3M (MMM) 2002 Q1 法說會逐字稿

Gentlemen, thank you for standing by, and welcome to the 3M first quarter 2002 earnings conference call.

During the presentation all participants will be in a listen-only mode. Afterwards, you will be invited to participate in the question and answer session. At that time, if you have a question, simply press star, then the number one on your telephone keypad and the questions will be taken in the order they are received. If you would like to withdraw your question, press the star, then the number two on your telephone keypad.

As a reminder, this conference is being recorded Monday, April 22, 2002.

Your speaker for today is Pat Campbell, the chief financial officer for 3M. We would now like to turn the call over to 3M.

Thank you, and good morning. I'm Matt Ginter, director of Investor Relations for 3M. I'd like to cover just a few housekeeping items before we begin today.

Today's discussion will follow a series of PowerPoint slides. If you received our press release via e-mail this morning, you also received the PowerPoint attachment containing these schedules. As a reminder, our second-quarter earnings conference is scheduled to take place on July 22. As always, we will send you a reminder notice via e-mail a few weeks before hand. Future scheduled earnings dates will also be posted on the calendar of events on our Investor Relations web site.

Before we get started, let me remind you that during this conference call we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. The MBNA section of our most recent form 10k lists some of the important risk factors that could cause actual results to differ from our predictions.

Now I would like to turn the program over to our chief financial officer, Pat Campbell.

Pat?

Thanks, Matt.

Good morning, and welcome to our 2002 first quarter business review. As Matt mentioned, our format will be slightly different today, which I hope will give you a better understanding of our results. With me this morning our treasurer, Jan Yeomans, and our controller, Ron Nelson.

Let's get started with a few highlights from the first quarter. Please go to slide number two.

Our reported earnings were $1.14 per share versus $1.13 per share in the first quarter of last year. Earnings were impacted by non-recurring charges laid to our current restructuring program, the details of which I'll explain in a moment. Excluding non-recurring items, profits were $1.23 per share, up 6 percent from last year's quarter. We deliver this result despite ongoing challenges in the world economy.

First quarter sales total $3.9 billion, down 6.6 percent in U.S. dollars. Despite a tough sales environment, we posted operating margins of 19.7 percent, the highest in many years. The five key corporate initiatives introduced earlier last year are beginning to have a dramatic impact on our results, and six sigma will no doubt have the greatest fundamental impact of them all.

We're in the midst of an ambitious and comprehensive six sigma implementation effort that will take 3M to a much higher competitive level. We now train over 6,000 people, which is about 10 percent of our work force, including approximately 500 black belts and master black belts. This is truly a global effort and soon every 3M employee will have been exposed to this initiative in some fashion. It's been only one year since implementation, but six sigma is quickly defining the way in which problems are solved and decisions are made everywhere within 3M.

We've initiated 1,900 projects, 275 which have been completed. Importantly, six sigma is helping to drive positive results in our remaining corporate initiatives; those being 3M acceleration, indirect cost reduction, global-sourcing effectiveness and e-productivity.

In other first quarter highlights, we continue to improve our balance sheet and cash efficiency. Inventories declined by $91 million sequentially and $341 million versus one year ago. Re-cash flow, which we define as cash from operations less capital expenditures, again exceeded $500 million for the quarter despite almost $100 million in

outflows, and our debt-to-capital ratio was a solid 32 percent, leaving plenty of capacity to fund future growth.

In terms of geographic performance two highlights come to mind: First, unit sales increased almost 10 percent in non-Japan Asia, reflecting improved local demand and a stronger flow of export-related products. And second, European operating margins improved significantly despite a sales decline of 9 percent in dollars.

Let's now turn to slide number three. As mentioned, worldwide sales in U.S. dollars declined 6.6 percent from the first quarter of 2001, but improved about 1 percent sequentially. Ore, or organic

, declined 5 percent versus last year's comparable quarter, while acquisitions added one-half percent to worldwide sales growth. First quarter selling prices increased .8 percent, while the impact of a stronger U.S. dollar that hurt sales growth by almost 3 percent.

Earnings per share, excluding non-recurring items, increased 6 percent versus the first quarter of last year, and over 25 percent sequentially. Year-on-year

impacts reduced first quarter earnings by $.03 per share, while required changes in goodwill accounting boosted earnings by $.02 per share. Recap flow for the first quarter was $510 million, up 17.5 percent year-on-year, reflecting continued strong operating results, combined with improved networking capital returns as well as lower capital expenditures. We also absorbed almost $100 million in severance payments this quarter. First quarter free cash flow was down sequentially due to incrementally higher severance payments and the $100 million fourth quarter payment received from Eli Lilly related to a pharmaceutical agreement.

I'll cover the balance sheet in greater detail towards the end of today's presentation.

Moving to slide number four let's examine sales geographically. International core volumes declined 4 percent, while acquisitions boosted sales by 70 basis points. Although not shown on the chart, volumes were up close to 10 percent in Asia, excluding Japan, driven by increased sales of health care products, industrial products and optical films for flat-panel displays. Volumes declined almost 6.5 percent in Europe, 3 percent in Japan and 9.5 percent in Latin America.

International selling prices increased 28 percent, while the impact of a stronger U.S. dollar hurt international sales by 5.3 percent. Currency translation was negative by about 7 percent in both Asia-Pacific and Latin America and 3 percent in Europe. In the United States volumes declined by 5.9 percent, including .4 percent positive impact from acquisitions and U.S. selling prices increased by .8 percent.

Let's look at the P&L in more detail starting with a comparison versus last year's quarter. This is slide number five in your packet. The numbers I'll discuss exclude non-recurring items recorded during the quarter.

Those margins were 48.4 percent, an improvement of 50 basis points year-over-year. Factory spending was impacted by accelerating improvements from six sigma, indirect cost reductions and employment reductions resulting from our current restructuring plan. (Inaudible) mission packs resulting from higher sales in Asia, excluding Japan, also boosted gross margins. Direct material cost declined almost 4 percent helped by positive benefits resulting from our global-sourcing initiative. We overcame significant margin pressures caused by lower factory

as compared to last year's first quarter, and we are continuing to balance inventory reductions with factory efficiency.

First quarter

expense was 22 percent of sales; an improvement of 90 basis points year-on-year. Lower employment levels, due to a restructuring, had as positive impact on

expense in the first quarter. It was six to eight months in indirect cost reduction efforts. We are making fundamental and sustainable changes to our overall cost structure, while maintaining the flexibility to accelerate growth-related investments, such as advertising and merchandising.

Overall, operating margins were 19.7 percent, up 1.4 points over the first quarter of 2001 and the strongest quarterly result in many years. Net interest expense was $10 million for the quarter, $16 million lower than the first quarter of 2001. Declining rates on floating rate debt, along with lower overall debt balances drove this reduction in expense.

Our first quarter tax rate was 32.5 percent, which was one point lower than last year's first quarter. We expect to maintain a 32.5 rate for the remainder of 2002. Net income for the quarter was $487 million; an increase of 4.4 percent year-on-year. Earnings per share improved by 6 percent to $1.23 per share. Average diluted shares outstanding declined from $402.4 million last year to $395.2 million this year; a reduction of almost 2 percent.

Slide number six examines our first quarter P&L on a sequential basis. Again, these numbers exclude non-recurring items. Sales improved

percent sequentially, but by the transportation graphics and safety segment of 6 percent and industrial markets at 4 percent. We leverage this increase into a 28.5 percent sequential increase in operating income; led again by the transportation graphics and safety and industrial market segments.

Operating margins improved by 4.2 points versus last quarter, driven by higher factory throughput, lower indirect costs, and continued employment reductions during the quarter. Of the improvement in margins, two points was due to better factor and

performance, and another 2.1 points was attributable to lower

expenses. Both net income and earnings per share increased over 25 percent on a sequential basis.

Slide number seven is a reconciliation of the P&L, excluding non-recurring items to our reported profit results. Included in our first quarter reporter results are $54 million of pre-tax charges or approximately nine cents per share associated with our current restructuring plan, and that was approximately one year ago. The charges relate primarily to employee severance costs and accelerated depreciation charges. Of the $54 million in pre-tax charges, $30 million impacted costs of sales, $21 million impacted

costs, and $3 million impacted R&D expense. We anticipate additional charges as we complete the plan.

In total, we expect to eliminate approximately 6,000 positions associated with this plan. And through March 31, we have eliminated about 4,500 positions. Total head count declined by approximately 1,400 during the first quarter.

On slide number eight you'll see sales and profits for six business segments. Again, excluding non-recurring items. Volume and transportation graphics and safety increased 5.3 percent, led by stronger demand for automotive, respiratory protection products, and optical films for flat-panel displays. Operating profits improved over 15 percent to $212 million. Health care volumes increased 6.9 percent, including just over two points of growth due to acquisitions. All business in this segment posted positive volume growth. Earnings leverage was substantial as operating income increased 27 percent to $222 million.

In industrial markets, volumes declined 7 percent, reflecting

weakness in most sectors of the global manufacturing economy and due to a difficult year-on-year comparison. As I mentioned earlier, sequential sales did increase 4 percent in U.S. dollars. Operating profit declined 18 percent to $139 million, reflecting the sales shortfall, as well as lower factory throughput.

Consumer and office volumes declined 8 percent, due primarily to the ongoing weakness in the office supply chain. Companies have dismissed workers in record numbers and quickly curtailed spending in many ways, including office supplies. This is obviously impacting sales of 3M office products.

On the positive side, our sales through the home improvement channel showed strong growth in the quarter. Operating income increased 3 percent to $117 million despite weak overall sales. Volumes declined 23 percent in the electrical and communication segment, reflecting broadbase weakness in the telecom and electronics manufacturing industries. Operating income declined almost 26 percent to $55 million.

In our specialty material segment volumes declined 17 percent in the first quarter, primarily impacted by the product-related phase-out, which we have discussed with you in the past. Operating profits declined 34 percent to $31 million.

Let me give you a few balance sheet and cash flow highlights on slide number nine. We continue to make strides in reducing inventory in the first quarter. As I mentioned, inventories declined by $341 million versus March of last year, a decrease of 14.5 percent. On a sequential basis, inventories declined $91 million. Similarly, receivables declined $338 million or 11.5 percent versus the comparable period last year. On a sequential basis, receivables increased due to normal seasonality trends.

Two of our highest impact 6 Sigma projects are aimed directly at reducing inventories and receivables. These teams continue to study our processes across all businesses and geographies identifying common obstacles and success factors, and they are rapidly implementing fundamental change. So, one day waste and process variation,

our operations, and reducing the required capital.

As of quarter end, networking capital

were 4.1, an 8 percent increase versus one year ago. Our goal is a minimum of six

by year-end 2004. Capital expenditures were $161 million in the first quarter which is lower than our expected

run rate. For 2002 in total, we are maintaining our forecast to be less than last year's expenditure of $980 million.

Using 6 Sigma, we are challenging status quo thinking and whenever possible looking to defer or prevent the need to spend additional capital without impacting defined growth opportunities. Free cash flow at $510 million was 17.5 percent higher than the comparable period of a year ago. Again, we absorbed almost $100 million in severance payments, and we expect approximately $200 million of estimated restructuring related payments for the remainder of 2002.

We use a portion of this free cash flow to pay $242 million in dividends to our shareholders during the quarter. And we also repurchased $420 million of our own stock.

Please now turn to our last slide which is number 10. Looking ahead to the remainder of 2002, although we're hopeful the global economy will improve, our plans assume that the economic environment will remain difficult. For 2002 in total, we now expect earnings, excluding non-recurring items, to be within a range of $4.80 to $5.10 per share, assuming sales volume growth over negative 2 percent at the bottom end of the range, and a positive 3 percent at the top end of the range.

Behind the range assumes a global economic recovery sometime during the second half of the year. Second quarter of 2002 appears to be shaping up similar to the first quarter with no clearer signs indicating a significant change in sequential sales. We expect second quarter earnings excluding non-recurring items, will be at or above the $1.23 per share earned in the first quarter.

Looking beyond this quarter or even this year, we are aggressively pursuing multiple avenues to improve our competitive position. In 6 Sigma for example, 20 percent of all of our current projects are aimed directly at improving sales growth. 6 Sigma teams are focusing on reducing overall commercialization cycle times, improving sales and marketing effectiveness, as well as accelerating commercialization of our most important new products.

We're also beginning to use 6 Sigma with our customers to jointly develop solutions to common problems. This is a great way to create sustainable growth and build long-term customer loyalty. And we're on track with 3M acceleration, a growth-oriented initiative aimed at improving the terms on our R&D expense.

We have a firm handle on where our best opportunities lie, and we are actively moving investment dollars in their direction. Regardless of economic conditions, we will forge ahead with our plans to make 3M even stronger and more competitive company. We're clearly focusing on accelerating long-term topline growth, improving cash efficiency and lowering our total cost structure thereby contributing to an improved shareholder value.

Thank you for joining us this morning. And now we'll welcome your questions.

In order to ask your question please press * then the number 1 on your telephone keypad. If you would like to withdraw your question, press * then the number 2 on your telephone keypad. If you are on a speaker phone, please pick up your handset before entering your request. We'll pause now for just a moment to compile the Q&A roster.

Your first call comes from John Inch of Bear Stearns.

Good morning, Pat.

Good morning.

Your pre-announcement of higher earnings said that you were seeing accelerating benefits from six sigma. Could you describe exactly what it is within the program that's accelerating, and if you didn't -- and basically, how much you think six sigma contributed, recognizing that it's early to operating earnings this quarter?

John, it's obviously a little bit hard to actually pinpoint, but one thing that you do experience is that six sigma is, as you go around the organization, gaining momentum on a day-by-day basis and it's impacting all areas of business, yet growth could be on the cost-side or cash-side of the business. And as we looked at what our previous guidance was versus where we were running, we're just feeling that we're getting more momentum than we had previously indicated.

OK. And my follow-up question is, in your electro and communication markets or businesses, are you tracking something like what to bill or anything that may suggest that either sequentially or near-term net business is likely to start to turn up?

We have not seen any

recovery at this point in time. We're running that business as if we're still kind of at the bottom. It's not clear at all when they will come back. But we are continuing to work with all of our customers, trying to get new applications approved and so forth. So when the industry does come back, we'll be very well positioned to grow that business.

OK. But there's nothing -- orders or anything else -- that suggests that there's any kind of improvement near-term?

No. We have not seen anything yet.

OK. Thanks, Pat.

The next question comes from Don Zwyer of Lehman Brothers.

Good morning, Pat, Matt. Don Zwyer, Lehman.

Could you discuss your acquisition search and what segments you might be focusing on? And what are the odds we might see some more acquisitions this year?

Good morning, Don. That's a good question.

And you probably know if -- I can't exactly give you an answer as to what we're working at and surely can't give you any kind of heads up as far as probability of if and when things will develop. We will continue to look at areas of the business that we feel, you know, fit our business very well that we could, you know, integrate quickly and, you know, become, you know, value to our shareholders.

I'm not going to eliminate any piece of the business that we may want to look at. Obviously, we've got some high-growth areas of the business in health care and so forth which we'll continue to look at. But I surely won't preclude any piece of the business that we'll, you know, continue to look at if there is a value that we can gain. In certain areas, providing additional product or technology will make us more valuable in any -- you know, any one of the segments, including some of the lower growth stuff. But, obviously, what we want to try to do is focus on, you know, while we continue to grow, shareholder value.

Pat, might we see you leave some businesses this year?

At this point in time, Don, I guess I'm not here to forecast if we will or we will not. We try to, obviously, focus on our whole portfolio. At this point in time, more of our focus is on, you know, how we continue to grow the business, but we'll continue to look at businesses to see if they really fit in our long-term plan.

OK. Thank you, Pat.

Your next question comes from Jack Kelly of Goldman Sachs.

Good morning, Pat.

Good morning, Jack.

Just a couple of questions. You, when going through the segments, reflected on a couple of markets that are doing well, some not so well, but you didn't comment on construction at all. Can you maybe just comment on a couple of buckets, you know, non-res, what you see, and kind of transportation, the government spending and maybe residential?

Then secondly, on the 142, any thoughts if there are going to be any impairment charges, I guess you have to finish that up by the end of the second quarter. And then third, if there are any comments you can make about pricing, you made them overall, but any markets that are particularly difficult either geographically or within the states?

Yes. Let me try to answer. I think you got three questions there; I'll somewhat take them in reverse. Funny thing is pretty broad-based. We continue to look at obviously every peace of business we've got, but our price change is not too different on a segment-by-segment basis in aggregate. Obviously, there's pieces of business that are higher lower in every one of them.

So there's no doubt that there's a lot of price competition in the market. That's why it makes it even more important that we make sure we've got our cost position well in line, so we can maintain our margins as well as our penetration.

On FAS 142, at this point, I will have no additional comments to make. We did not disclose anything this quarter, and we don't really see anything at this time.

On the issue on construction, one piece of business which I commented on which is really the home improvement section -- we've seen very good growth in the home improvement side of the business. Obviously, housing starts, I think, are in relatively good shape, but the government spending obviously is still kind of a constrained mode. You know,

has not increased spending a lot that I'm aware of.

And just on non-res, any things there, Pat?

He'll keep working that.

One area that we are specifically looking at, of course, as we look at indirect, there's a very important

growth element of that or sales increase, which relates to

what we're trying to do there is effectively make sure that we protect and grow our advertising and merchandising expenditures on a going forward basis by, you know, further reductions in other areas. So, you know, we're treating that, you know, different as we look at it, you know, to try to protect our growth.

OK. Fine. Following on the margin, you know, seasonality, mix wise -- I mean, would you expect to stay above 19 percent for full year, average?

Well, I mean, if you kind of work through the numbers there's not a huge seasonality impact that we see. So we think the numbers you quote there are, you know, well within range.

OK. Thanks a lot.

Your next question comes from John Roberts of Buckingham Research.

Thanks. And congratulations on a good quarter here.

Thanks, John.

Currency was a three cent penalty in the quarter, and 3M started its hedging programs mid last year. You're starting to now, I assume, have some effect from that. Can you comment on whether the three cents is annualizable if currency rates remain where they currently are?

I had a hard time hearing you a little bit, but I think I picked up your question on currency, John. I'd say it may be a little less for the year than the three cents, but that's, you know, definitely in the ball park.

And the two cent goodwill in the quarter and 12 cent guidance for the year, what's the difference between annualizing the two cents?

Just the way that the goodwill flows by quarter when they're played out, really, you know, last year.

Excuse me, John. You recall, we had some acquisitions we made in the first quarter of last year. That's the reason that the whole impact will be greater in the second, third and fourth quarters.

And lastly, advertising and merchandising has been protected

for well-over a year now, I think. The consumer and office, I guess, would have been down even more outside of the home improvement area, and home improvement probably would have been up, even if you weren't spending a lot, given the weather that we've had. So at what point do you become concerned that you're not getting productivity on this protection of the advertising and merchandising?

Well, what we've tried to do is try to time our ad

when we see the opportunity. If you look at probably over the quarters, the first quarter will be the lowest of our expenditures for ad and merch. And as we see, obviously, the opportunity in the market develop we'll put that money into the marketplace.

We continue to look at, obviously, the effectiveness of our ad and merchandising. They are not immune from the whole, you know, review of the efficiency of our spending. But if you look at it from first quarter through the rest of the year I think you will see that we'll be actually increasing a level of ad and merch as we see the opportunity.

OK. Thank you.

Your next call comes from

of Salomon Smith Barney.

Hi, guys. Couple of questions. First of all, the health care business, it seemed like the growth rate, I think, decelerated a little bit. I was just wondering what you see for the outlook there?

Also, second, just if you can comment on the material costs outlook for the year, has there been any change in that outlook? I think the original expectation was a 2 percent decline.

Thirdly, if there's any possibility of providing some kind of a breakdown of the savings in the quarter by program, i.e. productivity, indirect cost savings, just to get a little bit more granular on that, sort of in the nature that was broken out in the

. That would be helpful.

And then finally, I just wanted to clarify two things. I didn't catch, Pat, the revenue range that you gave for the year, if you could just reiterate that. And you had mentioned, I think you said Q2 sales flat, just want to clarify if that's sequentially or year-to-year. I'm assuming you mean sequentially.

Not so sure I captured all of your questions, Jonathan. So if I miss one, I apologize and you can come back.

Q-2 sales, we did not give guidance. Basically what we're saying is, we don't see any fundamental trend change yet coming off the first quarter. So I think more like the business is kind of like it was here in the first quarter.

For the year, we're basically at a minus-two to a plus-three, which is the same guidance that was given last year in the fourth quarter, which obviously the high-end resumes a recovery here in the last half of the year, which would imply a sales growth of maybe about 5 percent, you know, toward the back-end of the year versus the minus-two

flat situation.

On the initiatives, I'd rather really not get into a quarter-by-quarter reporting on initiatives. I want to try to look at these on an annualized basis as to what the impact is. You do get a little bit of a quarter-by-quarter move in the individual initiatives. And a lot of it has to do with the comparison versus prior years and so forth. So it becomes, you know, a little trickier to do that, but I think if you look at our overall results in the first quarter relative to cost management and waste elimination, it's obviously a very widespread reduction in the business, again focused on -- 6 Sigma is basically the process we're using to drive improvement in our overall process waste elimination.

And then, of course, it shows up in areas like indirect cost and in global sourcing and also part of

productivity,

primarily by factory

or employment. On the material costs, there's really no material change in our guidance on material costs going forward.

Did I forget one, Jonathan?

Yes, and I just want to follow up on one thing. The one thing that we didn't talk about was the health care growth rate, and I just want to come back to one thing. I know you can't comment on the savings by program, but if you can maybe just indicate, is there any particular program where we saw a particularly noteworthy acceleration in this quarter? Or was it all -- was it still largely the indirect cost savings and no real change directionally in any given program?

Sorry for forgetting the health care, because it's an important question. One of the biggest changes we've had -- we did not have any really new acquisitions here this year, OK? Which I think has probably slowed down the historical growth rate trend. We are seeing good growth in, you know, across almost all segments of health care -- we feel very good about our competitiveness there to continue to participate in a growing market.

On the initiatives, indirect was probably again the largest single contributor in the first quarter from that standpoint. And I think you'll see that probably the contribution of indirect will therefore diminish a little bit over -- through the rest of the year. But at the same time, you'll see probably more benefits coming in from the 6 Sigma overall effort as well as continued reduction obviously through our global sourcing activity as well as

.

Thank you.

Your next question comes from Mark Gully of Bank AmeriSecurities.

Morning guys.

Morning, Mark.

My first question is as follows. I concur that one of the most important impacts of 6 Sigma in the long term is going to be on growth initiatives. Pat, can you give us any examples of new products or customer partnering that are noteworthy, let's say in the last six to nine months, that you would want to highlight.

I guess six to nine months is kind of a long time, kind of precedes my time here a little bit, Mark, but I'll try to answer it. Probably the biggest ones, I would say, are in the health care field. IRMs as example. A lot of good work going on, the 6 Sigmas helped really drive the ability to develop a number of new compounds that we can eventually put in market.

I guess on a partnership basis, nothing that's new, obviously, we announced literally last quarter -- we continue to explore opportunities where it seems to make sense to leverage the R&D dollars. We'll continue to seek partnerships in those areas and then areas that obviously we have more of a direct channel to market.

We may continue to look at those areas by ourselves, but we'll continue to pursue partnership areas where it makes the most sense to be

pro-development.

OK. My second question had to do with the margins. The margins were much better than even I thought in this quarter. Maybe I'll talk about this in the main meeting, but can you give us some sense of where these margins can go, let's say, over the next couple of years? This is a high-water mark as far as I know in any quarter. How high can we go, let's say, if we're looking at this thing two years out?

Well, I mean obviously our job is here to grow the business and margins together. I'm not going to really quote a number. Obviously, we want to continue to grow margins, but we also have to grow the topline and the whole value of the business at the same time. I obviously would like to continue to increase margins and try to get additional volume at the same time.

But there's really no magical formula as to what the magical number is, but 20 percent is a starting point. Let's get there and we'll continue to run there, and then we'll kind of continue to look at it. But we've got to, you know, grow the business here at the same time and I'm comfortable we can do both; we can grow the business as well as maintain, you know, outstanding margins.

And I'll conclude with a follow-up question. In terms of the cost initiatives and your success, are there any areas where you think you're, you know, at risk of cutting into muscle rather than just cutting out fat?

I would say no. If you look at the first quarter, there are some timing-related items that we've consciously planned and I'll take advertising and merchandising as an example, in which I previously mentioned we'll spend probably more the last, you know, three-quarters of the year than we did the first part of the year. That's more of a timing issue than it is really, you know, cutting, you know, cutting muscle.

I would say that, you know, the focus in the organization is really to define how we can do work better not by, you know, slashing the organization. This has got to be a sustainable position. So all the initiatives that we have are based upon trying to get sustainable cost improvement and cost management within the organization. It's not, you know, just trying to hold your breath until the economy returns.

Thanks.

Your next call comes from Michael Reagan of Credit Suisse First Boston.

Thanks, Pat. I'm sorry if I missed it, but could you just address the sequential change in receivables? A pretty big jump; a couple hundred million dollars first quarter over a fourth quarter.

Yeah, the change is a couple-fold on receivables. Really, it's a seasonal issue that we run into, and if you look at the way sales flow in the quarter; as an example, in our fourth quarter, December was the lowest month, OK, within the quarter. And you just kind of look at then what your receivable balance, you know, is and so forth. It has a tendency to go down. First quarter sales are more in March than they are, you know -- so it's more of a timing as well as this overall seasonality of the way it flows. There's nothing structural that has changed.

Yeah, but I mean, sequentially, over the last three years or so, it's never been that big a difference. So I'm just wondering, you know, are you losing any momentum there or, you know...

Not losing momentum. To say I'm satisfied, I'm not satisfied with our progress there. We still have some more work to do there, but it is -- it's not a structural change. We actually did make some improvements here in the first quarter. But I think as we play out during the year, you'll see improved performance on the receivable front.

And first quarter charge $54 million; can you split that between severance and lower D&A?

Ron, do you have that number?

Yeah. Of that $54 million -- first of all, about $24 million of that was in separation benefits and about $26 million relative to accelerate depreciation on assets coming out of the system. Your question was relative to the SG&A versus the

line?

No, that answered it.

And then, finally, Pat, you know, your year-over-year change in margins and the margin performance in transportation safety and graphics was pretty exceptional. How much of that is mix) versus, you know -- or maybe the better way to ask it is, by segment where is six sigma taking the most hold? I mean, even consumer and office margins are up 2.4 percent year-over-year, you know, despite the kind of volume and price declines you saw there. Can you just walk through each segment? Is there any difference by segment for six sigma? And what happened in transportation safety?

I'd say, no, there are, you know, initiatives across the company on six sigma. It's very, very broad-based. Obviously, certain projects are helping, OK. Certain geographies or business segments are a little bit more. But there's really no big difference between any one of the business segments as far as, you know, where six sigma is really contributing. It is a very broad-based assistance to the whole structure of the business. So it's not simply -- it's more that the transportation group had more six sigma than anybody else did. It was a combination way of the businesses they've got. They're running, you know, relatively good factory throughput in that activity. So it's a combination of all those that really makes, you know, very good margins here for the first quarter.

But, I mean, it -- then, if we look, I mean, industrial's down 8.3 versus down 10 for consumer and office; and, yet, industrial margins year-over-year were down 2.2 percent and consumer and office up 2.4. So, you know, just use the two of them -- what's sort of a mix issue versus, you know...

Well, a couple of things. One is the year ago comparison is a little more difficult for the industrial group. They were, you know, running relatively, you know, decent at that point in time. Good factory throughput. We've been taking more inventory, reducing throughput in the industrial side here in the first quarter. That's probably why their margins were not, you know, as proportionate as the other activities. Again, same benefits from six sigma, but they're taking probably a little bigger hit here the first quarter relative to factory throughput.

OK. Thanks.

Your next question comes from Robert Ottenstein of Morgan Stanley.

If we can go into, again, on the operating margin side on the health care business. You know, not great volumes; nice pick up in the margin. How much of that was a result of payments from Lilly? And can you go through that and how that's hitting the income statement?

Well, Lilly is not a significant contributor there in the first quarter. It is a couple of cents, but it's not a, you know -- it's not significant from an overall perspective. It's basically improvements across the businesses and really across geographic, from a health care standpoint. We feel very good about -- you know, it's a business that we have in health care and, you know, kind of its growth opportunities that caused its margin outlook.

So if it's a couple of cents, it's about $10 to $15 million of sales and operating income?

I'd say it's a little more like 10 is kind of where I would probably peg it further.

OK. And did that correspond with a $10 million increase in R&D for the drugs. I'm just trying to understand how this works through.

Right. I mean, you have to look at R&D as to our overall effort on R&D activity. We are putting more money in the health care segment. If you look at our total mix, we've increased our allocation of R&D expenditures into health care, and specifically into pharmaceuticals. So when we say, you know, even $.10 that's, you know -- if you really look at how much money we're putting actually in R&D, we're probably not even up that much, OK, from a pure, you know, net basis because we are deploying research dollars towards health care, specifically pharmaceutical.

OK. Following up on the R&D, I think it's great how you've been able to get these tremendous reductions in costs without kind of slashing R&D and holding that in. What do you see in terms of R&D spending outlook for the rest of this year on an absolute basis because -- is this kind of 260-ish what we should expect or does it go up or down from there?

I think it should be pretty well flat. I'd say this: R&D will benefit from the same indirect conditions that we have in six sigma to improve the efficiency of R&D at the same time. So, obviously, that's how we've been able to actually been able to hold overall dollar share and, you know, probably get more throughput through it.

So again, R&D, you know, we need to maintain that. And, I guess, that's a good point, Robert. We're trying to basically, you know, through 3M acceleration and other initiatives, trying to protect the innovation R&D capability of the organization. We're trying to protect our advertising merchandising dollars, so we can continue to grow the business. And basically what we're trying to do is get the cost reduction out of the other side of the business.

OK. The minority interest line was a lot higher than I thought it was going to be. Sequentially, you know, it is, you know, double what it was -- more than double in the third and fourth quarters of last year. My recollection is that that's mostly your business in Japan, is that right? And have you taken a lot of costs out there? Can you give us a little idea what's going on there?

It is

I'll let Jan actually give you the numbers.

You're correct, Robert. The minority interest is primarily the

3M business in Japan. We had good results in the first quarter. We had some strong sales in our

business, for example, in the first quarter, but that is primarily a reflection of our Japan business.

OK. Great. And just final question. You had mentioned earlier on that there was, you know, some timing issues, in terms of the advertising and merchandising expenses, which probably contributed to the nice margin in consumer office. Is there anything else on a timing basis that we should know as we try to model the quarters going forward this year?

No. I don't think so, from a cost standpoint. That's pretty

the number or the category.

And the advertising, the amount, would it be in the area of like $30 million, $50 million, can you give us any order of magnitude there?

I really can't. But we definitely below the seasonal run rate here in the first quarter and it will be accelerating.

Great.

That's obviously part of our guidance.

I guess, the other thing is that, you know, as you do look at our business in the first quarter, you know, keep in mind if you just look at where we grew the business it, obviously, was in our higher margin businesses. So, you know, that's obviously, you know, helped us here in the first quarter.

Great. Thanks a lot. Nice job, guys.

Your next question comes from Steven Weber of

.

Good morning. Because the effect of currency, et cetera, could you be more specific about the throughput on both the year-over-year and a sequential basis, and maybe give us some feel about how that's looking as you go forward on inventories. Because my recollection, Pat, is that you hoped to do even better on the inventory side than maybe you showed in the first quarter.

Good morning, Steve. How are you?

Fine.

Let's start on the inventory question here. We do have to accelerate our rate of improvement in inventories to meet our objectives. So we do have some more work to do there. I think the throughput, if I look at year-over-year is about 7 percent below last year on a total throughput basis, up maybe about three points off of the fourth quarter, if I recall the numbers exactly right, Steven.

You know, if you look at the sales line, we're basically saying the world is not changing a lot here, so I think throughput, you know, remain about, you know, the same level we had in about the first quarter.

OK. More generally, you know, there's all these signs that supposedly or at least what the economists say that the U.S. economy is improving and there are some signs, I guess, that inventory, you know, some of this inventory run off by some of your customers has moderated, and I'm wondering just, do you have any feel why this hasn't shown up more in your results? I'm talking mostly state-side, because it's less clear what's happening in Europe, et cetera. Why it hasn't shown up more in your business than it has or at least it seems to have in the first quarter?

Well, obviously, I think there is a kind of bit of inventory adjustment period. I think that overall businesses are taking a much more cautious view as, you know, they kind of see, maybe, the economy rebounding here a little bit as to their own schedules a little bit. So I think people will be a little more cautious on how they come out of it. That's a personal view.

If you actually look at any of the

statistics for the first quarter, if you really try to break that down into segments and so forth, you know, we would have some segments that are down, you know, pretty significantly, you know, year-over-year as a piece of that. But, I guess, generally speaking, Steve, I think there is five years that are a more cautious outlook in view as people come back as to what they're ordering flow may look like. And we're all very hopeful that the economy really picks up here in the second quarter. We'll see a, you know, direct translation back in our results.

OK. And lastly, could you give us, or Jan, give us some feel for what the litigation recoveries might look like and where you stand from a legal standpoint on those?

I'll just give you my, I guess, opening comment. Basically, there's really been no material change in this whole asbestos area, so there's really not a lot of, you know...

I'm thinking about the implant.

Oh, I'm sorry. You said implant, OK.

Yes. Where supposedly you got all this money somewhere along the line.

I'll turn to Jan on the implants. Sorry.

OK. Good morning, Steve. The cash out flows, as you know, in connection with this matter have pretty much stopped, so our attention remains focused on the insurance recovery. We have a $15 million remaining liability on our balance sheet. And you'll recall that we started with a total liability of

billion. So of the $368 million receivable that we have, the $63 million is settled, but we haven't received the payment, and then the remaining $303 million subject of the ongoing litigation. And we're on course there, but I can't give you a date.

OK. Thank you.

Your welcome.

Your next question comes from

of New Vernon Associates.

Good morning. Maybe I missed it, but what was depreciation and amortization in the first quarter? And what would you see for the year?

Ron, do you have that -- I just don't have that number memorized now. Well, we'll get it to you in just a second here.

Want to come back to that question in

...

How about if we -- Paul, you got something else, or we'll just kind of answer it after

No. That's it. I'm just -- I'm also trying to figure out about improvement in margins here, and it seems to me the piece we're missing is depreciation and amortization.

It's not significantly different. Ron, I think you've got the numbers.

The depreciation was about $215 million, very similar to what the quarterly run rate has been.

How much?

About $215 million.

Two-one-five?

Right. That's on a non-recurring basis. The reported number you'd see would be $241 million.

Well, the two-one-five -- I must say I'm looking at the wrong table or something. That compares with $291 million in the fourth quarter of last year. Am I looking at the right thing?

You must be looking at a different schedule. We can follow up with you relative to that, but the reported depreciation's about $241 million.

OK, and that -- well, OK. I'm missing amortization then. What was amortization?

Amortization, of course now with the good will falling off, has moved from about quarterly run rate of $25 million down to about $10 million.

OK. So the total of depreciation and amortization would be about two and a quarter?

That's correct.

That's correct, yes.

OK. Well that answers my question, because I think the fourth quarter was $291 million.

That's correct on a reported basis, including our restructuring

. The similar number this time I guess would be $241 million plus -- $250 million on a reported basis.

OK. Well then, the improvement in margins is essentially a drop in non-cash charges. I'm talking sequentially.

Well, you've got obviously the goodwill piece of it is a direct improvement, and then the depreciation's down $8 million on a reported -- excluding special charges basis.

Here's where it's important for us to look at the non-recurring number, because within our restructuring charts is the accelerated depreciation. And those assets are coming out of commission.

No, I understand, but I'm looking at -- I think I'm right that the non-recurring number for depreciation and amortization in the fourth quarter of last year was $291 million. And if you're saying it was $225 million in the first quarter, the improvement is $66 million.

We may want to follow up with you to see where your number's coming from, but the fourth quarter amount of depreciation and amortization was $250 dropping to a total of $225 million.

OK. Then I'm looking at the wrong thing. Thank you.

Yeah, the $291 was as reported including the restructuring charges.

I'm sorry. Thank you.

Your next call comes from

of Delaware Investments.

Yes, one question, actually, here. I was going to ask you if you could outline for us the sales growth initiatives going forward -- just taking a microscope out on the topline. There's a lot of good things going on here on the productivity front that appear to be the key driver in the earnings growth. But at the same time, on the topline we're still looking at flat to low single digit topline growth.

Yes, I guess probably without giving specific programs, overall, we're still trying to grow the business organically. That's still our primary driver, and our whole 3M acceleration program is geared toward improving the topline growth. The sales force and market organization is really focused on increasing shares, and this is one of

personal jobs right now, is to really stimulate that group by leading a sales and marketing council to, you know, energize our growth capability there.

20 percent of our 6 Sigma projects are aimed at growing the business, and a piece of that is we're doing more and more work with our customers on 6 Sigma opportunities both for them as well as us. We're spending a lot of time focusing on how we continue to grow from an international perspective -- we think there's a lot of growth opportunities still in international markets that we haven't exactly tapped out significantly.

We're continuing to look at the way we define markets and making sure that we're not thinking of them too narrowly and looking at adjacent markets that we can pursue with the products that we have, looking at ways that we possibly could improve our service capability with customers as a business opportunity. And on top of that of course you've got acquisitions which obviously in the short-term won't be significant. Nothing to say today, but it's a very broad-based program.

We are working obviously with select customers and trying to gain additional business with them, but nothing specific that we are prepared to announce right now.

Now from a guidance perspective, can you help us in terms of gauging expectations on when we should expect to see the fruits of these labors here in the topline?

Obviously, they'll all play out over time. Can't really give you a quarter-by-quarter plan as to when that's going to happen. A lot of it will obviously depend upon our own success, but also as well as when the economy turns around here.

Thank you.

Your final question comes from

of Black Diamond Research.

Yes, just to follow up on looking at the cash flow statement for the full year. I was wondering if you had sort of a target for working capital for the full year, assuming that your top line growth is somewhere in the middle of the range of your current expectations. And could you repeat the number for cashout for restructuring -- I didn't catch that number, and then assuming that your excess free cash flow after dividends is somewhere in the billion dollar range, I'm just wondering what the current appetite is for share repurchases with the stock at the current levels.

Well, I guess the cash out through the remainder of the year for restructuring is probably north of $200 million, kind of what we're currently thinking of. Obviously, we've got a $2.5 billion repurchase program authorized. We've bought $400 million

, and we'll continue obviously to buy when we think it is the right time buying shares in the market.

I think there was one other questions you had which I...

Just wondering if you had a quantitative target for working capital.

We do have an objective to be 4.6

by the end of the year. This is what our objective is, so you can get kind of back into that number.

OK, and then just you mentioned -- you're pretty explicit about your volume expectations and the range and the assumptions for the second half. Just wondering if you could break that out by international versus domestic in terms of your assumptions going forward here.

I am really -- I think our guidance is from a topline perspective. Obviously, we hope to see broad-based recoveries in the U.S. as well as we think Europe maybe a little bit later. But that's kind of

generally we think.

All right. Well, thank you.

At this time, there are no further questions. We will now go back to Mr. Campbell for any closing remarks.

Thanks for your time this morning. We feel good about our first quarter performance, and we'll obviously continue to focus on the initiatives. And we'll talk to you again at the second quarter.

Ladies and gentlemen, that does conclude our conference for today. You may now disconnect and thank you for participating.