3M (MMM) 2003 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M fourth quarter 2004 earnings conference call.

During the presentation all participants will be in a listen-only mode.

Afterwards you will be invited to participate in the question-and-answer session.

At that time if you have a question simply press star then the number one on your telephone key pad 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 20, 2004.

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

Thank you.

Good morning, everyone, and welcome to our fourth quarter and calendar year 2003 business review.

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

I have just a few brief announcements before we begin today's call.

As in prior quarters, our discussion today will follow a series of Power Point slides which you can access on our Investor Relations Web site.

Our first quarter 2004 earnings conference call will take place on Monday, April 19.

Please mark your calendars accordingly.

During today's conference call we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results.

These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties.

The 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 expectations.

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

Pat?

Thanks, Matt, and good morning, everyone.

Happy New Years.

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

Jim McNerney will wrap up today's call with his perspectives on 2003 and our outlook for 2004.

And of course, we will leave time for your questions.

Let us begin with few highlights from our fourth quarter results.

Please go to slide number two. 3M reported another solid financial performance in the fourth quarter.

Sales increased 14% to a record $4.7 billion, with all of our businesses reporting worldwide volume growth during the quarter.

This marks the seventh consecutive quarter that we have posted positive volume growth.

Geographically, Asia Pacific continued to lead the way with fourth quarter volume growth of almost 29%.

Fourth quarter earnings were a record 77 cents per share, an increase of over 18% versus last year.

Operating income increased 18.4%, $942 million, highest fourth quarter in 3M's history.

This growth was broad-based as five of our seven business segments posted fourth quarter profit increases.

We also made significant improvements in working capital, driving networking capital turns to 5.5 versus 5 at the end of the third quarter.

In particular, we reduced inventories by $125 million sequentially for almost 7% adjusted for currency.

We continue to target a minimum of 6 turns by year end 2004.

Free cash flow topped $1 billion in the quarter driven by a combination of solid earnings and improved asset efficiency.

Our five corporate initiatives are helping to drive these improvements in sales, productivity and cash flow in every 3M business and subsidiary around the world.

On slide number three we recap our fourth quarter sales performance on a geographic basis.

As I previously mentioned, worldwide sales in dollar terms increased 14% versus last year's fourth quarter.

Core volumes increased 5.9%, our highest growth rate since the third quarter of 2000.

Acquisitions added 170 basis points in growth.

Volume prices declined 20 basis points while year-on-year currency translation boosted sales by 6.6 percentage points.

In the United States, sales improved 1.6% versus last year's fourth quarter.

Core volumes were flat and acquisitions added 110 basis points to growth.

We posted positive volume growth in our display and graphics, transportation, safety, security and protection, healthcare and consumer office businesses, while volumes declined in industrial and electro and communications.

Our international operations continued to post strong growth with sales up 23.9% in U.S. dollar terms.

Core volumes increased 10.7% and acquisitions added 210 basis points of growth.

Total volumes increased 28.7% in Asia Pacific with Japan up 19% and the rest of the region up 37%.

All of our businesses in Asia Pacific posted positive volume growth led by the display and graphics segment.

Latin America volumes increased by 23.3% with 17 points coming via acquisition.

Volumes declined by 1.4% in Europe reflecting continued tough economic conditions in Western Europe.

International selling prices declined 80 basis points in the quarter.

Currency effects boosted international sales by 11.9% driven by positive translation of 15% in Europe, 9% in Asia Pacific and 3% in Latin America.

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

Operating income of $942 million was up 18.4% year on year and margins improved 80 basis points to 20%.

Gross margins were 48.6%, down 30 basis points from last year's fourth quarter.

Currency impacts along with costs associated with access to accelerated productivity gains more than account for the decline in gross margins year over year.

SG&A expense was 22.5% of sales, a 60 basis point improvement year over year.

Lower head count levels, along with our continued efforts to leverage our indirect cost base helped drive the improvement.

Research and development and related expenditures increased about 5% year on year as we continue to invest in future growth opportunities.

As a percent of sales, R&D was 6.1% versus 6.6% in last year's fourth quarter.

Fourth quarter net interest expense was $4 million, versus $10 million last year, due to higher cash balances, lower debt levels and lower interest rates versus last year.

Quarterly net income increased 21.3% year on year and earnings per share improved 18.5%.

Slide number five details our quarterly results on a sequential basis.

For perspective, recall that Q3 was a record operating income for any quarter.

Sales were up 2.2% sequentially with volumes being essentially flat versus the third quarter.

Net income and earnings per share were off about 6 to 7% which is in line with our historical Q3 to Q4 patterns.

Slide number six details our performance by business segment.

In healthcare sales were over $1 billion, an all time high for the business with volumes increasing 2.4%.

The majority of our portfolio, dental, orthodontic products, Aldara Pharmaceuticals, medical products and closure systems for disposable diapers posted good growth but there were a few very specific items that detracted from growth this quarter.

Fourth quarter 2002 revenue included pharmaceutical development agreements that did not repeat in 2003.

Excluding these items, underlying growth in healthcare was north of 5%.

Going forward, we expect healthcare growth to accelerate during 2004 as we anticipate approval of two new IRM pharmaceuticals for basal cell carcinoma and for itinic irritosis [ph].

Operating income in healthcare was $254 million and margins were almost 25%.

Industrial volumes grew 2.2% in the fourth quarter.

Growth was strongest in Asia Pacific and Latin America while the U.S. and Europe remained soft reflecting the continued migration of basic manufacturing capacity to lower-cost countries.

Fourth quarter operating income declined 5.7% in industrial to $109 million.

During the quarter, we took additional actions in industrial to lower our cost structure and improve our competitiveness which hurt profit growth in industrial by about 12 percentage points.

We continue to carefully assess our cost structure in this business while insuring our costs are in line with end-user demand levels.

Growth in display and graphics continued to surge in the fourth quarter with volumes increasing more than 38%.

Core volumes grew 26.9% and acquisitions added another 11.5%.

Demand for our proprietary optical films and components was once again quite strong during the quarter as end users continue to purchase PDAs, LCD and projection TVs and other flat-panel devices at record levels.

In addition, we also saw some volume improvement in our commercial graphics business.

Operating income rose 89% in display and graphics to $243 million.

Excluding the visual systems business, consumer and office posted good results despite continuing pressures in Western Europe.

Growth was particularly strong in home care products for the consumer retail channel and in our construction and home improvement business.

Sales to the office supply market remained weak, particularly in our visual systems business which hurt top line growth by two points and operating income growth by almost seven percentage points.

We continue to evaluate ways to improve the visual system business including additional restructuring, sourcing arrangements and new products and/or technologies.

Volumes improved 8.2% in safety, security and protection services driven by double-digit gains in respiratory protection, securities systems and in our roofing granules business.

Profits improved over 25% year on year to $90 million.

Electro and communications volumes turned slightly positive in the fourth quarter, up 1.6%.

Over the past year this business has aggressively adopted the corporate initiatives to help drive productivity in a tough business environment as evidenced by this quarter's 27.9% increase in operating income.

And finally, volume growth was 2.6% in our transportation business, operating income up 9.8% versus last year.

On slide seven I will quickly highlight our calendar year results.

Excluding special items, earnings per share increased 17.5% for a record of $3.09 per share from $2.63 per share in 2002.

Sales topped $18 billion for the first time in the company's history.

Our organic growth rate improved for the second consecutive year to 4.7%, and is approaching our stated 5 to 8% target.

We supplemented this organic growth with acquisitions which added about two points of growth in 2003 and currency translation benefits added another five percentage points to the top line.

Gross margins improved 40 basis points to 49.1%.

Six Sigma and global sourcing continued to drive improvements in our gross margins.

Operating income grew by over 17% as we improved operating margins by a full point.

The tax rate for the year was 33% and we expect that to carry over into 2004.

Economic profit which is our version of EVA, improved by 23% for the year and ROIC was 21.8%, up 1.3 points from 2002.

Free cash flow was over $3 billion for the year, or an increase of almost 40% year over year.

Let us go to slide eight where I will summarize the full-year results by business segment. 2003 was a very good year as we saw year-over-year volume increases in six of our seven businesses.

Display and graphics led the way in 2003 with positive volume growth of almost 30%.

As mentioned previously, this growth was driven by strong demand for our proprietary brightness-enhancement films using PDAs, LCD TVs and other flat-panel devices.

Our December, 2002 acquisition of Corning's Precision Lens business added 11 points of growth.

Line growth and safety, security and protection services business of over 8% was driven by strong demands for our respiratory protection and securities systems solutions.

In healthcare, both up almost 5% was broad-based across the entire portfolio.

The transportation business posted a solid year with volumes increasing 3.9% over 2002.

Volumes improved 3.2% in consumer and office, again driven primarily by home care and construction and home improvement.

The visual systems business hurt sales growth by over two points and operating income growth by over six points for the year.

Industrial volumes improved 1.6% year over year, a strong growth coming from developing regions of the world and a continued softness in the U.S. and Europe.

Sales in electro and communications declined 3.3% due largely to the continued global weakness in the telecom industry.

Our telecom-related businesses were down over 10% in volume year over year on top of the 30% decline we had in 2002.

Six of our seven businesses posted operating income improvements over 2002.

We had four businesses posting double-digit growth.

Electro and communications and industrial earnings were impacted by ongoing employment reductions taken over the past several quarters.

Slide nine depicts our 2003 full-year results on a geographic basis.

In the U.S. volumes improved by 2.1% for the year.

Growth was led by healthcare, display and graphics and consumer office businesses where overall growth was held back by softness in both industrial and electro and communications.

Operating income was up 2.8% in the U.S. to $1.2 billion.

European volumes declined by 30 basis points in 2003.

While volumes improved in four of our businesses namely; healthcare, safety, security and protection services, display and graphics and transportation, overall growth was held back by softness in the other three businesses.

Most notably the weakness in the telecom industry and slow growth in the office supply channel continued to impact sales results.

Despite relatively flat volumes, our European team did a great job managing productivity in 2003 as profits improved over 16% to $800 million.

Asia Pacific volumes increased 22% in 2003 with all seven businesses posting positive volume growth.

Growth was strongest in China and Korea, we also posted a 12% volume gain in Japan, despite a fairly sluggish economic picture.

Operating income was $1.4 billion, a year-on-year increase of 36%.

Volumes increased 13% in Latin America, Africa and Canada, with acquisitions adding 9.4 points to growth.

Six of seven businesses posted volume growth for the year.

Operating income was $436 million, increasing almost 12% versus last year.

All regions improved operating income level versus 2002.

On slide number ten, you will see that the balance sheet and cash flow also improved in 2003.

We made significant progress on networking capital as turns reached 5.5 at year end.

This is .8 turns higher than one year ago, .5 turns higher sequentially.

Our goal remains a minimum of 6 turns by year end of 2004.

Inventories declined by $115 million versus last year or about 6% and were down $66 million sequentially.

Currency translation effects added $143 million to inventory year on year and $59 million sequentially.

Accounts receivables were up $187 million or 7 % versus the fourth quarter of 2002, down $77 million sequentially.

Currency translation effects added $222 million to accounts receivable year on year and $103 million sequentially.

Capital expenditures were $261 million in the fourth quarter, bringing the full-year total to $677 million.

We expect to invest close to $900 million in capital in 2004.

Fourth quarter free cash flow was just over $1 billion, which included an additional pension fund contribution of $74 million for some of our OUS subsidiaries.

This strong cash flow enabled to us pay $259 million in dividends for our shareholders during the quarter.

We also bought back $291 million of our own stock resulting in a net repurchase of $161 million.

Diluted shares outstanding were $801 million, up 1.2% from last year end and up .4 percent versus last quarter primarily driven by the improvement in our share price.

Our total debt to capital ratio was 27.2% at year end.

We also continued to carefully monitor our respirator mask and asbestos litigation and make appropriate adjustments to our reserves.

In fourth quarter we increased the reserve by $111 million along with a corresponding increase in insurance receivables of $95 million.

The net result of $16 million flowed through the income statement as part of SG&A.

Please turn to Chart 11 for an update on our global pension situation.

We finished the plan year at an 84% funded level with a net underfunded position of $1.8 billion versus $2.1 billion last year.

Asset returns in the U.S. were 18.7 for the plan year ending September 30, well in excess over 9% of return on asset assumptions.

At the end of our plan year we adjusted our discount rate assumption down 75 basis points to 6%.

Our U.S. pension [Inaudible] date is September 30 but with a significant change in equity values in the fourth quarter, I thought it was prudent to give you an update as many companies report balances as of 12/31.

Our calendar year returns were over 23% so if we measured our results as of December 31 our asset value would have been $500 million higher and, therefore, our U.S. funded status would have improved to 91% with our worldwide plan at 89%. 2004 pension expense will be 26 cents per share an increase of 14 cents over 2003.

Now I'd like to turn the presentation over to Jim McNerney who will offer his perspective on 2003 and our outlook for 2004.

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

I would like to recap '03, comment on our outlook for '04 and then we'll be happy to address your questions.

First, '03.

In overcoming continued sluggishness in the world's major economies, I am very pleased with the way 3M employees distinguished themselves and the company by delivering consistent economic profit growth by driving organic sales growth, by significantly improving asset utilization and by setting the stage for even faster growth in the future.

All in all 2003 was an exceptionally strong year for 3M.

As Pat mentioned, we generated record net income of $2.5 billion excluding special items and record sales of $18.2 billion.

We generated $3.1 billion in free cash flow after making a sizeable voluntary U.S. pension contribution.

In addition, we paid more than $1 billion in dividends to our shareholders in 2003.

These results, combined with our confidence in 3M's future, are at the core of the Board of Directors approval of a two-for-one stock split which we announced in August.

While we are pleased with the markets confidence in 3M, every 3Mer recognizes and is committed to earning that confidence by delivering results quarter on quarter and year on year.

Beyond the result I just mentioned, 2003 was noteworthy for the following accomplishments.

First, our continued focus on and execution of our five initiatives.

Six Sigma, 3M acceleration, E productivity, global sourcing effectiveness and indirect cost control.

The initiatives increased operating income by more than $400 million in '03 on top of about a $500 million-plus benefit in '02.

These initiatives are now imbedded in the everyday operations of 3M and we expect them to contribute an additional $400 million of operating income in 2004.

Second, the successful reorganization of the company into seven major businesses effective January 1, '03.

The swift and efficient transition to the new structure allowed us to quickly begin to realize the benefits of the reorganization including access to larger higher-growth markets.

And third, the realignment of research and development, consistent with the corporate reorganization and designed to develop technologies needed for the future to more closely align technical resources with business priorities and to shorten the distance between R&D and our customers.

We established a single global corporate resource lab which brings together 500 researchers focused on technology building, while also freeing up 400 other 3M technical people to directly support the growth of 3M business units.

I can't say enough about the job our people did last year, both in producing strong results and in fueling an even stronger future for 3M.

In 2003 the entire 3M organization continued its drive toward increased productivity and efficiency.

At the same time we made real and tangible progress in accelerating organic growth in the face of a continued difficult economic environment.

Especially noteworthy was the success of our display and graphics business and our safety security and protection services business which increased volumes by 30% and 8% respectively.

International remains 3Ms largest growth opportunity and the company's global organization a singular strength.

We continued our rapid expansion in emerging economies like China, Korea and Eastern Europe and pushed penetration in more mature markets.

For example our largest subsidiary, Sumitomo 3M again posted outstanding top-line growth while overcoming the stagnant Japanese economy.

At year end, international represented close to 60% of 3M sales and we expect that percentage to increase in the years ahead.

Two of our initiatives, Six Sigma and 3M acceleration, are at the forefront of faster organic growth.

Six Sigma, as you know is 3Ms over-arching initiative and it continues to drive growth, improve productivity, increase cash flow in 3Ms businesses around the world.

Our initial focus with Six Sigma was on our factories and internal processes but in '03 Six Sigma evolved into an exciting new dimension of interaction with customers everywhere.

Six Sigma with, at and for our customers.

Six Sigma with customers is all about working to solve our customers most important issues as they define them and a way to invest in their success and our own success simultaneously.

We have more than 100 major customer projects underway today and we expect that number to increase significantly over the next few years.

Six Sigma with our customers is starting to make a real difference and I'm convinced that it will have a very positive impact on our growth in the years ahead.

Our 3M acceleration initiative is a pure growth initiative with the objective of improving what 3M does best, innovation and new product development.

Along with the realignment of our R&D organization, 3M acceleration moved us closer to our goal of doubling the number of qualified new product ideas and tripling the value of items that went into the marketplace.

Progress in '03 included the adoption of a single, visible company-wide process for new product introductions.

New tools, like Six Sigma, applied as a critical disciplinary overlay to the processes of innovation, a focus on increasing speed and a budgeting process that directly links resource commitments to new product commitments.

Through these improvements we are building strength on strength in our technology and new product development.

Of all the pathways to growth, and 3M has many, I remain convinced that investing in people is the most important.

It's this simple.

If our people grow, our company grows.

Our accelerated leadership development program is now in its third year of offering intense high-energy learning experiences.

In addition to the emerging leaders who normally populate the program, our entire executive management team participated in an ALDP program in 2003.

Leadership development remains at the top of the company's agenda and at the top of my personal agenda.

To me it's the single most important contribution a CEO can make.

By any measure, 2003 was an outstanding year for 3M.

The people at 3M maintained their focus and their discipline and began to make real progress in top-line growth.

I know that 3Mers are proud of their performance last year and justifiably so.

But we are not done yet.

I have every confidence that our team will continue to make 3M an even better company for all of our constituents as we move to improve performance, growth and shareholder value.

Please turn to slide 12 where I'll discuss our outlook for 2004.

As we told you at our fall investor meeting, we remain committed to delivering solid sustainable earnings growth this year.

For 2004 in total we expect earnings to be within a range of $3.46 to $3.52 per share for a 12 to 14% year-on-year increase excluding special items in '03.

This assumes sales volume growth of 5% at the low end and 8% at the high-end.

For the first quarter we expect earnings to be between 80 and 82 cents per share, again about 12 to 14% growth, excluding special items in '03.

This also assumes that volumes improve somewhere in the range of 5 to 8%.

Although these are challenging goals in light of continued global, political and economic uncertainty, I am confident that we can deliver.

This concludes the formal part of today's call.

Joining Pat, Matt and I this morning are Ron Nelson, our Controller, and Mark Borseth, our Treasurer.

We'd be very happy to address your questions.

Let's begin the Q&A.

Ladies and gentlemen, 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 one follow up.

One moment, please, for your first response.

Your first question is from Jeff Cianci with UBS.

Hi, guys, strong performance.

I'm looking at the outlook and the guidance.

If you take accelerated volume growth and you take your guidance, does it imply maybe a little bit of conservatism on margins?

Pat, do you think 21% margin, is that inherent in your outlook?

Jeff, remember a couple of things that we got going on here.

We have some pension pressure coming at us here in '04.

We will continue to look at gradually improving margins with that volume growth but that's probably the order of magnitude.

Okay.

And specifically on one of the segments, display volume and margin, obviously little acquisitions help, but from what you guys can see for '04, at least for the first half, I know we had tougher economies, but do you think growth rates here can stay north of 20%?

I am not going to go that high, Jeff.

I think at our investor conference we said that they should be north of 8%.

We don't see any slow down necessarily.

But it's going to be hard to keep the growth rate of that business as much as it was but we still see very, very good growth in that business into '04.

Strong first half and then wait on the second, I gotcha.

All right.

Thanks.

Our next question is from David Begleiter with Deutsche Bank.

Thank you.

Jim, on the U.S. volume growth does the lack of any improvement in the quarter surprise you?

And can you give us some more details on the industrial, on E&C weakness in the quarter.

W. James McNerney, Jr.: Well, industrial and E&C are our two most economically sensitive businesses.

E&C telecom, there's not a big recovery there as you know, and industrial is facing a lot of migration to other places and we do a pretty good job of following that migration, by the way, in helping companies do it.

And we are seeing a modest uptick in those economically sensitive businesses right now.

So I would say I wasn't surprised and I'm cautiously optimistic about an economic recovery beginning to bring those back a bit.

Just on your capital spending increasing next year, that's due to following the migration of U.S. based customers overseas?

W. James McNerney, Jr.: That's all about new products.

That is, we are driving Six Sigma pretty hard with our existing capacity.

As a matter of fact, we don't see major needs with our existing stuff any time soon.

What you are seeing is major investments, often global as you point out, but largely against new products that are beginning to flow out.

Thank you very much.

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

Good morning, guys.

Can you elaborate a little bit on the growth you are seeing in displays?

Perhaps talk about films or LCD screens versus lenses for rear projection TVs?

Mark, I think it's fair to say that the film business is growing more rapidly, okay, than the lens business.

We still think they are both great, great businesses.

We think there are growth rates in both of them, but the film business is expanding more rapidly than the lens business is.

Geographically, I couldn't help but notice that operating income for the year in Asia actually exceeded that in the U.S. with double the margins.

I know there are some allocations things going on there but does it make you nervous, Jim, that so much of your operating income is now in Asia?

W. James McNerney, Jr.: I think it's, I understand the basis of your question.

I think the only thing that might temper it is that a lot of that Asia growth is for a mature market consumption.

So you look at what was just mentioned, the LCD growth and the film growth and some of our circuitry out of Austin that is imbedded in electronics products.

Really the end-use markets for both of those devices are back here or in Western Europe.

So you have to manage as you imply with your question but you feel a little bit better about it that it's really a globally driven growth.

The other thing I'd say is that it's not all that.

I mean, most of our base business in those places in Asia is growing at high single-digit, double-digit.

And so we've got a strong business both ways, both locally in these countries and the other part of it fueled by global demand.

So there's some nice diversity there.

Thank you.

Our next question is from Jack Kelly with Goldman Sachs.

Good morning.

Pat, just in terms of former, you had indicated some agreements you had made in fourth quarter of '02.

The group or that segment would have been up 5% and should accelerate throughout '04.

Can we get a double-digit comparison '04 over '03?

And then, secondly with regard to currency, assuming rates stayed about where they are, particularly the Euro, what kind of contribution from a translation effect would we have in '04 over '03 from currency and is that built into your numbers?

Jack, I guess first the pharma-question.

If I look at the way '04 is going to play out, the back half of the year will have higher growth rates than the first half of the year, assuming a successful approval and launch of both IRM products by the end of the year.

We should be getting close to double-digit rates.

I am not going to promise that, but that's the way it should be looking.

That would be in the second half, Pat, or average that.

It would be in the second half.

Okay.

You won't have double-digit rates for the whole year in healthcare.

Okay.

The currency question, that's a tough one, Jack.

I think we demonstrated to you that what we try to do with currency gains is to reinvest currency gains back into the business to improve the business for the long-term.

Therefore, 2004 is a long way off, who knows if currency rates will stay the way they are.

What Jim and I continually look at is, if currency rates remain favorable, how do we reinvest that money back into the business, either growth or productivity, for the good of the long-term.

So we will continue to play it out.

We try to look at the 12 to 14% as our commitment to you and we want to be able to live with that on a long-term basis and we will try to manage around the currency fluctuations.

Jim, your comment about industrial that you were kind of cautiously optimistic, et cetera, this is just in the U.S., does that suggest that December picked up because that's been the comment we made from a couple of companies including your Alma Mater last week that December seemed like there was a pick up in industrial?

W. James McNerney, Jr.: I think that's a fair statement, Jack.

We saw a modest December pick up in most of the base industrial and specialty chemical businesses.

Thank you.

Our next question is from Michael Judd of Greenwich Consultants.

I just had a quick housekeeping question.

The D&A for the quarter was what?

$937 million something for the quarter.

For the year would be $923 million excluding special items for the quarter, depreciation and software amortization would be $237 million.

Did you say voluntary pension was $74 million in the quarter.

Yeah, that was for some of our OUS subsidiaries.

We made our bigger contribution in the third quarter for the U.S. pension plan.

Okay.

And we are only into the early part of January here basically but do you see a continuation of the pick up that you talked about in December into January?

That's a hard one to read.

What Jim specifically talked about was the question on industrial.

Right.

Exactly.

That's what I mean about industrial.

That one seems to be holding at about that level.

Thank you.

Your next question is from Robert Ottenstein with Morgan Stanley.

Thank you.

In terms of increase on the Capex can you give us a sense of how much of that is in the optical side?

And, perhaps, you mentioned new products, can you talk a little bit about what those new products are?

Let me try to pick on this a little bit.

We ended up the year 677, we said we are going to invest about $900 million next year.

A big piece of this will be in the optical area, both in the supply of material area, as well as the converting areas in country.

That investment cumulatively will be well over $100 million increase year over year.

We are also increasing our investment in some of our OEGS product lines, which obviously we had good growth this year and we still see very strong demand.

Those are the two primary areas as well as continued investment in our healthcare area as well.

So it's really in our higher growth businesses.

I'm sorry, Pat, I didn't get the second one.

The second one was OEGS, our respiratory products.

Okay.

Can you also go through a little bit on the industrial business, particularly the margin issue why the weakness in the margins given all the cost cutting and what's going on there and whether business is just kind of going away faster than you can cut costs?

I guess, Robert, depending on how you look at the quarter and the year it's a similar issue.

We have been spending a fair amount of money in that business to restructure it all year long to increase productivity for the future.

The business is moving.

We've had very good results in both Asia, as well as in Latin America where some of that business is migrating.

We have a great organization to help pick up the migration of that movement.

Let's face it, it's a tough industry.

I think our margins are very good in industrial, neither Jim nor I are exactly happy with them and where they are at and we will continue to work at improving them, but we spent a fair amount of money this past year on special actions.

If you look at the calendar year, Robert, if you took special actions out industrial will be about flat on an OI basis.

On a calendar year basis?

On a calendar year basis, yes.

Thank you very much.

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

Good morning.

Pat, I apologize if you addressed this in your comments, but I was wondering if you could dive a little deeper into margins for consumer and office and display and graphics.

First in consumer and office, margins well below where they were in the fourth quarter last year, but sort of down in line with the last couple of years, trending about the mid 14s.

Despite a little bit of volume growth is it ex kind of to lower margin areas where you got better currency comparisons.

And then in display and graphics, the flow of margins again despite, it looks like priced down kind of 18% or so, is that mostly mix shift or how are you getting such great margins on tough price?

Let me take it in reverse, okay?

I thought Jim was taking notes for you.

W. James McNerney, Jr.: Yeah, let me take that one [laughter].

Jim's going to take display and I will take consumer.

There you go.

Jim gets the good ones.

Yeah, that's why he's CEO.

On the display and graphics, the price down in that business, Andy Wong and his team understand that to continue to grow profitability there that we are going to be in a price-down world.

They are as aggressive as any business we have and are working at the initiatives, getting sourcing reductions, driving productivity through the factories.

When you get a volume increase there's a fair amount of leverage you can have in the business.

We happen to be at a pinch point now where we are having to put some additional capacity in.

We are happening to run at a relatively sweet spot relative to utilization right now so we are in a very good period.

But from here the incremental volume leverage gets a little tougher because you pull up in D&G?

We are starting investing at the back half of this year and into '04 we are investing a fair amount of money in there and the reality is we think there's a lot more volume growth there as well, but we are a at a point where we are leveraging capital very sufficiently in that business right now and it is going to the bottom line despite the ongoing pricing pressures.

Consumer, I guess two-pronged or multi-pronged issue the way we see it.

You pull visual out, visual is a very tough business for us right now.

In the space it's in its, of course an eroding volume part of the business.

It happens to be a situation where we actually source some of that product out of Europe back into the U.S. which is a little bit unfavorable now with currency the way it's going.

The office channel remained weak most of the year, a little slower than we had anticipated.

And all of Western Europe, the economy in Western Europe remains very sluggish.

That's translating obviously into lower jobs, lower need for office supplies and so forth.

So, if you kind of split consumer into a couple of pieces, very good performance in the home care, the construction home improvement piece, but right now it's really office supply and the visual piece is really the two that are hurting us, visual by itself had an impact of about two points on our overall growth rate.

If you take that out, not bad.

We still have some more work to do on margins.

We continue to invest in that business long-term.

We think it's a very good business for us on a long-term basis.

We just have a few pieces that we need to get corrected in there.

Thank you.

Our next question is from Dmitry Silverstyen with Longbow Research.

Good morning, gentlemen.

A couple of questions.

First of all, you provided guidance for 2004 Capex and G&A.

Do you have any idea or any goals as far as debt pay down is concerned?

I think that will all depend upon how the year plays out and what we do on the dividends and what we do on the acquisition front, as well as a buy-back program.

We have $1.5 billion authorized as part of the buy-back program.

I feel very good about our debt situation.

As I mentioned, I think we are at 27.2 debt to cap at the end of the year.

We've got a lot of flexibility to either buy down or actually increase if we needed to, so I think we are in a very good position there.

That kind of leads me into my next question with $1.8 billion in cash and free cash flow generation, you went from $11.5 billion to $2 billion for next year.

It's a nice problem to have but what are you going to do with that cash over the next couple of years?

I know you talk about acquisitions and share buy-backs of $1.5 billion but I doubt that the share buy-back is going to happen all in one year.

Are you looking at acquisitions that are large enough to consume a lot of that cash or are you going to be cash rich for some time going forward?

I think your first statement was correct, it's a nice challenge to have, as to what to do with cash.

Jim and I continue to look at a number of acquisitions.

We are not changing the discipline of the process.

I don't care if we have $400 million or $1.8 billion in cash we have the same discipline for what we want to invest in.

So that's not going to change one bit.

We are going to take our capital spending up a little bit, but the great thing about this business is we do throw off a lot of cash flow so in '04 we'll have some more coming our way.

So we have a lot of flexibility as we consider dividends for the coming year, the repurchase program, as well as acquisitions but we don't have anything to report on the acquisition front other than we continue to look at it very aggressively.

Final question if I may.

You made a couple of little bolt-on acquisitions, and opportunistic acquisitions in the last couple of months, to the extent that some of your businesses are clearly not performing to expectations, the visual part of the consumer and office is obviously one example, are you looking at trimming the portfolio at all and getting rid of some of these businesses?

Right now we don't see a specific need, I address visual as an example that we just have to figure out how to make that a better running business.

We don't really see a need right now.

We have no businesses that are hurting us from a cash generation standpoint.

We continue to improve every business we've got from a productivity and a profitability standpoint.

We don't see a real need right now to do much in the way of pruning.

Very good.

Thank you very much.

Our next question is from John Roberts with Buckingham Research.

Congratulations on a good quarter, guys.

Jim, you had the reorganization this past year which is sort of the really big thing.

The year before was all the cost cutting.

Are there any big things on your platform or, I hate to say we are sort of going into maintenance mode here because this is a nice level to maintain or a nice pace to maintain, but anything discontinuous coming up in the strategy?

W. James McNerney, Jr.: I think there's a flow out on a lot of the growth things we've got going that are still fresh.

Whether it's a lot of our Six Sigma work with our customers, whether it's driving our new NPI process, I think there's a lot of growth-oriented things that where we want to prove to ourselves that we are as good as we can be and we don't think we are there yet.

So a lot of our focus is going to sustain itself there.

I think we are also taking a look on the productivity side at our corporate functions, to see whether they can be run more globally and more efficiently.

We are pretty decentralized with those functions.

I think we have an opportunity there to improve both our service levels to our businesses and our productivity there and that would be a multi-year kind of thing that would be in the spirit of your question.

Secondly, I think this is your first call since the Boeing search for a new CEO raised issues of your tenure with 3M.

You've only been there a short time so it's kind of unusual to have these questions come up so quickly, but is there anything you would like to share with us about your longer-term plans?

W. James McNerney, Jr.: Nothing that I haven't already shared with half the reporters that cover us.

I am in my fourth year here.

I am loving it.

We have a long-term plan and I want to be part of this future here.

There's no other company that I want to be with.

Thank you.

Our next question is from Robert Cornell with Lehman Brothers.

Good morning, everybody.

Just let's flush out the U.S. organic growth.

Could you go into a little more detail why we slowed to zero in this quarter versus the two and change in the third quarter, first of all?

What kind of question is that, Robert?

A good one.

It's a good question.

Realistically you have to kind of look at the way things played out.

Consumer was tougher for us in the fourth quarter in the office area.

I think most of the other businesses weren't too far off.

Now if you look at, and your question is really kind of how the third quarter versus fourth quarter we weren't two far off.

Well, now I am going to go to first quarter or fourth quarter so I hope the comments going forward are better than this.

You mentioned that in this quarter, for example, the only businesses that were down were industrial and electronics communication, yet you also observed that in December the industrial business and electronics communications business were starting to show some signs of life.

I guess what I'm thinking about is why do we show the deceleration here in the December quarter and what can we expect in the March quarter?

That's the essence of the full question.

I think as we look forward our expectations are that we will have some growth in the U.S. next year.

How about just, you mentioned to somebody's question the idea of the acceleration in December, then the bit of comment around January.

Should we expect this U.S. business to be growing here in the March quarter?

W. James McNerney, Jr.: Let me jump in here.

I think the reason we are hesitating a little bit is that making long-range predictions based on a month and a half makes us normally cautious Minnesotans a little cautious than normal, it is true though that we are seeing improving daily rates in the businesses that have been causing us issues and those improving daily rates happened in the last third, last quarter of the year.

We do have plans that say we are going to grow more in the U.S. than we did in '03.

I think we are going to do that.

Exactly at what rate is tough for us to predict precisely right now but we are feeling a little bit better about the U.S.

A corollary question, Jim, while you are on the box, would you want to update your outlook, your comments around the whole R&D pipeline.

At the analyst meeting you talked about it going from $3.5 to $5 billion, is there an update there, a comment on richness, any other further elaboration that would be relevant?

W. James McNerney, Jr.: I think it would be in line with the comments we talked about in September.

I think the pipeline feels and looks a lot more solid.

It's a little north of that $5 billion that we talked about which is sequentially up over the last 12 months from the $3.5 billion.

We are continuing to look at it in a disciplined expected value kind of way.

Products that we are saying we are going to introduce we are introducing.

Our cycle time is down.

It's better than it was.

I'm still in a position, though, and our organic rates are improving gradually.

You can point to a couple of new products that are doing it.

We are feeling better and better every quarter about that pipeline.

Thanks.

W. James McNerney, Jr.: Sure.

Thank you.

Our next question is from Stephen Weber with S.G. Cowen.

Good morning.

If I do the math right, to achieve the kind of forecast you are talking about pre the pension impact, your margins have to go up roughly two percentage points, the operating margin, which is very impressive.

Two questions here.

One, can you just kind of really broadly go over again what's driving that, obviously Six Sigma and all your productivity stuff, but the real question I have is how much more can you drive through in that business, in the margin part of the business if you look beyond 2004?

I guess, Steve, I'm not so sure where you got two points.

I thought it was closer to about a point.

But generally to get at your root issue, we still think we have a fair amount of opportunity left in, first of all driving growth, as well as driving additional productivity in Six Sigma, as well as some of the other initiatives that Jim talked about.

And our global sourcing program, we still think we have additional legs in global sourcing, dual sourcing activities to continue to drive improvements in that area.

Some of the staff areas that we want to take a look at to see if we can't get some more efficiency out of that piece of our business.

The well is not dry as far as opportunities go to continue to work at improving of our business.

W. James McNerney, Jr.: Steve, this is Jim, Steve, that $400 million we mentioned on the operating margin benefit, the initiatives, this would be well into our third year of similar programs.

We've got carry-overs from effort this year into next year.

These are long-term efforts where we think our ability to predict the benefits are improving.

And on top of that a continued increase in our organic growth rate and the mix on the products that are going to grow next year, namely a lot of our optical display and graphics, OH and ES, safety, security and healthcare, the mix on the growth products is pretty good from a margin standpoint.

So it's sort of the same balanced kind of year that we experienced this year in improving organic growth rate and $400 million on some efforts that we are now gaining confidence in our ability to deliver on.

Yes, if I can just follow up quickly, Jim, I buy off on '04, that looks like it's doable.

I just wondered how much do you think you could increase your margin on an annual basis post-'04?

I mean is it a half a point or a point, what are you driving for?

Steve, this question of how high can margins go is one that I deal all the time with shareholders.

Our objective, we think we have very, very good margins in this business today.

We will continue to try to improve them if volume isn't there.

Our challenge is, what we want to do is try to continue to drive overall growth of the business.

If I held margins where they are at and could grow margins at 5 to 8% a year and so forth, it's all about gaining additional economic profit in this business.

So we are not necessarily after raising margins for the sake of raising margins.

We want to grow the business.

We will probably get some margin expansion with that.

So the last thing we want to do is to grow the margins to such an extent that it effectively cuts off our growth.

It's really a balancing game between growth, productivity and the resulting margin growth that comes with it.

Okay.

Thank you.

W. James McNerney, Jr.: Listen, do you have another question, Matt, or is that it?

Thank you, everybody, for joining us this morning.

The 3M team is looking forward and anticipating another successful '04.

We appreciate your interest this morning.

Thank you.

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

You may all disconnect and thank you for your participation.