3M (MMM) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M first 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 keypad and questions will be taken in the order they are received.

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

As a reminder, this conference is being recorded, Monday, April 19, 2004.

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

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

And welcome to our first quarter 2004 business review.

Before we begin, I've got just a few brief announcements.

As in prior quarters, today's discussion will follow a series of Power Point slides which are currently available on our Investor Relations Web site.

Looking ahead, our second quarter 2004 earnings conference call will take place on Monday, July 19.

Please mark your calendars accordingly.

During today's conference call, we will make certain predictive statements that reflect our current views and estimates on 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-K lists some of the important risk factors that could cause actual results to differ from our predictions.

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

Thanks, Matt and good morning, everyone.

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

Please turn to slide number two.

The positive momentum that we have enjoyed during the past two years is continuing in 2004 as reflected by our strong growth and financial results in the first quarter.

First quarter sales increased 14.4% to a record of $4.9 billion with all seven of our businesses posting positive worldwide local currency growth.

Organic volume growth of 8.4% was the highest of any quarter since the second quarter of 2000.

Growth was strongest in our Display and Graphics business and we're also encouraged by continuing strengthening in many others, including Consumer and Office and several of our industrial-based businesses.

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

Geographically, all regions had positive local currency growth in the quarter, led by Asia Pacific.

First quarter earnings were up 27% to a record 90 cents per share, excluding special items in last year's first quarter.

Operating income was an all-time record $1.1 billion, a 27.8% increase, excluding special items from last year's first quarter.

This growth was broad-based as all seven of our businesses posted operating income growth of approximately 10% or better.

Free cash flow was $784 million in the quarter, driven primarily by solid earnings growth.

In February, our board of directors authorized an increase of 1.9% in our dividend for 2004.

This marks the 46th consecutive year of annual dividend increases for the company.

And finally, 3M received FDA approval in March to market Aldara imiquimod cream for the treatment of actinic keratosis.

Actinic keratosis are precancerous skin lesions that affect millions of people in the United States alone each year.

And Aldara is the first immune response modifier approved for this indication.

On slide three, we recap our first quarter sales performance on a geographic basis.

As I previously mentioned, worldwide sales in dollar terms increased 14.4% versus last year's first quarter.

Volumes increased 8.7%, which was above the top end of our 5 to 8% guidance.

Core volumes were up 8.4% and acquisitions added 30 basis points of growth.

Selling prices declined 40 basis points while year-on-year currency translation boosted sales by 6.1 percentage points.

In the United States, sales improved 4.2% versus last year's first quarter primarily due to a 3.4% increase in core volumes.

Acquisitions added 60 basis points of growth.

U.S. sales growth was led by our Consumer and Office, Transportation, Industrial and Safety, Security and Protection Services business.

Our international operations continue to post strong growth with sales up 21.6% in U.S. dollar terms.

Volumes increased 11.9% and currency translation added 10.5% to sales.

Overall, selling prices declined 80 basis points with most of the decline coming in certain businesses that serve the electronics industry.

Local currency growth, which is defined as volume growth plus selling price changes was 22.4% in Asia Pacific with Japan up 11.2% and the rest of the region up 31.4%.

All seven of our businesses posted positive local currency growth in Asia Pacific during the quarter.

We posted 11.5% local currency growth in the combined Latin America, Africa and Canada regions.

Again, all seven businesses increased sales in local currency.

In Europe, local currency sales grew by 1.2%.

Growth in Europe was led by our Transportation, Safety, Security and Protection Services, Industrial and Health Care businesses.

This was the highest local currency growth we have had in Europe since the second quarter of 2001.

On slide number four, we compare our first quarter P&L versus last year's comparable quarter.

Sales were up 14.4% year-over-year.

Gross margins were 50.7%, up 190 basis points from last year's first quarter primarily due to a combination of improving volumes and related productivity gains, positive currency impacts and favorable mix.

SG&A as a percent of sales was up slightly year-over-year.

Underlying these SG&A numbers is an ongoing mix shift toward faster growing businesses in geographic areas.

In the first quarter, we also increased our global investments in advertising and merchandising to support our brand.

As part of our SG&A results, let me provide a quick update on breast implant insurance receivable.

Earlier this month, we received an adverse final ruling from a London arbitration board regarding breast implant receivables from certain U.K.-based insurers.

A matter which we have discussed in prior public filings.

This ruling concludes that arbitration proceeding.

After carefully reassessing this matter and all of their available data, we've reduced our breast implant receivable by $16 million in the first quarter, which added to SG&A expense, and you'll see that in our corporate and unallocated segment.

After this adjustment, our breast implant receivable stands at $322 million, the largest majority of which relates to monies we expect to receive from 29 insurance carriers in Minnesota.

Minnesota's Supreme Court backed our position on this matter in August of last year.

Research and development and related expenditures increased 4.2% year-on-year as we continue to fund future growth for the company.

As a percent of sales, R&D was 5.7% versus 6.3% in last year's first quarter.

Operating income was up 27.8% to over $1.1 billion and margins improved 240 basis points to 22.6%.

First quarter net interest expense was $9 million versus $17 million last year, primarily due to lower net debt levels.

The tax rate for the quarter was 33%, a decrease of 10 basis points over last year's comparable quarter.

For 2004, we expect the tax rate to be 33%.

Quarterly net income increased 29% year-on-year and earnings per share improved 26.8%.

The P&L on a sequential basis is found on slide five.

Sales were up 4.7% versus the fourth quarter of last year as six of our seven businesses in all geographies experienced positive momentum in the first quarter.

We leveraged this sales increase into an 18.6% sequential operating income improvement.

Operating margins improved by 260 basis points sequentially, driven by a combination of higher volumes, continued focus on productivity and process improvements and a minor currency benefit.

Also, recall that the fourth quarter margins are typically the lowest of the year.

On a sequential basis, both net income and earnings per share increased almost 17%.

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

In Health Care, sales again exceeded $1 billion in the quarter with year-over-year local currency growth of 2.2%.

Similar to last quarter, first quarter sales growth was impacted by pharmaceutical agreements that did not repeat in 2004 which negatively affected top line growth by 2 percentage points.

Operating income in Health Care was $262 million, up almost 10%.

As I mentioned previously, we have also had some recent developments related to our IRM pharmaceutical platform.

Last month, the US FDA approved Aldara imiquimod cream as a treatment for certain patients with actinic keratosis or AK, a precancerous skin disease caused by cumulative sun exposure.

The response from dermatologists thus far has been favorable.

In addition, we received an approvable letter from the FDA in response to our supplemental new drug application on Aldara for the treatment of superficial basal cell carcinoma, a common form of nonmelanoma skin cancer.

The FDA noted no major deficiencies in the application and requested that 3M provide additional safety data as a condition of approval, which we will do shortly.

FDA's review of the additional data will take up to six months.

Therefore, we anticipate a potential approval in the second half of the year.

Our confidence in this important pharmaceutical platform is as high as ever.

Switching to industrial.

Local currency growth was 8.5% in the first quarter as we generated positive local currency growth in all major geographic areas led by Asia Pacific.

Acquisitions added about 1 point of growth in the quarter, due primarily to our previously announced acquisition of HighJump Software, a leading provider of supply chain execution software.

We generated good leverage in Industrial as operating income grew 25% to $166 million.

Display and Graphics growth continued to surge in the first quarter, increasing 20.4% on local currency.

Sales growth was strongest in optical systems as demand for flat panel devices continued to drive sales of our propriety optical films and components.

We also generated good growth in our commercial graphics business with supplies, films, inks and equipment for the commercial advertising industry.

Operating income in Display and Graphics increased 61.5% to $294 million.

Local currency growth in Consumer and Office was 7.4% with operating income increasing 10.8% to $122 million.

Growth was fairly broad-based across the many channels we serve, most notably in consumer retail, do-it-yourself and office retail and wholesale.

In Safety, Security and Protection Services, local currency growth was 9.2%, driven by double-digit gains in respiratory protection, along with strong demand for our cleaning and protection products for commercial building.

Acquisitions added about a point of growth in the quarter.

Profits improved by 19% year-on-year to $125 million.

Local currency sales in Electro and Communications increased 2.5% year-on-year, led by a strong demand for electrical products, consistent with the improvements we are seeing in our other industrial-related businesses.

Operating income was $65 million, up 36.1%.

And finally, local currency growth was 8.1% in our Transportation business, with operating income up 19.8% versus last year.

Top line growth in this business continues to benefit from new products and solutions to our customers, along with a strategy of replicating successful 3M solutions across several distinct sections of the transportation industry.

Now if you turn to slide number seven, I will review a few balance sheet and cash flow metrics.

Net working capital turns was 5.3 at the end of March, up .6 turns versus one year ago.

Turns were down slightly versus year-end due in part to a strong March sales, which resulted in our higher accounts receivable balance.

Our goal remains a minimum of six net working capital turns by the end of 2004.

Inventories declined by $77 million versus last year or 3.9%.

Inventories were up $64 million sequentially.

Currency translation effects added $125 million to an inventory year-on-year, but had minimal impact sequentially.

Accounts receivable was up $261 million or 9.9% versus the first quarter of 2003 and was up $190 million sequentially.

Currency translation effects added $198 million to accounts receivable year-on-year and as with inventories, had a minimal sequential impact.

Capital expenditures were $158 million in the first quarter, an increase of $38 million year-over-year.

We expect our capital expenditures to accelerate during the year, reaching a total investment of $900 million for 2004 in total.

Free cash flow was $784 million, up 22% year-over-year.

We paid $282 million in dividends to our shareholders during the quarter.

Recall that in February, our board of directors authorized a per share dividend increase of over 9%.

We also accelerated share repurchases for the first quarter.

In total, we acquired $438 million of our own stock, resulting in a net repurchase of $304 million.

Weighted average diluted shares outstanding was $799.5 million, up about 1% from last year and down just slightly versus year-end.

And our debt-to-cap ratio was 26% at the end of the first quarter.

One quick note on mask respirator litigation.

Incoming respirator mask asbestos claims were lower in the first quarter than we've seen over the past year.

In total, claims outstanding at quarter-end were 89,800, up about 1,000 versus December, 2003 levels.

Please turn to slide eight where I will discuss our outlook for the remainder of 2004.

Building upon our strong first quarter performance, we now expect full year 2004 EPS to be within a range of $3.60 to $3.70 per share, which represents a 17 to 20% year-on-year increase, excluding special items in 2003.

Sales volume growth is expected to be in the 6 to 8% range.

For the second quarter, we expect earnings to be between 94 and 96 cents per share or an increase of 20 to 23% over the second quarter of last year.

This also assumes total volume growth in the 6 to 8% range.

While global economic conditions are generally improving, there remains uncertainty in many areas of the world.

In particular, growth continues to be weak in Western Europe but on the whole, despite that it is still early in the year, we believe that we can deliver on these goals for 2004.

This concludes the formal part of today's call.

Joining Matt and me this morning are Ron Nelson, our Controller and Bill Schmall, who recently assumed executive responsibility for both treasury and taxes.

We'd be happy to address your questions.

Let's begin the Q&A.

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

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

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

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

Our first response comes from Michael Judd with Greenwich Consultants.

Good morning.

You mentioned that this last quarter, in the Industrials also in Consumer and Office, you saw a pickup there so you have a broadening of the performance in the overall portfolio.

Could you just provide, you know, a little bit more detail on what's going on in those two segments in particular and whether that continued into April, please?

Okay, let me just.

First of all, I think I made a mistake when I mentioned the dividend.

I think I mentioned 1.9% increase versus 9.1%.

I just want to clarify that for everybody on the call.

On the Consumer business, saw a good performance really across the board in all segments in the first quarter, as I think we mentioned across all channels and really across all the business units within Consumer.

And that business does seem to continue to be a, you know, performing about the same level thus far in the second quarter.

And in the Industrial area, please?

Industrial, I'd say, is continuing to perform at the same level it did in the first quarter so at this point in time, when you look at our top line guidance of 6 to 8%, we ran a little bit over 8% in the first quarter.

You know, the makeup would be pretty similar in the second quarter.

Are there any particular parts of the Industrial which are particularly strong, you know, in any areas that are sold out or, you know, any tightness there?

I would say in the Industrial there's really no particular areas of tightness going on, it's just obviously that piece of the business, you know, at least in the mature parts of the world has been, you know, depressed for the last couple of years, so we see that coming back.

And in Asia that just continues to expand at double-digit rates.

Thank you.

Our next question comes from Bob Cornell with Lehman Brothers.

Yes, good morning, everybody.

Hi, Bob.

Hi.

Display and Graphic is so strong, who do you compete with in that market?

If you want to talk about share, we'd like to hear about it.

And I think at the analyst meeting, you talked about the yield of that business improving.

Is that still happening or are your yields maxed out?

Maybe a little bit of help in that area would be good.

Who do you compete with, first of all, what is your share and market?

Well Bob, of course, Display and Graphics is made up of a number of different businesses.

The optical film business, the traffic safety systems as well as --

I'm thinking optical films, actually, Pat.

Okay, thanks for clarifying that.

Basically we have a very competitive position.

We have some propriety products in that space and there is no one that competes with us at the same level from a capability or a capacity level that we do.

On the yield side, we continue to work at yield improvements.

We are putting additional capacity across the board in all of our optical film products.

We're trying to obviously eliminate some bottlenecks but we actually have some expansion projects going in place that will come on, you know, in about a year's time.

You know we've seen with the demand for that business booming, that you could have, are you having any bottleneck?

Are there any sort of backlog problems in that regard?

Well, it is tight and Andy Wong who runs that business and Jim Stake, you know, do a great job of managing the supply chain on a, you know, on a need-be basis.

There is tightness across the whole supply chain in that industry right now.

The conversion to flat panels has moved a lot more rapidly than most people had forecasted.

So, there is some tightness in the supply chain but thus far we've been doing a good job keeping, you know, keeping pace.

Okay, thanks, Pat.

Our next question comes from Mark Gulley with Banc of America Securities.

I'd like to follow up on the Displays business a little bit.

Can you give us a little color as to the gains in that business, Pat?

I know that some other players in this business have said that their business was up maybe more than 10% sequentially.

Did you see the same kind of volume growth, as well?

Well, we don't release, you know, the optical film piece of it, but if you look at our Display and Graphics business, I think they've had, I believe it's about eight quarters now with double-digit growth at the Display and Graphics and it continues to improve on a sequential basis, Mark.

I'm not going to give you an exact number, but it continues to grow.

As I mentioned, we're continuing to put incremental capacity in, eliminate some bottlenecks, move some business around some of our factories to make sure that we can, you know, maximize obviously our production of optical films.

As a follow-up, Health Care volumes, even if you adjust for some of the pharma issues, was only up 4%.

I think it's one of the lower numbers there, of course, one of the lowest numbers in the quarter.

Are there some structural issues we ought to be aware of in Health Care?

Or is it just one soft quarter?

I would say there is really no structural issues.

We've got, as I mentioned, I guess in the fourth quarter and in this quarter, our drug delivery systems business had a very good first half of last year.

They've had, they've lost some contracts or let's put it this way, we haven't found new contracts to backfill in some cases, so that business is soft and down quite a bit.

And pharmaceuticals, of course, is, we're expecting a better second half of the year versus the first half, obviously as the indications for Aldara, you know, ramp up.

Thanks, Pat.

Our next question comes from John Inch with Merrill Lynch.

Hey, Pat, good morning.

Good morning, John.

I guess, you know, just in the short-term, if you look at your almost 35% margins in Display and Graphics and the surging demand, a couple-part question, I mean are you going to be able to get pricing in this business to help offset prospective bottlenecks?

I mean why the margins not just headed to 40%?

It's not apparent why those numbers shouldn't be continuing to grow very rapidly.

Good question, John.

Obviously we are trying to maximize our profitability in that business and that's a combination of volume, cost management and pricing.

You know, playing in a high gross base, we have to continue to balance the need of our end customers and their need to drive down prices in the end market.

And our ability, obviously, to continue to supply them and make the kind of financial returns that we need, as well.

I can guarantee that we will continue to work at continuing to see if we can't take those margins up further.

And then just as a follow-up, Pat, on your guidance.

You guys have been, for now, quite a few quarters pretty conservative in the guidance in terms of the ultimate results.

I guess that, you know, why would you think the volumes in '04 are up only 6 to 8% if your volumes are up over 8% today and you're seeing a broadening of the recovery into your other businesses and I mean why shouldn't the earnings be, you know, substantially ahead of the 370 top end of the range this year?

Well, John, they may be, okay?

Depending upon what we end up doing on volume.

I guess a couple of things, I mean you have to go back to last year and our volume did improve sequentially, okay, during the year.

Second quarter we were, you know, we'd had a favorable benefit of the SARS impact, you know, on our business and so forth.

So, you know, we think, you know, looking at the business on 6 to 8% provides a good balance of where we think the businesses are running.

It gives us what we think is the right kind of cost discipline in the organization to make sure that we continue to pull through productivity gains and the so forth.

And obviously as we talked to you guys before, you know, we run this business on a, you know, you can view it maybe as a conservative basis to keep the right kind of discipline in the organization, make sure that we're addressing bottlenecks where we have them from manufacturing standpoints so we're not missing sales, but on balance, you know, we think 6 to 8, if you look at, you know, a 17 to 20% return for the year isn't bad as, you know, going into the second quarter of the year.

Yep, thanks, Pat.

Next question comes from Stephen Weber with SG Cowen.

Good morning.

First off could you tell us what the currency impact was and my standard question of what's happening with the sales value of production and how that looks for the second and third quarters?

Steve, I'd be disappointed if you didn't ask the sales value production question.

You know, we were up about 9% give or take in the first quarter.

If you look at our guidance of 6 to 8% top line should imply, you know, some minor sequential changes probably in production in, you know, Q2, Q3.

We did build a little bit of inventory in the first quarter which we'll attempt to get back by the end of the year.

So, Steve, I would not expect that production on kind of a running rate basis would change all that dramatically.

It's plus or minus a percent here or there is what I'd expect it to be.

What was the first part of your question again, Steve?

Currency impact.

Oh, currency.

In EPS terms.

Well, I will try to frame the currency question for you guys.

As the dollar obviously has weakened, we've tried to continuously look at how we improve the business on an ongoing basis for the good of it.

You know, again, not only this quarter, but going forward.

If you do the pure currency arithmetic it would give you about 7 cents in the quarter.

But obviously we knew that was coming, we spent some more money in a few areas of the business to improve it for the long-term.

But if you took out the pure currency calculation it would be about 7 cents for the quarter.

Okay.

And my last question, Pat, when you talked about E&C, you mentioned electrical but the semiconductor business is going nuts and that's a big part of your business if my recollection -- is something happening there that's hurting you in that part of the business, share or something else or you just didn't mention it?

Well, semiconductor is not a huge piece of that business, Steve.

The, I guess we're up by I think it was 2.5% in total for electrical products.

Electrical products was the strongest of those pieces.

The telecom market is still spotty.

You know, if I kind of look at it kind of the other way around, is that is still down a little bit.

There is (sic) pockets of the world that it is growing quite rapidly but in the U.S. and Western Europe it's still quite soft on that side.

So, that's why E&C in total is only about 2.5%.

But the semiconductor is not that big a piece of that business.

There actually is a piece that's embedded in say Industrial which grew, you know, pretty good in the quarter.

Okay, thank you.

Our next question comes from David Begleiter with Deutsche Bank.

Thank you, good morning.

Good morning, Dave.

Pat, on Safety, can you discuss the mask business, whether you are at capacity right now, how growth is trending versus the tough comps last year?

Well, it's, you know, first quarter was a good quarter for us Dave, and then, of course, we start to run in a little tougher comps in Q2, Q3 and through the end of the year.

We have bought additional cells of capacity in place.

We got cells going in over the next couple of quarters so we're trying to get ahead of the demand side of this and it's a tough business to forecast because it generally is driven by some sort of an X factor change.

We made a decision last year that if you looked at historical data that first of all, you can't forecast X factors but they do happen.

So, we made a decision to go ahead and put some additional capacity in place to make sure that we could meet the demand when it started to show up.

So, the demand for those products remains very, very, very strong and again will run in tougher comps in the last half of the years, but we're challenging obviously the business to kind of find other ways of getting the business to grow, to compensate for that.

Okay.

And last thing, on the IRMs, any up-front marketing costs with promotional material?

And can you update us on your thought on total sales at maturity of these two products?

Thank you.

I guess there's really no new information on the update on maturity.

I think the best way to think about this is let's get those two products in the market, hopefully, you know, we'll get BCC approval later this year.

And then we'll see how, you know, see how they're performing and then we'll have a better, you know, read as to if we want to change our guidance on the long-term prospects for those products.

On the up-front expenses for promotional materials?

Yes, in the first quarter and second quarter we are spending some additional money in the pharmaceuticals business.

It's, you know I didn't think it was significant enough to pull out for you, it's just the nature of, you know, getting into that business.

A lot of it's, you know, marketing samples and getting the sales force trained and so forth.

Thanks, Pat.

Next question comes from Jack Kelly with Goldman Sachs.

Good morning, Pat.

A question --

Hi, Jack.

Question on pricing.

You did mention it, which is probably a good thing, except for, you know, price increases, but if we looked at raw material costs and how much they went up in the first quarter, can you give us any sense if there was an unrecovered margin there?

And if so, are you putting through price increases that might recoup that?

And then secondly as a follow-up question, you had mentioned strong March sales.

Was that pretty much across the board?

In other words, if we look at the volume gains for the first quarter, can we assume that March's gains year-over-year were stronger across the board or if not across the board, what areas was March stronger in?

Well, take them in reverse here, Jack.

March was a, you know, a strong across the board.

Part of it is the way, I hate to say the calendar fit, it was a high-billing-day quarter, as well, just the way the calendar fell out this year.

But it was strong across the board and it seemed to actually pick up as the month, you know, the month progressed.

So, that, you know, that felt good and obviously we'll have to see as April --

Okay.

Of course, you have Easter in April, so, you have to be able to kind of look at this over a longer period of time to see what trends happened and so forth.

But you're basically saying March year-over-year was stronger than the rest of the quarter, is that fair?

Yes, I would say it was, yes.

Okay.

On the pricing side, on the raw materials side, you know, there's no doubt that commodity prices are causing all of us some additional pressure and pain this year and I think it's going to be a different environment for industry.

You know, you look over the last, you know, who knows, five, seven years, where effectively inflationary costs have been relatively low.

I think it's going to create a little bit of a different dynamic in the marketplace in '04 on people trying to raise prices because commodity suppliers surely are raising prices.

Our first quarter, we didn't see a huge benefit but we are seeing that as we go through the year, Q2, Q3, Q4 that our commodity prices probably will be higher than they were in Q1 is (sic)the way that we're currently looking at it.

And I think you're well aware, we've got a very good global sourcing organization.

Their goal remains the same, even though they've got some higher commodity prices to have to deal with, but it does force a number of our businesses to have to look at their opportunity in the marketplace to drive pricing through and it is a focus of discussion within the company.

So the first quarter, you didn't really feel any margin pressure?

No, no.

Okay, thank you.

The next response comes from Robert Ottenstein with Morgan Stanley.

Thank you.

Just a follow-up on that.

Would you, as you look out for the rest of the year, would you say that higher commodity prices would be your largest challenge compared to where you were in the first quarter?

Or are there other things you're worried about as you look out that would make you cautious in terms of results?

That's one of I guess, Robert, obviously a number of things you look at from a business standpoint.

Raw materials will cause us additional pressure.

We think it may be worth a point or so for the year.

A point on gross margin?

A point increase in material cost okay?

Okay, a point of higher --

And I guess when you look at commodity prices that's still somewhat of a muted number because our team is doing a great job actually of offsetting that with some other productivity gains through, you know, e-auctions, dual sourcing, low-cost country sourcing and the like.

So we obviously just put that in the blend, but it is spottier by certain businesses and therefore we got some of our businesses more focused on making sure that they get end-market pricing, okay, where they're going to get the same kind of pressures that a number of the other competitors may be facing.

So, at least an increase of sensitivity of that.

Obviously that's a market by market decision you have to make.

But within our guidance for the year, you know, that's a manageable number.

And in the first quarter, would it be fair to say that raw material costs were flat?

I'd say flattish, yeah it was somewhat different by business and geography, but pretty much flat.

As you looked on the other see of that, on pricing, you know, there is a price decline, most of that on the electronics side.

If you Xed out the electronics end markets and I'm assuming most of that is Display, would pricing have been flat or up?

I don't have exactly that number because, of course, we don't always have the end market stuff, Robert, with all the products that we sell, but I, my own assessment would be if you take the electronics out, we're about a flat price for the quarter.

And are you starting, given that you have a fair amount of visibility on these commodity prices, are you starting to put in, you know, wide ranging price increases and do you think you'll be able to offset that just in terms of price raw material equation?

We're not putting broad-based pricing.

We really have to look at it product by product, customer by customer, competitor by competitor to really understand, you know, what the competitive dynamics are before we make that happen.

We have our businesses looking at, you know, where there are opportunities for pricing, specifically, where certain commodities are causing them problems because obviously 1% for us could translate to individual businesses to be higher numbers and they have to manage, you know, their bottom lines, as well.

So, they've got the incentive to make sure that they're balancing the price and the cost equation, as well.

Thank you very much, Pat.

Next question comes from Dmitry Silversteyn with Longbow Research.

Good morning.

I have a couple of follow-up questions.

First of all, in the Electro and Communications segment, you've had about 2% growth, about 7%, including currency and you had a pretty significant expansion in margins.

So, my question is, what accounted for such an expansion in margins and high growth in profit dollars year-over-year given relatively low 2% internal growth?

And secondly, is that sustainable through the balance of the year, or are there some one-time items in there?

Dmitry, I guess if you followed us for the last two years we've been kind of riding the E&C down from a profitability standpoint.

We've had to take some restructuring actions that have been embedded in results, really over the last year, last two years, as a matter of fact.

And I think you're starting to see the benefits of that, you're starting to see the benefits of obviously some, you know, a leaning of the organization, a lot of focus on, you know, productivity enhancements and so forth within the business.

So, as E&C volume does improve, I would expect that you would see a good leverage on the bottom line.

Okay.

So you've gotten your costs down low enough to where any growth in volume, it looks like translates into pretty significant margin expansion.

That's a way we've positioned the business, Dmitry, yes.

That's very good.

Second follow-up question, I guess, on the Consumer and Office, one of the areas where you're trying to improve the business was in Europe and Europe was soft overall for the company.

How are your efforts in Consumer and Office in Europe faring?

Consumer in Europe continues to be one of the toughest challenges we have.

It's a, you know, it's a different market than it is in the U.S. where we are, you know, very, very successful.

A lot more private label activity goes on in Europe.

You've got a lot more competitors on a country by country basis.

Europe still is a tougher market to not only compete in from a growth standpoint, but also from a margin standpoint.

We continue to work at that but, you know, our U.S. business is growing great.

Our Asian business continues to improve all the time and we will continue to work on Europe to get our brands, you know, better established.

We are continuing to invest in our brands in Europe so, you know, eventually we'll, you know, get more and more growth but it is still very tough market.

Okay, thank you very much.

Next question comes from John Roberts with Buckingham Research.

Good morning, Pat.

Good morning.

Could you give us a little update on the M&A environment?

We've seen a big pickup I think in deals in general and a lot of deals in industrial markets and so forth but maybe nothing specific in your areas yet.

There is a lot more activity.

I think most people would say that they saw an inflection point probably sometime in the fourth quarter last year.

And that's good news and bad news.

There is a lot more strategic buyers currently at the table.

A lot of private capital in the market today so in many cases you are competing both against strategic as well as private funds.

So, it's a very competitive world out there right now.

We haven't changed our strategy one bit.

We continue to want to focus on the areas of the business that we feel have good long-term growth potential for us that are good, technology-rich companies or people who need help from a geographic expansion standpoint that we can help with and so forth.

So, we haven't modified our standards, even though I'd say that the pricing in the market probably has increased somewhat in the last two quarters.

Have you lost out on any opportunities because of price or is it still just a, you know, a search and execute kind of issue?

I'd say, I don't believe we've lost out on prices.

In some cases maybe we weren't willing to pay the price that the market wanted at that point in time.

We're a very patient buyer.

One of the interesting things, of course, about financial buyers is that normally those properties come back available again at some point in time, so we're not jumping at deals just for the sake of, you know, the market's tougher now and so forth, we continue on the same strategy of what makes sense for us, what's the right price for us and then we'll, you know, execute those as they come available.

Okay, thank you.

Our next question comes from [William Patsner] with Goldman Sachs Asset Management.

Pat, I had a question about shares outstanding.

I know that you're suffering from year-over-year comparisons being high, but when will we start to see year-over-year shares outstanding decrease?

I know they did quarter-to-quarter.

I have a second question after that.

It will take a while for that to play through and I forget exactly which quarter we had the inflection point in.

Specifically when you look at diluted shares, okay?

Because we had some options that were under water, okay?

Uh-huh.

Early in the year, which all became in the money I'd say the third quarter, guys, do you recall that?

I think it was the third quarter.

So, I'd say probably by the third quarter is when you'd start to see an actual reduction.

Okay.

Now, what's the internal, do you have a sense of what the kind of internal share creation is?

In other words, year by year, how much do you have to offset so that there won't be an increase in the shares?

Well, that number kind of floats because obviously of where the stock price --

Bill, this is Matt.

Again, varies a little bit, I think somewhere in the 6 to 8 million share per year range.

Okay.

Is about where it is typically.

Great.

Okay, thanks very much.

Next question comes from Jeff Cianci with UBS.

Close enough.

Good morning, Jeff.

I'm doing a calculation on your return on capital.

I want to check that.

If you come in toward the higher end of your range, given the capitalization right now, do you think you'll see this number well into the low 20s?

I'm coming up with potentially for the year 22% return or better.

Well, obviously we'll kind of release that number when we get closer to the end of the year.

Did you do it for the first quarter?

Well, last year we ran I think 21.8 if I recall right for the year.

Of course, we ran better than that in the first quarter.

If you just look at our profitability and our, you know, capital base and so forth.

So, that number should continue to improve in '04.

Right.

All right, I have another question on the share repurchase.

If you accelerated that here and barring no major acquisition, could we not do a net, you know, billion dollars in stock buybacks this year?

Well, with let me refresh.

The board has authorized $1.5 billion, okay.

Right.

From a gross repurchase.

That's over time, right?

That's for the year, that's for the full year.

We spent a little over 400 in the quarter.

Right.

So, we spent a little more in the first quarter than effectively we're authorized for the whole year to do, so that kind of gives you the kind of order of magnitude of what we're at least authorized to do at this point in time.

If we obviously wanted to do something more than that, we'd have to go back to the board for approval.

Okay.

And then finally, you didn't provide a gross margin outlook.

Some of the discussion was implying that maybe gross margin comes down.

There's not many industrial companies that have 50% or better gross margin, but given your forecast and the mix we're talking about with, you know, Display and others growing faster, should this not be north of 50 for the year?

Jeff, you always try to corner me in these --

Well, you've given a lot of guidance on a lot of other things.

Well, we give you adequate guidance for the piece itself.

Again, we're trying to run the business from a long-term standpoint.

We're very pleased with our first quarter results.

You know, margins were good.

And, you know, based upon the guidance that we're giving you on kind a top line and bottom line, you know that would lead you to believe that, you know, the operational improvements that we've got, we're going to continue, you know, continue into the rest of the year.

Fair enough.

Thanks, Pat.

Our next question comes from Jeff Sprague with Smith Barney.

Thanks, good morning.

Good morning, Jeff.

Being about 20th in line here, I've run out of the good questions, but a couple of follow-ups.

Just on the issue of kind of repurchase and, you know, stock creep and the like, as you look at, you know, potentially expensing options and the like, looking into next year, any changes in the how you compensate people or any thoughts about just how you handle compensation moving forward?

Well, Jeff, we have a three-year option program that's been approved by shareholders that expires in May of next year.

So we're currently obviously in the assessment process of what we want to do for the '05, you know, compensation planning period and that obviously will be a subject of discussion over the next year within the company and with the board as far as, you know, what the right competitive makeup of that program is in light of stock option expensing and so forth.

So, we're kind of set for another year and then, you know, we'll have to kind of decide, you know, if we like the program we've got or we'll make some modifications over the next year.

Great.

And then on Display and Graphics, you know, I guess there is some data out there suggesting, you know, the OEMs are spending something like $10 billion this year on capacity expansions and the like.

Just wondering if, you know that links up to, you know, you have spoken about expanding capacity and debottlenecking.

Do you think that meets that OEM capacity expansion that's going on out there?

Or does perhaps that expansion leave the door open for some of these competitors you mentioned that maybe are not as good but maybe good enough if things are getting really tight here.

Jeff, I guess our intelligence and Andy Wong that runs that business is obviously very well connected with each one of the manufacturers.

That's why we do so well there.

To fully understand what all of their plans are, our job is to make sure that we are able to supply them and at this point in time we are, you know, we are marching with them through their capacity plans.

We obviously have to step back and look at our, you know, our own view of, you know, where is the flat panel market going and so forth as a supplier, to make sure that, you know, what kind of total capacity is being put in place and we think that's, you know, going materialize or not in the end market.

So, as a supplier you always have to make somewhat your own judgments but we're committed to maintaining our competitive position with each one of those customers and continue to march our supply capability up with their needs.

And then just one last one.

Given the strength, are you actually hiring anybody in the U.S. yet?

We are hiring, you know, on a selective basis.

We still have, you know, some skill sets that, you know, you run into that you always have to hire.

We continue to hire in the R&D organization, we're hiring some sales and marketing talent here and there.

But it's really not broad-based.

Our productivity programs on Six Sigma and so forth continue to drive additional productivity enhancements.

If the business continues to grow the way it is, and U.S. as an example, we grew about 4% for the year.

If you actually include exports in that number, we'd actually probably be another three points on top of that because we are a net exporter out of the U.S. so when you look at production in the U.S., we're probably growing closer to about 7%.

So, you know, from a productivity standpoint, you know, we have to, our goal is to continue to run about 8% productivity as an organization.

So at that level, you know, you're about flat on employment.

So, that's about where we're at from an employment standpoint.

We continue to hire on a specific basis where we have a skill-set needs.

Great.

Thanks a lot.

Our next question comes from Mark Gulley with Banc of America Securities.

Yes, a follow-up to some of the balance sheet and cash flow questions, Pat.

An observation here, I'd like your reaction.

I calculate you'll be net debt free by the end of the second quarter, maybe third quarter.

So, with no net debt and maybe acquisitions getting a little pricey, does it make more sense perhaps to throttle up the pace of share repurchases?

Well, Mark, we continue to look at all the variables there.

And I think I mentioned earlier that we've got, I think it was Jeff Cianci's questions on the repurchase program, we're authorized at $1.5 billion right now.

We spent 400 out in the first quarter, 438 I think was the number.

So, if we decided when we look at the landscape on acquisitions and so forth that there's not the opportunities out there, obviously, we have to kind of then take another look at that.

But that's not in my current schedule of things to do.

I think $1.5 billion for the year still seems to me a very reasonable buy back environment that we ought to keep in front of us and then as we go through the year, obviously we'll see what happens.

Your math probably, I'm not going to confirm your math or not, but if you just go through our guidance, you know, sometime, you know, mid-mid-year, that's a possible likelihood.

But the other observation is your share repurchases this year would be below your free cash flow so that...

Yes, you'd actually still generate cash flow.

Yes.

Right.

Okay.

Thanks.

Ladies and gentlemen, that concludes the question and answer portion of our conference.

At this time, we will now turn the call back over to 3M for some closing comments.

Again, thanks for joining us this morning.

We thought we had a good quarter.

I appreciate all your, you know, your questions and dialogue here.

And we're looking forward to continuing success in 2004 and see you again with our second quarter release.

Thank you so much.

Thank you, ladies and gentlemen.

That does conclude our conference for today.

You may all disconnect and thank you for participating.