3M (MMM) 2002 Q4 法說會逐字稿

Ladies and Gentlemen, thank you for standing by and welcome to the3M fourth 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, press star then the number one on your telephone keypad and questions will be taken in the order they are received.

If you would like to withdraw your question, press star then the number two.

As a reminder, this conference is being recorded today, Tuesday, January 21, 2003.

We would now like to turn the call over to 3M.

Thank you and good morning, everyone.

I'm Matt Ginter, Director of Investor Relations for 3M.

Welcome to our Fourth Quarter and Calendar Year 2002 Business Review.

I have a few brief announcements before we begin today.

As in prior quarters, today's discussion will follow a series of Powerpoint slides which you can access on our Investor Relations web site.

Our 1st Quarter 2003 Earnings Conference Call will take place on Monday, April 21.

Please mark your calendars accordingly.

During today's conference we will make certain predictive statements that reflect our current views and estimates about out 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 MD&A section of our most recent Form 10-Q lists some of the most important risk factors that could cause actual results to differ from our predictions.

Now I would like to turn the program over to Pat Campbell, 3M's Chief Financial Officer.

Pat?

Thanks, Matt and good morning, everyone.

Today I will review our fourth quarter and calendar year financial results.

Jim McNerney will wrap up today's call with his perspectives on 2002 and our outlook for 2003.

Let's begin with a few highlights from our fourth quarter results.

Please go to slide No. 2.

3M reported another solid earnings performance in the fourth quarter.

Earnings were $1.29 per share and we reported no nonrecurring items this quarter.

Compared to the fourth quarter last year, this is up 34% on a reported basis and up almost 32% excluding nonrecurring items in 2001.

Sales totalled 4.1 billion, up 7.3% compared to a year ago with five of our six business segments reporting higher worldwide volume growth.

Asia Pacific continued to lead the way with growth over 20% and the U.S. reported their second consecutive quarter of growth.

Fourth quarter operating margins were 19.2%, an increase of 370 basis points over last year.

This improvement was broad-based, as all six of our business segments posted double digit profit increases.

All five of our corporate initiatives contributed to the fourth quarter, paving the way for a solid entry into 2003.

They're helping to drive better operating excellence as evidenced by our networking capital turns improvement and positively impacting our sales growth as well.

On slide 3, we recap our fourth quarter sales performance on a geographic basis.

As I mentioned, worldwide sales in dollar terms increased 7.3% versus last year's fourth quarter.

Core volumes in the fourth quarter increased 5.3%, and acquisitions added 70 basis points.

Selling prices were down 70 basis points, while year-on-year currency translations boosted sales by 2 points.

In the United States sales improved 1.8% with core volumes increasing 1.3%, led by positive volume growth in Consumer and Office, Transportation, Graphics and Safety, Industrial, and Health Care.

Acquisitions added 90 basis points, while selling prices were down 40 basis points compared to a year ago.

International sales increased to 12.2% in U.S. dollar terms compared to the previous year.

Core volumes increased 8.9%, led by a 22% increase in Asia Pacific.

Volumes improved 15% in Japan and 29% in the rest of the region.

All business segments experienced positive growth in Asia Pacific with 5 of 6 segments posting double digit sales growth.

Volumes also increased in Latin America by 6.5%, but were flat in Europe.

Acquisitions added 50 basis points of growth in International while selling prices declined 1 point.

Currency affects boosted International sales by 3.8% driven by positive translation of 10% in Europe and 4% in Asia Pacific.

Translation negatively impacted Latin American sales by over 20%.

On slide number 4, we detail the P&L, starting with the comparison versus the fourth quarter of last year.

The numbers I will discuss exclude nonrecurring items reported in the fourth quarter of 2001.

Gross margins were 48.9%, up 250 basis points over last year's fourth quarter.

Corporate initiatives such as Six Sigma, indirect cost reduction, global sourcing effectiveness, and E-productivity continue to improve our cost structure.

Raw material costs declined by about 1%.

SG&A expense was 23.1% of sales.

A 100 basis point improvement versus the fourth quarter of 2001.

Lower head count levels, along with our continued efforts to reduce indirect costs, helped contribute to the decrease in offset increased spending in advertising and merchandising.

Overall, operating income was up 33% compared to a year ago, and margins were 19.2%, up 3.7 points year-on-year.

Fourth quarter net interest expense was 10 million, 6 million lower than a year ago, due primarily to lower interest rates.

As expected the tax rate was 32.5%, which is 90 basis points higher than the fourth quarter of 2001 but equal to the first nine months of this year.

Quarterly net income of 511 million and earnings per share of $1.29 were both up almost 32% year-on-year.

Average diluted shares outstanding declined slightly from 396.8 million last year to 395.6 million this year.

Slide number 5, details our quarterly results on a sequential basis.

Sales were close to flat sequentially and as expected, operating income, net income, and EPS were down from last quarter by about 6.5%.

Fourth quarter profits and margins are typically down from third quarter levels due to seasonal slowdowns in certain U.S. businesses and higher advertising and merchandising costs to support holiday-related sales.

Consistent with prior guidance, advertising and merchandising spending increased sequentially by about $13 million.

Slide number 6 details our performance by business segment.

Overall this was a very solid quarter as five of our six segments posted higher sales volume versus a year ago and all grew operating income by double digits.

Again, this is an example of how our initiatives have gained broad-based traction and are driving significant improvements throughout the company.

Transportation, Graphics, and Safety volumes increased 14.2% versus the fourth quarter of 2001.

The strongest growth was in Optical Systems, automotive OEM products, and traffic control materials.

Operating leverage remains strong as profits improved by 49% to 222 million.

Volumes in Health Care increased 3.6% versus last year led by strong performances in dental and medical products.

As we discussed last quarter, a generic competitor of our branded [indiscernible] product impacted growth in this segment.

In addition, the revenue associated with our partnership with Eli Lilly began in the fourth quarter of 2001, therefore, it did not add to this quarter's growth rate.

On a combined basis, these two events impacted our growth rate in Health Care by about 3 points.

Operating income improved 13.2% to $243 million.

In Industrial markets, volumes improved 4.6% versus a year ago.

Our automotive aftermarket and engineered adhesive businesses led overall growth.

Operating income increased almost 35% versus last year to $134 million, driven by the combination of higher sales, process efficiency gains, and savings from restructuring actions.

Growth was broad-based in Consumer and Office as volumes improved 4.5% compared to last year.

Operating income increased over 30% to $126 million.

Electro and Communications volumes increased 2.2% versus last year.

This is the first quarter of year-on-year growth since early 2001.

Our electrical components and electrical products businesses experienced good growth in the quarter.

However, our telecom business was down 19% this quarter and down 32% for the year.

As a result of continued weakness in the telecom end market, we took additional actions in the quarter to further right-size our telecom business.

Even with these actions, operating income almost doubled to 56 million, reflecting the terrific effort that has been undertaken by our people.

In our Specialty Materials segment volumes decreased 1.7% year-on-year, impacted by the continued phase-out of the previous Scotch Guard chemistry.

Operating profits improved 15% to $26 million.

On slide 7, I will review our calendar year results.

Excluding nonrecurring items, earnings per share increased over 20% to $5.26 a share from $4.36 a share in 2001.

Sales grew 1.7% despite a continued tough global economy.

More importantly, year-over-year sales growth improved every quarter during 2002.

Gross margins improved 1.5 points to 48.7%.

Our global sourcing initiative helped reduce raw material costs by about 3%.

Gross margin also benefited from significant flat level productivity efforts.

We again expect lower raw material costs in 2003 to the tune of about 1%.

SG&A as a percent of sales decreased one point to 22.3%.

Operating income improved 17% to 19.9% of sales, an improvement of 2.6 points.

The tax rate for the year was 32.5%, and we expect a similar rate in 2003.

Average shares outstanding equal 395.5 million in 2002, down 1% from 2001.

On slide 8, we summarize sales and operating income by segment for 2002.

Transportation, Graphics, and Safety, and Health Care led the way with positive sales growth for the year.

Sales growth in Transportation, Graphics, and Safety was fueled by Optical Systems while Health Care's growth was much more broadbased.

Industrial was near flat for the year with growth improving in the second half.

Volumes in Consumer and Office declined 1.6% primarily due to continued office layoffs and inventory contraction in the retail channel affecting office supplies.

On the plus side, our construction and home improvement business posted strong sales growth throughout 2002.

Electro and Communication sales were down in 2002 primarily due to the weakness in the global telecom industry as specialty material sales were lower due to the transition of Scotch Guard and weaker sales in electronics end markets.

Despite the weak economic environment, four of our six segments posted a double digit profit increase in 2002.

Slide 9 depicts our results on a geographic basis.

In the United States, although volume growth was positive during the last two quarters, sales volumes declined 1.2% for the year.

Weak overall sales in Electro and Communication, Specialty Materials, and Industrial were partially offset by strong growth in Health Care and Consumer and Office.

Europe's 2002 volumes declined 3.5% versus 2001.

The significant downturn in the telecom industry negatively impacted Europe sales, however, strong growth in Health Care did mitigate this somewhat.

Volumes in Asia Pacific increased 14.4% in 2002.

Driven by significant growth in Transportation, Graphic, and Safety, Health Care and Industrial.

Volumes declined 1.1% in Latin America, Africa and Canada.

Economic and political instability negatively impacted sales in many parts of Latin America during 2002.

All regions improved their operating income significantly compared to 2001.

On slide number 10, you will see that the balance sheet and cash flow also improved in 2002.

Networking capital turns were 4.7, up 0.7 turns versus one year ago and up 0.2 turns sequentially.

Our goal remains a minimum of six turns by year end 2004.

Inventories declined by 160 million versus the fourth quarter of 2001, a decrease of 7.7%.

Inventories were down 14 million sequentially.

Accounts receivable was up 45 million or 1.8% versus the fourth quarter of 2001 but decreased 58 million versus last quarter.

Capital expenditures were 233 million in the fourth quarter and 763 million for the year. 2002 will be a low point for capital spending and we expect to invest 900 million in capital in 2003.

Fourth quarter free cash flow was 766 million, which included additional pension funding contributions of over 200 million for some of our O.U.S. subsidiaries.

Strong earnings and improved working capital turns drove higher cash flow.

Free cash flow in the quarter did benefit from differences in the timing of certain tax payments.

This strong cash flow enabled to us pay 242 million in dividends to our shareholders during the quarter.

We also bought back 129 million of our own stock which resulted in a net repurchase of 34 million.

Overall, debt levels increased by 438 million sequentially due to the fourth quarter acquisition of Corning's Precision Lens business and the final payment of [indiscernible].

Our total debt to capital ratio was 36% at the end of the year.

Please turn to slide 11 for a pension update.

Our strong business results and cash generation allowed to us contribute an additional 212 million in the fourth quarter to various O.U.S. plans, bringing the global total for 2002 to just over $1 billion.

Once again, no contribution was required, but we felt it prudent to do so in light of the multi-year decline in the global equity markets.

As I mentioned on last quarter's call in accordance with FAS 87 we booked a charge to equity in the amount of approximately 1.1 billion in the fourth quarter.

This event does not impact the P&L or cash flow statement.

Pension expense impacted 2002 earnings by 17 cents per share compared to 8 cents in 2001.

We expect pension expense to grow by another 10 cents per share to approximately 27 cents in 2003.

With a 2003 U.S. pension plan our return an asset assumption will remain at 9% and our discount rate assumption will be 6 3/4.

At this time Jim will summarize 2002 from his perspective and provide you with our outlook for 2003.

Jim?

W. James McNerney, Jr: Thanks, Pat and good morning.

For 3M 2002 was a year of significant challenge given the uncertainty and the tough economic conditions around the world.

It was also a year of significant accomplishment.

In the year in which we celebrated 3M's 100th anniversary we took several important steps forward.

We reorganized the company, fully integrated Six Sigma, jump-started the 3M acceleration initiative, and completed several very attractive acquisitions.

We reorganized the company into seven businesses to move us more quickly into larger, higher growth markets.

And in doing so we gave some of our best emerging leaders opportunities to make larger contributions.

Of our five initiatives, all of which are vitally important, Six Sigma and 3M acceleration are gaining in importance.

As of year end, we have 3,300 active Six Sigma projects and have closed more than 1200.

A big jump over the previous year.

Six Sigma is the primary reason we are on track to hit our networking capital turns target.

3M acceleration is beginning to make an impact on our top line.

We are encouraged by early 3M acceleration successes like optical, pharmaceuticals and dental, china, and construction and home improvement markets.

We completed several strategic acquisition also to accelerate growth and to bolster our international strength.

Corning Precision Lens, the world's leading supplier of optical lens sets used in rear projection televisions,is now 3M Precision Optics, building on opticals organic strength.

In dental we completed one of our most successful acquisitions ever, ESPA with a final payment in December.

And earlier this month we purchased NEC's interest in Sumitomo 3M, our company in Japan giving us 75% ownership.

While the reorganization, the acquisition, and the continued integration of Six Sigma are all noteworthy, I am most pleased that we were able to deliver solid results under tough conditions and build some momentum going forward.

Excluding nonrecurring items we improved operating income by over 20% compared to 2001.

The story here is operational excellence and especially the success of the initiatives for the combined impact of more than half a billion dollars in '02.

Credit here goes to our employees who drove the initiatives hard from the start, gaining almost immediate traction.

As a result of their efforts we realized the impact of the initiatives more quickly than planned and in this slow growth environment, we needed every bit of it.

At this time last year we anticipated earnings of 4.60 to $5.05 per share.

As we reported today, earnings for the year were $5.26 per share, excluding nonrecurring items.

We talked earlier about the emerging cash flow story at 3M.

We generated 2.2 billion of free cash flow in 2002, and as Pat mentioned earlier, we are well on our way to our goal of a minimum of six turns on net working capital.

A strong balance sheet is getting even stronger and expanding our range of strategic options.

Speed, flexibility and the ability to act opportunistically have never been more important.

Again, I want to acknowledge the efforts of 3Mers around the world.

We have a tremendous global team working hard and working together to increase shareholder value, but we are far short of declaring victory by any means.

We are staying intensely focused on operational excellence going forward.

In fact, this year we expect the initiatives to contribute 300 million incrementally compared with 2002.

And we are driving just as hard, if not harder, on organic growth as we are on operational excellence.

As I told all of you in May, our 3M acceleration initiative is helping us not only secure the process of innovation, but to build on it.

We are rejuvenating organic growth by digging deep into the new product introduction process itself.

We recognize that it is really comprised of two processes.

On one hand, more quality ideas and on the other hand, improved success when we launch and execute the launch of a greater number of products more successfully than we have in the past.

With these two processes we have defined entitlement, established metrics, and set some tough goals for ourselves.

The integration of Six Sigma tools and discipline both DMAIC and DFSS into the new product development process ensures that the voice of the customer will be at the heart of 3M's NPI efforts.

Soon we will see a greater percentage of customer-inspired products.

More market-driven opportunities, along with perhaps fewer, but much higher impact projects.

In other words we want to create a Renaissance of innovation of 3M.

But a Renaissance directly connected to and reflected in real organic growth.

To energize growth we need energized leadership and leadership development remains at the top of our agenda.

We are beginning to get the right people into the right jobs.

I mentioned earlier the reorganization puts some of our best emerging leaders into prime time slots.

We have also made some key external hires to supplement our internal strength.

With the early waves of Six Sigma leadership coming back into the mainstream, we are well on our way to raising the game of our entire leadership team.

And it's a leadership team committed to results.

On slide 12 you can see we are determined to deliver on the commitment we made in May by sustaining double digit earnings growth in 2003 despite the uncertain global economic and political landscape.

For '03 in total we expect earnings to be within a range of 5.80 to $6 per share which is about 10 to 14% growth, excluding nonrecurring items in 2002.

This assumes sales volume growth of 3% at the bottom end and 7% at the high end, reflecting the fact that we still see economic conditions constraining normalized market conditions in '03.

For the first quarter, we expect earnings to be between $1.38 and $1.43 per share or about a range of 12 to 16% growth, again excluding nonrecurring items in 2002.

This assumes volume increases in a range of 4 to 7%.

In addition we expect to end 2003 well on our way to exceeding our three-year objective of increasing working capital turns by a minimum of plus 50%.

These are challenging goals, but once again, I have complete confidence that our team will continue to deliver consistent solid growth on a long-term basis.

This concludes the formal part of today's call.

Joining Pat and myself this morning are Ron Nelson and Jan Yeomans [phonetic] who will help to address your questions.

Jan, by the way, recently accepted an opportunity to run our M&A group working on Bob Burgstahler's team.

Mark Borsette, [phonetic] who previously was General Manager of our Canadian subsidiary, has been named Treasurer and will join us on future calls.

At this time we would be glad to help address your questions.

Matt, why don't we begin.

At this time I would like to remind everyone in order to ask a question, please press star and the number one on your telephone keypad.

To withdraw your question, press star and the 2.

If you're on a speaker phone, please pick up up your hand set before making your request.

Please limit your participation to one question and one follow-up.

Your first question is from Mr. Jeff Sprague with Salomon Smith Barney.

Good morning, everyone.

Two questions, one for Jim and one for Pat.

First, Jim, on the acquisition front, I was wondering if you could give us a little bit of color on what the pipeline looks like, and to the extent you can, what your priorities are there for '03?

And Pat I was wondering if you could give us more detail on pension, where you ended up in terms of funded status and whether you're likely to make any other voluntary contributions in '03?

W. James McNerney, Jr: With regard to the acquisitions, I think this year was fairly reflective of our strategy going forward.

We are setting some pretty high standards financially and operationally for the deals we look at, the pipeline remains strong, we are seeing most deals.

And as we have guided all of you going forward, somewhere in the neighborhood of 20 to -- up to 30% of our growth could be explained by acquisitions, it could be as little as 15%.

It will be guided by the standards that we have for the deals, but the pipeline is in pretty good shape.

Pat?

On the pension front, Jeff, we have not concluded our final evaluation of all of our O.U.S. funded status, but let me kind of give you a direction of where we are headed.

At the end of '01 we were just under a billion dollars underfunded on a global basis, 500 in the U.S., about 500 outside the U.S.

In the U.S. about 250 of that was in the nonqualified plan which will not be funded.

Anyways, these are not a tax efficient way of doing that.

Right now my thinking in '02 is that that underfunded status will probably grow by about $1.1 billion so we'll be about 2.1 at the end of '02.

About a billion 3 in the U.S. and about 800 O.U.S..

Thanks.

Your next question is from Jack Kelly with Goldman Sachs and Company.

Good morning.

In terms of the 3 to 7% outlook for this year, Jim, in terms of volume, can you give us a sense of how much acquisitions would account for -- wherever you come in that range, is it that 30% number or the 15% number?

Secondly, just focusing on raw materials versus pricing, you have a lot of good things going on with Six Sigma, etc., but if we could isolate in terms of how you see '03 in terms of raw materials going down, Pat mentioned 1% versus what now might get in pricing, how do those two interplay regarding margins, just again focusing on raw materials and pricing?

Because it looks like pricing got a lot tougher as the year progressed in '02.

W. James McNerney, Jr: Jack, with regard to next year, it's close to two points acquisition, close to two of the range.

Two of the basis points of the range.

W. James McNerney, Jr: Close to two points are the flow-through on the acquisition we have already done.

Theoretically if you did 3% in volume for the year, 200 basis points of the 300 basis points would be acquisitions?

W. James McNerney, Jr: Yeah.

That would reflect a pretty tough economic environment, which is possible.

Yeah, okay.

W. James McNerney, Jr: So it's close to 2 points.

Let me handle the other part of your question, Jack, on raw material and pricing.

Let's talk about top line first.

There's no doubt the economic situation remains very difficult relative to getting price.

I think we do about as well as anybody maintaining price.

We did have a tougher back end of the year relative to price retention but still have outstanding products that we can still gain the price on, but I would say the general trend will be flat to down pricing on a total company basis which means we really have to continue to work on the cost reduction side on materials.

I did give you a number of 1% for the year.

We still have significant opportunities in the global sourcing initiative, but there's no doubt '03 will be a tougher year from a raw material perspective.

Good.

Thank you.

W. James McNerney, Jr: Thanks, Jack.

Your next question is from Don McDonald with JP Morgan.

Thank you.

That's Don McDougal.

Two questions.

First on For.

Ex., Pat.

I'm wondering if we had foreign exchange rates stay where they were today for the rest of the year what the impact on the bottom line at 3M would be?

A second question just on the environment, The economic environment.

Any trends that you saw in the fourth quarter?

Exceleration, deceleration?

And just on that same topic.

How much of the volume strength that you saw in the fourth quarter is a function of your own specific product lineups and business performance versus their end markets?

You kind of went two different directions, Don, so I'll try to address them.

On the volume front, Asia continues to be very, very strong.

We have an outstanding organization in Asia that continues to build their business on a day by day, month by month, quarter by quarter basis, and also on a broad basis, across a number of industry segments, so it's not only one segment, one product we are being successful on.

That has been our biggest success.

The U.S. we have had two quarters of year-over-year growth now.

You could argue the comparables may have been a little bit easier, but we are starting to see we are getting some growth back out of the U.S. side as well.

And so we feel pretty good about our positioning in the economy.

On foreign exchange, who knows where rates are going to go.

I would hate to kind of get into a forecasting game as to where it's going to go.

There's no doubt that if the dollar remains weak against the Euro, that it would help us from a translation of earnings perspective, as well as for a few products that we export.

But I think you kind of have to do that in the context of what does that mean for global economic growth and so forth.

We have to see how that plays out.

Generally speaking as an exporter having more U.S. content,a weaker dollar will help our results.

But don't forget that our FX plan as we have 50% hedges in place, so it takes a while to get the full effect of a significant move in the foreign exchange to the bottom line.

Thanks.

Your next question is from Mike Reagan with Credit Suisse First Boston.

Good morning.

Jim, I was wondering if you could address two issues.

First of all, your guidance for the first quarter is for better growth than, sort of for the full year, and given where you came in for '02 versus your original expectations, whether or not you're being deliberately conservative, if there's something that you're seeing in the business that makes you cautious?

In other words the first quarter upside from an easier comparison and comparisons get tougher through the year, or is there something else in what you're seeing?

W. James McNerney, Jr: Mike, the whole year is-- a cautious economic outlook is reflected in the whole year's range we have given you.

I think in the first quarter we still have a little tailwind from the restructuring plan that is helping us a bit,, and I think that largely explains any difference in the first quarter as compared to the whole year.

And you gave some sort of broad generalizations about where you thought 3M's acceleration successes were coming from.

Can you go into any more specific detail, whether or not there's specific products that you feel particularly good about or something showed significant development in the fourth quarter or going forward?

W. James McNerney, Jr: I think we have focused our 3M acceleration, Mike, on products, and products within geographies, which are often adapted or often generated from within the geographies themselves.

I think the places we are getting the earliest traction against that framework are products broad-based in Asia.

For example, China, many of our products are locally adapted and we are getting some very quick traction there because the market is more favorable there and things are moving fast.

I think on a business basis, Optical and Pharma and some other of our Health Care businesses, I would mention dental, just in passing, are places where we are beginning to see earlier traction as well.

This effort is across the company, it is partially constrained by some very tough market conditions, and -- but nonetheless, I think we are beginning to do a lot better than we would have had we not implemented this initiative.

Let's put it that way.

Back in May you gave us sort of updated statistics on the number of R&D projects and the percent of those R&D projects that was focused on potential sales of 25 million or more.

Do you have any updated statistics on that?

W. James McNerney, Jr: I would say, with Kentucky windage behind the numbers, I would say about 10% of the projects we showed you in May have moved out, another 10% have moved in.

We are getting some normal movement.

The number has stayed about the same.

The issue is cycle time.

The issue is market -- the markets into which we are selling these things.

We are working hard to make sure we are not the issue.

Got ya.

Thank you very much.

W. James McNerney, Jr: Thank you.

Your next question is from John Inch with Merrill Lynch.

Thank you.

Good morning.

My first question is just to the guidance of 5.80 to $6, I'm wondering, back to the earnings front, where do you see the cash flow coming in for the year, if you X out pension, you converted almost 100% of your net income gap in free cash, should we be looking for something comparable?

On a broad basis, John, I would say you should be looking at something comparable.

You know, it's hard to predict what we'll do on pension contributions and so forth in '03, but if you look at the cash generation of the business, we have indicated that earnings should be higher, Cap Ex will be up year-over-year, working capital, we want to continue to make the same kind of progress that we made in '02.

So those are kind of the broad factors.

The wild card will be how much we eventually contribute to our pension plan in '03, but basically the cash generation in '03 should be as good as it was in '02.

Pat, while you're on working capital, it looks like your payables jumped a fair amount in the fourth quarter.

Was there something behind that and does that revert in the near term?

No.

We have had an ongoing program with suppliers on supplier terms and this program will work out over time.

We did get a little more of a boost here in the tail end of the year.

I wouldn't necessarily extrapolate that data point, though, as being what the trend will be.

It will probably come more of what we did in the first three quarters.

My followup is just: The core volume forecast of 1 to 5%, your core business forecast for '03 of 1 to 5%.

How would you based on where we sit today, how would you prospectively delineate that amongst your segments?

Could you just talk in terms of, perhaps, trends or what may be different slightly from what we have seen this year?

When you look at areas, start a little bit at what didn't perform this year, and it's telecom.

We were down 32% this year in telecom, who knows where that's going to go?

I doubt it goes down another 32%.

So I think that piece of the business should be more stable on a year-over-year basis.

But on the plus side, we continue to look at good growth in our health care business, our display graphics, which will be kind of our new business side, our automotive business, both OEM, as well as the automotive aftermarket remains very strong.

Being very good growth.

Asia, we don't -- we have continued growth in both the base business in Asia, as well as some of the businesses, display film and so forth.

Geographically we see Asia continuing to grow strong in 2003 from a geographic perspective.

Thank you.

Your next question is from Steven Webber with SG Cowen.

Good morning.

Couple of questions here.

One, what happened to your sales value of production in the quarter?

What are you assuming for the full year '03 and I'm particularly interested to hear because you have emphasized more than once how much of a push you're going to have on working capital, and I assume that means a lot for inventories, so how much of a depressant was that on margin in '02 and how much do you think it will depress the margin in '03?

Steve, I'll turn it over to Ron Nelson who usually answers this question every quarter.

The fourth quarter sales value production was down about 2% compared to the third quarter level.

And one thing that Six Sigma is enabling to us do is get a more consistent focus on our overall supply chain process, so the fourth quarter factor cost was really an excellent one, very similar to the third quarter level and that through-put in fourth quarter was down only slightly from the third quarter level.

As we had this consistent focus relative to inventory turnover and supply chain process, we think we'll manage that through-put in a consistent manner as we get into 2003 and have a fairly constant improvement in our overall cost of goods sold.

Okay.

And did -- I know Jan's still there.

I would assume she's still Treasurer, or somebody.

Can we get a status report on the implant insurance recovery litigation and what are your expectations?

One of my disappointments is we didn't get closure on this issue during my time as Treasurer, Steve.

It's an ongoing saga.

The Minnesota Supreme Court did agree to review our case that we put up on appeal.

We don't have any final verdict on that and don't anticipate it certainly in the first quarter.

I wouldn't venture a guess on when we'll get that, so there's no news.

Thank you.

You're welcome.

Your next question is from Mark Gulley with Banc of America.

Good morning, everybody.

As we look at the $900 million in Cap Ex for 2003 and given the chronic weakness in volumes that we see in Europe, can you kind of talk about where you're going to put your money to work on a geographic basis?

I would say that the -- we haven't exactly finalized where we'll spend it all at this point in time, Mark, because we are still kind of reviewing it.

We have had an effort to continue to grow more of our O.U.S. business.

So I think that versus our traditional spending path, it will be more O.U.S. than U.S. from a historical perspective, but not a significant difference.

In terms of playing to your strong suits, you've already talked a lot about Health Care and TGS, it looks like Industrial is showing some signs of life.

Can you provide more color there as to which of your industrial areas are doing the best and can you reverse years of, kind of subpar performance there?

Mark, our biggest growth was outside the U.S.

Asia again continues to be a very strong business for us, really across the region.

And it's kind of a little bit difficult because when we report our new segmentation to you next year, we will be moving businesses around, what's in industrial, the old segment versus the new one.

But I would say geographically, we would say that Asia will be the strongest -- Europe and the U.S. are still going through from an economic standpoint, a relatively, slow growth from an industrial production standpoint.

I wouldn't say that either one of those will really have significant growth in '03.

Thanks.

Thank you.

Your next question is from David Begleiter with Deutsche Bank.

Thank you.

Jim, Can you update us on the IRM pipeline, how that is progressing?

And also, in Electro & Communications, can you discuss the margin potential, that business margins were up in '02 and with the restructuring in telecom, can you get back to the 17% plus operating margins as you have seen in the past with that business?

W. James McNerney, Jr: With regards to IRMs, it remains one of our strongest technical bases, and as you know, we are working on a number of different chemical elements from that base technology in a number of different indications.

I think our review -- our view remains where it has before, which is as a billion dollars, significantly plus a billion dollar actually, opportunity longer term, and we are fighting through our new product development process, the regulatory maze, developing partnerships to get it commercialized most effectively.

So I feel about the same about IRMs as I have historically, it remains one of our biggest opportunities.

On the telecom --

Let me take the telecom one.

I guess, Dave, when you look at it, we ended the year at about almost 14% margins in D&C, we're 10 in '01.

The team has done a marvelous job this past year.

I don't know if it will be 17, but we are surely striving to get our way back.

When you take a 32% reduction in telecom in a given year, it takes a big, big hit.

So as that business stabilizes on us, and at some point in time, we hopefully get some growth back into it.

I sure hope we can get back to the levels that we previously had, but we are working at it day by day and quarter by quarter.

Was telecom profitable in 2002?

We do not release that kind -- that level of segmentation detail.

Thank you very much.

Thank you.

Your next question is from Chris Kapsh with Black Diamond Research.

Just wanted to follow up on the pricing dynamic a little bit as it relates to international more specifically.

Looks like in the third quarter, pricing internationally was actually up almost a full percent, in the fourth quarter down a full percent.

Just wondering if that just relates to the depreciation in the dollar and therefore, the ability to, sort of reduce prices without hurting margins, or does it reflect some competitive change in competitive landscape?

Could you just explain that a little bit, and also maybe help me understand how you see that playing out in 2003?

Well, it's obviously a difficult competitive dynamic.

Part of our growth in price, O.U.S. that I think showed up in the third quarter, Chris, was related to really the deval in Latin America which because of the devaluation of prices, the currencies, we try to go back after price increases in Latin America.

So that was what drove the third quarter more than anything else.

We are not planning, other than on selected products where we have a significant advantage of actually price increases to run the business.

We obviously push our businesses to take as much price as possible in the marketplace, but I would say the general trend in the marketplace will be continued competitive environment until the economy rebounds.

Just a follow-up on the Corning acquisition.

You have closed for a little more than a month, I was wondering if there were any surprises in that business, now that you've had a chance to dig in there a little bit more, either positively or negatively?

I would say only positively.

It's just been a fantastic acquisition for us.

The two companies, the cultures of the two organizations, we did get a little bit of tail end profit at the end of the year, just -- I have to tell you, give a lot of credit to the Corning organization, they have been very, very good in this whole transition.

We've got a great business and Corning is a very outstanding organization as well.

W. James McNerney, Jr: It's nice when you find two teams that want to be together for the right reason.

That's the feel.

Your next question is from Robert Ottenstein with Morgan Stanley.

The Japanese business continues to do extremely well and you've raised your stake there.

Can you just give us a little bit better feel for the mix of business in Japan, perhaps how much of that business is export business back to the U.S. and whether the optical is a significantly higher percentage of the Japanese business than the rest of the world?

W. James McNerney, Jr: Robert, this is Jim.

The surprising thing about the Japanese performance is the broad base of it.

Which in a tough environment reflects taking a little share in a couple of places, but there is really no business that is doing poorly there.

I think -- it's a testament to being there for a long time and having a mature management team that embraces what we are trying to do as a total company and applying it aggressively to their local market.

The purchase of the NEC shares, the 25%, will not change the way we operate day-to-day, as you know.

It will increase our stake there and we are sorting through some of the legalities of being a 75% owner, but our relationship with the players over there is very strong and that is providing zero turbulence as we continue to attack the markets.

Pat, do you have any --

Robert, let me -- I probably won't answer your question specifically, Robert, but our base business in Japan is performing very well.

Health care is growing at good rates.

Our automotive OEM business is running very well, and actually, Industrial is moving pretty well, as well in Japan.

It's always hard in Japan because, to some degree we supply material to manufacturers who then re-export, so to some degree, whatever we are selling to Japan, a big piece of that probably does get re-exported back out of Japan, which of course is kind of the nature of some of the Japanese economy, but I do not have a specific number, Robert, off the top of my head as to what the percentage of exports are.

It's just remarkable how well that business does compared to the Japanese economy.

And do you have any sense of what percent of the increases are from market share gains, and again, is the optical a very large part of the business?

I would say optical is a big piece of the business, but don't underestimate the penetration gains that the teams made in Japan itself.

All the businesses I just talked about, Health Care, Automotive, and Industrial are really share gains in the Japan economy, but a big piece of it does remain the optical business.

And then a follow-up question, the Scotch Guard business, and especially materials continues to hamper growth.

Can you give us an update there?

I thought we would have anniversaried the phase-out and I thought that we were stepping up the new product introductions there or the new kind of rollout?

I would say we are still at the tail of the decline here, Robert.

We have not seen the rebound at this point in time.

It will be some time next year before we see the growth.

W. James McNerney, Jr: There's a -- as you can appreciate, Robert, there are long sales cycles here, with implementing the new chemistry.

The -- we are in discussions with a broad number of players and a broad number of industries to reinstitute the technology we shared with you a little bit about in May, but you have the dynamic of a long phase-out and it all didn't go out at once.

And a long sales cycle.

We are still in that awkward stage, but we remain confident that over time we can rebuild that business.

Thank you very much.

Your next question is from John Roberts with Buckingham Research.

Morning.

I wonder if you've had a chance to look at your cash tax outlook and were there any changes the Bush plan would be fully available to your shareholders either in the dividends or reinvested earnings?

It's kind of hard to hear.

Sorry, John.

The Bush plan?

Yeah.

Have you looked at your forecast for cash taxes and will any changes be fully available to your shareholders either in the reduced dividend tax or in reinvested earnings in a higher step up?

I think we will wait and see, okay, what happens to the Bush tax plan before we kind of get into too many comments as to what we are going to do.

We are obviously looking at what our options are under a number of scenarios, but I think it's premature to really talk about what we would do under a plan that has not been approved through the legislative body.

Secondly, three businesses you cited as strong are mostly OEM type of businesses, I was kind of surprised.

You cited auto OEM and traffic control materials, and also engineered adhesives down in the industrial segment.

Any additional color, because those go into markets that I didn't perceive as necessarily strong during the quarter?

The automotive OEM piece heavily is with foreign manufacturers.

Some of the Japanese manufacturers where we have made penetration gains.

They are also gaining their penetration relative to the global economy as well.

That's one that is kind of a mix of who we supply.

W. James McNerney, Jr: And some share gains in Detroit actually, but I think we got the mix favorability on the O.U.S..

Engineered adhesives in traffic control.

Traffic control is more of an issue of growing in other parts of the globe.

We obviously -- we have high share positions in the more -- some of the more mature markets we have been in for a while, but we are gaining penetration in other parts of the world.

Engineered adhesives is more of a broad-based growth story.

New products and good execution there.

Thank you.

Your next question is from Jeff Cianci with UBS Warburg.

Hey guys, thanks.

First question, Jim, good numbers on Six Sigma projects, so maybe use your crystal ball out a year from now, how many projects do you think at the end of '03, just a range would be great, you think might be completed and how many would be under way at that point, trying to get a sense of magnitude going forward?

W. James McNerney, Jr: I think, Jeff, you'll see a steady increase.

I think we are at a level now of black belt -- master black belt, greenbelt effort and what we'll continue to grow is the greenbelt efforts.

So I think the growth will be less as a percent as compared with '01 but still significant, I don't want to give you a point number because we are sorting through where we'll apply the effort, but it will be significantly more and support similar kinds of results.

Looking back, do you have a metric per project, either a revenue or a -- you know, a cost savings, has that surprised you, is that trending in any direction?

W. James McNerney, Jr: It's about where we thought it would be.

It ranges anywhere from $150,000 in margin either generated through growth or efficiency, up to a million dollars.

And the mix -- the mean is probably in the lower end of that span, but -- and a similar range on cash projects and the mix would be in the lower end of that span.

Great.

One last follow-up, maybe Pat on incremental margin on the forecast range, if you do the math 3 to 7% volume growth are two very different environments, I'm coming up with a much wider range of 3% volume versus 7% volume on EPS.

You just kind of assuming no difference in incremental margin, just take your 20% to the bottom line or would you acknowledge that perhaps you're just trying to give a mid point sort of consensus on this?

We are just trying to give you kind of a broader perspective of where we may end up for the year.

Again, we ended up at 19.9% margin for the year which we feel very good about.

And with the initiatives and so forth that Jim talked about, we will try to do both.

We'll try to get a little growth as well as margin expansion at the same time.

You see my point, if you take 3 to 7, take the extra 4%, wouldn't that incremental margin be higher than the 20%?

What we are -- be careful.

The linkage, okay, between the earnings range and the volume range are not necessarily, exactly --

They're not mathematical.

They're not tied together.

Thanks, guys, for the help.

That concludes the question and answer portion of our conference.

At this time we will turn the call back over to 3M for closing remarks.

Again, thanks for joining us this morning.

Despite the continued challenges presented by the economies everywhere, we are increasingly confident about the future of 3M and about our ability to deliver both earnings and revenue growth.

Our leadership team and our work force are energized and committed and we are looking forward to a very successful 2003.

Thank you for joining us this morning.

Ladies and gentlemen, that does conclude our conference for today.

You may all disconnect and thank you for your participation.