3M (MMM) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen and thank you for standing by and welcome to the 3M third quarter 2003 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 1 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 2.

As a reminder, this conference is being recorded Monday, October 20, 2003.

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

Good morning and welcome to our third quarter 2003 business review, I'm Matt Ginter, Director of Investor Relations for 3M.

Our speaker, again, today will be Pat Campbell, our Chief Financial Officer and with us also, are Ron Nelson, 3M's Controller and Mark Borseth, our Treasurer.

Our fourth quarter conference call is currently scheduled for Tuesday, January 20, 2004, so, please mark this on your calendars.

As you listen to today's call, you should refer to the accompanying power point slides which you can find on our investor relations website at www.3M.com.

During today's presentation, 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 MD&A section of our most recent form 10-Q lists some of the important risk factors that could cause actual results to differ from our predictions.

With that said, let's begin.

Pat?

Thanks, Matt and good morning everyone.

I want to remind you that the results we are presenting today reflect the 2-for-1 stock split at the end of the third quarter.

Let's begin with some key highlights for the quarter.

Please turn to slide number 2.

The third quarter reflects the continued acceleration of our top and bottom line and cash flow growth story.

Reported earnings were 83 cents per share, a 20.3% increase over last year's third quarter.

Sales totaled a record $4.6 billion, a year on year increase of 11.4%, driven by a combination of higher volumes and favorable currency translations.

We have now posted year on year volume increases for six consecutive quarters.

Volumes, in total, increased 7.8% with core volume growth for the quarter being up 5.8%.

Six of our seven business segments posted positive volume growth in the quarter.

All geographic regions had volume growth in the quarter, with Asia Pacific leading the way at 22.3%.

Operating income exceeded $1 billion for the quarter with margins reaching 22.3%.

On a year-over-year comparative basis, we have now expanded operating margins for seven consecutive quarters.

Networking capital turns were five at quarter end, an improvement of 0.5 turns versus third quarter last year.

Free cash flow was $465 million for the quarter, a year on year increase of $235 million.

We made a special U.S. pension plan contribution of $600 million, down from last year's $789 million contribution.

As previously mentioned, we executed a 2-for-1 stock split in the third quarter to shareholders of record as of September 22nd.

Please turn to slide number 3 for a recap of our sales results on a geographic basis.

As I mentioned, worldwide sales increased 11.4% versus the third quarter last year.

Worldwide volumes improved 7.8% driven primarily by organic growth of 5.8% and acquisitions, completed within the last year, added another two points of sales growth.

Global selling prices were down slightly and currency translation impacts added 3.9% to third quarter sales.

Growth in the quarter was impacted by the termination of a product development agreement in our pharmaceuticals business.

On September 2001, we signed an agreement with Eli Lilly & Company to collaborate on Resiquimod, a potential treatment for genital herpes.

In the third quarter, we reached a final agreement with Lilly to return control of Resiquimod to 3M.

On termination of the agreement, we recorded the majority of the remaining unrecognized revenue.

This acceleration of revenue added 50 basis points to this quarter's growth rate.

In the United States, sales were up 3.7%.

Core volumes increased 2.1% while acquisitions added 1.5 points of growth.

Total U.S. volumes improved in five of our seven businesses, namely Consumer and Office, Healthcare, Safety, Security and Protection Services, Display and Graphics and Transportation.

U.S. selling prices increased 10 basis points in the quarter.

Our international operations posted another strong sales performance in the third quarter with volumes up 11.5%.

Core volumes increased 9.1%, and acquisition added 2.4 percentage points.

Asia Pacific continued to lead the way as volumes increased over 22% in the quarter.

Growth was strongest in Display and Graphics but all businesses posted positive volume growth in the quarter.

Volumes improved 14% in Japan and 29% in the remainder of the Asia Pacific region.

Volumes increased 21.2% in Latin America with volume increases in all business segments versus the same quarter last year.

Acquisitions added 17.4% to growth in Latin America.

In Europe, volumes were up 0.9 percentage points.

Though we see growth in many of our businesses, general economic conditions still remain soft, overall, in western Europe.

For international in total, acquisitions added 2.4 points of growth while selling prices were down 0.7%.

Currency translation affects boosted international sales by 7.2%, driven by positive translation of 11% in Europe and 4% in Asia Pacific.

On slide number 4, we detail the P&L starting with a comparison versus last year's third quarter.

Gross margins were 49.7% in the quarter, a 70-basis point increase for the quarter over last year.

Six Sigma projects continue to help drive overall factory efficiency aimed at improving through-put, yield and productivity.

In the raw material area, our Global Sourcing efforts are helping to keep costs relatively flat year on year.

Also, the termination of the Lilly agreement added 20 basis points to the gross margin for the quarter.

We continue to see a positive benefit from mix as our highest margin businesses continue to grow at an accelerating rate.

SG&A was 21.5 percent of sales, down 50 basis points versus last year's third quarter.

Our continued efforts in Six Sigma, Indirect Cost Management, and lower head count levels helped to reduce SG&A spending.

During the quarter, we invested $270 million in research, development, and related expenses which is about a 2% increase versus the third quarter of last year.

Total operating income increased 20.9% year on year and margins were 22.3%, up 170 basis points versus the third quarter of last year.

The Lilly termination added 30 basis points to operating margins in the third quarter.

Third quarter net interest expense was $16 million compared with $10 million last year.

The tax rate for the quarter was 33.4%, an increase of 90 basis points over last year's comparable quarter.

We continue to expect that we will finish 2003 at a 33% tax rate.

Year on year growth in net income was 21.6% and earnings per share increased 20.3%.

Average diluted shares outstanding increased about 1% year on year due to lower repurchase levels and a higher share dilution factor.

This hurt third quarter earnings per share by about a penny.

Now, let's look at the P&L results on a sequential basis found on slide 5.

Sales increased almost 1% versus last quarter primarily driven by increases in Display and Graphics and Consumer and Office.

We leveraged this sales increase into a 7.3% sequential operating income improvement.

Operating margins improved 130 basis points sequentially driven by a combination of higher volumes, ongoing productivity and process improvements, as previously mentioned, as well as the impact of discontinuing the agreement with Eli Lilly.

On a sequential basis, net income increased 7.1% and earnings per share increased 6.4%.

Please turn to slide number 6, where we will examine our results by business segment.

Six of our seven businesses posted positive volume growth and four of our seven business segments reported greater than 20% operating income growth versus the same quarter last year.

Volumes in Healthcare increased 6.8%.

The accelerated revenue recognition associated with the Lilly termination accounted for 2.3% of the Healthcare revenue growth rate.

Excluding our pharmaceutical business, our growth rate would have been about 7% for the quarter.

Operating income improved by 21.4% year on year with 9 points of this growth attributed to the Lilly transaction.

Industrial markets volumes were up slightly year on year with growth in Asia Pacific being offset by continued softness in the U.S. and Europe.

Operating profits in Industrial declined 11% year on year.

Display and Graphic volumes increased over 30% compared to last year.

Growth was led by optical systems, where we continue to maintain leading global positions in optical films for flat panel displays, touch systems and precision optical lenses.

Acquisitions added about 12 points of growth to the Display and Graphics segment.

Display and Graphics operating income growth was about 78% versus last year, reflecting the leverage in this business.

Volumes improved 5% in Consumer and Office.

In the U.S., volume growth exceeded 8% while international was down versus last year.

Profits improved 5.9% year on year.

Safety, Security and Protection services posted a strong quarter with volumes up 9.3% and operating income up 25.5%.

We saw a positive volume growth in several parts of this business led by continuing strong growth in respiratory protection products.

In the Electro and Communications, volumes declined 2.6 percentage points with operating income declining 70 basis points.

In the third quarter, we took additional actions to realign this business from five divisions down to three to provide better alignment with the market environment and more focus on key customers.

Our Transportation business grew 3.9% with operating income up over 20% versus last year.

Seven percentage points of the operating income improvement came from our decision to exit the Durel joint venture announced on September 30th.

Now, let's turn to the balance sheet and cash flow metrics.

Please turn to slide number 7.

Networking capital turns were 5, an improvement of 0.5 turns versus one year ago and up 0.2 turns sequentially.

Our goal remains six turns by year end 2004.

Inventories declined both year on year and sequentially.

Currency translation added $128 million to inventory year-over-year and $12 million on a sequential basis.

Accounts receivable was up 8% versus last year which was less than our sales increase and flat on a sequential basis.

Currency translation also increased accounts receivables by $188 million year-over-year and $34 million on a sequential basis.

Third quarter capital expenditures were $152 million versus $167 million in last year's third quarter and [Loss of Audio] capital expenditures.

One is Six Sigma, where the inherent discipline required is helping in two ways: One, in improving utilization of existing assets and, two, refining our process for determining new capacity needs.

In addition, through our Global Sourcing Initiative, we are better able to procure plant and equipment with much more favorable terms than we have in the past.

Free cash flow was $465 million, a $235 million increase over last year's third quarter.

The increase was primarily driven by higher net income and a lower pension contribution versus last year's third quarter.

Again, during the quarter, we voluntarily contributed $600 million to our U.S. pension plan versus $789 million last year.

We paid $268 million in dividends to our shareholders during the quarter and we also bought back $114 million of our own stock.

Our total debt-to-cap ratio was 28.5% at quarter end.

During the quarter, we have modified some of our legal reserves.

We refined our estimate on expected respiratory claims resulting in a $20 million increase in the reserve.

We offset $16 million of this by increasing the related receivable.

Similarly, we increased our breast implant reserve by $15 million and the related receivable by $13.5 million.

The reserve increase reflects our estimate of future contributions to the revised settlement program and legal costs associated with our insurance recovery actions in both Minnesota and in London.

Please turn to chart 8 where we will discuss our pension status.

First, to remind everyone, our U.S. pension measurement date is September 30th which means we had to make a funding decision in the third quarter.

Our U.S. pension assets returned almost 19% for the full year 2003 and we continued to assume a 9% return on assets for future years.

The bond market was not particularly friendly this year, pushing the discount rate down to 6%, a reduction of 75 basis points from 2002.

Our strong cash flow in the third quarter allowed us to make a special contribution of $600 million to the plan.

As of September 30th, our PBO funded status for the U.S. was 86% versus 82% last year.

Absent the 75-basis-point change in the discount rate, our ratio would have been 93%.

On a global basis, we anticipate a funded status of about 83% and we expect 13 to 14 cent increase in our pension expense for 2004.

Please turn to our slide 9 where we discuss our fourth quarter outlook.

For the fourth quarter, we expect earnings to be between 73 and 75 cents per share with sales volumes anticipated to again grow between 5 and 7%.

This forecast increases our full year earnings expectations, excluding special items, to a range of $3.05 to $3.07 per share, up from $2.95 to $3.02.

On a reported basis, we anticipate 2003 earnings to be between $2.98 and $3.00 per share, up from $2.88 to $2.95.

Both ranges assume volume growth of 6 to 7% for the full year.

Before we begin the Q&A, let me quickly summarize: This was another strong quarter for 3M.

Sales increased over 11% with broad-based contributions across our portfolio businesses and geographic regions.

Operating margins improved over 22% and earnings per share improved over 20%.

We are well positioned for a solid finish for the year.

This concludes my formal part of today's call.

John, Mark and Matt are here to help me answer any questions you may have.

So, let's go to the Q&A.

At this time, I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone keypad.

If you would like to withdraw your question, press star then the number 2.

If you are on a speaker phone, please pick up your handset before entering your request.

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

One moment, please, for your first response.

Your first question is from Robert Cornell with Lehman Brothers.

Yeah, good morning everybody.

Good morning.

Hey, looks like a better quarter than you guys signaled in that analyst meeting a couple weeks ago.

Pat, I thought I heard like four unusual items; the Lilly issue, an action in Electronics and Communications, a venture issue in Transportation and this breast implant reserve.

I mean, could you sort of give us a review of those items, what was the net effect in the quarter of those four sort of unusual items?

Well, the net effect of all of them, if you take everything that happened in the quarter, Robert, I would say were about flat for the quarter.

Net of the four was roughly a wash, you're saying, Pat?

The way I look at it, versus kind of the guidance we had been giving, when you look tax rate, as well as where our shares were for the quarter, in all these actions together, it's about a push.

Would you want to just take a minute, we heard the Lilly comment.

The actions in Electronics and Communications, the venture, I didn't hear you articulate exactly what sort of dollars were involved there.

If you took and, again, every business has kind of pluses and minuses to them.

Lilly, we said, is about give or take, if you take Lilly and the action that we had in Transportation, which was the sale of our position in the Durel, that's about 2 cents.

Two of those are a positive 2?

A positive 2, yes.

The other actions, in Electro and Communications, we're not going to give a specific number but you can see, it did impact them in the quarter.

If you take everything together on the action side, including, you know, tax rate and so forth, we probably have a minus 2 cents against guidance.

Okay.

Just one other thing, I mean, you guys are now looking at margins in this quarter of 22.3%, I mean, where can these margins go, I mean, as mix and various things continue to contribute, I mean, is there an upper bound we should think about?

Good point, Robert.

I mean, 22.3 is not a bad number at all.

Again, what we're trying to do is balance growth, we've got good growth in the quarter, we want to keep the momentum going on the growth side for the business.

We've had reasonably good mix, as I think we covered at the investor meeting.

A couple of our higher margin businesses are growing faster than in the cases of, say, Electro or Industrial.

There's a lot of factors that will play into, you know, where that margin number goes but we will continue to work on making it better.

Thanks, Pat, very much.

Your next question is from John Inch with Merrill Lynch.

Thank you, good morning.

Good morning, John.

Hey, Pat, in Electro, could you maybe just qualitatively tell us how Telecom did versus Electrical and Electronics and maybe just sort of profile that a little bit, North America versus rest of world?

Well, Telecom was worse than the total, so electrical was up, you know, a little bit.

Geographically, Asia was stronger than the rest of the world.

Europe continues to be very difficult in the Electro space, and we're not seeing any growth in the U.S., so geographically, it would be Asia is up and U.S., Europe down and, if you look across the business, Electrical up a little bit with Telecom, you know, continuing to be down.

Did Telecom show any kind of improvement, Pat, sequentially, either in the U.S. or other parts of the world?

No, we're not really seeing any kind of growth rate there at all.

It's pretty well flat.

Okay, I just have a follow-up question on your Healthcare business.

You know, even if you X-ed out this Lilly issue, you got pretty good leverage in a business that may not be intuitive to people as to why, you know, up 6 to 7% core growth is leading to such high proportionate operating leverage.

Could you talk a little bit about why that may be the case, given, sort of, orthodontics and the other things you sell?

Why are you seeing profit growth so strong there?

Not too dissimilar from most of our other businesses, John.

As we're driving the initiatives across the business, be it Six Sigma, Indirect, it could be sourcing, all businesses are benefiting from that level of productivity enhancement across the business.

So, you know, we'd expect that kind of leverage from the top line in, you know, all of our businesses.

Yeah, hey, just lastly, Pat, if you were to think about your factory footprint globally, we see what the, you know, U.S. industrial utilization rates are picking up a little bit, I mean, how would you characterize 3M's manufacturing footprint in terms of slack, or do you have excess capacity, or we know you're prospectively increasing cap ex next year for Display and Graphics and, I think, a couple of the other businesses.

I mean, how tight are you running things right now?

I would say that in some of the higher growth businesses, like optical film, we are running very, very tight right now.

Some of our respiratory products are in the same boat.

So, those that have seen a much more accelerated growth rate were, you know, probably, we are on the tight side right now and we're spending some money to alleviate some bottle necks and get us positioned for the longer term in both areas.

Most of the rest the businesses, though, I would say that were in reasonably good shape, we continue to address bottle neck issues to alleve those but we do have a few spots that we're trying to work our way through.

Okay.

Thank you.

Your next question is from Robert Ottenstein with Morgan Stanley.

Hey, Pat.

Hey, Robert.

Despite, you know, all your tremendous efforts, I guess, Industrial, Consumer, Electro are still showing margins below last year.

At this point, is it all just, is it simply a volume issue, do you have all or pretty much most of the costs you can get out and you just need the end markets here to pick up, or are there other things we should think about?

How should we look at?

Robert, give me a break, okay?

A 22.3% margin and you want to spend all this time on the three businesses that didn't perform as well?

Hey, it all counts, Pat.

Actually and all three of those give us up side, going forward.

Industrial, I think it's pretty clear that we have more work to do on the cost side of the business.

They have been hit by, you know, probably a bigger volume down-take.

They've been one of the more aggressive units in getting inventory out of the system which has affected their margins as well.

So we probably have some more work to do there.

Electro and Communications, I'd say, is more so.

I think we've got the business to where it needs to be.

Now, it's kind of a volume recovery.

Consumer and Office I think is kind of a split issue.

It's a U.S. versus international issue.

U.S., I think, is going very, very well for us and those of you that had a chance to go through the display a couple weeks ago, I think, hopefully, were very impressed with what's kind of in the pipeline there and in the stores.

The bigger issue there is really on the international side.

That is a tougher market for us right now from a growth and a profitability prospective.

We don't quite have the strongest position outside the U.S. and that is receiving a lot of our focus.

So on the Industrial side, can you give us any kind of sense of what the inventory take-downs did to the margins?

Offhand, I do not know specifically for the Industrial.

But maybe like one to two hundred basis points?

Offhand, I'd be purely guessing the number, Robert, so we'll have to get back to you on that.

Okay, so, basically, besides that, you do think that there's more costs you can take out on the Industrial side?

I think there is and, you know, pieces of that business are very, very volume-sensitive, specifically the piece that is more chemical-related.

In the chemical business that, you know, volume is a huge leverage and the volume on that side of the business has been down pretty significantly

Thanks a lot, Pat.

Thanks.

Your next question is from Don Macdougall with J.P. Morgan.

Good morning, Pat.

Couple of questions.

First on pricing, you've got pricing going positive in the U.S. but deteriorating on the international front.

If you could, maybe, walk through what some of the dynamics behind that are.

Secondly, on the Lilly conclusion, are there any future financial impacts from the termination of that relationship?

Let me, I'll try to deal with the pricing issue, first of all, you know, U.S., we were able to scrape a little bit of price in the quarter which we, you know, keep working hard at.

International is actually a good news story, I mean, it is heavily related to our optical film business, you get volume and, of course, there's a price dynamic there.

That's the largest element of probably the negative price in the quarter, so, you have to kind of look at both volume and pricing together, probably, on the international side but, you know, long term, again remains on pricing that we're not planning the business that there is price in the marketplace.

We continue to eke out every tenth that we can with the outstanding products that we have.

On the Lilly side, there's really nothing of significance from a, you know, a long term issue, you know, with terminating that agreement.

Go ahead.

No, sorry, you weren't finished.

There really isn't anything there that would be material in nature.

There are some things that if we decide to go forward and specifically the indication that we had jointly worked on, there may be some, you know, future payments but they're not, you know, not significant.

And just as a follow-on, when will you make a decision as to whether to pursue that genital herpes application?

That is not an immediate decision, that is some time we'll probably make in the next year or so.

Thank you.

Your next response is from Stephen Weber with SG Cowen.

Good morning.

Couple of questions, Pat.

Could you tell us what currency did for you at the bottom line in Q3 and for the year to date and where you think, based on current parodies, where that would be in the fourth quarter and then, it appears, you took your inventories down in constant currency terms rather significantly sequentially.

What happened to the sales value of your production in the quarter and what is the outlook there for Q4 and how does that affect the margins?

Holy smokes, Steve, I've got to write all this down.

Currency; currency in the quarter was about a penny, favorable.

I think, going into the quarter we were about 4.5 cents on the new basis, favorable.

Fourth quarter, if you kind of look at current rates, about maybe 2 cents in the fourth quarter is what we're looking at.

SVOP, I think if you adjust for currency, we're up about 2.5 to 3% increase in SVOP for the quarter.

Is that right, Ron?

That's correct, Stephen.

Certainly, inventory take-down in the third quarter was not a surprise for us, very consistent with our objectives relative to the inventory turn-over.

As Pat indicated, sales volume production in the third quarter was pretty comparable to the second quarter level and about 2.5 to 3 points higher than the third quarter of last year.

Did that, so that was, I would assume that there was not much, if any, margin effect than from the inventory take down, or was there?

You're correct, no significant impact on margin as a result of that.

Okay, thank you very much.

Your next question is from David Begleiter with Deutsche Banc.

Thank you.

Pat, on Japan, good growth in Japan but ex optical, can you discuss some of the trends in Japan that might be driving growth in that country?

It's really very broad-based across all businesses, we grew in Japan and the way we run the business there is, we look at the base business then we look at it, obviously, with the optical element with it but we try to size the organization more towards, you know, kind of what the base business is.

So, their growth, you know, was really outstanding in the third quarter and I think, you know, hopefully those of you who were at the investor meeting and sat through Joe Harlan's presentation got a good feel for how, you know, they're really embracing the customer and really growing the business on a very broad-based.

So, we feel very good about the underlying growth rate in Japan.

And, Pat, in North America, can you comment on any signs of a broad-based manufacturing recovery yet?

No.

We haven't seen anything that is a broad-based recovery yet, you know, especially on the manufacturing side of the business.

What's your view on a recovery in late '04, early '01, I'm sorry, early '04 picking up?

Dave, I'm not an economist but as I look at the, let's just put it, from our planning standpoint, we remain very cautious and conservative in our view of what '04 is going to look like.

There are a lot of factors out there yet but we're keeping a very close control on cost, making sure we do have the right kind of capacity in place, if there is an up-tick in the market but we haven't seen anything, yet and, from a customer standpoint, we haven't seen any significant longer term projections that would, you know, give us clarity as to a big recovery in '04.

Thanks a lot, Pat.

Your next question is from Michael Regan with Credit Suisse First Boston.

Thank you.

Pat, I tried to do some math here.

Looks like the Lilly gain from Resiquimod was in the low 20 millions and probably another couple million from the termination of the joint venture in Transportation.

So, it would suggest that the charges in Electronics, after about $5 million of higher tax expense and about $5 million of legal reserves, would have been somewhere in the $15 million range.

Is that about the right number?

You are just a little high but in the right ballpark.

Okay, great, thanks and then on Display and Graphics, you know, outstanding margin performance really throughout the year but it notably accelerated in the third quarter, so margins were up 4.5 in the first, year-over-year margin change was 4.4 points in the first, 4 points in the second and then almost 8 points in the third.

Was there anything unusual in the quarter or should we expect that the acceleration we've seen should continue into the fourth quarter?

I think what you're seeing is just the leverage effect of volume in that business.

There's nothing unusual from a kind of an earnings or mix perspective of the business.

Good outstanding growth in the quarter, you know, we, our big focus right now is making sure that we can supply all of our customer needs in that business.

Plus, you just have to be a little cautious as to, you know, where that business may go.

We've seen very good growth rates all year, we've kind of planned it quarter by quarter and kind of look at what their long-term needs are but, you know, we feel very good about our position there but there wasn't anything unusual in the quarter.

It was just volume, I mean, again, it was sort of volume year-over-year, third quarter over second quarter was up 11, it was 11 points higher, so.

Let me, I guess, maybe volume is too easy of an answer, as I think about it.

Volume, of course, is a piece of it but I don't want to take away from the team that's running that business on their focus, again, on cost management, getting productivity, both on the labor side as well as on the material usage side to really drive the cost down because it is going to be a price-down market and we've got to make sure we've got our costs in line.

So, it's really a combination of both volume and, you know, aggressive cost actions in that business.

Why did volume accelerate so much in the quarter on a year-over-year basis?

I think, as we showed you guys a couple of weeks ago, the number of applications that we are designed into continues to grow and a lot of it, of course, is really the end market demand, or the customer demand for their cycle.

Obviously, they're trying to gear up, I would guess, for the Christmas and holiday selling season as well.

Thanks for the clarification.

Your next question is from Dmitry Silversteyn with Longbow Research.

Good morning, gentlemen, please excuse me.

A couple of questions to follow up on pricing.

You did mention the pricing was down or is in a price-down environment in Display and Graphics, can you talk a little bit about the volume guidance that you provided for the fourth quarter in terms of, is there any acquisition components left in that or is that going to be pure volume?

No, there's still be about a quarter million to 2-points in the fourth quarter related to acquisitions.

The big acquisition that we had, of course, was the Corning Precision Lens and that did not close until mid-December, so, most of that will be about 2-points, again, in the fourth quarter.

Okay, and is there a, you know, besides mix or perhaps, as you said, the chemical business not doing as well within the Industrial, what is the reason the EBITDA's down so much, given the, you know, basically flat volumes in the Industrial business?

Oh, in the Industrial business?

Again, it gets back to, you know, volumes are kind of flat, they are up in Asia and kind of down in both U.S. and Europe.

You do have, of course, as I mentioned is a more volume sensitive business, specifically on the chemical side and we have some more work there to do, you know, to get some people, you know, some more structure out of that business, going forward.

And to follow-up on the Display and Graphics, it sounds like what you are saying is, you know, you had a pretty good volume growth and that, obviously, was leveraged to increase in margins but, to the extent that you are running close to capacity right now and the volume growth, going forward, may not be as dramatic, is cost, not cost cutting necessarily, but let's say a more efficient use of materials and productivity improvement that you talked about, is that really the extent to which the margins can improve going forward, in other words, we shouldn't look for these, you know, fairly significant margin improvements sequentially in the fourth quarter and going forward?

Well, we are not planning, okay, on exorbitant growth.

You know, the challenge we have is we want to make sure that we are able to meet our customer needs.

It is very much of a, you know, very close customer contact on new product innovation constantly and, as part of that, of course, for them to be successful in the marketplace, they have to continue to drive down retail prices which means that supplier costs is going to go down as well.

So, a lot of focus on continuing to improve the material usage and design end capability as much as possible.

Okay, I mean the retail costs have gone down over 50% in some cases, I am assuming that your costs or your prices have not come down so much?

That would be a little high for us.

Yeah, okay, thank you.

Thank you.

Your next question is from Jeffrey Cianci with UBS.

Hey, Pat, I want to ask you the "loaded" question which you danced around a little on the leverage.

On the growth end, we have seen great leverage here bottom line, perhaps growing, I don't know, call it 2 to 3-times as fast as the top line and, I presume it is a result of all the initiatives and I presume that those initiatives are equally successful in the Industrial and Electronics and you know, the more cyclical businesses, if I may use that term, so would we expect to see it?

In other words, we are not seeing it yet but could you see leverage, cyclical, upside of as much as 3-times as much on the bottom line as on the upside, on the top line, in other words, for every 1% sales growth there, we will see, you know 3% income growth, would you expect to see that?

That is a heck of a model you got there, Jeff.

Listen, I think your premise is right, the initiatives drive across every business we have, they may impact some a little more, you know, than the others depending on where they started from but it is being driven across all the businesses.

My own belief is that, as Industrial, Telecom come back, we will have very significant leverage capabilities in those businesses.

We have spent the better part of the, you know, two years trying to get the cost structures of those two businesses more in line with, you know, what the sales rates are and, therefore, I think when the markets do come back in both those areas, that we will have very significant leverage capability in both of them.

And the sub-question is, would we expect to see it flow through, in other words, it is easier to keep it on the bottom line in the growth business, in a cyclical business, there may be temptation to pass it to customers.

Do you see any of that competitive price pressure?

There is constant price pressure in every one of those markets, I mean, you look at the Telecom space and that's, you know, constantly a, you know, very pricey, priced-down business.

It is such a tough market right now.

Well, you are holding your income, anyway.

Yeah but a lot of that, of course, has to do with, you know, managing our portfolio, managing our mix and managing our costs.

On the Industrial side, let's face it, a lot of price pressure on the Industrial space, I don't know of too many manufacturers who are willing to give anybody any price increases in the manufacturing space right now.

So, the focus in those markets in those businesses has to constantly be at, how do we get productivity and efficiencies of those businesses up so, when we do get volume, we can get some leverage on the bottom line because, more than likely, we will not be getting price in those markets.

Okay, hey, thanks for your help.

Okay.

Your next question is from Jeff Prague with Smith Barney.

Yes, good morning, it's Jeff Sprague.

Maybe a couple of questions on Healthcare, Pat, trying to strip out the Lilly joint venture impact, it looks like Healthcare margins are maybe down slightly year over year but maybe, more notably, on equivalent sales to the second quarter, down, you know, probably over 100 basis points or so.

Is there anything in particular going on there relative to the mix, I think you mentioned Pharma in your comments as maybe lagging?

Well, I mean, I guess, nothing specific.

Healthcare, our margins in Healthcare, I still feel very, very good about.

When you think about it, as to, you almost have to take Pharma out of it a little bit because, I think, you are well aware of what the initiatives are in Pharma relative to the IRM platform.

We are spending a significant amount of R&D in the Pharma space right now and, of course, therefore in the whole Healthcare space to get those products ready for the marketplace.

The rest of the Healthcare space has good growth rate and, you know, the profitability of those businesses are continuing to, you know, to improve.

And if I could just clarify, when you were talking about the one-off, I thought you said two-cents from Lilly and two-cents for Transport but then, in response to Mike's question, it sounds like it was two-cents in both of those collectively?

Yeah, let me clarify, it is two-cents collectively.

The Durel one doesn't round, okay, so if you put them together, it is two-cents.

I will tell you that Lilly is a little under two-cents.

Right.

Okay, but if you put them together, you probably have a full two-cents.

And, just looking at the Q4 guidance, I mean you are looking at similar volumes in Q4 that you had in Q3, the midpoint of your range is earnings up 14%, they were up 20% in the third quarter, the share count is creeping on you, is there anything else that gives you a little bit of pause about converting in the same way in the fourth quarter versus the third quarter?

Well, the volume guidance would probably say the fourth quarter is going to be down about 3% or so coming off of the third quarter.

Our fourth quarter is traditionally lower than the third quarter because of, we have some businesses that are weather sensitive, ie.

TCM Industrial Minerals or are very much aligned with manufacturing which would, it is kind of in the Industrial space, Transportation and probably some pieces in Safety/Security as well that, because of the holiday season, around Thanksgiving and Christmas end up with normally lower production through-put in the manufacturing sector in the fourth quarter than you would in the third and, therefore, we would normally follow, you know, that trend.

And just one last quick one, if you are shooting for 33% tax rate for the year, why didn't you accrue at that in the third quarter?

We had to, we were a little bit below that going into, you know, at the end of the second quarter, so, effectively, we caught up at 33.4% at the end of the third quarter and then, for the fourth quarter, we should be expecting a 33% tax rate for the fourth quarter.

Great, thanks a lot.

Your next question is from John Roberts with Buckingham Research.

Thanks.

Pat, on the Durel transaction, not that it is big here but when you look at Rogers Corp. and watch them, Durel wasn't losing money, I don't think, where did the benefit come from?

Well, we obviously got some money, the purchase price was $26 million, is what we got out of the transaction.

Okay.

And, obviously, that is not all gain, we had a book value of that asset.

Alright, thank you.

Your next response is from Jack Kelly with Goldman Sachs.

Good morning, Pat.

Good morning, Jack.

Looking at unit volume in the U.S. and maybe Lilly had some impact on this but unit volume was up 2.1% in the U.S., second quarter it was up about 0.4, can you just kind of characterize in general terms sequentially and maybe it is a year over year basis but sequentially, what kind of kicked up in the U.S. in the various groups and, likewise, in Europe, you know, results are kind of hunched from the second quarter, maybe up a couple of basis points more, if we looked at the mix in Europe, is it just a matter of the Industrial economy not doing well over there, kind of restraining results or, you know, is it impacting things across the board?

Well, you look at sequential activity, Q2 to Q3 in the U.S., Jack, to your point?

Yes.

The biggest change, really is Consumer and Office.

Consumer and Office is bigger in the third and fourth quarter because of back-to-school and holiday sales, okay?

Okay.

So, there trend is bigger third and fourth quarter versus second, that is the biggest change when you look at the sequential move.

You look year over year, you know, where we are up, you know, 2%, again a piece of that is the Lilly in the U.S., that is probably a point of the U.S. growth rate so we are up one and, you know, it is kind of a mixed bag of, you know, who was up and who was down.

I mentioned before who was up, so you can pretty well determine who was, you know, who was short there.

Right, so you are saying, in the U.S., an acceleration in Consumer and Office in the third quarter was essentially responsible for a good chunk of the overall acceleration in the U.S.?

From Q2 to Q3, yes.

Right, got it, okay.

Then, in Europe, the Europe 0.6% in the second quarter, year over year 0.9, you are up a couple bits but, you know, what is kind of going on there that, you know, you are only up 0.9, is it Industrial just doing a lot worse, holding down gains more so than in the U.S.?

Well, it is both Industrial and well as Telecom, they are both still very tough in Europe.

Hey, we feel good that we've actually been able to start to see, you know, favorable overall volume growth in the market there but, I would say, it is the Industrial Communications, Industrial and, I also mentioned previously, Consumer.

We are not seeing the Consumer growth there and, of course, a lot of that is economic related.

Western Europe is still going through a very difficult economic period here and, of course, you see it on the, kind of the Office/Supply side of the business.

And just lastly, in terms of your appeal, then, in Mississippi of that asbestos judgement, is that still hanging, have they given you any indication when that might be resolved?

No, it is still open, nothing new to report there.

Okay, thanks.

And, ladies and gentlemen, as a reminder, if you do have any questions, press star then the number one on your telephone keypad.

Your next response is from Mark Gulley with Banc of America Securities.

Good morning, this is Marshall Reid filling in for Mark.

Just wanted to drill down, real quick, just one layer in the Displays business.

We noticed that Phillips LCDs Displays reported an 83% year over year gain in sales, is 3M enjoying similar results in OSD?

Well, we don't release individual business results but, if you look at, you know, how we reported Display and Graphics, their volume level, I think you can get a pretty good indication that, you know, it was up pretty significantly in the quarter, you know, just Display and Graphics was up 33 and, I think if I recall right, about 12 of that is acquisitions, so, it was up about 20 and, obviously the optical film was, you know, much larger than the average.

Okay, thank you.

You have a follow-up response from Stephen Weber with S.G. Cowen.

Yes, you said something just a couple of minutes ago, Pat, that you expected volume to be 3 percentage points lower in the fourth quarter than the third, was that U.S. or was that a worldwide counting because that seems larger than the historic/seasonal trend when I go through the numbers, that doesn't sort of fit with the 5 to 7 or the 3 to 5 in the, uhm, on an organic basis?

Now, we think the 5 to 7, okay, would be consistent and, again there is two points of, you know, acquisitions embedded in that number, that would leave us about 3 points down, 3 percentage points down in the fourth quarter versus the third quarter.

Now, again, third quarter ended up a little higher than what our guidance was, came in a little bit higher, a little bit stronger than what we, you know, had given guidance to, I think 5 to 7 is still a reasonable planning standpoint right now and I think the math will work, Steve.

Okay but is there anything, are you getting some indication or something unusual that we ought to be careful about?

Nothing to be alarmed, there is nothing that says that the normal seasonal trends, you know, are changing, you know, at all.

Business is not falling off or anything, it is just, you know, our view of what our normal Q3 performances, Q4 by business, that is, you know, how the things stacked up.

Okay, thank you very much.

Yeah, thanks, Steve.

Your next question is from Philip Marriott with Arnholm.

Yes, good morning, just a pension question, could you remind me of expected pension expenses for 2003 and then, if you could, comment on the likely possibility of a contribution next year?

I know that is sort of looking out a little bit but, given the contribution this year and last year, I assume that it is possible that there will be one next year as well?

Well, there is a lot of variables that will play into the contribution next year, we will have to see where interest rates are next year, we will have to see, you know, asset return ends up being and so forth but we feel very good about our current cash flow position, so, we have got a lot of flexibility, you know, in deciding how much we need to put in.

The numbers will come out in '03 that we are probably, in the U.S., about $1.2 billion under funded, I mentioned previously that probably 750 of that is related to the change in interest rates.

Mm-hm.

If interest rates pop back up, we will then maybe have a gap of say, $500 million or so at the end of next year, so, very manageable.

On the expense side, in '03 we are running at about $150 million of expense level.

Okay, thank you very much.

Okay.

There are no further questions at this time.

I would now like to turn the call back over to 3M for some closing comments or further remarks.

Okay, thanks.

Again, thanks for joining us this morning.

This was a solid quarter for 3M representing another step in our quest to deliver sustainable long-term value to our shareholders via improved top-line growth, productivity and cash flow.

Thanks, again, for your continued interest in the company.

Thank you, ladies and gentlemen, again, that does conclude our conference for today, you may all disconnect and thank you for participating.