The pro forma impact of stock-based compensation on net income and earnings per share provided in Note 1 for the years ended December 31, 2005, 2004 and 2003, was recognized over the nominal vesting period, whereby if an employee retired before the end of the vesting period, the Company would recognize any remaining unrecognized compensation cost at the date of retirement. SFAS No. 123R requires recognition under a non-substantive vesting period approach, requiring compensation expense recognition when an employee is eligible to retire. 3M employees in the U.S. are eligible to retire beginning at age 55 and after having completed five years of service. Approximately 25 to 30% of the number of stock-based compensation awards are made to this population. The Company will change to the non-substantive vesting period approach for new stock compensation grants made after the Company’s adoption of SFAS No. 123R on January 1, 2006. Therefore, primarily beginning in May 2006 with the annual Management Stock Ownership Program grant, immediate expensing of those stock-based compensation awards granted to employees eligible to retire will result in a higher compensation expense than historically recognized in comparable prior periods. The total expense in 2006 and beyond will depend on several variables, including the number of share-based awards granted, the fair value of those awards, and the period the vesting of those awards is recognized over; therefore the actual expense may be different from this estimate.

 

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



FINANCIAL CONDITION AND LIQUIDITY

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

 

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

 

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