3M (MMM) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen and thank you for standing by.

And welcome to the 3M second quarter 2004 earnings conference call.

During the presentation all participants will 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 today, Monday, July 19, 2004.

We will now like to turn the conference over to 3M.

Good morning.

I'm Mark Colin, Director of Investors Relations for 3M and welcome to our second quarter 2004 business review.

Before we begin I have 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 third quarter 2004 earnings conference call will take place Monday, October 18.

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 these important risk factors that could cause actual results to differ from our predictions.

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

Pat?

Thanks, Mark.

And good morning, everyone.

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

Please turn to slide number two.

The second quarter was another very good quarter for 3M.

Second quarter sales increased 9.5% to a record $5 billion, with all seven of our businesses posting positive, worldwide local currency growth.

This represents the first time in company history the sales have exceeded $5 billion in a quarter.

The broad-based volume growth of 7.7% represents the fourth consecutive quarter of volume growth greater than 7% and the ninth consecutive quarter of positive volume growth.

Geographically, we achieved positive local currency growth in all regions.

Again, led by the Asia-Pacific region at over 18% in the quarter.

Second quarter earnings were a record 97 cents per share, an increase of over 24% versus last year.

Operating income improved to an all-time record of just under $1.2 billion, or 23.7% of sales.

Earnings growth was broad-based as five of our seven businesses posted double digit operating income growth, led by our Industrial and our Display and Graphics businesses.

Free cash flow was almost 1.1 billion in the quarter.

Economic profit, which is defined as after-tax operating income, less a charge for operating capital, was 480 million, or up 35.6% versus last year.

Overall, the strength of our broad portfolio and a continued focus on our customers and our operational excellence drove growth in both the top and bottom line in all seven of our businesses versus the second quarter of 2003.

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

As I previously mentioned, worldwide sales in dollar terms increased 9.5% versus last year's second quarter.

Global volumes increased 7.7%, with core volumes up 7.2%, and growth from acquisitions adding 50 basis points.

Selling prices declined one percentage point while year-on-year currency translation added 2.8% to second quarter sales.

Sales were up 3.1% in the United States as core volumes improved 2.3%, and acquisitions added 80 basis points of growth.

U.S. sales growth was led by our Industrial, Safety, Security, and Protection Services, Consumer and Office, and Electrical and Communications businesses.

U.S. selling prices declined 40 basis points in the quarter.

Our international operations continued to post strong growth with sales up 14.4% in U.S. dollar terms.

Core volumes increased 10.6% and acquisitions added 30 basis points of growth.

Currency effects boosted sales by 4.8%, driven by positive translation of 6.1% in both Europe and Asia-Pacific, while currency effects in the combined Latin America, Africa, and Canada regions, reduced sales by 2.3%.

Overall, international selling prices declined 1.3% in the quarter, with most of the decline coming from businesses that serve the electronics industry, where it is important to look at the impact of both volume and price.

Local currency growth which is defined as volume growth plus selling price changes, was 18.5% in Asia-Pacific, with Japan up 8.6%, and the rest of the region up 25.6%.

Six of the seven businesses posted positive local currency growth in Asia-Pacific during the quarter.

We posted a 13.8% local currency growth in the combined Latin American, Africa and Canada region with all seven businesses increasing sales local currency.

In Europe, local currency sales grew by 50 basis points in the quarter versus last year.

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

Total operating income was up 23.4% to approximately 1.2 billion, with margins improving 270 basis points to 23.7%, as six of our seven businesses improved their operating income margins in the quarter.

Gross margins were 51.1%, a 1.8 point improvement over the second quarter of last year.

The combination of improving volumes, factory efficiency and the ongoing benefits of the corporate initiatives continued to drive improvements in gross margins.

SG&A was 21.6% of sales, a 70 basis point improvement year-over-year.

This leverage is primarily due to the faster growth of our businesses in the Asia-Pacific region.

Research and development and related expenditures increased 5.3% year-on-year, as we continue to fund future growth for the company.

As a percent of sales, R&D was 5.8%, versus 6% in last year's second quarter.

Second quarter net interest expense was $6 million, versus $19 million last year.

The tax rate for the quarter was 33%, which was in line with last year's comparable quarter.

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

This could change, however, depending upon the outcome of proposed federal tax legislation.

Quarterly net income increased 24.8% year-on-year, and earnings per share improved 24.4%.

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

Sales increased 1.5%, versus the first quarter of 2004, as five of our seven businesses posted sequential dollar increases.

The leverage of sales increase into a 6.2% sequential operating income.

Operating margins improved by 110 basis points sequentially, driven by the higher volumes and the corporate initiatives.

On a sequential basis, net income increased 7%, and earnings per share increased 7.8%.

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

Healthcare's operating income was 274 million, or 26.1% of sales in the quarter.

This represents a 4% increase versus the second quarter of last year.

Healthcare's global sales again exceeded $1 billion in the second quarter, with year-over-year local currency growth of .3%.

Similar to last quarter, second quarter sales growth was negatively impacted by about two percentage points by the Lilly and IVAX pharmaceutical agreements which did not repeat in 2004.

Also impacting growth in Healthcare was a challenging year-on-year comparison in our drug delivery business.

Comparing to all-time records in the second quarter of 2003, this business negatively impacted Healthcare sales by over 2%.

Excluding pharmaceuticals and the drug delivery business, Healthcare revenues grew 6.5% in local currency, versus the second quarter of last year.

The negative sales growth impact of the combination of Lilly, IVAX and our drug delivery business will continue for another quarter.

We expect fourth quarter revenue growth rates in Healthcare to improve as both Lilly and IVAX year-on-year comparables will be behind us.

Moving to Industrial.

Local currency growth was 10.4% in the second quarter, versus the same quarter last year.

The growth was broad-based across all geographies and businesses.

The HighJump acquisition added 1.3% to growth in the quarter.

Operating income grew 64% to $167 million, reflecting the significant leverage in this business.

Display and Graphics continued a strong track record of growth in the second quarter, increasing 18.2% in local currency.

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

Commercial graphics business which supplies films, inks and equipment for the commercial advertising industry, also maintained its first quarter momentum, hosting year-over-year high-single local currency sales growth in the quarter.

Operating income in Display and Graphics increased 48.7%, to $311 million.

Local currency growth in Consumer and Office was 4.2% with operating income increasing 14.4% to $123 million.

Geographically, growth was led by the United States.

Our Safety, Security and Protection Services business, local currency growth, was 3.4% in the quarter.

Growth in this business was restrained by the strong 2003 second quarter performance of our respiratory products business due to the global SARS outbreak.

The Hornell acquisition added 2.5% of growth in the quarter.

Year-on-year profits improved 3.7% to 136 million.

Excluding the Hornell acquisition-related costs, year-on-year profits would have improved by about 6.6%.

Electrical and Communications local currency growth was 4.8% versus last year, led by strong demand for electrical products for insulating, testing and sensing, along with connectivity and diagnostic solutions for the communications industry.

Operating income was 79 million, up 12.3%.

And finally, local currency growth was 4.3% in our Transportation business, with operating income up 11.3% versus last year.

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

Net working capital turns were 5.4, an improvement of .6 turns versus one year ago, and up .1 turn sequentially.

Our goal remains a minimum of six networking capital turns by the end of this calendar year.

Inventories declined by $50 million, versus last year, or 2.5%.

Inventories were up 60 million sequentially.

Currency translation effects added 57 million to inventory year-on-year and reduced inventory sequentially by $12 million.

Accounts receivable were up $142 million, or 5.1%, versus the second quarter of 2003, and were up 9 million sequentially.

Currency translation effects added 100 million to accounts receivable year-on-year and reduced receivables by 29 million sequentially.

Capital expenditures were 220 million in the second quarter, an increase of 76 million year-over-year.

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

Second quarter free cash flow was $1.75 billion, up both year-over-year and sequentially.

This strong cash flow enabled us to pay $282 million in dividends to our shareholders during the quarter.

We also bought back 354 million of our own stock, resulting in a net repurchase cost of $136 million.

Weighted average diluted shares outstanding were 799.7 million, up 1% from last year, up just slightly versus the first quarter.

And our debt to cap ratio was 24% at the end of the second quarter.

For your planning purposes, we have decided to change our U.S. pension plan measurement date from September 30th to December 31st.

This change will align the measurement date of our U.S. pension plan with our international pension plan.

These changes will not impact our funding plans for the last half of the year.

In the third quarter, we'll be making a special pension contribution to our Japanese pension plan in the amount of approximately $160 million.

This contribution was included in our pension plan funding assumption for 2004, as disclosed in our first quarter 10-Q filing.

On slide number eight, I will give you a quick update on our Six Sigma initiative.

Six Sigma continues to grow in importance and is the way work is done across the whole company.

As of the end of June, we have now trained more than 31,000 employees in 60 countries in Six Sigma methodologies and have greater than 700 full time Nassar Black Belts and Black Belts currently leading projects.

We currently have more than 10,800 active projects underway in the company, and have closed more than 10,000 projects.

Of the active projects, approximately 50% are focused on cost, 35% on growth, and 15% on working capital.

We continue to shift more of our Six Sigma efforts to growth.

Six Sigma with our customers continues to gain traction as there are now over 200 active projects focused on solving our customers' most critical issues.

And finally, we have greater than 200 active designed for Six Sigma programs focused on driving higher organic growth.

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

Building upon our strong first and second quarter performance, we now expect full-year 2004 EPS to be within a range of $3.72 to $3.75 a year.

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

For the third quarter, we expect sales and earnings to be very similar to the all-time record second quarter, with EPS of 97 cents per share.

Total volume growth will be in the 5 to 7% range.

You'll recall that in last year's third quarter, we accelerated the recognition of the majority of the remaining revenue from the termination of the agreement with Eli Lilly and Company to collaborate on resiquimod, a potential treatment for genital herpes.

This increased last year's third quarter sales growth rate by approximately 50 basis points and earnings per share by about 2 cents.

Included in both our third quarter and full-year guidance is the adoption of FASB Number 106-2, is the accounting and disclosure requirements related to the Medicare Prescription Drug Improvement and Modernization Act of 2003.

Implementation of this Act will increase our earnings per share for the last half of 2004 by approximately a penny and a half per share.

Before we begin the Q&A, let me quickly summarize the quarter.

This was another very good quarter for 3M.

Sales increased 9.5% exceeding $5 billion for the first time in company history.

Operating income margins improved to a record 23.7%, earnings per share improved 24.4%, and we generated greater than $1 billion of cash flow, reflecting the broad-based contribution of our business portfolio.

This concludes the formal part of today's call.

Joining Mark and me this morning are Matt Ginter our Director of Financial Planning and Analysis, who most of you recognize as our former IR Director, and Bill Schmal, our executive responsible for Treasury and Taxes.

Ron Nelson, who's been on these calls in the past, as our Controller, retired earlier in the second quarter.

We'd be happy to address your questions.

So 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 keypads at this time.

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

If are you on 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 question comes from Steven Weber with S.G. Cowen.

Good morning.

I've got a couple of questions.

One, Pat, can you tell us what the currency impact on an earnings per share basis was, and what, if the rates stop right here, what it would look like in the second half of the year?

And then I have a couple of follow-ups.

Steve, on the currency side, again, as I've kind of explained to everybody in the past, is due to the literal currency translation impact, but the way we manage the business, is the currency is favorable, we have a tendency to want to use some of that money to spend towards productivity efforts across the company.

But if you do the math, it's about 6 cents in the quarter.

If you were to pick the Q2 ending rates, it probably is about 4 cents a quarter in the third and fourth quarter.

Okay.

I see your inventories went up a little bit sequentially, notwithstanding currency.

How did the sales value of production look year-on-year and sequentially?

Basically it was in line with our volume, Steve.

Nothing unusual.

Obviously, production was up a little bit sequentially because inventories did grow a little bit, and most of that's related to some seasonal business that we have in the third quarter.

All right.

And then lastly, in the past, you've alluded to the fact that you have some, you have a problem division in visual.

Can you just give us some update on how that looks, and should we be looking forward to some sort of action there?

Visual did impact the Consumer business, I think by about 1% on the top line.

It is a, they obviously, a decreasing volume business for us.

We obviously continue to look at various alternatives for that business.

It is a cash positive business for us.

And so we will continue to work on the solutions for that and as soon as we have a solution other than what we're currently doing, we'll let everybody know.

Okay.

Thank you.

Our next question comes from Bob Cornell with Lehman Brothers.

Good morning.

Good morning, Bob.

The contribution margin in the quarter looks like it was over 50%.

Maybe you could comment on, you know, why that was, and how sustainable it is?

And then I have one follow-up question, too.

Well, I guess, you know, as in previous quarters, Bob, I guess, you know, your point is right on, is that we continue to strive to get both top line growth of the business sequentially and year-over-year, and obviously continue to drive the corporate initiatives, for really ongoing productivity and growth enhancements to the business.

So, and you know, in that light, obviously the, you do end up with, you know, good leverage of the business.

You know, you mentioned earlier you changed the pension plan, you know, date, I mean was there anything in this quarter that reflected, you know, some accounting issue in pension and medical that was a weight in the full year?

Is there anything unusual in the corporate line?

There is nothing in the second quarter at all related to, be it pensions or post retirement healthcare that would affect the second quarter results off of the first quarter.

Just one final question.

I mean the organic growth was good, but I actually thought it would be higher.

You know, how did the quarters, how did the months track through the quarter in terms of, you know, if you have that data, April, May and then June?

Well, it was not that unusual of a quarterly activity.

Now, Bob, you may have expected a higher number, I think, you know, doing 77 total growth is, we think a pretty respectable --

That's good, all right.

-- number for the company and we've got four quarters in a row that we've been above 7% growth and our target range is, you know, for the year was in that 6 to 8 so we've been running at the higher end of the volume range, so that's, you know, completely in line with our, you know, expectations.

Okay.

Thanks Pat.

Our next question comes from David Begleiter with Deutsche Bank.

Thank you, good morning.

Good morning, David.

Pat, on the films business, can you discuss whether there's any acceleration in pricing pressure, how your capacity addition is coming along, and the competitive landscape in that business today and going forward?

Well, I guess it was kind of a lot of issues there, David.

I guess, you know, all on optical film.

The pricing pressure obviously remains a significant piece of the growth of that overall business.

When you look at, you know, one of the largest growing segments of that business, obviously it will be LCD TVs, and the end market pricing of TVs have to come down, to, you know, get the growth rate up in LCD TVs, and as a critical supplier in that industry, obviously we will be a part of that, you know, that solution for them.

The pricing though has not necessarily accelerated against any of our expectations that we had.

Our capacity is continuing to come online, you know, based upon our conversations in previous quarters.

There does appear to be a little bit maybe of a inventory correction going on in some of the, with some of the manufacturers right now.

That obviously we'll have to, you know, pay close attention to.

Nothing that is significantly changed from the long-term trend of the business.

Just a normal quarter-on-quarter movement.

And competition, we obviously stay very, very close to our customers.

Working with all of them on providing value to them.

So obviously, you know, we maintain our competitive position with each and every one of them.

Thank you, Pat.

Next question comes from John Roberts with Buckingham Research.

Hi, Pat.

John Roberts here.

Good morning, John.

The 35% margins that you had in the Display and Graphics segment, I mean sequentially, sales were down, but sequentially margins were up a whole lot.

Could you talk about maybe what happened there in terms of mix or whatever caused that and should we think about those margins as a new sustainable level?

Well, it's you know, a number of businesses embedded within Display and Graphics, and optical film of course gets a lot of the press, but we've got a number of good businesses in there including the commercial graphics business whose profitability has improved.

Of course you got our traffic systems business in there as well.

Which is, you know, still performing at a very, you know, a very high level.

So nothing, you know, nothing unusual.

You know, on a going forward basis, you know, as Bob mentioned, or I guess David mentioned, on, you know, optical films is, we were going to obviously have to play a volume and price combination game in that business.

The LCD TV market probably doesn't have the same margins as some of the other products they have.

But you know, 35% margin is a reasonable point to, you know, kind of keep working off of.

And as a follow-up, were you surprised that the Industrial segment wasn't up sequentially?

It was down 1% in sales and it was down meaningfully in terms of earnings sequentially.

No, not at all.

We're very happy, actually, with our Industrial, you know, our Industrial sales.

When you look at, you know, again, you'd say sequentially, they're down a little bit, but year-over-year, you know, they're up, what, 10%, a little bit of that at one point of it was HighJump related so nine points of organic growth in Industrial, we're very pleased with the performance in Industrial, and on a total geographic basis as well.

Thank you.

Our next question comes from Michael Judd with Greenwich Consultants.

Yes, can you just give us a quick update in terms of the amount of cash flow that's going to be spent on voluntary pension expenditures in the third and fourth quarters, please?

Yeah, Michael, in our 10-Q for the first quarter, we had said that our contribution would be in the 100 to $600 million range the last half of the year.

And the contribution could be in Q3, and Q4, it could all be in Q3, we haven't exactly decided what the timing of those contributions is going to be.

In that Japan is now 160, obviously we'll have to increase the lower end of that range when we do our Q filing this next time around.

A lot will depend upon of course where the equity markets run the rest of the year, and where interest rates go.

That will determine what our final contribution to the pension plan will be.

But we've got plenty of cash flow and cash in the business that we've got a lot of flexibility of, you know, adequately getting after whatever needs we have in the multi-U.S. as well as the global pension plan.

Okay.

So just to make sure what you said, it's going to be 100 million-plus because the 162 to 600 million, and that would be for the second half of the year total?

Let me go back.

Our contributions are normally back-end loaded.

Based some during the year in countries where you have to make them on an ongoing basis.

Our guidance was 100 to 600 million last, in the first quarter.

Subsequent to that, we did decide to put $160 million into our Japanese pension plan which will occur here in the third quarter.

So we'll be updating our guidance in the Q filing so, you know, the low end obviously has to go at least to 160.

Which is, which would be the Japan program.

So, you know, the upper end of the previous guide was a 600.

And it will all depend again upon how well the equity markets and the interest rate markets perform between now and our measurement date to determine exactly what the final funding will be.

Okay.

Again, I just want to make sure I understand the time frame here, okay?

The numbers that you're talking about here, I know that you've mentioned them in the first quarter, okay, but were they for the second half of the year?

Yeah, they're back-end loaded so they're for the second half of the year.

Normally, the contributions go in in the September time frame, could be a little bit later than that.

Thank you.

Next question comes from Jack Kelly with Goldman Sachs and Company.

Good morning.

Good morning, Jack.

You had talked, Pat, a little bit about Industrial, which ex-ing acquisition it's still accelerated year-over-year in the second quarter.

Can you just give us some geographic flavor, you know, how did the U.S. do, how did Europe do, you know, specifically?

Actually, we had very, Industrial had very, very broad-based growth on a geographic basis.

U.S. was very, you know, U.S. was very strong, Asia continues to be very strong for us.

Latin America was, you know, continuously strong for us as well.

And of course Europe, as the economy is still running relatively low growth rates, so that would be, you know, one of the slower growers, but really across all geographies, Industrial continues to perform very, very well.

So you're saying in the U.S. then, if we just focus on the U.S. ex acquisition for Industrial, year-over-year growth was stronger the second quarter than it was in the first?

They were about, it was pretty comparable I think between the first and second quarter.

Okay.

Great.

And then in terms of pricing, it was, you were down, you know, 1% companywide in the quarter, versus about half of that in the first quarter.

Can you talk about the dynamics of that?

I mean I would have thought that pricing actually would have improved in the second quarter, just, you know, given commodity pass-throughs, et cetera.

Or is it, you know, maybe a function of what's happening in Display and Graphics that's kind of skewing things?

No.

It obviously is a, part of it's a mix answer, Jack, is that we're in the businesses that are tied to electronics, which of course optical film is a big piece of that, is obviously a volume price game.

So pricing in that market continues to, you know, go down.

And obviously, we get to volume, volume with that.

You know, the pricing, as I say, we're constantly looking at our competitive position.

We look at, you know, a 23.7% operating margin, so we look at obviously the combination of where our cost position is, our pricing position in every market, and make a judgment as to, you know, where we want to take price, where we want to go after, go after volume, and we think, you know, right now is, you know, a good organic growth in the business, with the good margin structure we've got.

We've got, you know, the right balance in the business.

So, in terms of the pricing pressure that you might have seen, you're saying it's more tactical on your part than maybe not getting pass through on certain commodity?

I'd say it's a combination of both.

In certain industries, obviously where prices are down, as well as certain areas that we obviously decided to take, you know, and go after obviously some volume with our increasing margins at the same time.

And just finally on Asia-Pacific, can you break down Japan and non-Japan Asia on that 18.5% growth number that you showed for the region?

Yeah, Japan was 8.6% for the quarter, the rest of the region was 25.6%.

Thanks.

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

Good morning, guys.

Hey, Mark.

I am trying to do a little math here on what you said about Displays and Graphics.

I think you indicated that Graphics was up 8%.

If I do some math on that I kind of conclude that the rest of that segment must be up in the kind of low 40% area.

Is that about right?

I'm sorry, Mark, what did you say was 8%?

I think you said of the D&G area, Graphics was up 8% in the quarter.

I think you said that in your prepared remarks and so I was trying to back into what the other part must have been up.

You're talking about commercial graphics?

Right.

Well, I'm not going to take you business by business, okay, Mark, through that?

You can see 18% for total, commercial graphics was up, you know, high single, you know, high single digits.

So, you know, that's optical systems would be above the, you know, 18%.

Okay.

Dramatic slow down sequentially in Safety and Consumer and Office.

Can you kind of talk about why those businesses slowed so much sequentially?

Well, there's really no particular I guess reason that's seasonality related, Mark.

Consumer business, there wasn't anything that was really unique with that business that, you know, is worth calling out.

Safety, Security, kind of the same thing.

There's nothing was unusual in the quarter from a trend standpoint.

We expect both of those businesses to actually, might be up sequentially again in the third quarter.

Mark, I'd point out one thing and although I don't have it by business, this is Matt, translation sequentially hurt by about a point, roughly.

Okay.

That's helpful.

And then lastly, were there any prelaunch costs worth talking about for AK in the quarter which may have hurt Healthcare results?

There were.

Of course there's, you know, samples, and so forth, within the Healthcare business that were part of the quarter, you know, quarter results.

You know, I'm not going to use that as a kind of a reason, you know, why the results were what they were though, because that's part of that business.

But that obviously did affect the second quarter a little bit.

Okay.

Thanks.

Our next question comes from John Inch with Merrill Lynch.

Thank you, good morning.

Good morning, John.

Hey, Pat, if were you to take your electronics businesses and exclude the negative impact of pricing there, what happened to pricing within the rest of the company?

Was it better or worse sequentially or year-over-year?

If you could give just a little more color there?

I would, we don't aggregate it exactly that way, John.

So I'm going to just do kind of a --

Just roughly.

Back of the envelope.

We're probably a little worse, okay, in second quarter than we were in the first quarter.

And Pat, was that, is that result, because, you know, it seems to be somewhat different than other companies that are talking about price increases.

Has it been tactical on your part, and is it, you know, product-launch specific or regionally specific?

Just what, how should we be thinking about pricing in 3M ex electronics businesses?

Well, I would say that somewhat consistent with tradition is we've been, you know, flat to slightly, you know, down on pricing.

As we plan the business, we plan the business on the basis that we do not have price recovery potential.

Which, you know, is, and then obviously we go after whatever we can.

A piece of it obviously was tactical in nature, though, you know, we're going after certain businesses.

The other thing that skews the mix here a little bit on pricing is, generally pricing and Healthcare is more positive than some of the other segments, and with Healthcare's volume down, you know, as a percent of the total in the quarter, obviously that does affect the, you know, the overall percent as well.

Yeah, that's helpful.

And then just lastly on the profit conversion, the 50%, if you were to look at that U.S. versus other regions, is there much of a difference or is everybody pretty much up the 50%?

It'd be, it's hard to kind of say exactly John, as to where that played out.

The U.S. had, I think, decent, you know, decent leverage, Europe has, you know, very good leverage, and of course, Asia keeps running very, very, very strong.

But at the same time as we are investing a lot back into Asia, for long-term growth in the region, so, you know, obviously we don't disclose, you know, geographic until we get to the end of the year, but I would say that from a leverage standpoint, probably more so in the U.S., okay?

In Europe and to some degree even in Latin America in the quarter.

Okay.

Thanks, Pat.

Our next question comes from Dmitry Silversteyn with Longbow Research.

Good morning, gentlemen.

Thank you for taking the call.

Couple of questions.

First of all, on the bookkeeping side, what was the depreciation and amortization in the quarter?

Oh, guys, I guess you can kind of pull it up.

I think it's, was about 235 before intangibles.

Is that about right, Matt?

241 in total, Dmitry and--

Keep going and I'll get that.

Okay.

Excuse me.

My second question is, if you look at the Consumer and Office, was there much of a difference in terms of growth rate between the U.S. and Europe?

I understand that Asia has been very strong, but in Europe, have you seen any improvement in that business or it continues to be slow?

Europe continues to be a very tough consumer market, with you know, the growth rate relatively low, jobs down in Europe, that remains, a very, you know, tough, tough market.

And have there, of your businesses, given that Europe was essentially flat and excluding currency, were there any of your divisions that actually had negative year-over-year comps in sales?

In Europe?

Yes.

Well, I mean if a whole business was up 50 basis points, it's bound to have some that are, you know, some that are above and some below.

Any idea which were above and which were below?

Yeah, let me just, I have to kind of pull that out here just for a second.

Okay.

If you look at Europe, probably the strongest businesses we had were Industrial, Transportation, Safety, Security were the three that probably stood out as being the largest growers there.

And then the others were either, you know, flat to down some.

Okay.

And of the three that were the strongest growers, I'm assuming it was relatively speaking, so probably low to mid single digits excluding currency?

Some of them were, you know, in the low single digits, probably a fair read.

Low single digits.

Okay.

And you know, you talked about pricing pressures excluding electronics being an issue, and I'm also assuming excluding the generic competition in the pharma business, have you experienced raw material pressures on the other side or are you able to keep your raw material costs fairly under control given all the internal initiatives have you as far as global sourcing and cost reduction efforts?

I guess I'll rephrase a little bit your question.

I don't see pricing as being an issue.

I think with the cost structure we have, the competitive position we have, I think we've got flexibility now with certain customers and so forth to obviously gain, you know, gain some business at the same time.

On the raw materials side, we're obviously, if you look at commodity indexes and so forth, they've obviously been increasing.

However, our global sourcing efforts continue to work at keeping those, the total cost of materials down.

Okay.

Okay.

So overall, if you look at year-over-year, your direct material costs are down despite the --

I would say direct material costs are, you know, flat to down just a little bit.

Excellent.

Thank you very much.

Hey, Dmitry, back on the depreciation --

Yes.

D&A was 245.

245.

Great.

Thank you.

Including the [inaudible].

Right?

Excellent.

Our next question comes from Jeff Cianci with 3M.

I'm with UBS.

Unless Pat, it's something you want to talk about.

Maybe I'll get some stock options at 83.

Jeff, you'd be way too expensive for me.

I wish.

Incremental margin.

Could you go into that a little bit?

If I look here at these two big driver division display, it's like a 65%, Industrial's like the same thing, 60-some percent incremental margin, you're seeing leverage there and then if I look, I'm sure the math is wrong here, but 2Q versus 1Q, if I look at the sales growth, the profit growth is almost all, you know, it was close to 100%, so it looks like, you know, sales grew sequentially, what, 70-some million and profits grew sequentially 60-some million.

Can you give a little color there what's going on A, and B, do you expect that kind of incremental margin to continue?

Jeff, there's no way on a long, long-term basis you're going to get almost 100% leverage.

I was thinking about second half is the question.

Top to bottom line.

Our view, and if you take Q3 just as an example, we're looking at about flat volumes Q2 to Q3, and of course, the same EPS so, you know, we're basically holding, okay, the margin position that we currently have so, you know, we continue to look at the business, of course year-over-year as well as sequentially to add business.

But I would not anticipate a long-term leverage, okay, of effectively being 100, you know, 100%.

I think our history of being more 50, 60% is probably, you know, more realistic.

50, 60?

Okay.

And if I recall the significant Six Sigma question, you said you closed 10,000 projects and, you know, I could think in round numbers, let's say if you got out of that a billion dollars in profit.

I don't know if that's right.

It's be somewhere around 100,000 a project.

If that's the case, you got another 10,000 projects.

More biased towards growth going forward.

Assuming they take, you know, a couple years each type of thing, are we looking at another billion dollars profit generation from this next round of Six Sigma?

How does it compare with the first round?

Well, Jeff, I'm not going to quote numbers, okay?

I think the important part here is the following: We're getting everybody engaged in Six Sigma, we're accelerating the organizational capability for long-term, sustainable improvements in the business.

Part of the focus here on Six Sigma is we still have a lot ahead of us, okay, to go in the way of further improving the business.

The mix may change a little bit as I kind of mentioned in my words, maybe a little more towards growth, as we, you know, move through time.

We still have a fair amount of effort, as I mentioned, 50% on the cost side, so if you look at, you know, where we were to where we're at, and you get everybody engaged in it, that just, you know, there's a lot more opportunity to just identify additional opportunities for the business to get better.

Do you see a difference in, in other words, are the new Six Sigma projects qualitatively different than the old ones?

I think the organization gets better.

You know, you get better at doing them.

Cycle time improves on them.

So it's a, you know, there's, I think the change is that it becomes, is changed from really the way you do business across the company, Jeff.

Okay.

Lastly, if I could ask, are you allowed to be in the market today buying stock, your buy back program?

No, we're not.

And when can you do that?

I guess the third trading day after earnings season.

And you know, we did close to 800 million first quarter, you have a billion five authorized, you know, is, do you expect to finish that in the second half?

Would we look for more after that?

What's your feeling now?

Well, you're right.

We've got a board authorization of a billion and a half, and we'll obviously, you know, keep working through that.

We've spent 800 as you said, so we still have another 700 or so to go and we'll obviously keep, you know, keep an eye on while we're doing pension funding as well as buy back shares in the last half of the year.

Okay.

Thanks, Pat.

Thanks, Jeff.

Our next question comes from Robert Ottenstein with Morgan Stanley.

A couple of questions.

First, can you give us some more details on the SG&A line, which was down sequentially, I think it's generally up sequentially due to higher marketing, can you go maybe through the foreign exchange impact on that, whether there were any one-time positive items that helped it, and what you're doing with your various marketing programs, and you know, were there any, you know, additional cost-cutting or what kind of additional cost cutting was there on the SG&A line?

I guess, Robert, there was nothing unusual in SG&A in the second quarter that drives it, you know, where it is.

Now of course part of that is just leverage, okay, with the volume growth we have.

But on an absolute basis the numbers stand, right?

Yup.

And I think you had actually given some guidance, I thought, in the first quarter to expect it to go up, both due to Aldara marketing and also the increased marketing for the consumer business.

[Add] more spending was up when you look at first quarter to second quarter.

But a lot of this is good control of the, you know, of the cost side, Robert, in our whole, you know, administrative side of the --

So you're doing a great job cutting costs still?

There's a difference between cutting, okay, and managing, you know, managing costs, okay?

I'd say it's more managing our SG&A costs as compared to --

Do you know what the foreign exchange impact was in the quarter?

It was virtually nil, Robert.

From the first quarter, I mean if sales were hurt by foreign exchange I would think that SG&A would be helped a little bit.

Sequentially, you're saying.

Yeah, sequentially.

Sequential impact on SG&A, close to zero.

Really?

Yup.

Okay.

So it's all on the control side.

Great.

And would you expect to, expect it to kind of go back up again in the second half on an absolutely basis?

Well, generally speaking, in the third quarter, it is a little bit higher.

Our Consumer business that has seasonal back-to-school and Christmas has a tendency to run a little higher in Q3 and Q4.

We are putting more money in the marketplace and trying to grow our Asian business on the consumer front as well, Robert.

So in that, on that side, the answer would be yes.

Okay.

And then just a last question.

The Healthcare business, volume is pretty much flat.

I know you talked about some tough comps in some particular areas but if I go back to last year, organic volume growth for that business is only up 5.6%, which wasn't particularly strong.

I mean pardon the pun, but you know, how do you give us some confidence that this business isn't sick here?

Well, it's not sick, and I appreciate the pun.

You know, we've got a lot of effort on a number of pieces of the business.

As you're well aware of, on the pharmaceutical side, we've been, you know, focused heavily on getting the new Aldara products launched, you know, last week we got approval for Basal Cell Carcinoma which was good news.

Again, long-term growth prospect for the business.

Healthcare is a, you know, it's a somewhat of a tougher business than, you know, I think a lot of people anticipated it would be.

We still think it is one of our higher growers.

We, you know, put it above that 5 to 8% long-term growth rate for the portfolio.

And we still think it's, you know, it's going to get there.

And I think, you know, by the, you know, the tail end of the year you'll see, you know, good growth rates in Healthcare.

But do you think, I mean is there new competition or is the markets just slow?

Because I mean you averaged this out over two years, and it's well less than the bottom end of your goal.

Yeah, that's, you know, that's true, Robert.

I mean is it the end market growth?

Or is it competition or --

I think it's, in end market, there's a combination, let's face it.

There still is a very significant demand for Healthcare services.

You know, one of the, of course, the challenges is there's more and more price pressure on the Healthcare space than probably has historically been there.

But you know, Healthcare, you know, premiums and so forth continues to rise on the other side of this.

So the demand is, you know, is very good in that space.

We have to get, you know, our pharmaceutical business growing, our drug delivery business had a great 2003.

We got to get, you know, some of that back here in the 2004, or back end as well as 2005.

Dental remains a very, very strong franchise for us.

The medical supply business is, you know, is a very good business.

Again, not a high grower, okay, but a very good, you know, grower for us, solid there, piece of business, and HIS continues to grow significantly for us as well as the personal care products as well.

Great.

Thanks a lot, guys.

Okay.

Our next question comes from Gene Baron with Capital International.

Hi, three quick questions.

First, on Six Sigma, I'm just curious, in the 3M version of Six Sigma who's running each of the projects?

You got 700 Black Belts and Master Black Belts so --

Yes.

Pretty clear they're not running --

Well, yeah, Gene, there's a, if you look at the hierarchy, okay, we have, the other day, business leaders, okay, are in charge of the responsibility of getting Six Sigma projects done.

But the hierarchy within the Six Sigma community is we got Master Black Belts, Black Belts, and Green Belts.

And one of the things of course that over time as you get more and more Green Belts trained is Green Belts start to run more and more of their own projects, and Black Belts and Master Black Belts take on the more complex ones.

They also are in charge of managing, though, a number of projects underneath them, so they are managing projects themselves and they are also overseeing other projects within.

So you're comfortable the way you're managing it that the Black Belt, the Master Black Belts kind of averaging projects?

I'm sorry, I missed the last part of that, Gene.

To kind of sum up the Black Belts and Master Black Belts, 700 and you got 10,000-plus projects that's about 50 per person.

Yeah we're very comfortable we can manage that number.

Again, as I mentioned, one of the critical things is to get Green Belts engaged in managing and running their own projects.

The second question is, essentially you guys have no debt, no net debt or shortly will have no net debt.

Is that where you want to be?

If you don't want to be there, where do you want to be?

And how do you want to get there if we assume that you're going to generate, continue to generate good cash flow, more than enough to fund the type of acquisition activity?

Well, Gene, I guess having flexibility, balance sheet flexibility is a great asset for a company, it's a lot better than I think the alternative.

We will continue to focus on generating cash flow of the business, and then with that cash flow, we'll obviously look at, you know, various alternatives around, you know, what's the best return for shareholders that could be investing further into growth, you know, or you know, eventually acquisitions.

But on the acquisition front, we're focused on doing only the right deals that make sense for us, and we're not going to let our cash position necessarily drive when that timing is.

Your dividend increases have not kept up with your earnings growth.

Is that something you want to continue?

Well dividends, we raised dividends 9% last year.

You're right that the earnings growth of the company is growing faster than dividends.

It is something that we take a look at on a continuous basis with the board of directors to make a decision as to what that payout ratio will be and again, we got 46 consecutive years of dividend increases, which there is only, I think, less than five or so that I think have that history.

I hope you won't be hurt if you hear me say that you really haven't told me something there or answered the question to give me kind of an understanding of what your thought process is.

Well, our thought process is, first of all, our thought process is to generate all the cash flow we can in the business.

What we then do with that, will depend upon organic needs of the business, or, is the number one priority, we think that's the highest leverage thing we've got in the business.

We'll continue to look at acquisitions to see what makes sense on that front.

So we've got a billion and a half dollar buy back program.

Again that's an '04 program.

We haven't, you know, looked at what the '05 program would be at this point in time and then we'll address what the new dividend, you know, payout will be, you know, with the board on an ongoing basis, depending upon what our, you know, our balance sheet position is.

So -- at that time.

And the last question, what isn't growing in Healthcare?

The things you talked about, you know, where Healthcare is, something has to be not growing in order to get to the number where you're at.

Well what I mentioned is drug delivery, okay?

If you look at the comps '03 to '04, is down.

But we had a record performance on both product sales as well as R&D, the contracts, in '03.

Those have not repeated here in '04.

So that business is down year-over-year.

We had some pharmaceutical agreements that were more one-time in nature that affected our, you know, our comps for 2000, 2003.

Right, we know the impact of those.

Yup.

Anything else?

That's it.

Thanks, guys.

Appreciate it.

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 the 3M for some closing comments.

Okay.

Again, thanks for joining us this morning.

And we're looking forward to a continuing success in 2004.

And thanks for supporting us.

Ladies and gentlemen, that concludes your conference for today.

You may all disconnect.

And thank you for participating.