10-K 1 a07-5153_110k.htm 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x                                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2006

 

Commission file number 1-3285

 

3M COMPANY

Delaware

 

41-0417775

(State of Incorporation)

 

(I.R.S. Employer Identification No)

 

 

 

3M Center, St. Paul, Minnesota

 

55144

(Principal executive offices)

 

(zip code)

 

(651) 733-1110

(Telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange 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 
x  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  x

 

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

 

Indicate by check mark 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.  x

 

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 x

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  x

 

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 $54.5 billion as of January 31, 2007 (approximately $60.8 billion as of June 30, 2006, the last business day of the Registrant’s most recently completed second quarter).

 

Shares of common stock outstanding at January 31, 2007: 733,885,504.

 

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, 2006) for its annual meeting to be held on May 8, 2007, 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 88 pages.

The table of contents is set forth on page 2. The exhibit index begins on page 86.

 




3M COMPANY

FORM 10-K

For the Year Ended December 31, 2006

TABLE OF CONTENTS

 

 

 

PAGES

PART I

 

 

 

 

ITEM 1

 

Business

 

3

 

 

 

 

 

ITEM 1A

 

Risk Factors

 

8

 

 

 

 

 

ITEM 1B

 

Unresolved Staff Comments

 

9

 

 

 

 

 

ITEM 2

 

Properties

 

9

 

 

 

 

 

ITEM 3

 

Legal Proceedings

 

9

 

 

 

 

 

ITEM 4

 

Submission of Matters to a Vote of Security Holders

 

9

 

 

 

 

 

PART II

 

 

 

 

ITEM 5

 

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

 

9

 

 

 

 

 

ITEM 6

 

Selected Financial Data

 

11

 

 

 

 

 

ITEM 7

 

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

 

11

 

 

 

 

 

ITEM 7A

 

Quantitative and Qualitative Disclosures About Market Risk

 

33

 

 

 

 

 

ITEM 8

 

Financial Statements and Supplementary Data

 

34

 

 

 

 

 

 

 

Index to Financial Statements

 

34

 

 

 

 

 

ITEM 9

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

84

 

 

 

 

 

ITEM 9A

 

Controls and Procedures

 

84

 

 

 

 

 

ITEM 9B

 

Other Information

 

84

 

 

 

 

 

PART III

 

 

 

 

ITEM 10

 

Directors, Executive Officers and Corporate Governance

 

84

 

 

 

 

 

ITEM 11

 

Executive Compensation

 

85

 

 

 

 

 

ITEM 12

 

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

 

85

 

 

 

 

 

ITEM 13

 

Certain Relationships and Related Transactions, and Director Independence

 

85

 

 

 

 

 

ITEM 14

 

Principal Accounting Fees and Services

 

85

 

 

 

 

 

PART IV

 

 

 

 

ITEM 15

 

Exhibits and Financial Statement Schedules

 

86

 

 

 

 

 

 

 

Index to Exhibits

 

86

 

2




 

3M COMPANY
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2006
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. In addition, for any references to Note 1 through Note 19, refer to the Notes to Consolidated Financial Statements in Item 8 of this document.

Available Information

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 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.

3M 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: industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services; and electro and communications. 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, 2006, the Company employed 75,333 people, with 34,553 employed in the United States and 40,780 employed internationally.

Business Segments

3M manages its operations in six operating business segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security and Protection Services; and Electro and Communications. 3M’s six business segments bring together common or related 3M technologies, enhancing the development of innovative products and services and providing for efficient sharing of business resources. These segments have worldwide responsibility for virtually all 3M product lines. 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.

Industrial and Transportation Business: The Industrial and Transportation Business segment serves a broad range of markets, such as appliance, paper and packaging, food and beverage, personal care and automotive. Industrial and Transportation products include tapes, a wide variety of coated and nonwoven abrasives, adhesives, specialty materials, supply chain execution software solutions, closures for disposable diapers, and components and products that are used in the manufacture, repair, and maintenance of automotive, marine, aircraft and specialty vehicles. The August 2005 acquisition of CUNO, Incorporated (“CUNO”) added a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases.

Major industrial products 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 a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases; fluoroelastomers for seals, tubes and gaskets in engines; engineering fluids; supply chain execution software and solutions; and closures for disposable diapers.

3




Major transportation products 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. In addition, 3M provides paint finishing and detailing products, including a complete system of cleaners, dressings, polishes, waxes and other products.

Health Care Business: The Health Care segment serves markets that include medical, surgical, pharmaceutical, dental and orthodontic, and health information systems. Products provided to these and other markets include medical and surgical supplies, skin health and infection prevention products, pharmaceuticals, drug delivery systems, dental and orthodontic products, health information systems and microbiology products. As discussed in Note 2, the global branded pharmaceuticals business was sold in December 2006 and January 2007.

In the medical and surgical areas, 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.

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; computer screen filters; 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) hand-held devices such as cellular phones, 4) notebook PCs and 5) automotive displays. Other optical products include lens systems for projection televisions, in addition to desktop and notebook computer screen filters that address needs for light control, privacy viewing and glare reduction. The touch systems business includes touch screens and touch monitors. In traffic safety systems, 3M provides reflective sheetings used on highway signs, vehicle license plates, construction work-zone 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 graphics 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, and home improvement. Products provided to these and other markets 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, such as 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, Command Adhesive products and Filtrete™ Filters for furnaces and air conditioners; 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, and 3M™ Nexcare™ Adhesive Bandages. Visual communication products serve the world’s office and education markets with overhead projectors and transparency films, as well as equipment and materials for electronic and multimedia presentations.

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. In August 2006, 3M completed the acquisition of Security Printing and Systems Limited, a producer of finished, personalized passports and secure cards.

This segment’s products include maintenance-free and reusable respirators, personal protective equipment, electronic surveillance products, films that protect against counterfeiting, and reflective materials that are widely used on apparel,

4




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.

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. This segment provides 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 cooling electronics and lubricating 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 for rapid deployment in fixed and wireless networks.

Distribution

3M products are sold through numerous distribution channels, including 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 a confidence 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 169 sales offices worldwide, with 10 in the United States and 159 internationally.

Research and Patents

Research and product development constitutes an important part of 3M’s activities and has been a major driver of 3M’s sales growth. Research, development and related expenses totaled $1.522 billion in 2006. This amount included a $95 million in-process research and development charge (discussed in Note 2) and $75 million in restructuring actions (Note 4). Research, development and related expenses totaled $1.274 billion in 2005 and $1.246 billion in 2004. Research and development, covering basic scientific research and the application of scientific advances in the development of new and improved products and their uses, totaled $943 million in 2006, including the $95 million for purchased in-process research and development discussed above. Research and development expenses totaled $818 million in 2005 and $792 million in 2004. Related expenses primarily include technical support provided by 3M to existing customers who are using 3M products, and the 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 generate a steady stream of 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 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 Display and Graphics segments is described in “Performance by Business Segment” — “Display and Graphics Business” in Part II, Item 7, of this Form 10-K.

Raw Materials

In 2006, the Company experienced price increases affecting metals, wood pulp and oil-derived raw materials. During the fourth quarter of 2006 total market demand for metals and oil-derived raw materials began to soften and the Company is therefore pursuing price reductions for those commodities. To date the Company is receiving sufficient quantities of all raw 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. 3M has avoided disruption to its manufacturing operations through careful management of existing raw material inventories and development and

5




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 and Other Liabilities and Insurance Receivables” in Note 13, Commitments and Contingencies).

Environmental expenditures relating to existing conditions caused by past operations that do not contribute to current or future revenues are expensed. Reserves for liabilities for anticipated 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 2006, 3M expended about $18 million for capital projects related to protecting the environment. The comparable amount in 2005 was about $28 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 $20 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, and their age, present position, the year elected to their present position and other positions they have 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 23, 2007).

Name

 

Age

 

Present Position

 

Year
Elected to
Present
Position

 

Other Positions

Held During 2002-2006

George W. Buckley

 

60

 

Chairman of the Board, President and
Chief Executive Officer

 

2005

 

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

 

 

 

 

 

 

 

 

 

Patrick D. Campbell

 

54

 

Senior Vice President and
Chief Financial Officer

 

2002

 

 

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

 

 

 

 

 

 

 

 

 

Joe E. Harlan

 

47

 

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

 

 

 

 

 

 

 

 

 

Michael A. Kelly

 

50

 

Executive Vice President,
Display and Graphics Business

 

2006

 

Division Vice President, Occupational Health and Environmental Safety Division, 2003-2006

General Manager, Performance Materials Division, 2003

Managing Director, 3M Korea, 2001-2003

 

6




 

Executive Officers

(continued)

 

Name

 

Age

 

Present Position

 

Year
Elected to
Present
Position

 

Other Positions

Held During 2002-2006

Angela S. Lalor

 

41

 

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

 

54

 

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

 

 

 

 

 

 

 

 

 

Robert D. MacDonald

 

56

 

Senior Vice President,
Marketing and Sales

 

2004

 

Division Vice President, Automotive Aftermarket Division, 2002-2004

Managing Director, 3M Italy, 1999-2002

 

 

 

 

 

 

 

 

 

Moe S. Nozari

 

64

 

Executive Vice President,
Consumer and Office Business

 

2002

 

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

 

 

 

 

 

 

 

 

 

Frederick J. Palensky

 

57

 

Executive Vice President,
Research and Development and
Chief Technology Officer

 

2006

 

Executive Vice President, Enterprise Services, 2005-2006

Executive Vice President, Safety, Security and Protection Services Business, 2002-2005

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

 

 

 

 

 

 

 

 

 

Brad T. Sauer

 

47

 

Executive Vice President,
Health Care Business

 

2004

 

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

Executive Director, Six Sigma, 2001-2002

 

 

 

 

 

 

 

 

 

Hak Cheol Shin

 

49

 

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

 

 

 

 

 

 

 

 

 

James B. Stake

 

54

 

Executive Vice President,
Enterprise Services

 

2006

 

Executive Vice President, Display and Graphics Business, 2002-2006

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

 

7




Executive Officers

(continued)

 

Name

 

Age

 

Present Position

 

Year
Elected to
Present
Position

 

Other Positions

Held During 2002-2006

Inge G. Thulin

 

53

 

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

 

 

 

 

 

 

 

 

 

John K. Woodworth

 

55

 

Senior Vice President,
Corporate Supply Chain Operations

 

2006

 

Vice President, Asia Pacific, 2004-2006

Division Vice President, Electronic Solutions Division, 2003-2004

Division Vice President, Electronic and Interconnect Solutions Division, 2002-2003

Division Vice President, Interconnect Solutions Division, 2001-2002

 

 

 

 

 

 

 

 

 

Richard F. Ziegler

 

57

 

Senior Vice President,
Legal Affairs and
General Counsel

 

2003

 

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

 

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 more than 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 adverse changes in interest rates, tax, or regulations 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 the 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 the success of products offered by our competitors, and 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 more than 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, or gain market acceptance of new products. 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 be 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

8




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 integrate acquired businesses quickly 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 lean Six Sigma, to improve operational efficiency and productivity. There can be no assurance that all of the projected 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 susceptible of reasonable estimates, such as a significant judicial ruling or judgment, a significant settlement, significant regulatory developments 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. For a more detailed discussion of the legal proceedings involving the Company and the associated accounting estimates, see the discussion in Note 13.

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 10 sales offices in eight states and operates 66 manufacturing facilities in 26 states. Internationally, 3M has 159 sales offices. The Company operates 79 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 13, “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, 2006.

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 and Related Stockholder Matters,” of this document, and should be considered an integral part of Item 5. At January 31, 2007, there were approximately 123,824 shareholders of record. 3M’s stock is listed on the New York Stock Exchange, Inc. (NYSE), the Pacific Exchange, Inc., the Chicago Stock Exchange, Inc., and the SWX Swiss Exchange. Cash dividends declared and paid totaled $.46 per share for each quarter of 2006, and $.42 per share for each quarter of 2005. Stock price comparisons follow:

 

9




Stock price comparisons (NYSE composite transactions)

(Per share amounts)

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

Year

 

2006 High

 

$

79.83

 

$

88.35

 

$

81.60

 

$

81.95

 

$

88.35

 

2006 Low

 

70.30

 

75.76

 

67.05

 

73.00

 

67.05

 

2005 High

 

$

87.45

 

$

86.21

 

$

76.74

 

$

79.84

 

$

87.45

 

2005 Low

 

80.73

 

72.25

 

70.41

 

69.71

 

69.71

 

 

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. On February 13, 2006, the Board of Directors authorized the purchase of $2.0 billion of the Company’s common stock between February 13, 2006 and February 28, 2007. In August 2006, 3M’s Board of Directors authorized the repurchase of an additional $1.0 billion in share repurchases, raising the total authorization to $3.0 billion for the period from February 13, 2006 to February 28, 2007. In February 2007, 3M’s Board of Directors approved a  $7.0 billion two-year share repurchase authorization for the period from February 12, 2007 to February 28, 2009.

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, 2006

 

140,646

 

$

75.33

 

30,000

 

$

2

 

February 1-28, 2006

 

754,242

 

$

73.46

 

665,100

 

$

1,951

 

March 1-31, 2006

 

1,819,405

 

$

73.75

 

1,771,700

 

$

1,821

 

Total January 1 — March 31, 2006

 

2,714,293

 

$

73.75

 

2,466,800

 

$

1,821

 

April 1-30, 2006

 

182,838

 

$

81.90

 

0

 

$

1,821

 

May 1-31, 2006

 

3,670,467

 

$

85.17

 

3,388,200

 

$

1,532

 

June 1-30, 2006

 

2,566,065

 

$

80.65

 

2,535,300

 

$

1,328

 

Total April 1 — June 30, 2006

 

6,419,370

 

$

83.27

 

5,923,500

 

$

1,328

 

July 1-31, 2006

 

3,761,920

 

$

70.71

 

3,741,900

 

$

1,063

 

August 1-31, 2006

 

8,407,073

 

$

69.71

 

8,398,200

 

$

1,478

 

September 1-30, 2006

 

5,768,298

 

$

72.96

 

5,758,200

 

$

1,058

 

Total July 1 — September 30, 2006

 

17,937,291

 

$

70.96

 

17,898,300

 

$

1,058

 

October 1-31, 2006

 

830,432

 

$

77.98

 

761,300

 

$

999

 

November 1-30, 2006

 

1,227,465

 

$

80.67

 

1,155,400

 

$

905

 

December 1-31, 2006

 

2,038,281

 

$

78.71

 

1,997,400

 

$

748

 

Total October 1 — Dec. 31, 2006

 

4,096,178

 

$

79.15

 

3,914,100

 

$

748

 

Total January 1 — December 31, 2006

 

31,167,132

 

$

74.82

 

30,202,700

 

$

748

 


(1) The total number of shares purchased includes: (i) shares purchased under the Board’s authorizations described above, and (ii) shares purchased in connection with the exercise of stock options (which combined totaled 110,646 shares in January 2006, 89,142 shares in February 2006, 47,705 shares in March 2006, 182,838 shares in April 2006, 282,267 shares in May 2006, 30,765 shares in June 2006, 20,020 shares in July 2006, 8,873 shares in August 2006, 10,098 shares in September 2006, 69,132 shares in October 2006, 72,065 shares in November 2006, and 40,881 shares in December 2006).

10




Item 6. Selected Financial Data.

(Dollars in millions, except per share amounts)

 

2006

 

2005

 

2004

 

2003

 

2002

 

Years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

22,923

 

$

21,167

 

$

20,011

 

$

18,232

 

$

16,332

 

Income before cumulative effect of accounting change

 

3,851

 

3,146

 

2,841

 

2,286

 

1,832

 

Per share of common stock:

 

 

 

 

 

 

 

 

 

 

 

Income before cumulative effect of

 

 

 

 

 

 

 

 

 

 

 

accounting change — basic

 

5.15

 

4.11

 

3.64

 

2.92

 

2.35

 

Income before cumulative effect of

 

 

 

 

 

 

 

 

 

 

 

accounting change — diluted

 

5.06

 

4.03

 

3.56

 

2.88

 

2.32

 

Cash dividends declared and paid

 

1.84

 

1.68

 

1.44

 

1.32

 

1.24

 

At December 31:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

21,294

 

$

20,541

 

$

20,723

 

$

17,612

 

$

15,339

 

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

 

1,112

 

1,368

 

798

 

1,805

 

2,142

 

 

The above income and earnings per share information exclude a cumulative effect of accounting change in 2005 ($35 million, or 5 cents per diluted share). Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004) and used 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 for more detail on these two items.

2006 results included net gains that increased operating income by $523 million and net income by $438 million. 2006 included net benefits from gains related to the sale of certain portions of 3M’s branded pharmaceuticals business ($1.074 billion pre-tax, $674 million after-tax) and favorable income tax adjustments ($149 million), which were partially offset by restructuring actions ($403 million pre-tax, $257 million after-tax), acquired in-process research and development expenses ($95 million pre-tax and after-tax), settlement costs of a previously disclosed antitrust class action ($40 million pre-tax, $25 million after-tax), and environmental obligations related to the pharmaceuticals business ($13 million pre-tax, $8 million after-tax). 2005 results included charges that reduced net income by $75 million. This related to a tax liability resulting from 3M’s reinvestment of approximately $1.7 billion of foreign earnings in 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).

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. 3M manages its operations in six operating business segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security and Protection Services; and Electro and Communications.

3M’s strategy emphasizes a commitment to grow at a faster pace, using a four-pronged approach, which includes reinvesting in its core businesses, developing adjacent emerging business opportunities, expanding on the Company’s already world-class capabilities outside the United States, and acquiring companies in faster-growing industries.

·                  3M’s reinvestment in the core is evidenced through its 2006 investments in new production capacity in a number of growing and highly profitable businesses, such as medical, respiratory protection, LCD films and others. In addition, 3M is investing in research and development, which should position our existing business portfolio for accelerated growth.

·                  3M launched five new emerging business opportunities, including our Track and Trace initiative, global mining, food safety, filtration, and energy. 3M made great progress on its Track and Trace initiative in 2006, merging a number of formerly disparate efforts into one single growth engine for the future. Track and Trace has a growing array of applications — from tracking packages to managing medical and legal records.

·                  3M continued to build its capabilities in many of the world’s fastest-growing emerging economies in 2006. 3M began construction of three new plants in China, one in Russia, one in Poland and one in India. By the end of 2007, 3M expects to have 10 or more plants open or under construction in China. 3M also drove outstanding growth in more developed countries. European sales growth was about 10% in U.S. dollars, and 8.3% in local currencies.

11




·                  3M closed on 19 acquisitions in 2006, all contributing to growth in different ways. Acquisitions were made to add products and gap-fillers, to expand our offerings and become more important to our customers, to add capacity, to get access to local markets via local brands, and to augment our existing technology base.

With a continued focus on these strategies into 2007, 3M believes it can transform itself into a faster-growing company.

The Company expects to increase both research and development (excluding the pharmaceuticals business, acquired in-process research and development charge and restructuring-related items) and capital expenditures in 2007, with investments in growth programs around the world. Research, development and related expenses totaled $1.522 billion in 2006. This included a $95 million in-process research and development charge (discussed in Note 2) and approximately $75 million in restructuring-related items (discussed in Note 4). Adjusted for these items, research, development and related expenses still increased by over 6%. Total capital expenditures for 2006 totaled $1.168 billion, up $225 million compared with 2005. The Company expects capital expenditures to total approximately $1.4 billion to $1.5 billion in 2007, providing the capacity to meet expected growth.

3M announced in April 2006 that it would explore strategic alternatives for its global branded pharmaceuticals business. 3M believes that in today’s very competitive pharmaceuticals marketplace, continued success in brand pharmaceuticals requires broad pipelines of new drugs, significant investments, and a longer-term risk-reward model than applies to most other 3M businesses. In December 2006 and January 2007, 3M completed the sale of its branded pharmaceuticals business. As discussed in Note 2, the January 2007 transaction will be recorded in the first quarter of 2007. As previously disclosed, 3M had indicated that it would likely incur some restructuring-related costs associated with selling the business.

As a result of the above, in the fourth quarter of 2006, 3M recorded a gain on sale, which was partially offset by restructuring and other items. Including these items, in 2006, 3M reported record net sales of $22.923 billion and record net income of $3.851 billion, or $5.06 per diluted share, compared with net sales of $21.167 billion and net income of $3.111 billion, or $3.98 per diluted share. Excluding these items, the Company still achieved strong underlying operating performance, helped by the combination of an 8.3% increase in net sales, including core local-currency sales growth of 5.6% (which excludes the impact of businesses acquired in the last 12 months).

In 2006, the gain on sale, net of restructuring and other items, increased operating income by $523 million and net income by $438 million, or $0.57 per diluted share. 2006 included net benefits from gains related to the sale of certain portions of 3M’s branded pharmaceuticals business ($1.074 billion pre-tax, $674 million after-tax) and favorable income tax adjustments ($149 million), which were partially offset by restructuring actions ($403 million pre-tax, $257 million after-tax), acquired in-process research and development expenses ($95 million pre-tax and after-tax), settlement costs of a previously disclosed antitrust class action ($40 million pre-tax, $25 million after-tax), and environmental obligations related to the pharmaceuticals business ($13 million pre-tax, $8 million after-tax). These items are discussed in more detail in Note 2 (Acquisitions and Divestitures), Note 4 (2006 Restructuring Actions), Note 8 (Income Taxes), and Note 13 (Commitments and Contingencies).

In 2005, 3M adopted Financial Accounting Standards Board Interpretation (FASB) No. 47, “Accounting for Conditional Asset Retirement Obligations,” and repatriated approximately $1.7 billion of foreign earnings to the United States pursuant to the provisions of the American Jobs Creation Act of 2004 (refer to Note 1 and Note 8 for more detail). 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, 2006 and 2005. Refer to the Performance by Business Segment section for discussion of the net impact of the gain on sale, restructuring and other items that increased Health Care operating income, but which reduced most of the other business segments’ operating income.

12




 

 

 

2006

 

2005

 

2006 vs. 2005
% change

 

 

 

Net

 

% of

 

Oper.

 

Net

 

% of

 

Oper.

 

Net

 

Oper.

 

(Dollars in millions)

 

Sales

 

Total

 

Income

 

Sales

 

Total

 

Income

 

Sales

 

Income

 

Business Segments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Industrial and Transportation

 

$

6,754

 

29.5

%

$

1,343

 

$

6,144

 

29.0

%

$

1,211

 

9.9

%

10.9

%

Health Care

 

4,011

 

17.5

%

1,845

 

3,760

 

17.8

%

1,114

 

6.7

%

65.6

%

Display and Graphics

 

3,765

 

16.4

%

1,062

 

3,511

 

16.6

%

1,162

 

7.2

%

(8.6

)%

Consumer and Office

 

3,238

 

14.1

%

579

 

3,033

 

14.3

%

561

 

6.8

%

3.2

%

Safety, Security and Protection Services

 

2,621

 

11.4

%

575

 

2,292

 

10.8

%

537

 

14.4

%

7.0

%

Electro and Communications

 

2,483

 

10.8

%

438

 

2,333

 

11.0

%

447

 

6.4

%

(2.1

)%

Corporate and Unallocated

 

51

 

0.3

%

(146

)

94

 

0.5

%

(178

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Company

 

$

22,923

 

100

%

$

5,696

 

$

21,167

 

100

%

$

4,854

 

8.3

%

17.3

%

 

3M’s sales performance in 2006 was broad-based, with all six business segments contributing to positive local-currency sales growth. Sales growth in the Industrial and Transportation segment was led by industrial adhesives and tapes, along with the automotive aftermarket business. Acquisitions, primarily CUNO, added 4.6% to Industrial and Transportation sales growth. Sales growth in Health Care was led by 3M’s core medical and dental businesses. Display and Graphics sales growth was led by display enhancement films used in flat-panel devices and strong growth in the commercial graphics 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. 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. Acquisitions, primarily Security Printing and Systems Limited, which was acquired in August 2006, added 4.0% to Safety, Security and Protection Services sales growth. For the Electro and Communications segment, sales growth was led by demand for 3M electronic products for semiconductor manufacturers, along with continued strong growth in electrical products for insulating, testing and sensing. 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 7.1%, Asia Pacific local-currency sales (which exclude translation impacts) increased 9.2%, European local-currency sales increased 8.3%, and the combined Latin America and Canada area local-currency sales increased 6.1%. Refer to the Performance by Geographic Area section for a more detailed discussion of the results for the respective areas.

Operating income improvement for the year, excluding the gain on the branded pharmaceuticals sale and restructuring and other items, was led by the Industrial and Transportation segment and the Safety, Security and Protection Services segment. Display and Graphics was hurt by sales price declines, a sales mix shift towards larger LCD displays, and operational challenges related to the Company’s new optical film manufacturing production line, which have since been resolved. The Display and Graphics segment and Electro and Communications segment were impacted the most by business-specific restructuring actions (Note 4 and business segment discussion). 3M’s operating income margins remained at healthy levels, even after adjusting for net gains related to the branded pharmaceuticals sale, restructuring and other items.

For the year 2006, the Company utilized $3.7 billion of cash to repurchase 3M common stock and pay dividends. In August 2006, 3M’s Board of Directors authorized an additional $1 billion in share repurchases of the Company’s stock, raising the total authorization to $3 billion between February 13, 2006 and February 28, 2007. As of December 31, 2006, $748 million remained available for repurchases. In February 2007, 3M’s Board authorized a dividend increase of 4.3% to 48 cents per share, equivalent to an annual dividend of $1.92 per share for 2007, marking the 49th consecutive year of dividend increases, and also approved a $7 billion two-year share repurchase authorization for the period from February 12, 2007 to February 28, 2009. 3M’s debt to total capital ratio (total capital defined as debt plus equity) as of December 31, 2006 was 26%. 3M has an AA credit rating from Standard & Poor’s and an Aa1 credit rating from Moody’s Investors Service.

In 2006, the Company experienced price increases affecting metals, wood pulp and oil-derived raw materials. During the fourth quarter of 2006 total market demand for metals and oil-derived raw materials began to soften and the Company is therefore pursuing price reductions for those commodities. The Company to date is receiving sufficient

13




quantities of all raw materials to meet its reasonably foreseeable production requirements, but it is impossible to predict future shortages of raw materials or the impact any such shortages would have. 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 continued, as it has for many years, to incur expenses (insured and uninsured) in managing its litigation and environmental contingencies.

The sale of the pharmaceuticals business is not presented as a discontinued operation due to the extent of the projected continuing cash flows from our contractual supply relationship with the buyers in relation to those of the business that was sold. Therefore, it will create both a sales and profitability comparability issue beginning with first quarter 2007 results. Annual sales in 2006 for pharmaceuticals were $774 million, and reported operating income was $1.039 billion, including net gains of $783 million as discussed in the “Pharmaceuticals Business” discussion that follows. Sales growth in 2007 will be negatively impacted as these pharmaceutical sales are in the base 2006 period. 3M’s Drug Delivery Systems Division will be a source of supply to the acquiring companies, with expected annual revenues of approximately $100 million from the various arrangements with the three buyers. Such outsourcing arrangements involve a lower profitability than the other product and service offerings of most of our existing Health Care businesses.

3M restructured many areas in parallel with divesting the global branded pharmaceuticals business. The great majority of those costs will not be eliminated until late in the first quarter or early in the second quarter of 2007. Earnings growth is expected to be slowest in the first quarter of 2007 due to these continued expenses and the strong comparable first quarter in 2006. 3M expects earnings to improve somewhat in the second quarter of 2007, and accelerate more into the second half of the year.

Beginning in 2007, the Company is modifying its long-term and short-term incentive compensation programs to align employee and shareholder interests more closely. The Company’s short-term incentive compensation plan is moving away from its quarterly year-over-year focused profit sharing plan toward an annual bonus plan with payouts tied principally to performance measured by the operating plan. The Company is also reducing the number of traditional stock options granted under its long-term incentive compensation plan by reducing the number of employees eligible to receive annual grants and by shifting a portion of the annual grant away from traditional stock options primarily to restricted stock units. These changes will reduce the annual dilution impact from 1.5% of total outstanding common stock to about 1%. However, associated with the reduction in the number of eligible employees, the Company decided to provide a one-time “buyout” grant to the impacted employees, which will result in increased stock-based compensation expense in 2007. In addition, 3M’s change in the vesting period for stock options from one to three years starting with the May 2005 grant also results in higher expense in 2007 compared with 2006. Stock-based compensation expense is expected to total $0.21 per diluted share in 2007, compared with $0.17 per diluted share in 2006.

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).

As discussed in Note 1, effective January 1, 2006, 3M adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), which required 3M to expense stock-based compensation. The Company adopted SFAS No. 123R using the modified retrospective method. Effective January 1, 2006, all prior periods were revised 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 expense for the years ended December 31, 2006, 2005 and 2004 is summarized by business segment in the table that follows.

Stock-based compensation expense

 

Year ended

 

 

 

December 31,

 

(Dollars in millions)

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Industrial and Transportation

 

$

51

 

$

47

 

$

74

 

Health Care

 

42

 

35

 

58

 

Display and Graphics

 

27

 

19

 

34

 

Consumer and Office

 

24

 

21

 

34

 

Safety, Security and Protection Services

 

21

 

16

 

26

 

Electro and Communications

 

20

 

17

 

26

 

Corporate and Unallocated

 

15

 

 

 

Total Company

 

$

200

 

$

155

 

$

252

 

 

14




The $45 million increase in stock option expense in 2006, compared with 2005, is primarily due to two reasons. First, effective January 1, 2006, accounting rules required the acceleration of stock-based compensation expense recognition to when an employee is eligible to retire, instead of over the entire vesting period for these retirement-eligible employees, resulting in recognition of approximately 25 percent of the expense in the month of grant (second quarter for 3M’s annual stock option grant). Second, 3M changed its vesting period from one to three years starting with the May 2005 grant. The third and fourth quarters of 2006 include expense from both the 2005 and 2006 stock option grants, while the third and fourth quarters of 2005 only include expense from the 2005 stock option grant. The decrease in the 2005 expense, compared with 2004, is primarily due to the change in 3M’s option vesting period.

INDEX TO MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:

 

Reference (pages)

 

Item 7

 

 

 

Results of operations

 

15

 

Performance by business segment

 

18

 

Performance by geographic area

 

25

 

Critical accounting estimates

 

26

 

New accounting pronouncements

 

27

 

Financial condition and liquidity

 

28

 

Financial instruments

 

32

 

Forward-looking statements

 

33

 

Item 7A

 

 

 

Quantitative and qualitative disclosures about market risk

 

33

 

 

RESULTS OF OPERATIONS

Net Sales:

 

 

2006

 

2005

 

 

 

Worldwide

 

U.S.

 

International

 

Worldwide

 

U.S.

 

International

 

Net sales (millions)

 

$

22,923

 

$

8,853

 

$

14,070

 

$

21,167

 

$

8,267

 

$

12,900

 

Components of
net sales change:

 

 

 

 

 

 

 

 

 

 

 

 

 

Volume — core

 

6.1

%

3.1

%

8.0

%

3.5

%

1.0

%

5.1

%

Volume — acquisitions

 

2.1

 

2.6

 

1.9

 

1.0

 

1.4

 

0.7

 

Volume — total

 

8.2

 

5.7

 

9.9

 

4.5

 

2.4

 

5.8

 

Price

 

(0.5

)

1.4

 

(1.8

)

0.6

 

2.5

 

(0.7

)

Local currency

 

7.7

 

7.1

 

8.1

 

5.1

 

4.9

 

5.1

 

Translation

 

0.6

 

 

1.0

 

0.7

 

 

1.2

 

Total

 

8.3

%

7.1

%

9.1

%

5.8

%

4.9

%

6.3

%

 

In 2006, local-currency sales growth of 7.7% was broad-based. All business segments made positive contributions to local-currency sales growth and have done so for three consecutive years. Acquisitions increased 2006 sales by 2.1%, driven by the August 2005 acquisition of CUNO and the August 2006 acquisition of Security Printing and Systems Limited. Refer to both the “Performance by Business Segment” and “Performance by Geographic Area” sections for additional discussion of sales change.

Operating Expenses:

 

 

 

 

 

 

 

 

2006

 

2005

 

 

 

 

 

 

 

 

 

versus

 

versus

 

(Percent of net sales)

 

2006

 

2005

 

2004

 

2005

 

2004

 

Cost of sales

 

51.1

%

49.2

%

50.0

%

1.9

%

(0.8

)%

Selling, general and administrative expenses

 

22.1

 

21.9

 

22.2

 

0.2

 

(0.3

)

Research, development and related expenses

 

6.6

 

6.0

 

6.2

 

0.6

 

(0.2

)

Gain on sale of pharmaceuticals business

 

(4.6

)

 

 

(4.6

)

 

Operating income

 

24.8

%

22.9

%

21.6

%

1.9

%

1.3

%

 

15




The dollar impact of stock-based compensation by major caption for the consolidated statement of income is provided in Note 1. As discussed in the preceding overview section, the gain on sale, restructuring and other items benefited 2006 operating income by $523 million, or 2.2% of net sales. The following table summarizes these impacts by operating expense category. Additional details on restructuring actions are in Note 4. Items included in the “Other” category of the table are acquired in-process research and development expenses ($95 million), settlement costs of a previously disclosed antitrust class action ($40 million), and environmental obligations related to the pharmaceuticals business ($13 million). Refer to Note 2 and Note 13 for additional details on these items.

 

 

2006 Restructuring and Other Summary

 

 

 

Pharma-
ceuticals

 

Overhead

 

Business

 

Total
restruc-

 

Gain on sale
of pharma-

 

 

 

 

 

 

 

restructuring

 

reduction

 

specific

 

turing

 

ceuticals

 

 

 

 

 

(Millions)

 

actions

 

actions

 

actions

 

actions

 

business

 

Other

 

Total

 

Cost of sales

 

$

32

 

$

24

 

$

74

 

$

130

 

$

 

$

13

 

$

143

 

Selling, general and administrative expenses

 

66

 

81

 

51

 

198

 

 

40

 

238

 

Research, development and related expenses

 

68

 

7

 

 

75

 

 

95

 

170

 

Gain on sale of pharmaceuticals business

 

 

 

 

 

(1,074

)

 

(1,074

)

Total operating income penalty (benefit)

 

$

166

 

$

112

 

$

125

 

$

403

 

$

(1,074

)

$

148

 

$

(523

)

 

Cost of Sales:

Cost of sales increased 1.9 percentage points in 2006. Approximately 1.2 percentage points of this increase related to numerous items, such as higher raw material costs, slightly lower selling prices, and higher costs associated with scaling up additional manufacturing capacity. In addition, there were supply chain inefficiencies caused by capacity-constraints. Finally, we accelerated the pace of acquisitions in 2006, which increased cost of sales slightly for the year. After these acquisitions are integrated and begin meaningful contributions to growth, we expect positive impacts. Broad-based sales volume growth and productivity gains helped offset some of this impact. Raw material costs increased approximately 3% for 2006, compared with 2005. Restructuring and other items also negatively impacted cost of sales by $143 million, or 0.7 percentage points. Cost of sales includes manufacturing, engineering and freight costs.

Cost of sales decreased 0.8 of a percentage point in 2005. Cost of sales as a percentage 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% for 2005, compared with 2004.

Selling, General and Administrative Expenses:

Selling, general and administrative (SG&A) expenses as a percentage of net sales increased 0.2 of a percentage point compared with the same period in 2005. In dollars, SG&A increased $435 million, with restructuring and other items increasing SG&A by $238 million, and other spending increasing SG&A by $197 million. 3M continues to invest in growth-oriented SG&A as sales and marketing costs increased faster than sales, while administrative expenses remained relatively flat in dollars, attributable in part to cost-control efforts.

Selling, general and administrative (SG&A) expenses as a percent of net sales decreased 0.3 of a percentage point when comparing 2005 with 2004, primarily due to lower stock-based compensation expense driven by the change in vesting period from one to three years (further discussed in Note 1). 3M continued 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 antitrust class action and two individual such actions, all involving direct purchasers of transparent tape.

Research, Development and Related Expenses:

Research, development and related expenses increased as a percent of sales by 0.6 of a percentage point, or $248 million, when comparing 2006 with 2005, while decreasing as a percent of sales by 0.2 of a percentage point when comparing 2005 to 2004. The 2006 spending included a $95 million in-process research and development charge (discussed in Note 2) and $75 million in restructuring actions (Note 4). Other spending increased approximately $78 million, representing an increase of approximately 6% compared with 2005, reflecting 3M’s continuing commitment to fund future growth for the Company.

Gain on Sale of Pharmaceuticals Business:

In December 2006, 3M completed the sale of its global branded pharmaceuticals businesses in the United States, Canada, and Latin America region and the Asia Pacific region, including Australia and South Africa. 3M received proceeds of $1.209 billion for these transactions and recognized a pre-tax gain on sale of $1.074 billion. In January 2007, 3M completed the sale of its global branded pharmaceuticals business in Europe to Meda AB for $817 million.

16




This transaction will be reflected in 3M’s financial statements for the period ending March 31, 2007. For more detail, refer to Note 2.

Operating Income:

3M uses operating income as one of its primary business segment performance measurement tools. Operating income in 2006 was 24.8% of sales, up from 22.9% of sales in 2005 and 21.6% of sales in 2004. Operating income in 2006 included the gain on sale, restructuring and other items that benefited operating income by $523 million, or 2.2% of net sales.

 

Interest Expense and Income:

(Millions)

 

2006

 

2005

 

2004

 

Interest expense

 

$

122

 

$

82

 

$

69

 

Interest income

 

(51

)

(56

)

(46

)

Total

 

$

71

 

$

26

 

$

23

 

 

Interest Expense: Interest expense increased in 2006 compared with 2005, primarily related to increased short-term debt levels and higher interest rates. Interest expense increased in 2005 compared with 2004, primarily due to higher interest rates.

Interest Income: Interest income was lower in 2006, with lower average cash balances partially offset by higher interest rates. Interest income was higher in 2005, benefiting primarily from higher interest rates.

Provision for Income Taxes:

(Percent of pre-tax income)

 

2006

 

2005

 

2004

 

Effective tax rate

 

30.6

%

33.7

%

32.5

%

 

The tax rate for 2006 was 30.6%, compared with 33.7% in 2005. In 2005, the Company repatriated approximately $1.7 billion of foreign earnings under the American Jobs Creation Act of 2004 (Jobs Act). Refer to the following paragraph for additional discussion. No similar repatriation occurred in 2006 since this Jobs Act provision only applied to 2005. As a result, the Company’s tax rate decreased by 1.6% in 2006. In addition, the Company’s tax rate was reduced by 1.5% as a result of a number of items (both positive and negative), including adjustments to its reserves for tax contingencies, the sale of its pharmaceutical business and book/tax differences on the write-off of in-process research and development related to the Brontes Technologies Inc. (Brontes) acquisition. Refer to Note 2 and Note 8 for additional information.

The effective tax rate for 2005 was 33.7%, compared with 32.5% 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 $1.7 billion of foreign earnings in the United States pursuant to its provisions. The Jobs Act provided 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 1.6%. A half-point tax rate reduction, compared with 2004, was primarily attributable to a combination of the effects of the Medicare Modernization Act and the domestic manufacturer’s deduction, which was a part of the Jobs Act.

Minority Interest:

(Millions)

 

2006

 

2005

 

2004

 

Minority interest

 

$

51

 

$

55

 

$

62

 

 

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 2006 related primarily to foreign currency translation effects which reduced Sumitomo 3M Limited’s operating income as reported in U.S. dollars, as the U.S. dollar strengthened significantly against the Japanese yen, compared with 2005. The decrease in 2005 related primarily to lower 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

17




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 at December 31, 2005 and an after-tax charge of $35 million for 2005, which was 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. At December 31, 2006, the asset retirement obligation liability was $57 million.

Currency Effects:

3M estimates that year-on-year currency effects, including hedging impacts, increased net income by approximately $20 million in 2006, $115 million in 2005 and $181 million in 2004. 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 had an immaterial impact on net income in 2006 and increased net income by approximately $50 million in 2005 and $48 million in 2004.

PERFORMANCE BY BUSINESS SEGMENT

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. The reportable segments are the Health Care segment, Industrial and Transportation segment, Display and Graphics segment, Consumer and Office segment, Safety, Security and Protection Services segment, and Electro and Communications segment. 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.

As discussed in the preceding overview section, the gain on sale, restructuring and other items benefited 2006 operating income by $523 million, or 2.2% of net sales. The following table summarizes these impacts by business segment. Additional details on restructuring actions are in Note 4. Items included in the “Other” category of the table are acquired in-process research and development expenses ($95 million), settlement costs of a previously disclosed antitrust class action ($40 million), and environmental obligations related to the pharmaceuticals business ($13 million). Refer to Note 2 and Note 13 for additional details on these items.

 

 

2006 Restructuring and Other Summary

 

 

 

Pharma-
ceuticals

 

Overhead

 

Busi-
ness-

 

Total
restruc-

 

Gain on sale
of pharma-

 

 

 

 

 

 

 

restructuring

 

reduction

 

specific

 

turing

 

ceuticals

 

 

 

 

 

(Millions)

 

actions

 

actions

 

actions

 

actions

 

business

 

Other

 

Total

 

Industrial and Transportation

 

$

 

$

 

$

15

 

$

15

 

$

 

$

 

$

15

 

Health Care:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain on sale of pharmaceuticals business

 

 

 

 

 

(1,074

)

 

(1,074

)

Restructuring actions and other

 

166

 

112

 

15

 

293

 

 

108

 

401

 

Display and Graphics

 

 

 

39

 

39

 

 

 

39

 

Consumer and Office

 

 

 

 

 

 

 

 

Safety, Security and Protection Services

 

 

 

10

 

10

 

 

 

10

 

Electro and Communications

 

 

 

46

 

46

 

 

 

46

 

Corporate and Unallocated

 

 

 

 

 

 

40

 

40

 

Total operating income penalty (benefit)

 

$

166

 

$

112

 

$

125

 

$

403

 

$

(1,074

)

$

148

 

$

(523

)

 

18




Industrial and Transportation Business (29.5% of consolidated sales):

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

6,754

 

$

6,144

 

$

5,711

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

9.1

%

6.5

%

7.2

%

Translation

 

0.8

 

1.1

 

4.1

 

Total sales change

 

9.9

%

7.6

%

11.3

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,343

 

$

1,211

 

$

1,050

 

Percent change

 

10.9

%

15.4

%

27.6

%

Percent of sales

 

19.9

%

19.7

%

18.4

%

The Industrial and Transportation segment serves a broad range of markets, such as appliance, paper and packaging, food and beverage, personal care and automotive. Industrial and Transportation products include tapes, a wide variety of coated and non-woven abrasives, adhesives, specialty materials, supply chain execution software solutions, closures for disposable diapers, and components and products that are used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles. The August 2005 acquisition of CUNO adds a comprehensive line of filtration products for the separation, clarification and purification of fluids and gases.

In 2006, local-currency sales grew 9.1%, including 4.6% growth from acquisitions, primarily related to the August 2005 acquisition of CUNO. Since CUNO was acquired in early August 2005 and is thus considered part of organic growth effective in August 2006, the acquisition benefit reflected in 2006 only reflects the months from January 2006 through July 2006. The industrial adhesives and tapes business, along with the automotive aftermarket business, which sells products to body shops for vehicle repairs, led organic sales growth in 2006. 3M also posted good sales growth in its abrasives business and its energy and advanced materials business. Growth in the automotive OEM business continues to be impacted by softness in the U.S. domestic automotive industry as new car builds continue to remain soft. Geographically, local-currency sales growth in dollars was strongest in the Asia Pacific and Europe areas. Operating income increased 10.9% to $1.343 billion in 2006. Operating income included $15 million in restructuring expenses, primarily comprised of asset impairments and severance and related benefits, which negatively impacted operating income growth by 1.2%.

In 2005, Industrial and Transportation local-currency sales grew 6.5%. The August 2005 CUNO acquisition, whose results are included in Industrial and Transportation, added 3.1% of growth in 2005. In addition, growth was led by the adhesives, tapes, and abrasives businesses. 3M continued to selectively raise selling prices to offset commodity raw material price pressures. 3M sales growth also benefited 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 cleanup time while also reducing the use of solvents for cleaning paint guns. Sales growth in transportation was 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). The strength of the Industrial and Transportation businesses helped overcome the sales growth challenges of the personal care business. 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. Industrial and Transportation continues to demonstrate strong operational discipline, as operating income grew 15.4% in 2005.

In March 2005, 3M’s automotive business completed the purchase of 19% of TI&M Beteiligungsgesellschaft mbH (TI&M), the parent company of I&T Innovation Technology Entwicklungsund Holding Aktiengesellschaft (I&T), a maker of flat flexible cable and circuitry founded in Austria in 1999. 3M and I&T intended to 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 in 2005 as “Investments” in the Consolidated Balance Sheet and as “Purchases of marketable securities and 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 TI&M. I&T filed a petition for bankruptcy protection in 2006. As part of its agreement to purchase the shares of TI&M, the Company was granted a put option, which gave the Company the right to sell back its entire ownership interest in TI&M to the other investors from whom 3M acquired its 19% interest. The put option became exercisable January 1, 2007. The Company exercised the put option and has recovered approximately half of its investment from one of the other investors. The other two TI&M investors have filed a bankruptcy petition in Austria. The Company is in the process of seeking to collect the balance of its investment.

19




Health Care Business (17.5% of consolidated sales):

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

4,011

 

$

3,760

 

$

3,596

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

6.0

%

4.2

%

0.6

%

Translation

 

0.7

 

0.4

 

4.2

 

Total sales change

 

6.7

%

4.6

%

4.8

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,845

 

$

1,114

 

$

973

 

Percent change

 

65.6

%

14.6

%

7.2

%

Percent of sales

 

46.0

%

29.6

%

27.0

%

The Health Care segment serves markets that include medical, surgical, pharmaceutical, dental and orthodontic, and health information systems. Products provided to these and other markets include medical and surgical supplies, skin health and infection prevention products, pharmaceuticals, drug delivery systems, dental and orthodontic products, health information systems and microbiology products. As discussed below, the global branded pharmaceuticals business was sold in December 2006 and January 2007.

In total, the combination of the following items positively impacted total year 2006 Health Care operating income by $673 million, primarily in the fourth quarter of 2006. As discussed in Note 2, in early December 2006, the Company sold its branded pharmaceuticals business in the Asia Pacific region, including Australia and South Africa. The Company also sold its branded pharmaceuticals business in the United States, Canada and Latin America in late December 2006. The operating income gain related to this sale, which is included in Health Care, totaled $1.074 billion. In addition, as discussed in Note 4, the Health Care segment for the year 2006 included $293 million in restructuring costs, primarily employee-related severance and benefit costs. Of the $293 million, $166 million was related to the pharmaceuticals business and $15 million related to Health Care severance and other costs. In addition, $112 million of severance and benefit costs were recorded in the fourth quarter of 2006 related to worldwide staff overhead reduction actions taken to streamline the Company’s cost structure in response to the sale of 3M’s branded pharmaceuticals business. The Health Care business is being charged with these overhead costs until such overhead costs are reduced to zero through various restructuring actions. These costs will reduce cash flows in 2007 when the related severance is paid. Health Care also included $95 million of expensed in-process research and development costs related to the Brontes acquisition and $13 million in environmental reserves related to the pharmaceuticals business.

In 2006, Health Care sales were $4.011 billion. Organic local-currency growth was 5.3%, with acquisitions adding an additional 0.7% of growth. Local-currency growth was led by the medical supplies and dental businesses. 3M’s pharmaceutical business was approximately 19% of Health Care sales in 2006. Pharmaceutical local-currency sales declined 3.5% in 2006, while the remaining businesses’ 2006 local-currency sales growth increased 8.5%. Geographically, Health Care’s local-currency sales growth in dollars was strongest in the United States, Europe and Asia Pacific areas. Operating income for 2006 was up 65.6%, impacted by the gain on sale of our branded pharmaceuticals business, restructuring impacts and other items as discussed in the preceding paragraph, which positively impacted operating income growth by 60.4%.

In 2005, Health Care reported local-currency sales growth of 4.2%. 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 business. Sales of certain products within 3M’s pharmaceuticals business, primarily comprised of prescription drugs for inhalation, women’s health, and cardiovascular conditions, declined due to price pressure in Europe and decreased demand for some of these older products. Health Care continued to focus on operational efficiency, which helped drive a 14.6% increase in operating income in 2005.

Looking ahead, as discussed in the preceding “Overview” section, the sale of our branded pharmaceuticals business will impact both sales growth and operating income margins in Health Care and the total company in 2007. Sales growth in 2007 will be negatively impacted as significant pharmaceuticals sales will be in the base 2006 period. In addition, Health Care operating income is expected to decline in 2007 by approximately 2 percentage points year-on-year, negatively impacted by this sale. As a result, 3M believes the following disaggregated information for 3M Health Care’s remaining businesses (after the sale of pharmaceuticals) and for pharmaceuticals on a stand-alone basis provides useful information.

20




Health Care Business without Pharmaceuticals:

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

3,237

 

$

2,963

 

$

2,803

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

8.5

%

5.3

%

2.9

%

Translation

 

0.7

 

0.4

 

4.2

 

Total sales change

 

9.2

%

5.7

%

7.1

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

806

 

$

888

 

$

779

 

Percent change

 

(9.1

)%

14.0

%

12.8

%

Percent of sales

 

24.9

%

30.0

%

27.8

%

The following discussion provides information on 3M Health Care’s remaining businesses (after the sale of pharmaceuticals).

In total, the combination of the following items negatively impacted 2006 fourth quarter and total year operating income by $110 million. Health Care without pharmaceuticals included $95 million of expensed in-process research and development costs related to the Brontes acquisition. Business-specific restructuring actions totaled $15 million, primarily comprised of severance and related benefits plus asset impairments.

In 2006, sales were $3.237 billion. Organic local-currency growth was 7.4%, with acquisitions adding an additional 1.1% of growth. Local-currency growth was led by the medical supplies and dental businesses. Geographically, local-currency sales growth in dollars was strongest in the United States, Europe and Asia Pacific areas. Operating income for 2006 decreased 9.1%, impacted by restructuring impacts and other items as discussed in the preceding paragraph, which negatively impacted operating income growth by 12.4%.

In 2005, local-currency sales growth was 5.3%, led by 3M’s medical, dental and health information systems businesses. Operational efficiency helped drive a 14.0% increase in operating income in 2005.

Pharmaceuticals Business:

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

774

 

$

797

 

$

793

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

(3.5

)%

0.3

%

(6.7

)%

Translation

 

0.6

 

0.3

 

4.3

 

Total sales change

 

(2.9

)%

0.6

%

(2.4

)%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,039

 

$

226

 

$

194

 

Percent change

 

N/A

 

16.6

%

(10.5

)%

Percent of sales

 

N/A

 

28.4

%

24.5

%

In total, the combination of the following items positively impacted total year 2006 pharmaceuticals operating income by $783 million, primarily in the fourth quarter of 2006. As discussed in Note 2, in early December 2006, the Company sold its branded pharmaceuticals business in the Asia Pacific region, including Australia and South Africa. The Company also sold its branded pharmaceuticals business in the United States, Canada and Latin America in late December 2006. The operating income gain related to these transactions, which is included in pharmaceuticals, totaled $1.074 billion. As discussed in Note 4, $112 million of severance and benefit costs were recorded in the fourth quarter of 2006 related to worldwide staff overhead reduction actions taken to streamline the Company’s cost structure in response to the sale of 3M’s branded pharmaceuticals business. As also discussed in Note 4, the pharmaceuticals business for total year 2006 included $97 million in employee-related severance and benefits and $69 million of asset impairments and other expenses. In addition, an environmental reserve of $13 million was recognized related to the pharmaceuticals business.

In 2006, pharmaceuticals sales totaled $774 million, a local-currency sales decrease of 3.5%. The early December 2006 sale of the branded pharmaceuticals business in the Asia Pacific region negatively impacted total year 2006 sales by approximately 0.6%. In 2005, local currency sales increased slightly. Given the relatively flat sales, operating income dollars and margins have remained at a healthy level, even after considering the impact of net gains related to the sale of branded pharmaceuticals in 2006.

21




Display and Graphics Business (16.4% of consolidated sales):

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

3,765

 

$

3,511

 

$

3,346

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

6.9

%

4.7

%

12.4

%

Translation

 

0.3

 

0.2

 

4.7

 

Total sales change

 

7.2

%

4.9

%

17.1

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

1,062

 

$

1,162

 

$

1,115

 

Percent change

 

(8.6

)%

4.2

%

28.8

%

Percent of sales

 

28.2

%

33.1

%

33.3

%

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; computer screen filters; 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) hand-held 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 more 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 2006, the Display and Graphics business posted local-currency sales growth of 6.9%. Optical film sales volumes increased at double-digit rates in 2006. 3M saw an acceleration in the LCD industry due to strong consumer demand for LCD TV’s, which drove record sales of 3M’s proprietary optical films, despite ongoing downward pricing pressure in these consumer electronic applications. Commercial Graphics, a supplier of large-format graphics solutions that cut across a range of industries, delivered strong double-digit local-currency growth in 2006. Traffic Safety Systems also posted solid local-currency growth. Operating income declined by 8.6%. Operating income included $39 million in restructuring expenses, primarily comprised of asset impairments and severance and related benefits, which negatively impacted operating income growth by 3.4%. These asset impairments relate to decisions the Company made in the fourth quarter of 2006 to exit certain marginal product lines in the Touch Systems and Optical Systems businesses. In optical film, selling price declines, the sales mix shift towards larger LCD displays, and operational challenges related to the Company’s new optical film manufacturing production line penalized operating income in 2006.

In 2005, Display and Graphics local-currency sales grew 4.7%, 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 United States 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 show 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. The continued decline in lens systems for the CRT rear projection television market negatively impacted Display and Graphics sales growth by approximately 3% in 2005 and negatively impacted operating income by approximately 7.5% in 2005.

22




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

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

3,238

 

$

3,033

 

$

2,901

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

6.1

%

3.6

%

7.1

%

Translation

 

0.7

 

1.0

 

2.8

 

Total sales change

 

6.8

%

4.6

%

9.9

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

579

 

$

561

 

$

514

 

Percent change

 

3.2

%

9.1

%

17.3

%

Percent of sales

 

17.9

%

18.5

%

17.7

%

The Consumer and Office segment serves markets that include consumer retail, office retail, education, and home improvement. Products provided to these and other markets 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 2006, Consumer and Office local-currency sales growth of 6.1% was broad-based across the portfolio, led by the construction and home improvement division, which serves the do-it-yourself retail channel. 3M also posted very good sales growth in the mass retail channel. 3M continues to penetrate large key accounts, primarily in the United States, with an array of unique, highly functional products featuring customer-inspired designs. Operating income was $579 million, up 3.2% year on year. 3M experienced slower sales growth in the construction and home improvement market in the fourth quarter of 2006, impacted by a housing slowdown in the United States that is expected to continue into 2007. 3M’s visual systems business, which traditionally has offered analog overhead and electronic projectors and film, continued to experience a decline and reduced overall Consumer and Office sales growth by approximately 1% for the year.

In 2005, Consumer and Office local-currency sales increased 3.6%, 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 compared with the exceptional fourth quarter of 2004, when local-currency 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 and customer-inspired design in new and mature products such as Scotch® Tape, Post-It® Notes, Filtrete™ Filters and O-Cel-O™ sponges. Operating income increased 9.1% in 2005.

Safety, Security and Protection Services Business (11.4% of consolidated sales):

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

2,621

 

$

2,292

 

$

2,125

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

13.2

%

6.9

%

6.6

%

Translation

 

1.2

 

1.0

 

3.6

 

Total sales change

 

14.4

%

7.9

%

10.2

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

575

 

$

537

 

$

465

 

Percent change

 

7.0

%

15.4

%

11.9

%

Percent of sales

 

21.9

%

23.4

%

21.9

%

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 August 2006, 3M completed the acquisition of Security Printing and Systems Limited, a producer of finished, personalized passports and secure cards, which expands the 3M product line related to border and civil security solutions.

23




In 2006, local-currency growth in the Safety, Security and Protection Services business was up 13.2% to $2.621 billion. Growth in the business continues to be driven by strong global demand for personal safety products, especially respiratory protection. Acquisitions contributed 4.0% of growth, primarily due to the Security Printing and Systems Limited acquisition in August 2006. 3M continues to invest in additional respirator capacity, such as a new respirator manufacturing facility in Korea, which will serve the Asia Pacific region. 3M also posted outstanding growth in the corrosion protection division, a smaller but growing business, which supplies coatings for all types of commercial and industrial applications in a variety of industries. 3M’s roofing granules business experienced a challenging fourth quarter, with a sales decline of nearly 50%, resulting in sales in this business declining nearly 10% when comparing total year 2006 with 2005. Geographically, local-currency growth was positive across all regions of the world, led by Europe and the United States. Operating income increased 7.0% to $575 million in 2006. Operating income includes $10 million in restructuring expenses, primarily severance and related benefits, which negatively impacted operating income growth by 1.9%.

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 posed by 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 showed solid sales growth. Operating income improved 15.4% in 2005.

Electro and Communications Business (10.8% of consolidated sales):

 

2006

 

2005

 

2004

 

Sales (millions)

 

$

2,483

 

$

2,333

 

$

2,224

 

Sales change analysis:

 

 

 

 

 

 

 

Local currency (volume and price)

 

5.6

%

4.2

%

2.7

%

Translation

 

0.8

 

0.7

 

3.1

 

Total sales change

 

6.4

%

4.9

%

5.8

%

 

 

 

 

 

 

 

 

Operating income (millions)

 

$

438

 

$

447

 

$

316

 

Percent change

 

(2.1

)%

41.5

%

18.6

%

Percent of sales

 

17.6

%

19.2

%

14.2

%

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. This segment provides 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.

In 2006, the Electro and Communications business posted sales of $2.483 billion. Organic local-currency growth for 2006 of 4.2% was attributable to the electrical and electronics markets. Acquisitions contributed 1.4% to sales growth. 3M generated good top-line growth in its electrical markets division, which sells a number of insulating, testing and connecting products and solutions to both power utilities and manufacturing OEMs. 3M also continues to see good growth from its electronics markets business, driven by double-digit growth in its semi-conductor and assemblies business. Partially offsetting this was some sales softness in our U.S. communications markets business due to higher copper costs. Operating income declined by 2.1% to $438 million. Operating income includes $46 million in restructuring expenses, primarily comprised of asset impairments and severance and related benefits, which negatively impacted operating income growth by 10.3%. Operating margins continue to be impacted by rising raw material costs, specifically copper costs, in our electrical and telecommunications markets businesses.

In 2005, local-currency sales in Electro and Communications increased 4.2%, with improving end market conditions and success in developing new applications for 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 from 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 19.2% in 2005, with operating income increasing 41.5% in 2005.

 

24




PERFORMANCE BY GEOGRAPHIC AREA

Financial information related to 3M operations in various geographic areas is provided in Note 18. A summary of key information and discussion related to 3M’s geographic areas follow:

Geographic Area

 

2006

 

2006 vs. 2005 % Change

 

Net Sales and

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

Operating Income

 

 

 

% of

 

Oper.

 

Local

 

Trans-

 

Sales

 

Oper.

 

(Dollars in millions)

 

Sales

 

Total

 

Income

 

Currency

 

lation

 

Change

 

Income

 

United States

 

$

8,853

 

38.6

%

$

1,908

 

7.1

%

 

7.1

%

59.0

%

Asia Pacific

 

6,251

 

27.3

%

2,097

 

9.2

%

(0.4

)%

8.8

%

0.6

%

Europe, Middle East and Africa

 

5,726

 

25.0

%

1,092

 

8.3

%

1.4

%

9.7

%

3.3

%

Latin America and Canada

 

2,080

 

9.1

%

629

 

6.1

%

4.4

%

10.5

%

22.7

%

Other Unallocated

 

13

 

 

(30

)

 

 

 

 

 

 

 

 

Total Company

 

$

22,923

 

100

%

$

5,696

 

7.7

%

0.6

%

8.3

%

17.3

%

 

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 geographic area are not indicative of end-user consumption in that geographic area.

U.S. sales revenue increased 7.1%, as all six business segments contributed to this increase. Asia Pacific local-currency sales (which exclude translation impacts) increased 9.2%. All six business segments contributed to this increase in the Asia Pacific area, with optical film being the largest growth component. Sales in Japan totaled approximately $2 billion, with local-currency sales up 1.5% from 2005. European local-currency sales increased 8.3%, with good growth in Industrial and Transportation and Safety, Security and Protection Services. In the combined Latin America and Canada area, local-currency sales increases of 6.1% were led by Industrial and Transportation, Safety, Security and Protection Services and Consumer and Office. Foreign currency translation positively impacted the combined Latin America and Canada area sales by 4.4%, and the European area sales by 1.4%, as the U.S. dollar weakened against these currencies. Foreign currency translation had a minimal impact on Asia Pacific sales. For 2006, international operations represented 61.4% of 3M’s sales.

Since 3M sold its global branded pharmaceuticals business in December 2006 and January 2007, both sales growth and operating income will be negatively impacted in 2007. Sales in 2006 for pharmaceuticals totaled $332 million in the United States, $315 million in the Europe, Middle East and Africa area, $77 million in the Asia Pacific area, and $50 million in the Latin America and Canada area. The gain on sale, restructuring and other items in 2006, as discussed in the preceding overview section, increased worldwide operating income by $523 million, with the largest impact in the United States.

Geographic Area Supplemental Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employees as of

 

Capital

 

Property, Plant and

 

(Millions, except

 

December 31

 

Spending

 

Equipment — net

 

employees)

 

2006

 

2005

 

2004

 

2006

 

2005

 

2004

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

34,553

 

33,033

 

32,648

 

$

692

 

$

532

 

$

565

 

$

3,382

 

$

3,291

 

$

3,290

 

Asia Pacific

 

12,487

 

11,574

 

10,439

 

252

 

228

 

182

 

959

 

865

 

810

 

Europe, Middle East

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and Africa

 

17,416

 

16,722

 

16,574

 

134

 

120

 

143

 

1,162

 

1,076

 

1,288

 

Latin America and Canada

 

10,877

 

9,898

 

8,583

 

90

 

63

 

47

 

404

 

361

 

323

 

Total Company

 

75,333

 

71,227

 

68,244

 

$

1,168

 

$

943

 

$

937

 

$

5,907

 

$

5,593

 

$

5,711

 

 

Employment:

Employment increased by approximately 4,100 people since year-end 2005, partially due to acquisitions, with more than 750 people added by our three largest 2006 acquisitions alone. In addition, 3M has increased employees in faster-growing areas of the world, such as Brazil, India, Russia, China and Poland, where on a local-currency basis sales increased more

25




than 20% in 2006. The increase in 2005 compared with 2004 of approximately 3,000 people was primarily attributable to the August 2005 acquisition of CUNO, which added approximately 2,300 employees. Employment increases at a manufacturing plant in Latin America also contributed to increases of approximately 600 people and 700 people in 2006 and 2005, respectively. Sales per employee in local currencies increased 7.7% in 2006, approximately 3% in 2005 and approximately 7% in 2004.

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 United States. The Company is striving to more closely align its manufacturing and sourcing with geographic market sales, and because more than 60% 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.

Capital expenditures are expected to increase from this $1.168 billion in 2006 to $1.4 billion to $1.5 billion in 2007. The majority of this spending is aimed directly at accelerating top-line growth in many of our core businesses. 3M has about 15 significant plant construction projects under way, some adding to existing facilities and a few of the greenfield variety. Internationally, 3M is building respiratory protection capacity in Russia and Korea, medical products capacity in China, an LCD plant in Poland, abrasives and tape capacity in China and India, and chemical facilities in China, just to name a few. This is backed up by similar investments in the U.S.

CRITICAL ACCOUNTING ESTIMATES

Information regarding significant accounting policies is included in Note 1. 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 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.

The Company believes its most critical accounting estimates relate to legal proceedings, the Company’s pension and postretirement obligations, and asset impairments. 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 13) 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,” SFAS No. 106, “Employer’s Accounting for Postretirement Benefits Other than Pensions,” in measuring plan assets and benefit obligations and in determining the amount of net periodic benefit cost, and SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans an amendment of FASB Statements No. 87, 88, 106 and 132(R),” which was issued in September 2006 and effective as of December 31, 2006. SFAS No. 158 requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income, which is a component of stockholders’ equity. As a result of the implementation of SFAS No. 158, the Company recognized an after-tax decrease in accumulated other comprehensive income of $1.187 billion and $513 million for the U.S. and International pension benefit plans, respectively, and $218 million for the postretirement health care and life insurance benefit plan.

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 11 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

26




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 this methodology, the Company determined a discount rate of 5.75% to be appropriate as of December 31, 2006, which is an increase of 0.25 of a percentage point from the rate used as of December 31, 2005.

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 2006 and will remain at 8.75% for 2007. Refer to Note 11 for information on how this rate is determined.

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 also increased pension expenses for 2006 by $64 million and postretirement expenses by $17 million.

For the year ended December 31, 2006, the Company recognized total consolidated pre-tax pension expense (after settlements, curtailments and special termination benefits) of $347 million, up from $331 million in 2005. Pension expense (before settlements, curtailments and special termination benefits) is anticipated to decrease to approximately $174 million in 2007. 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 of a percentage point would decrease/increase U.S. 2007 pension expense by approximately $24 million for U.S. pension plans and approximately $9 million for international pension plans. Also, holding all other factors constant, an increase/decrease in the discount rate used to measure plan liabilities by 0.25 of a percentage point would decrease/increase 2006 pension expense by approximately $32 million for U.S. pension plans and approximately $17 million for international pension plans. See Note 11 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.

Asset Impairments:

3M net property, plant and equipment totaled $5.9 billion as of December 31, 2006. 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. During the fourth quarter of 2006, the Company sold its branded pharmaceuticals business. In exiting this business, the Company incurred $61 million of asset impairments for this business as assets that were not sold with the transactions did not have future value to the Company. During the fourth quarter of 2006 the Company also decided to exit certain product lines, resulting in fixed and intangible asset impairment costs of $83 million. The fair value of the assets impacted by these product exits was determined based on discounted cash flows. See Note 4 for further details of the 2006 restructuring actions.

3M goodwill totaled approximately $4.1 billion as of December 31, 2006, 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. 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

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. This Interpretation is effective as of January 1, 2007 and the cumulative effects, if any, of applying this Interpretation will be recorded as an adjustment to retained earnings as of January 1, 2007. The Company does not expect the adoption of FIN 48 to have a material impact on 3M’s consolidated results of operations or financial condition.

27




In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R).”  Refer to Note 11 for additional information concerning this standard.

Additional information regarding other accounting pronouncements is included in Note 1.

FINANCIAL CONDITION AND LIQUIDITY

The Company generates significant ongoing cash flow. Net debt increased slightly in 2006, primarily related to increased short-term debt supporting share repurchase activities and acquisitions. The increase in 2005 primarily related to the $1.36 billion CUNO acquisition.

At December 31

 

 

 

 

 

 

 

(Millions)

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Total Debt

 

$

3,553

 

$

2,381

 

$

2,821

 

Less: Cash, cash equivalents and marketable securities

 

2,084

 

1,072

 

2,757

 

Net Debt

 

$

1,469

 

$

1,309

 

$

64

 

 

Cash, cash equivalents and marketable securities at December 31, 2006, were higher compared with December 31, 2005, due to the significant pharmaceuticals sales proceeds received in December 2006. 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 10 in this document).

The Company’s financial condition and liquidity are strong. Various assets and liabilities, including cash and short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. Working capital (defined as current assets minus current liabilities) totaled $1.623 billion at December 31, 2006, compared with $1.877 billion at December 31, 2005. This decrease was primarily related to an increase in debt classified as short-term borrowings and current portion of long-term debt, partially offset by increases in cash and cash equivalents, short-term marketable securities, and inventories.

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 5.4 at December 31, 2006, down from 5.7 at December 31, 2005. Receivables increased $264 million, or 9.3%, compared with December 31, 2005. Currency translation (due to the stronger U.S. dollar) increased accounts receivable by $113 million year-on-year. Inventories increased $439 million, or 20.3%, compared with December 31, 2005. Currency translation increased inventories by $92 million year-on-year. Accounts payable increased $146 million compared with December 31, 2005, with $53 million of this year-on-year increase related to currency translation.

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.

28




Cash Flows from Operating Activities:

Years ended December 31

 

 

 

 

 

 

 

(Millions)

 

2006

 

2005

 

2004

 

 

 

 

 

 

 

 

 

Net income

 

$

3,851

 

$

3,111

 

$

2,841

 

Depreciation and amortization

 

1,079

 

986

 

999

 

Company pension contributions

 

(348

)

(654

)

(591

)

Company postretirement contributions

 

(37

)

(134

)

(168

)

Company pension expense

 

347

 

331

 

325

 

Company postretirement expense

 

93

 

106

 

110

 

Stock-based compensation expense

 

200

 

155

 

252

 

Gain from sale of pharmaceuticals business

 

(1,074

)

 

 

Income taxes (deferred and accrued income taxes)

 

(178

)

402

 

326

 

Excess tax benefits from stock-based compensation

 

(60

)

(54

)

(54

)

Accounts receivable

 

(103

)

(184

)

56

 

Inventories

 

(309

)

(294

)

7

 

Accounts payable

 

68

 

113

 

35