3M 2004 Annual Report Download - page 88

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62
Interest Rate and Currency Swaps: The Company manages interest expense using a mix of fixed and floating rate
debt. To help manage borrowing costs, the Company may enter into interest rate swaps. Under these arrangements,
the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts
calculated by reference to an agreed-upon notional principal amount. The Company uses interest rate and currency
swaps to manage interest rate risk related to borrowings.
At December 31, 2004, the Company had interest rate swaps with a fair value of $3 million ($21 million at December
31, 2003) designated as fair value hedges of underlying fixed rate obligations. The mark-to-market of these fair value
hedges is recorded as gains or losses in interest expense and is offset by the gain or loss on the underlying debt
instrument that is also recorded in interest expense. All existing fair value hedges are 100% effective and, thus, there
is no impact on earnings due to hedge ineffectiveness.
As circumstances warrant, the Company also uses cross-currency interest rate swaps to hedge foreign currency and
interest rates. As part of this strategy, in September 2003, the Company entered into a three-year combined interest
rate and currency swap with a notional amount of $300 million. This transaction is a partial hedge of 3M’s net
investment in 3M’s Japanese subsidiaries. This swap converts a variable rate U.S. dollar exposure to a variable rate
yen-denominated exposure.
Net Investment Hedging: As circumstances warrant, the Company uses foreign currency debt and forwards to hedge
portions of the Company’s net investments in foreign operations. For hedges that meet the effectiveness
requirements, the net gains or losses are recorded in cumulative translation within other comprehensive income, with
any ineffectiveness recorded in cost of sales. Hedge ineffectiveness was not material in 2004, 2003 and 2002.
Commodity Price Management: The Company manages commodity price risks through negotiated supply contracts,
price protection swaps and forward physical contracts. The Company uses commodity price swaps as cash flow
hedges of forecasted transactions to manage price volatility. The related mark-to-market gain or loss on qualifying
hedges is included in other comprehensive income to the extent effective (typically 100% effective), and reclassified
into cost of sales in the period during which the hedged transaction affects earnings. 3M has hedged its exposure to
the variability of future cash flows for certain forecasted transactions through 2005. No significant commodity cash
flow hedges were discontinued during the years 2004, 2003 and 2002.
Net Investment Hedging and Cash Flow Hedging: Amounts recorded in cumulative translation related to net investment
hedging, and cash flow hedging instrument disclosures follow. Reclassification adjustments are made to avoid double
counting in comprehensive income items that are also included as part of net income. The amount of the
reclassification adjustment recognized in other comprehensive income is equal to, but opposite in sign from, the
amount of the realized gain or loss in net income.
DERIVATIVES Twelve months ended
Net of Tax December 31
(Millions)
2004 2003 2002
Unrealized gain/(loss) recorded in cumulative translation
Net investment hedging $ 5 $ – $(17)
Cash flow hedging instruments balance and activity
Beginning balance $(45) $(39) $ 9
Net unrealized holding gain/(loss) (48) (102) (78)
Reclassification adjustment 51 96 30
Total activity 3 (6) (48)
Ending balance $(42)* $(45) $(39)
Tax expense or benefit (cash flow hedging instruments)
Net unrealized holding gain/(loss) $ 29 $ 47 $ 46
Reclassification adjustment (32) (44) (18)
* Based on exchange rates at December 31, 2004, the Company expects to reclassify to earnings over the next 12 months a
majority of the cash flow hedging instruments after-tax loss of $42 million (with the impact largely offset by foreign currency
cash flows from underlying hedged items).