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

 

(651) 733-1110

(Telephone number)

 

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

 

 

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.

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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,

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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™ Scotchtint™ Window Film for buildings; 3M™ Scotchshield™ Ultra 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

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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

 

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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

 

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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

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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:

 

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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).

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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.

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·                  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.

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		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

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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.

 

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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	%

 

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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.

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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:

 

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:

 

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:

 

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

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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	)

 

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