interests, changes in cash overdraft balances, and principal payments for capital leases.

 

Liquidity:

The Company’s liquidity remains strong. Primary short-term liquidity needs are provided through U.S. commercial paper and euro commercial paper issuances. As of December 31, 2005, outstanding total commercial paper issued totaled $514 million and averaged approximately $823 million during 2005. Medium-term note shelf borrowing capacity totaled $1.438 billion as of December 31, 2005. Credit support for outstanding commercial paper is provided by a $565 million credit agreement among a group of primary relationship banks.  In March 2005, the Company replaced its 364-day credit agreement with a five-year credit agreement with similar terms. This $565 million credit facility provides up to $115 million in letters of credit ($97 million of which was utilized at December 31, 2005), with provisions for increasing this limit up to $150 million. Committed credit facilities of $53 million are in place across several international subsidiary locations.

 

The Company believes it is unlikely that its access to the commercial paper market will be restricted. Cash and cash equivalents and certain other current assets could provide additional liquidity to meet near term obligations, if necessary. At year-end 2005, certain debt agreements ($350 million of dealer remarketable securities and $165 million of ESOP debt) had ratings triggers (BBB-/Baa3 or lower) that would require repayment of debt. The Company currently has AA/Aa1 debt ratings. In addition, the $565 million, five-year credit agreement requires 3M to maintain a capitalization ratio at no more than 0.60 to 1 at the end of each quarter. This ratio is calculated as funded debt (including all borrowed money and letters of credit utilized) to the sum of funded debt and equity. At December 31, 2005, this ratio was approximately 0.20 to 1.

 

3M’s cash balance at December 31, 2005 totaled $1.072 billion. 3M’s strong balance sheet and liquidity provide the Company with significant flexibility to take advantage of numerous opportunities going forward. The Company will continue to invest in its operations to drive growth, including continual review of acquisition opportunities. 3M paid dividends of $1.286 billion in 2005, and has a long history of dividend increases. In February 2006, the Board of Directors increased the quarterly dividend on 3M common stock by 9.5% to 46 cents per share, equivalent to an annual dividend of $1.84 per share. In February 2006, 3M’s Board of Directors also authorized the purchase of up to $2.0 billion of the Company’s common stock between February 13, 2006 and February 28, 2007. The Company may also make additional contributions to its pension plan in the future, but exact amounts are uncertain and will depend on market conditions.

 

Off-Balance Sheet Arrangements and Contractual Obligations:

As of December 31, 2005, the Company had not utilized special purpose entities to facilitate off-balance sheet financing arrangements. 3M’s accrued product warranty liabilities, recorded on the Consolidated Balance Sheet as part of current and long-term liabilities, are estimated at approximately $22 million. 3M does not consider this amount to be material. The fair value of 3M guarantees of loans with third parties and other guarantee arrangements are not material.

 

In addition to guarantees, 3M, in the normal course of business, periodically enters into agreements that require 3M to indemnify either major customers or suppliers for specific risks, such as claims for injury or property damage arising out of 3M products or the negligence of 3M personnel, or claims alleging that 3M products infringe third

 

30



 

party patents or other intellectual property. While 3M’s maximum exposure under these indemnification provisions cannot be estimated, these indemnifications are not expected to have a material impact on the Company’s consolidated financial position or results of operations.

 

A summary of the Company’s significant contractual obligations as of December 31, 2005, follows:

 

Contractual Obligations

 

 

 

Payments due by year

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

After

 

(Millions)

 

Total

 

2006

 

2007

 

2008

 

2009

 

2010

 

2010

 

Long-term debt, including current portion (Note 8) 

 

$

1,801 

 

$

492 

 

$

 622 

 

$

 85 

 

$

 44 

 

$

 0 

 

$

 558 

 

Interest on long-term debt

 

882

 

83

 

56

 

39

 

35

 

33

 

636

 

Operating leases (Note 11)

 

362

 

79

 

61

 

46

 

27

 

21

 

128

 

Capital leases (Note 11)

 

71

 

5

 

4

 

4

 

4

 

4

 

50

 

Unconditional purchase obligations

 

370

 

160

 

78

 

44

 

25

 

19

 

44

 

Total contractual cash obligations

 

$

3,486

 

$

819

 

$

821

 

$

218

 

$

135

 

$

77

 

$

1,416

 

 

Long-term debt payments due in 2006 include $350 million of dealer remarketable securities (final maturity 2010) and $62 million of medium-term notes (final maturity 2044). These securities are classified as current portion of long-term debt as the result of put provisions associated with these debt instruments. The next date on which investors can require repurchase of the Convertible Notes is 2007, thus in the above schedule this is considered due in 2007 (final maturity 2032).

 

Unconditional purchase obligations are defined as an agreement to purchase goods or services that is enforceable and legally binding on the Company. Included in the unconditional purchase obligations category above are certain obligations related to take or pay contracts, capital commitments, service agreements and utilities. These estimates include both unconditional purchase obligations with terms in excess of one year and normal ongoing purchase obligations with terms of less than one year. Many of these commitments relate to take or pay contracts, in which 3M guarantees payment to ensure availability of products or services that are sold to customers. The Company expects to receive consideration (products or services) for these unconditional purchase obligations. The purchase obligation amounts do not represent the entire anticipated purchases in the future, but represent only those items for which the Company is contractually obligated. The majority of 3M’s products and services are purchased as needed, with no unconditional commitment. For this reason, these amounts will not provide a reliable indicator of the Company’s expected future cash outflows on a stand-alone basis.

 

As discussed in Note 10 to the Consolidated Financial Statements, the Company does not have a required minimum pension contribution obligation for its U.S. plans in 2006. Thus, Company contributions to its U.S. and international pension plans are expected to be largely discretionary in 2006 and future years. Contractual capital commitments are also included in the preceding table, but these commitments represent a small part of the Company’s expected capital spending in 2006 and beyond.

 

FINANCIAL INSTRUMENTS

The Company enters into contractual derivative arrangements in the ordinary course of business to manage foreign currency exposure, interest rate risks and commodity price risks. A financial risk management committee, composed of senior management, provides oversight for risk management and derivative activities. This committee determines the Company’s financial risk policies and objectives, and provides guidelines for derivative instrument utilization. This committee also establishes procedures for control and valuation, risk analysis, counterparty credit approval, and ongoing monitoring and reporting.

 

The Company enters into foreign exchange forward contracts, options and swaps to hedge against the effect of exchange rate fluctuations on cash flows denominated in foreign currencies and certain intercompany financing transactions. In 2001, the Company increased the amount and duration of its foreign currency hedges to help lessen year-over-year impacts and to improve the predictability of future earnings. However, this hedging program does not make 3M immune to currency impacts.

 

The Company manages interest rate risks 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

 

31



 

an agreed-upon notional principal amount. The Company manages commodity price risks through negotiated supply contracts, price protection agreements and forward physical contracts.

 

A variance/co-variance statistical modeling technique was used to test the Company’s exposure to changes in currency and interest rates and assess the risk of loss in after-tax earnings of financial instruments, derivatives and underlying exposures outstanding at December 31, 2005. The model (third-party bank dataset) used a 95% confidence level over a 12-month time horizon. Based on this analysis of the Company’s interest rate risks, possible increases in interest rates would not have a material adverse effect on after-tax earnings ($2 million at December 31, 2005 and $5 million at December 31, 2004). A decrease in interest rates would have increased after-tax earnings by $2 million at December 31, 2005. Based on this analysis of the primary foreign exchange risks, possible changes in foreign exchange rates would have adversely impacted after-tax earnings by $69 million at December 31, 2005 ($61 million at December 31, 2004). A positive change in exchange rates would have benefited after-tax earnings by $66 million at December 31, 2005. When including certain commodity risks, possible changes in commodity rates would have adversely impacted after-tax earnings by an additional $4 million at December 31, 2005 (an additional $10 million at December 31, 2004). A positive change in commodity rates would not have materially impacted after-tax earnings at December 31, 2005. The model used analyzed over 20 different currencies and five commodities, but does not purport to represent what actually will be experienced by the Company. This model does not include certain hedge transactions, because the Company believes their inclusion would not materially impact the results.

 

The global exposures related to purchased components and materials are such that a one percent price change would result in a pre-tax cost or savings of approximately $45 million per year. The global energy exposure is such that a 10% price change would result in a pre-tax cost or savings of approximately $35 million per year. Derivative instruments are used to hedge less than two percent of the purchased components and materials exposure and are used to hedge approximately 10% of this energy exposure.

 

 

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.The Company may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases.  In addition, the Company’s representatives may from time to time make oral forward-looking statements.

 

Forward-looking statements relate to future events and typically address the Company’s expected future business and financial performance.  Words such as  “plan,” “expect,” “aim,” “believe,” “project,” “target,” “anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other words and terms of similar meaning, typically identify such forward-looking statements.  In particular, these include statements about the Company’s strategy for growth, product development, market position, future performance or results of current or anticipated products, interest rates, foreign exchange rates, financial results, and the outcome of contingencies, such as legal proceedings. The Company assumes no obligation to update or revise any forward-looking statements.

 

Forward-looking statements are based on certain assumptions and expectations of future events and trends that are subject to risks and uncertainties. Actual future results and trends may differ materially from historical results or those reflected in any such forward-looking statements depending on a variety of factors. Discussion of these factors is incorporated by reference from Part I, Item 1A, “Risk Factors”, of this document, and should be considered an integral part of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

In the context of Item 7A, market risk refers to the risk of loss arising from adverse changes in financial and derivative instrument market rates and prices, such as fluctuations in interest rates and foreign currency exchange rates. The Company discusses risk management in various places throughout this document, including discussions in Item 7 concerning Financial Condition and Liquidity, and Financial Instruments, and in the Notes to Consolidated Financial Statements (Long-Term Debt and Short-Term Borrowings, Derivatives and Other Financial Instruments, and the Derivatives and Hedging Activities accounting policy). All derivative activity is governed by written policies, and a value-at-risk analysis is provided for these derivatives. The Company does not have leveraged derivative positions.  However, the Company does have contingently convertible debt that, if conditions for conversion are met, is convertible into shares of 3M common stock (refer to Note 8 in this document).

 

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Item 8. Financial Statements and Supplementary Data.

 

Index to Financial Statements

 

 

 

Reference (pages)

 

 

 

Management’s Responsibility for Financial Reporting

 

34

 

 

 

Management’s Report on Internal Control Over Financial Reporting

 

34

 

 

 

Report of Independent Registered Public Accounting Firm

 

35-36

 

 

 

Consolidated Statement of Income for the years ended December 31, 2005, 2004 and 2003

 

37

 

 

 

Consolidated Balance Sheet at December 31, 2005 and 2004

 

38

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2005, 2004 and 2003

 

39

 

 

 

Consolidated Statement of Cash Flows for the years ended December 31, 2005, 2004 and 2003

 

40

 

 

 

Notes to Consolidated Financial Statements

 

41-76

 

 

 

Note 1.Significant Accounting Policies

 

41-46

Note 2.Acquisitions and Divestitures

 

46-48

Note 3.Goodwill and Intangible Assets

 

49

Note 4.Supplemental Balance Sheet Information

 

50-51

Note 5.Supplemental Stockholders’ Equity and Comprehensive Income Information

 

51-52

Note 6.Supplemental Cash Flow Information

 

52

Note 7.Income Taxes

 

52-54

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

 

54-56

Note 9.Derivatives and Other Financial Instruments

 

56-57

Note 10. Pension and Postretirement Benefit Plans

 

57-63

Note 11. Commitments and Contingencies

 

63-70

Note 12. Employee Savings and Stock Ownership Plans

 

70-71

Note 13. General Employees’ Stock Purchase Plan

 

71

Note 14. Management Stock Ownership Program

 

72

Note 15. Business Segments

 

73-74

Note 16. Geographic Areas

 

75

Note 17. Quarterly Data (Unaudited)

 

75-76