3M (MMM) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the 3M third 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 1 on your telephone keypad and questions will be taken in the order they are received.

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

As a reminder this conference is being recorded Monday, October 18, 2004.

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

Good morning.

I'm Mark Kolwin, Director of Investor Relations for 3M.

And welcome to our third 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 PowerPoint slides which are currently available on our Investor Relations Website.

Looking ahead our fourth quarter 2004 earnings conference call will take place Tuesday, January 18, 2005.

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 Q&A section of our most recent Form 10-Q lists some of the important risk factors that could cause actual results to differ from our predictions.

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

Pat.

Thanks, Mark, and good morning everyone.

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

Please turn to slide number two.

The third quarter reflected the strength of 3M's business and geographic diversity and our continued focus on driving operational excellence through several corporate-wide initiatives.

Reported earnings per share were 97 cents per share, an increase of 16.9% over last year's third quarter.

Third quarter sales increased 7.6% to 4.97 billion as six of our seven businesses posted positive worldwide local currency growth.

Volume growth was 5.6%, led by our industrial, display and graphics, consumer and office, and safety, security and protection services businesses.

We now have posted year on year positive volume growth for ten consecutive quarters.

Geographically the Asia Pacific region continued to lead the way with local currency growth of over 12% in the quarter.

Operating income was up 14.9% to almost $1.2 billion.

Earnings growth was very broad-based as five of our seven businesses posted double-digit operating income growth led by industrial, electro and communications, consumer and office, display and graphics, and safety, security and protection services businesses.

Operating margins increased to 23.8% a 150-basis point improvement versus the third quarter of last year and slightly ahead of the second quarter.

Free cash flow was 487 million in the quarter, up 4.7% year on year.

We made special pension contributions of 455 million. 300 million to the U.S. pension plan and 155 million to the Japanese pension plan in the quarter.

Economic profit which is defined as after-tax operating income, plus a charge for operating capital, was 476 million, or up 22.1% over last year.

And finally, return on invested capital is running just under 25% year to date.

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

As I mentioned, worldwide sales in dollar terms increased 7.6% versus last year's third quarter.

Global volumes increased 5.6% with core volumes up 5% and growth from acquisitions adding 60 basis points.

Selling prices declined 50 basis points while year on year currency translation added 2.5% to third quarter sales.

In the United States, sales improved 3.5% with core volumes up 2.3% and acquisitions adding 90 basis points of growth.

U.S. sales growth was led by our consumer and office, industrial, safety, security and protection services businesses.

U.S. selling prices increased 30 basis points in the quarter.

Outside the United States, sales were up 10.8% in U.S. dollar terms compared to last year's third quarter.

Core volumes increased 7.2%, and acquisitions added 30 basis points to growth.

Currency effects increased international sales by 4.4% driven by positive translation of 7.5 in Europe, 2.7% in Asia Pacific, and 1 percentage point in the combined Latin America, Africa, and Canada region.

As mentioned in previous quarters international selling prices continue to be impacted by our businesses that serve the consumer electronics space, declining 1.1% during the quarter.

Local currency growth, which is defined as volume growth plus selling price changes, was 12.2% in Asia Pacific with Japan up 3.6% and the rest of the region up 18.4%.

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

Local currency sales increased 8.4% in the combined Latin America, Africa, and Canada region, with six of our seven businesses increasing sales in local currencies.

In Europe local currency sales declined by 30 basis points versus last year's third quarter.

On slide number 4 we compare our third quarter P&L versus last year's comparable quarter.

Total operating income increased 14.9% to approximately $1.2 billion with margins improving 150 basis points to 23.8%.

As five of our seven businesses improved their operating income margins in the quarter.

Gross margins were 50.6% up 90 basis points from last year's third quarter, primarily driven by a combination of increased volumes, factory efficiency, and the ongoing benefits of the corporate initiatives.

Our Global Sourcing initiative was particularly important in enabling us to effectively manage raw material increases during the quarter for commodity price inflation.

SG&A was 21.1% of sales, a 40-basis-point improvement year-over-year.

During the quarter we invested $282 million in research and development and related expenditures, which is a 4.5% year on year increase.

As a percent of sales R&D was 5.7% versus 5.9% in last year's third quarter.

Third quarter net interest expense was $5 million versus 16 million last year.

The tax rate for the quarter was 33% which is 40 basis points lower than last year's comparable quarter but in line with our expectations.

Both quarterly net income and earnings per share increased 16.9% year on year.

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

Sales decreased .9% versus last quarter due in part to a sequential slowing of 4.4%, or $40 million in our display and graphics business.

Consistent with what I mentioned on our second quarter earnings conference call we anticipated some inventory-related adjustments in the LCD channel in the third quarter, which affected short-term demand for our proprietary optical film and components.

We see this as a short-term correction only.

We remain confident in the long-term growth prospects of the LC display market.

Due to the strength of our overall portfolio operating margins improved slightly versus the second quarter to 23.8%.

Both net income and earnings per share were comparable for the second quarter.

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

Healthcare's third quarter operating income was 277 million, or 26.8% of sales.

This represents a 1.9% increase versus the third quarter of 2003.

Healthcare's global sales again exceeded $1 billion in the third quarter with year-over-year local currency declining slightly.

As you recall, in the third quarter last year we terminated an agreement with Eli Lilly & Company to collaborate on Resiquimod a potential treatment for genital herpes.

Upon termination of the agreement, though returns control of Resiquimod to 3M and we recognize the majority of the remaining unrecognized revenue or approximately $20 million in the third quarter of 2003.

Excluding the impact of Lilly and our IVAX pharmaceutical agreement third quarter sales and operating income growth rates would have been higher by approximately 3% on the top line and 5% on the bottom line.

This will be the last quarter that healthcare results will be impacted by these agreements.

Healthcare's growth this quarter was also impacted by our drug delivery business which experienced a year on year decline in sales of CFC aerosol products and a lower level of research and development contracts.

The drug delivery business reduced worldwide healthcare revenue by about 1.5% versus last year's third quarter.

Looking ahead to the fourth quarter we expect revenue growth rates to improve in the healthcare business as the year on year effect of these items will be behind us.

In our industrial segment local currency growth continued to accelerate with 10.5% in the third quarter.

As we generate positive local currency growth across almost all geographies and businesses.

The HighJump acquisition added 1.4% to growth in the quarter.

Operating income grew almost 48%, $170 million, reflecting the continued strong operational leverage in this business.

Display and graphics local currency growth was 6.6% versus the third quarter of last year.

As previously noted, year on year local currency growth in our optical systems business was slower than past quarters primarily due to inventory channel adjustments in the LCD market.

This resulted in reduced demand for our proprietary optical films and components.

Despite moderating growth this quarter in our optical film business we remain highly confident in our long-term value proposition and believe that this business will continue to be a significant growth engine for 3M.

Display and graphics operating increased 14%, 286 million in the third quarter.

Local currency sales grew 7.7% in our consumer and office business compared to last year.

Growth was strong across the many retail channels that we serve, most notably mass market consumer retail and home improvement.

Operating income increased 17.3% to $150 million.

Our safety, security and protection services business, local currency growth was 6.4% in the quarter driven by strong global demand for personal, protective products and solutions, along with cleaning and protective products for commercial buildings.

Our acquisition of Cornell, the European-based global supplier of personal safety equipment, added 2.6% of growth in the quarter.

Cornell is performing ahead of expectations in both sales and operating income.

Safety, security and protection services year on year profits improved by 10.2% to $123 million.

Electro and Communications local currency growth was 1.5% year on year.

Geographically local currency growth in this business was led by the Latin America, Canada, and Africa region along with Asia Pacific.

Operating income was 79 million, up 20.8%.

And finally, local currency growth was 3.7% in our transportation business with operating income declining 1.3% versus last year.

Operating income leverage was impacted by our decision to exit the Durell joint venture in last year's third quarter.

Excluding this impact third quarter year on year operating income was up 5.1%.

Now if you'd turn to slide number 7, I will review a few balance sheet and cash flow metrics.

Networking capital turns were 5.4, an improvement of .4 turns versus one year ago, and flat sequentially.

While we continue to work on improving our working capital efficiency our goal of obtaining a minimum of six networking capital turns by the end of 2004 does not appear to be achievable.

Inventories increased by 71 million versus the third quarter last year, or 3.8%.

Inventories were up 13 million sequentially.

Currency translation and effects added 55 million to inventory year on year and 10 million sequentially.

Accounts receivable were up 62 million, or 2.2% versus the third quarter of 2003, and were down 60 million sequentially.

Currency translation effects added 73 million to accounts receivable year on year and 7 million sequentially.

Capital expenditures were 235 million in the third quarter, an increase of 83 million year-over-year.

We still expect our capital expenditures to reach a total of 900 million for 2004.

Third quarter free cash flow is 487 million, up 22 million year-over-year.

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

Again, during the quarter we voluntarily contributed 155 million to the Japanese pension plan and 300 million to the U.S. pension plan versus a U.S. pension contribution of 600 million in the same quarter last year.

As we mentioned in our second quarter earnings call, we have decided to change our U.S. pension plan measurement date from September 30, to December 31.

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

If we measured our results as of September 30, our U.S. funded status would have been about 93% versus 86% last year.

We also paid $147 million in U.S. tax payments in the third quarter versus 17 million last year, as well as we paid out 97 million as part of the yellow pages settlement in the third quarter.

We paid 281 million in dividends to our shareholders during the quarter.

We also bought back 443 million of our own stock resulting in a net repurchase of $372 million.

Weighted average diluted shares outstanding were 796.2 million, down slightly from both last year and the second quarter.

And our debt-to-cap ratio was 23.4% at the end of the third quarter.

Please turn to slide 8 where I will provide an update on a recent pending legislative development and an anticipated accounting ruling and the potential impact on the fourth quarter.

First let me address the recent pending legislative development.

As you may be aware, the American jobs creation act of 2004, which encourages the reinvestment of foreign earnings in the U.S., is awaiting President Bush's signature.

As a result of this act, we would likely repatriate approximately $800 million of cash in 2005 that has been generated over time by some of our foreign operations.

This, however, would result in an increase in our tax provision in the fourth quarter of approximately $40 million as required by APB-23, which would reduce our earnings per share by approximately 5 cents in the fourth quarter.

If the pending legislation is implemented our fourth quarter tax rate would be 37% with the full-year 2004 tax rate being 34%.

Secondly, the financial accounting standard board's emerging issues task force recently reached a consensus on EITF issue number 04-08 for the effective continuously convertible debt on diluted earnings per share.

This ruling will require the dilutive effect of shares from contingency convertible debt to be included in the diluted earnings per share calculation regardless of whether the contingency has been met.

We expect this accounting change to be effective for fourth quarter.

As disclosed in our annual report we issued 693 million of 30-year 0 coupon senior notes that are convertible into shares of 3M common stock if certain conditions are met.

The EITF requires to us treat this bond issue as if converted and includes 6 million additional shares in our diluted earnings per share calculation this would result in a reduction of approximately 1 cent in our fourth quarter earnings per share.

If implemented the combination of the pending legislation and anticipated accounting ruling would result in a combined reduction in our earnings per share in the fourth quarter of approximately 6 cents.

Please turn to slide 9 where I will discuss our outlook for the remainder of 2004.

While we face many challenges, such as rising raw material prices, short-term inventory correction in the LCD market, and continued geopolitical concerns, we remain confident that our diverse portfolio of businesses and broad-based initiatives will drive top-line growth, productivity and cash flow.

Consistent with seasonal patterns in previous years fourth quarter earnings per share are expected to decline from third quarter levels.

For the fourth quarter we expect earnings to be between 90 and 91 cents per share excluding the impact of pending legislation to encourage the repatriation of foreign earnings and the anticipated change in the accounting rule related to contingently convertible debt instruments, or 17 to 18% increase over the fourth quarter of 2003.

The sales volume growth in the 5 to 7% range.

As I previously explained the combined fourth quarter impact of these items is expected to be 6 cents per share, therefore the Company would expect fourth quarter 2004 earnings in the range of 84 to 85 cents if enacted.

Excluding these fourth quarter adjustments, full-year 2004 earnings are expected to be $3.74 to $3.75 per share, an increase of more than 20% over 2003.

Full-year earnings including these adjustments are expected to be in the range of $3.68 to $3.69 per share.

We expect full-year sales volume to grow approximately 7%.

Before we begin the &A let me quickly summarize what was another solid quarter for 3M.

Sales increased 7.6% in the quarter, with broad-based contribution across all businesses and geographies.

Operating income margins improved to a record 23.8%, earnings per share increased by 16.9%, and ROIC year to date was just under 25%.

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 and Bill Schmoll our Executive responsible 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 1 on your telephone keypad.

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

If you are on a speakerphone please pick up your handset before entering your request.

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

And we'll pause for just a moment to compile the Q&A roster .

Your first question comes from Robert Ottenstein with Morgan Stanley.

First can you give us a sense of the magnitude of the inventory correction in the LCD market, how we would have seen it in your numbers, and to what extent you think it's finished?

I'm sorry.

We lost you, Robert.

Let me try again.

Can you give us a sense of the magnitude of the LCD market correction, how we would see it in your numbers, and to what extent is it finished?

Well, I'm not going to give you an exact number.

Depending upon -- we track a number of players in the LCD market.

Obviously the OEMs and supply base, and most of them saw a sequential reduction in the third quarter.

Just look at our D&G growth rate, and you can see the impact on us.

I still expect, Robert, that a piece of it will occur in the fourth quarter.

That would be my current expectation.

So would you say you're 90% done? 80%?

Robert, it's hard to tell, because at the end of the day it will all determine what the success of the holiday season is going to be on selling through LCD units.

So, you know, we're a critical supplier into that space, and obviously we'll respond as the OEMs demand, you know, and our material.

Have you seen increased pricing pressure on your business?

I'd say it's a constant pricing pressure in the business.

To say it's increasing, that's kind of hard to say, Robert, from the standpoint that I think what's important is that the OEMs are facing a, you know, a continued price down to the -- to the end consumer, and, you know, consequently there will continue to be price pressure back into their own manufacturing as well as their suppliers.

So it's not going to get any better.

All right.

But it doesn't sound to me that it's got, in your numbers, that it's gotten worse.

It's continued to be tough and will stay tough, but it's not getting worse, is that a fair assessment?

It's a continued tough environment.

Has great long-term growth prospects to.

And just last question.

The gross margin fell sequentially in a quarter usually that it goes up.

Can you parse that between energy, raw materials, and mix, or other effects sequentially?

I have a tendency to look at, of course, the operating income did improve sequentially slightly, so I kind of view that our quarter is very similar to the second quarter.

We have low mix between gross margin and SG&A.

If you look, of course, the mix of our business is a little bit between Q2 a little bit different, consumer is up,[ inaudible] and the D&G piece of it is down a little bit.

We did get hit a little heavier with raw material going into the third quarter versus the second.

And would it be that much worse in the fourth quarter?

Which piece?

The raw material side.

Does that look like that's building, in terms of magnitude?

If you look at the market, the market will continue to get worse in the fourth quarter versus the third quarter.

That's why we have a very active Global Sourcing program to try to fight off some of those increases.

But if you just look at the underlying marketplace it would it indicate that the fourth quarter would be slightly worse than the third quarter.

Thank you very much.

Your next question is from Jack Kelly with Goldman Sachs.

Good morning, Pat.

Good morning, Jack.

Just to take another crack at the display and graphics, just to be clear, so whatever the rate of decline was, or is, in LCA display materials, it hasn't changed, so it's still negative but it's still the same as it was in the second quarter is that fair?

I'm not so -- can you kind of rephrase that?

Yeah.

If we look at pricing --.

Oh, pricing?

Pricing, which is negative, based on your comments.

Is the rate of decline in pricing -- or was it, in the third quarter, the same as the second quarter?

Well, Jack, let me just kind of refresh everybody.

Our approach to selling into this industry is really trying to sell a value proposition.

We try to continue to add value to the OEMs by providing better optical qualities and features.

The pricing is a, you know, a net outcome of both volume as well as what we can provide from a design and value to a customer standpoint.

There's no doubt that the pricing environment is very tough, as it is in most consumer electronics business that is trying to experience a pretty rapid growth in volume, and we will, you know, continue to be part of the growth of that industry and the pricing that -- I guess for me right now is I see it as being very similar to what we've been experiencing.

Okay, great.

Then just moving over to the cash side of the equation here, assuming you bring back the 800 million, given your current cash position, is it fair to think that the stock repurchase program might pick up in subsequent quarters, versus, you know, the 400 million a quarter currently?

Well, we haven't -- we've got a repurchase program authorized through the remainder of the year.

We've got about 350 million or so if I remember the number right to go this year.

We will address the repurchase program again for '05 we're not ready to announce what that will be.

Very good.

Thanks.

Your next question is from John McNulty with Credit Suisse First Boston.

Good morning guys.

Quick question, or actually two quick questions for you.

First of all, did I understand you correctly saying that the working capital turns target of six this year is not something that you're going to get, and if so, you know, where is it coming in a little bit harder than what you kind of expected early on?

Well, let's put it -- it would be a herculean effort, okay, to get to 6.

We've kind of flattened out at about 5.4 here for about three quarters.

We're not giving up on getting to the 6.

It's just more than likely won't be at the end of this year right now.

But I would say the toughest area that we've got is probably inventories, to try to get inventory turns up to where, to where they need this will probably take some longer term efforts on modifying some processes within the Company, even within some of our manufacturing processes to get that level of performance.

We are not at all giving up on what our long-term expectations are.

It just looks like it may take us a little bit longer to get there, and as we look at prioritizing resources inside the Company between growth and profit, you know, profit and productivity programs and working capital, at the end of the day, you know, working capital probably just hasn't gotten the resources that we need on it yet.

Okay.

And then one last question.

From time to time you give us an update on what you've got in terms of size in your new product pipeline.

I know the last number that you had given out, you thought the present value of those opportunities was about $5 billion or so.

Any update on that at this point?

That number has not changed materially from the last time we provided a value of our pipeline.

Great.

Thanks a lot, guys.

Your next question is from John Roberts with Buckingham Research.

Good morning, Pat.

Good morning, John.

I assume that repatriation of foreign earnings is a one-time fourth quarter event but that the dilution from the convert is going to continue.

Is that a 3 or 4 cent hit to next year or a 4 or 5 cent hit?

And would you advise us to take our estimates down for that or do you think there's something incrementally that's going to offset that?

Well, okay, John let me -- I'll address the two pieces individually.

The repatriation is a one-time impact, and, of course, the law has not been passed yet, okay, so we're still kind of waiting to see exactly how it's written and what all the provisos are around it but at this point in time we anticipate it would be a fourth quarter '04 impact only, and, you know, assuming that it is a one-year window of time that this repatriation at 5.25% is allowed, we're just going to have to see how that plays out.

But assume right now that it would be just a kind of a one-quarter impact.

On the convert, that'd be a -- on a going forward basis, the way to look at it is six million shares, okay, of dilution.

Of course, the EPS impact will vary based upon what your earnings assumption is.

Okay.

And as a follow-up are you still expecting basil cell carcinoma indication in the fourth quarter here?

We've already had approval for it in the third quarter.

I thought you got actnenin keratosis?

Well, we have both of them approved.

Was it July, Mark, on basil cell?

Yeah.

Okay.

So are you fully ramped in terms of getting information out to doctors and so forth?

It's just an indication approval, so you didn't have any inventory effects or anything with that.

No, it's not.

This is really just getting people educated on selling it now.

It hasn't shown up as having any impact to the business, I guess, having dose indications earlier this year.

To our knowledge there's no meaningful impact yet.

Okay.

Thank you.

Your next question is from Robert Cornell with Lehman Brothers.

Yeah, hi, everybody.

Hi, Robert.

Getting back to LCD, beat that to death, did you see any incremental competition evolve in that marketplace in the last three months?

GE has been thought to be a potential supplier.

Do you see them at all in the market?

Our competitive position remains as the same as it was a quarter ago relative to direct competitors in that space, I don't -- I'm not aware of anything that is staged significantly.

Another question, this may be too detailed for this format, but did you continue to run the film plants hard in this quarter?

In other words, I'm looking for manufacturing variances.

So if you let the plants run down, reflecting the volume decrease then you would have had adverse variances, if you ran the plants run hard you would have maintained margins but left with an inventory problem.

Can you give us any visibility into what really was going on below the surface in that business?

Yes.

The -- I would characterize, Robert, the first half of the year of being 24/7 to just meet demand.

Got into the third quarter more that we were unable to put some inventory back in the system to provide a little bit of a ; a little bit of a customer buffer.

What do you mean, third quarter you were able to put inventory in the system?

Is that what you said?

Yeah.

We were able to stock some material in the third quarter, because basically we were almost running hand to mouth the first half of the year, so we were able to actually build up a little bit of inventory here in the third.

Third quarter, we were also able to do some testing on some new film that we hadn't been able to do in the first half of the year because things were just running so strong.

So we're still running very, very strong but as compared to the first half of the year where we had absolutely no breathing room, the third quarter we did at least have an opportunity to kind of get a little more inventory back in the system to provide, you know, some customer service as well as to run some testing that we hadn't been able to do the first half of the year.

What are customers telling you with regard to demand in the December quarter and the March quarter?

Well, [inaudible] it's the lead -- the customer feedback is relatively short cycle from, their perspective.

At this point in time, it's good solid orders, Robert.

Everybody still has very, very high expectations.

There's a lot of capital that's been put in the ground.

To me, the holiday selling season will be a key determinant as to how rapidly the LCD TV market takes off.

I think this past year we had about 8 million units, we're forecasting about 14 million this year.

People are forecasting it to go at about 75% increase year-over-year on LCD TVs.

You know, that's -- but, you know you're playing in a very -- somewhat of a uncertain world as to how this is going to actually play out on a quarter by quarter basis.

One unrelated question, Pat.

Your decision to expense the COCOs, I mean, is that an option that 3M chose to adopt, or is this a formal FASB ruling that companies must expense these things?

I wasn't aware that it was required at this point.

It is currently being reviewed but all indications we're getting from the EITF, is basically will be -- we have no option in the fourth quarter, unless you are willing to fundamentally restructure your entire convertible, and we're not so sure at this point in time we want to take on the added cost to do it, because our converts a outstanding debt instrument.

It's like a half a percent interest rate.

The convert premium is very significant, I think we'd have to have a stock price today of $119 to convert at today's price.

I'm not going to let the accounting rules, I think dictate the economics of having a very good instrument out there.

Okay.

Thanks.

Your next question is from Mark Gulley with Bank of America Securities.

Good morning, guys.

Good morning, Mark.

Some mixed questions here on LCD.

On the one hand I know you've talked about incorporating other films' properties into your best films.

Are you able to update us there?

And a related question on the other side, Samsung made a lot of noises by trying to, of course, reduce its overall manufacturing cost and one of those areas would be reducing back light costs and one of those could influence film content.

But, can you update us on both positive maybe negative trends regarding how you go to market in LCD?

Nothing's really changed there.

You know, comes all back to there is a need and let's just talk about LCD TV's just for the sake of narrowing the discussion, there's a need for pricing on LCD TVs to drop to get the volume expectations that the OEMs have to support the capital investment that they've put in the ground.

We're continuously with all the OEMs on trying to work out the right blend of films that they need to make their products have the performance characteristics that they expect.

So it's a little bit different, manufacturer by manufacturer.

What you're hearing out of Samsung is very clear.

Everybody has a need -- if OEM prices are going to drive down they're going to have to drive some of those back into the supply chain, and this is nothing new, and, you know, we are actively working with all the OEMs, including Samsung, to figure out exactly where that right optimal point is between value of the product and pricing that they need to drive the end market pricing for everybody's long-term benefit, because, you know, having the industry grow from 8 to 14 and 75% growth rates thereafter, if you believe the numbers, is to our advantage as well.

We just have to keep working with each one of them to figure out exactly where that right combination of price and value is.

Then on the economy you made some comments in the press release regarding, you know, head winds from the economy.

Are you seeing, in your businesses, volume pressure due to higher oil prices, and if so, how long do you see that continuing until people adapt?

Mark, not specifically.

As a matter of fact, I'm somewhat a little bit surprised it's taken $55 in oil, you would have thought it maybe would have had even a bigger impact.

So, no, we're not, but, again, I think most of you are aware, our operating mind-set within the Company is to probably be a little more conservative, okay, than optimistic when it comes to a planning window.

I just look at the macro conditions, the $55 barrel of oil and so forth, and, I think it's just prudent for to us think of the business on a more conservative tone or basis.

But we really haven't seen anything significant play through.

Of course, we're a supplier in the transportation business.

You can, argue, you know, are they seeing some impact, especially mix wise, on auto builds and so forth.

There's little pieces of it but nothing that I can see as being broad-based.

And finally, in previous conference calls you've indicated that healthcare should be turning up and it's been difficult.

Why do you think the fourth quarter guidance that healthcare will do better, why will that you think come true this time?

Well, I think a couple of things, one is, a lot of noise that we have in our comps goes away in the fourth quarter.

We do have, you know, of course, high -- we have expectations for, you know, Eldara's continued growth in the business, DDSD is going to have a more favorable comp in the fourth quarter coming off the third quarter.

So just the underlying comparisons as well as the business is running reasonably well there.

So that is my expectation.

One thing, back on the economy, that I didn't mention, and you get, of course, different signals from the retailers, I do think there is a question on the retail side and the consumer side with higher gas prices and so forth, does that affect consumer spending, especially at the lower end of the economy?

We'll obviously have to keep a close eye on that as well.

Thanks, guys.

Your next question is from David Begleiter with Deutsche Bank.

Good morning Pat.

Pat, on industrial, very good margin, the best since, I think 2000.

Could you talk about how sustainable those are going forward, and is the strength more U.S.-based or more overseas based?

Well, industrial has really done a marvelous job of restructuring itself over the last couple of years.

The growth is very broad-based.

Doing as good a job as anybody connecting with customers.

And, you know, taking care of their needs.

So it's a very broad-based improvement there -- they're saying, and U.S., of course, is a piece of it, but outside the U.S. continues to grow very significantly.

And they've got very good momentum behind them right now.

And it's across all businesses as well.

It's not just this one business that's helping them out right now.

So they've got very good momentum in all geographies and all businesses.

So is that 18 or high 17% range you think sustainable going forward?

Well, I just have to be careful when there's talk, I don't want to get trapped quarter by quarter, if I look at it more of a longer term trend standpoint.

I do think the business can run at that level.

And just on healthcare, any up-front costs for CCC or 8K either in this quarter or in the back half of the year that are impacting operating profits?

Most of the costs is we've got a sales force in place, the cost is primarily more around samples and so forth for the dermatologists, but I'm not going to use that as a reason or excuse on why our earnings aren't higher.

So it's not a material impact on the business at this point in time, David.

One last thing.

On Japan, if you X out the films business, how is Japan doing?

Japan is actually doing reasonably well.

They did come down a little bit from prior quarters, and, a piece of that is the -- is part of the film business, but all in all they still performed -- are running, you know, reasonably well across most businesses.

Again, a little bit hit or miss.

If you look at the portfolio there, consumer is probably not what we like, and healthcare is probably not performing as strong, but industrial seems to be going well, so does transportation, and electro and communications isn't doing bad, either, and display and graphics is just an issue of how strong is the optical film business.

Thank you very much, Pat.

Your next question is from John Inch with Merrill Lynch.

Thank you.

Good morning.

Hey, Pat, I just want to go back to optical for a second and your comments that pricing trends have generally held constant.

If you look at the structural capacity in the industry that's got to go in, and a lot of people will view the price of these LCD televisions are going to have to come down by 50% plus I guess I'm just curious as to why, looking ahead, 3M optical isn't going to to have face incremental pricing pressures given what's structurally going on in the industry until the volumes pick up.

I guess I don't want to be misconstrued here, John.

I'm not saying that there's not a fair amount of pressure, okay, in the industry and from the OEMs.

Of course we expect to see that.

But the OEMs have put a lot of capital in the ground with fab plants that, as we look at it, obviously should significantly improve their overall cost position to manufacture LCD TVs as well.

And, you know, let's face it, as OEMs are going to try to continue to drive down the cost of the supply chain.

We're not getting to be immune to that.

It's just that, you know, we're trying to obviously sell in to what's the right value/price relationship as -- on a going forward basis.

We are working on, from a -- look at it from a cost management standpoint inside the business, we are anticipating that we are going to have to continue to participate in a very priced down market and we're going to have to keep our costs down as volume ramps up to maintain our margin and profitability of that business, and this will be a quarter by quarter, month by month negotiation with the OEMs on what that, you know, the pricing is going to be in that business.

That's just the dynamics of that industry.

And as time passes, you know, as we get actual changes in prices and so forth you'll see that, of course, in our results.

Okay.

Now that makes sense.

So basically what you're saying, I think, is that pricing is likely to get worse but you're optimistic on the long term business, just because of the volume backfill.

Well, yeah, that's, you know -- you look at any kind of consumer electronics that has gone from very rapid change, the challenge in all this industry is to -- how do you maintain your cost position.

As volume goes up, how do you get the leverage on the cost side so you can participate in a price down market and maintain profitability.

So that's going to be the challenge we have.

Okay.

Pat, just switching gears, if you were to look at your European businesses with European volumes down very slightly, not that much of a significant difference, but where was the drag coming from?

Is it geographic?

Is it business specific?

Maybe just a little bit more color on what's going on in Europe.

Well, I mean, you just take western Europe in total, there's like virtually no growth in western Europe.

And, of course, the other thing that you do find, John, is the third quarter is one of the tougher quarters to really do a good comparison, because there's a fair amount of the continent, okay, that's on holiday for at least one-third of the period.

So it's a little tougher, but, of course, that's the same on a year-over-year basis.

But it's the same -- our view of western Europe is that it will be a relatively slow growth market from a underlying economic perspective.

We're focusing our efforts on making sure that we're growing resources in the -- I call it the former central Europe part of Europe, Poland, Czech Republic, Hungary, and so forth, I do believe you'll see that manufacturing and value-add jobs do migrate from West to the East.

Also going up, our Russian business.

Our focus in Europe is to increase penetration where we can, make sure our cost structure is in line, our margins in Europe continue to get better.

Our industrial business is performing very well.

I think we mentioned that previously across the -- on the whole industrial side.

Healthcare continues to perform very well.

So does the whole safety and security business.

So if you look at it kind of on a business basis that's kind of what we're seeing.

Consumer is a tough business in Europe, more so than it is in the U.S. where U.S. business is much more of a key account management, Europe is much more of a private label market.

And the whole electro and communications business in Europe is still paying the price for significant over builds, okay, a number of years ago.

So if you look at it business by business, probably half of our businesses are doing well, half are kind of below growth at this point in time, and it's really the western Europe side that I think is more the stagnant side, from a geographic perspective.

So basically more of the same.

More of the same.

Okay.

Thanks, Pat.

Your next question is from Dmitry Silversteyn with Longbow Research.

Good morning.

Let me take care of a couple of questions first.

Excuse me.

If you look at the healthcare business you already talked about the one-time effects that you've had in the first quarter of last year that supposedly anniversaried by now.

As you look forward, and then with the Eldara getting two additional indications and the R&D pipeline that you currently have and other similar molecule, what rate of growth do you think that business can post in a normalized environment without these one-time issues?

Well, Dmitry, we've indicated before that within our portfolio mix that it should be at the higher end of our 5 to 8 -- at the higher end of that.

Okay.

So organic growth in the high single digits, it sounds like?

Yes.

Okay, and second question, if I may, you know, you've mentioned one loss that you had to pay damages on, there's been a couple of others filed, do you see this becoming an issue longer term or do you think these are isolated cases that you will resolve shortly?

Well, they're, you know, they're one-off cases and we'll continue to decide how we want to approach it, but we really are not going to get into, you know, the legal issues and how we're going to resolve these cases.

We'll make as much disclosure as we feel is warranted within the Q.

Okay.

Well, thank you.

Okay.

Your next question is from Michael Judd with Greenwich Consultants.

Yes, good morning.

A question about the seasonality in the fourth quarter in your industrial business.

If you look back to 2001 there was about a $20 million decline in operating profit.

If you look at 2002, the decline was around 15, and then if you look at last year, 2003, it was only around 6 million.

Can you kind of give us a sense of, based on what you're seeing in October, whether you expect, you know, a similar type of sequential downturn this year, or do you think that what we're hearing from some people, at least on the industrial side, is that there may not be as much of a slowdown this year as compared to previous years, please?

Thank you.

Well, Mike, I wish I could give you a exact answer there.

It's always a little bit of a wildcard with the holiday season between Thanksgiving and Christmas.

Depending upon how strong people are running in their inventory position in October and November, then they will decide what they want to do between the holidays.

Because at many times people basically shut factories down over that period of time, and then we're selling into, you know, a lot of different kind of industrial spaces.

We obviously can be impacted by that.

Right now, you know, I don't see any big change there.

I have my fingers crossed that maybe this year we won't to have go through quite as much of an adjustment, but, you know, history says you don't know until you kind of get to November that you know what's going to happen there.

Can you provide just a little bit more detail in terms of which areas of industrial are sort of, you know, performing very well and maybe some which are still -- need a little bit room for improvement?

Thank you.

I'd say, Mike, our business, really across the board in industrial, be it tape, be it the abrasives, are performing very, very, very well.

Electronic solutions business is performing -- or I should say electronics markets business is performing very well outside the U.S., so our industrial business is performing well, you know, in all businesses right now.

Okay.

Lastly, on display and graphics, I realize an operating rate for that business is probably not especially meaningful, but do you have a sense of what, sort of, the operating rate was in the second quarter versus the third quarter?

Well, it's, again, you're right, operating rate is a little bit in the eyes of the beholder as to what the definition is.

I had mentioned previously to somebody that the first half of the year we were running pretty much 24/7 just to meet customer needs.

We're still running almost the same kind of schedule but we're now able to both run new product samples and experimentation at the facilities as well as provide a little more inventory buffer for us as well.

So does that mean you're still running at 100%?

Again, probably over 100% if you define that on a five-day week.

Thank you.

Your next question is from Jeff Cianci with UBS.

Hey, Pat.

First, just to finish out the display, maybe I'll ask it this way.

If you normalize things, would your growth rate have been double digit, mid double digit this quarter?

In other words, if you take out any swings that you thought were downstream correction, just trying to get a read through, and going into the Christmas season, you know, would you expect if you had a Christmas like last Christmas to see a mid double-digit growth there?

Any way you choose to answer that would be helpful.

Well, it would be nice if somebody could define what normal, you know--

Perhaps from last year.

Normal is, okay, -- for this space.

Jeff, I guess the way I think of it is -- I think of it -- as kind of what's a long-term prospect for this business.

Most people have written to -- say the TV space, 75% annual growth rates.

They probably have more intelligence than I do relative to all the dynamics that are going on here.

But, if you were to look at, you know, who knows, you take the first -- where do you see this, where we saw the significant increase was last -- third quarter and fourth quarter last year is where we saw probably the biggest growth rates in that industry, to say was that piece, you know, the high point, is that where part of the inventory is built, or is it earlier this year, not exactly sure.

But the growth rates in that business still run, you know, very, very high.

It's just that in any given quarter we're going to have some sort of an adjustment to it.

But I think the focus ought to be, I think from a shareholder's standpoint, is really what's the long-term potential for this business, and we're just going to have to kind of play through the quarter by quarter adjustments, because I'm not so sure anybody's exactly figured out where the sweet spot is relative to pricing in the end market, and that's why I think a fair amount of people who try to look at this holiday season as being kind of an important data point relative to, you know, what's that right price point, vis-a-vis other products in the marketplace, and that will probably then determine what the success rate will be for the '05 year.

Okay.

You guys like to put two of the divisions below trend, healthcare and electro, in healthcare even if you add back Lilly and IVAX, I think you kind of come out of the mid single-digit growth rate.

I presume you'd tell me that's below the long-term trend.

Yes, it is.

And is there any other reasons you can point to now, with the tough comp with respirators or something, or?

Well, it was a tough comp, but I guess we -- our drug delivery business is the other business that I kind of quoted is coming off a strong '03, has both reduction in volume and both price as low as R&D contracts here in '04, so that's having a tendency to drag down the healthcare rate I think by about a point and a half in the -- in this quarter.

So that's the other business that is impacting them right now.

And electro and telecom, Pat, is there anything other than Europe that would bring this back to -- I presume the trend would be high single digits, long-term trend.

I mean, their business, I guess, is you know, it's -- like I say, it's kind of -- the communications piece is very spotty.

The Asia piece and the Latin Americas piece remain very strong.

The U.S. and western Europe are still going through a significant overbuild situation there.

The rest of the business is running at about where we'd like to see it.

Are we getting easier comps now with telecom in particular by next quarter?

Well, if you look at the communications space actually we have somewhat stabilized that at -- we've run a little bit, in total, on a global base, a little bit to the positive here for a couple of quarters in a row.

But, again, if you look at it geographically you'd have kind of a different answer.

But I think the thing to look at that business is, if you look at the leverage we've got in that business, top to bottom line, then we've got the structure of that organization right, that as we do get volume that it will give us good bottom line, but we are after growth in that business as well.

Can you be in the market in a couple of days buying the stock, and would you consider increasing the authorization given your cash flow year-round?

Well, we've got, I think I mentioned, about 350 million left of authorization.

Of course, that's a board decision.

If they want to pick that up.

That's something we obviously keep our eyes on.

But as you know we can't be in the market for probably another couple of days.

Thanks a lot.

That concludes the question and answer portion of our conference.

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

Again, thanks for joining us this morning.

Our leadership team and our work force are energized and committed to delivering sustainable long-term value to you, our shareholders.

Thanks again for your continued interest in the Company.

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

You may all disconnect, and thank you for participating.