3M (MMM) 2004 Q4 法說會逐字稿

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

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

Afterwards you will be invited to participate in the question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, the conference is being recorded Tuesday, January 18, 2005.

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

Thank you.

Good morning, everyone, and welcome to our fourth-quarter and calendar year 2004 business review.

I am Mark Colin, Director of Investor Relations for 3M.

Before we begin I have a few announcements.

As in prior quarters today's discussion will follow a series of PowerPoint slides which you can access on our investor relations website.

Our first quarter 2005 earning conference call will take place on Monday, April 18th.

Also, I would like to remind you of our investor day in New York on February 18th.

Please mark your calendars.

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

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

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

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

Thanks, Mark, and good morning everyone.

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

Jim McNerney will then share his perspectives on the business and I will wrap up the call with our 2005 guidance.

And of course we will leave time for your questions.

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

Please go to slide number 2.

The fourth quarter continued our trend of consistently improving business results.

The fourth quarter sales increased 7.9 percent to 5.1 billion with volume growth of 4.8 percent, as six of our seven businesses reported worldwide volume growth during this quarter.

This marks the 11th consecutive quarter that we have posted positive volume growth.

Earnings per share in the fourth quarter were 91 cents per share, an increase of over 18 percent versus last year.

These results do not include any effect from the foreign dividend reinvestment provision of the American Jobs Creation Act of 2004 or the proposed accounting changes related to continuously convertible debt instruments since neither of the relevant roles has been finalized.

Operating income increased 16 percent to 1.1 billion.

This growth was broadbased as five of our seven business segments posted double-digit operating profit increases in the fourth quarter.

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

Net working capital turns improved to 5.8 versus 5.4 at the end of the third quarter.

This result was just short of our year end goal of six turns.

On slide number 3 we recap our fourth-quarter sales performance on a geographic basis.

As I previously mentioned, worldwide sales in dollar terms increased 7.9 percent versus last year's fourth quarter.

Worldwide volumes increased 4.8 percent with core volumes up 4.2 percent and growth from acquisitions adding 60 basis points.

Volume prices declined 90 basis points while year-on-year currency translation boosted sales by 4 percent.

In the United States sales improved 5.4 percent with core volumes up 4.8 percent and acquisitions adding another 90 basis points of growth.

We posted positive volume growth in five of our seven businesses led by consumer and office, safety security and protection services, healthcare and industrial.

Our international operations sales were up 9.5 percent in U.S. dollar terms.

Core volumes increased 3.8 percent, with acquisitions adding another 30 basis points of growth.

Local currency growth which is defined as volume growth plus selling price change was 3.7 percent in Asia-Pacific with Japan down 4.7 percent and the rest of the region up 10 percent.

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

Local currency growth was 3.9 percent in the Latin America, Africa and Canada region and up 1.3 percent in Europe.

International selling prices declined approximately 120 basis points in the quarter.

Selling prices again were impacted by our businesses that serve the consumer electronics market where it is typical to trade off price and volume.

Currency effects continue to boost international sales this quarter, up 6.6 percent, driven by positive translation of 9.4 percent in Europe, 4.8 percent in Asia-Pacific and 4.2 percent in the combined region of Latin America, Africa and Canada.

On slide number 4 we detail the P&L starting with the comparison versus the fourth quarter of last year.

Earnings per share was 91 cents, up 18.2 percent versus the fourth quarter last year.

As I stated earlier earnings were not affected by either the dividend repatriation provision of the American Jobs Creation Act of 2004 or the accounting ruling related to contingency convertible debt that we discussed in our third-quarter earnings conference call.

First, let me address the American Jobs Creation Act of 2004.

Last week the IRS released their comments regarding the dividend repatriation provisions of the Act.

Even with the IRS guidance, some uncertainties remain.

As such we are not yet in a position to determine the precise earnings per share impact to the Company.

Based on our analysis to date regarding the repatriation of foreign dividends, however, it is possible that we may repatriate somewhere in the amount of $800 to $950 million.

Secondly, regarding the accounting ruling on continuously convertible debt, we are awaiting finalization of FASB's amendment to the statement of financial accounting standards 128.

Operating income increased 16 percent to 1.1 billion, and margins improved 150 basis points to 21.5 percent.

This improvement was mainly driven by increased volumes and productivity improvements driven by our initiatives.

Gross margins were 48.7 percent, up 10 basis points from last year's fourth quarter.

SG&A expense was 21.5 percent of sales, a 100 basis point improvement year-over-year.

Our continued efforts to leverage our existing cost base during volume expansion helped drive the improvement.

Research and development and related expenditures increased about 1 percent year-over-year as we continue to invest in future growth opportunities.

As a percent to sales R&D was 5.7 percent versus 6.1 percent last year's fourth quarter.

Quarterly net income increased 16.3 percent year on year.

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

Sales were up 2.5 percent sequentially, more than accounted for by favorable translation.

Net income and earnings per share were down 7.1 percent and 6.2 percent, respectively.

This reduction is in line with our historical Q3 to Q4 earnings patterns as Q4 is normally our lowest production quarter due to lower customer related volume requirements, including holiday shutdowns in many industries.

Slide number 6 details our performance by business segment.

Five of our seven businesses posted positive local currency growth and double-digit operating income growth.

Local currency sales growth in our healthcare segment was 5 percent versus the fourth quarter of last year.

Sales exceeded 1.1 billion in the quarter as the growth was broadbased across all of our health care businesses.

Operating income in healthcare was 310 million, up over 22 percent versus last year.

Our industrial segment continued its strong performance with sales and local currency increasing 7 percent to $960 million.

Geographically growth remained strong in all of our industrial businesses.

The HighJump acquisition added 1.2 points of this growth.

Operational discipline continued to be strong as profits increased 46.6 percent to $158 million.

Display and Graphics fourth-quarter operating income was 240 million or 28.5 percent to sales.

Local currency sales declined slightly to 842 million versus the same quarter of last year.

We announced the phase-out of our commercial videotape business during the quarter, and this action combined with the continuing decline in the CRT rear projection television market negatively impacted sales and operating income by approximately 3 percent and 4 percent, respectively.

We continue to see a shift in the rear projection television market from CRT to Micro display.

Our Optical film business continued to expand in the fourth quarter, albeit at a lower growth rate in line with well-documented short-term channel and product adjustments in the industry.

We remain highly confident in the long-term value proposition of this business; although from time to time there will be these types of channel and product adjustments.

Overall Display and Graphics remains one of our fastest-growing businesses, and we are investing aggressively across the portfolio to maintain our industry-leading leadership positions.

Local currency growth in consumer and office was 8.3 percent with operating income increasing almost 29 percent to $147 million.

Growth was broadbased across the many channels we serve most notably in consumer retail and office retail and wholesale.

Our Safety Security and Protection services businesses local currency grew up to 7.9 percent in the fourth quarter driven by gains in respiratory protection along with strong demand for our cleaning and protection products.

Acquisitions added about 2.9 percentage points of growth in the quarter.

Profits improved almost 20 percent year on year to $107 million.

Local currency sales in electro and communications declined 7.3 percent in the quarter and operating income declined 5 percent.

Despite a negative growth rate in the fourth quarter, we were encouraged by positive local currency growth in micro communications for the calendar year, the first since 2000.

We continue to post good results in our electrical markets business.

However, fourth-quarter sales in the electronics and telecommunication segments were impacted by the general slowdown in the semiconductor industry, continued softness in the hardline infrastructure segment of the telcom market and seasonal plant shutdowns with corresponding inventory reductions by some large customers in the Flexible Circuit business.

Finally, local currency growth was 4.8 percent in our transportation business with operating income up 11.7 percent versus last year.

Sales growth is broadbased, led by our businesses that serve the automotive OEMs and body repair shops.

Let's now turn to some financial highlights for the calendar year. 2004 marks the first time in the Company's history that sales exceeded $20 billion.

Sales increased 9.8 percent versus 2003 with local currency growth increasing 6 percent for the year.

All seven of our businesses posted positive local currency growth.

Earnings per share for 2004 were a record $3.75 per share, an increase of 21.4 percent versus last year excluding special items in 2003.

Operating income increased 20.3 percent to 4.6 billion with all seven businesses increasing their operating income.

Operating margins increased to 22.9 percent, a 200 basis point improvement versus 2003. 2004 economic profit which is defined as after-tax operating income plus a charge for operating capital was 1.8 billion, up 27.4 percent excluding special items in 2003.

2004 free cash flow was 3.3 billion dollars up 8 percent versus 2003 driven primarily by continued improvements in earnings.

And finally, return on invested capital was 23.4 percent versus 28 1.8 (ph) percent at the end of 2003.

Our continued focus and discipline at driving initiatives allow us to continue to improve sales, productivity, cash flow and returns across every 3M business.

Let us go to slide 8 while summarizer (ph) our calendar year results by business segment. 2004 was a year that demonstrated the overall strength of our portfolio as we registered year on year local currency growth in all seven of our businesses.

Local currency growth in healthcare was 1.7 percent.

As mentioned in our 2004 quarterly earnings conference calls, we experienced some tough year on year comps for the first three quarters of the year.

Now that is behind us, and we expect our local currency growth rates and our healthcare business to improve (inaudible).

Operating income improved 9.3 percent versus 2003 with operating margins at 26.5 percent.

Our industrial business delivered a strong performance with local currency growth at 9.1 percent.

This pickup in business from 2003 was broadbased across all of our businesses and geographies.

Operating income of 661 million was up 44.5 percent.

Display and Graphics led the way in 2004 with a positive local currency sales growth of 10.4 percent versus 2003.

Strong demand for our proprietary brightness enhancement films used in cell phones, monitors, laptops, LCD TVs and other flat-panel devices continued to drive results in 2004.

Display and Graphics generated over 1.1 billion of operating income up 27.8 percent year on year.

Consumer and offices local currency growth improved almost 7 percent again driven by broadbased performance across most of the portfolio with operating income improving almost 18 percent.

Local currency growth and Safety Security and Protection services business of 6.6 percent was driven by continued demand for our respiratory protection products along with strong demand for our cleaning and protection products.

Operating income was 491 million, up 12.3 percent.

Sales in local currency in electro and communications increased 30 basis points versus 2003 with operating income up 14.1 percent.

This represents the first positive local currency growth in the electro communications since 2000 reflecting the strength of the electrical markets business and a plateauing of the telcom business.

(indiscernible) and communications leverages local currency growth into a 14.1 percent increase in operating income during 2003.

The transportation business posted a solid year with local currency growth of 5.2 percent over 2003 led by the automotive, OEM and repair markets.

Year on year operating income was up 10.1 percent to $428 million.

Slide 9 depicts our 2004 full year results on a geographic basis.

In the United States sales grew 3.9 percent for the year.

Growth was led by the consumer and office, safety, security and protection services and our industrial businesses.

Operating income was down 1 percent in the United States, 1.2 billion as higher pension expense year on year impacted operating income by 12 percent.

European local currency growth increased 80 basis points in 2004.

Local currency growth improved in four of our businesses, namely safety, security and protection, transportation, industrial, and healthcare.

Favorable exchange rates coupled with ongoing productivity efforts boosted profits by 24.4 percent to just under $1 billion.

Local currency growth in Asia-Pacific increased 13.6 percent in 2004 with all seven businesses posting a positive local currency growth.

Growth was strongest in China, Korea and Taiwan.

And we also posted a 4.3 percent local currency gain in Japan, despite a fairly sluggish economic picture in the second half of the year.

Operating income was 1.9 billion, a year on year increase of 36.4 percent.

Latin America, Africa and Canada local currency sales increased 9.3 percent for the year.

Six to seven businesses posted positive volume growth for the year led by electro and communications, transportation, industrial and healthcare.

Operating income was 502 million increasing over 15 percent versus last year.

On slide number 10 we will see some of the balance sheet and cash flow improvements we made in 2004.

Net working capital turns reached 5.8 at year end.

This is 0.3 turns higher than one year ago and 0.4 turns higher sequentially.

Inventories increased by 81 million versus last year for 4.5 percent.

Inventories were down 56 million sequentially.

Currency translation effects added 80 million to inventory year on year and 84 million, sequentially.

Accounts receivable was up 78 million or about 3 percent versus the fourth quarter of 2003 but down 61 million sequentially.

Currency translation effects added 120 million to accounts receivable year on year at 150 million (inaudible).

Capital expenditures were 324 million in the fourth quarter, bringing the full year total up to $937 million.

We expect to invest close to 950 million in capital in 2005.

Fourth-quarter free cash flow of almost 1 billion was comparable to last year.

The strong cash flow enabled us to pay $280 million in dividends to our shareholders during the quarter.

We also bought back 556 million of our own stock, resulting in a net repurchase of $471 million.

Diluted shares outstanding were 790.4 million, down about 1.3 percent from last year end and down 70 basis points versus last year.

Our debt to cap ratio was 21.4 percent at year end.

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

In the fourth quarter we increased the liability reserve by $40 million along with a corresponding increase in insurance receivables of $20 million.

The net result of $20 million both through the income statement is part of SG&A.

Please turn to chart 11 for an update on our global pension situation. 2004 was a strong year of market returns and coupled with our cash contributions we finished the year at 91 percent global DDL funded ratio with a net underfunded position of $1.2 billion versus $1.8 billion last year.

As we stated in our third-quarter conference call we changed our U.S. pension measurement date from September 30 to calendar year end.

U.S. planned asset returns were 13.5 percent for the calendar year and 23.8 percent for the 15-month plan year.

For measurement purposes we will be reducing both our U.S. return on assets and discount rate assumptions by 25 basis points to 8 3/4 and 5 3/4.

As a consequence of our U.S. plan asset returns and pension contributions, our plan assets exceeded our accumulated benefit obligation or ABO at year end.

Consequently our equity will increase by $1.2 billion at year end. 2005 pension expense will be approximately 29 cents per share, an increase of 3 cents over 2004.

Now I would like to turn the presentation over to Jim McNerney who will offer his perspective on the Company.

Thanks, Pat, and good morning everyone.

I would like to recap '04 comment on the momentum we have in place as we move into '05 and turn it back to Pat for some specific '05 guide detail.

First our '04 results. 2004 was another solid year for us.

As Pat mentioned, we reached the $20 billion milestone in sales, close to a 10 percent increase over '03.

Achieved another all-time high in earnings to 3 billion in net income, a 21.5 percent increase over last year.

We generated more than 3.3 billion in free cash flow, including voluntary cash contributions to our pension funds of 455 million.

Today as Pat mentioned our pension funds are at 91 percent funded.

Continued to advance toward our working capital goal; we achieved 5.8 turns, and there is still opportunity to improve and we have plans in place to do that.

And we paid out more than 1.1 billion in dividends to our shareholders in 2004.

All in all the kind of year we expect from ourselves.

I'd like to spend a few minutes discussing our progress beyond the financial results. 2004 was noteworthy for the following accomplishments and sets us up well for 2005.

First I am pleased with the broader base of our performance.

Display and Graphics has become a focal point of attention because of its strong performance and growth but we can't overlook the 2004 success of established businesses like industrial, consumer and office and safety, security and protection services, all of which had terrific years.

The main point is all of our businesses contributed to sales growth in '04 and I am very happy to be able to make that statement.

International operations again proved that it is our largest single growth platform growing at a rate of 13.5 percent over the last three years and posting 13.9 percent growth in 2004.

I said before that 3M's international team is unmatched.

And after this year I am more convinced of that than ever.

Third, the initiatives continue to make a significant difference to our Company.

Together the initiatives increased operating income by more than 400 million again in 2004, on top of a similar amount in 2003.

These initiatives are now embedded in the everyday operations of 3M and we expect them to continue to contribute another 400 million in '05.

I want to disabuse everyone of the notion that the initiatives have run their course.

We are still far closer to the beginning than the end of their effect on our Company.

And there is more on the table in front of us.

In fact, we have achieved an important Six Sigma milestone. 100 percent of our salaried employees have been trained in depth on Six Sigma, more than 36,000 people worldwide.

That group has already closed over 14,000 projects, more proof that 3M is adopting Six Sigma faster than any company I know.

With regard to another core initiative, 3M acceleration, we have made tangible progress on our new product pipeline and will be talking a lot more about that at our analyst meeting in February.

Product development is moving through the companywide new product development process, and the progress therein is palpable and real.

In February you will also hear about some of the emerging technologies in technology platforms and how they form the basis for new generations of products in high-growth market spaces all across the Company.

The bottom line is we have strengthened our ability to develop and deliver customer inspired innovation.

In part to energize 3M acceleration, early in 2004 we launched a full court press to reconnect and re-engage with our customers.

To reinforce and re-energize our customers requirements in voice all across 3M.

Throughout the year our leadership team more than doubled their direct contact with customers, and I am convinced that by sustaining this effort indefinitely and by ramping up Six Sigma projects with our customers will strengthen our growth momentum.

As you know, in the last few years we've invested tremendous energy and effort in growing our people.

We're beginning to see the returns on that investment, and I'm confident that we will see benefits for years to come.

As a result, we had a deeper bench of talent to draw from in 2004 for a number of key openings.

For example, Brad Sauer is now heading up our healthcare business;

Joe Harlan now heads our electro and communications business, Jean Lobey is leading our safety, security and protection services business with Fred Palensky moving over to lead our newly formed enterprise services unit and Bob MacDonald is our new Senior Vice President of Marketing.

We look forward to introducing you to the new members of the team at our meeting next month.

I think we have a very strong and strengthening team at the top.

That team and all our people remain committed to results.

We will deliver by leveraging the power inherent in the 3M business model, a model that has been improved and significantly strengthened in recent years.

Seen our 2005 guidance in the press release and I will turn it back over to Pat for a little more detail.

Then we would be glad to take your questions.

Thanks, Jim.

For the 2005 calendar year we expect earnings to be within a range of $4.15 and $4.25 per share.

This assumes sales volume growth of 5 percent at the low end to 8 percent at the high end.

Including in this 2005 guidance is approximately 2 cents per share resulting from a change in accounting rules related to continuously convertible debt instruments.

As I earlier mentioned, Pat included in her 2005 guidance as of yet is the impact of the dividend repatriation provision of the American Jobs Creation Act of 2004 and the impact of an accounting ruling (indiscernible) regarding the expensing of options.

We estimate that the impact of the Act will be a reduction of earnings per share in the range of 5 to 6 cents and that the implementation of expensing options will further reduce earnings per share.

We will provide further clarity on the impact of both of these items in 2005 once we finalize our plans for these two items.

For the first quarter we expect earnings to be between $1 and $1.02 per share.

This assumes that volumes improve somewhere in the range of 5 to 7 percent. 2004 was a very solid year, demonstrating our ability to consistently improve business results.

We continue to carry on the momentum of the corporate initiatives to drive sales, operational efficiency and cash flow growth.

I would like to remind everyone of our scheduled analysts meeting in New York on February 18 where we will discuss our plans in further detail for 2005 and beyond.

This concludes the formal part of today's call.

Joining Jim, Mark and me this morning are Matt Ginter, our director of financial planning and analysis and Bill Schmale (ph) our Vice President of treasury and tax.

I will be happy to address your questions so let's begin the Q&A.

(OPERATOR INSTRUCTIONS) Steven Weber with SG Cowen.

Good morning.

Jim and Pat, you seem to -- the core unit volume growth slowed to about 4 percent in the fourth quarter, 4.2 percent and you seem to be looking for some pickup in that in the first quarter of 2005.

Could you just discuss some of the transients you see and in particular I'm sure all of us are interested in how you see the inventory adjustment in optical films.

Let me just kind of start by indicating that a lot of our core historical business had very, very good momentum as Jim mentioned.

You look at our consumer business, industrial, safety, security, very good, both momentum in all those businesses which we expect to carry us forward.

As we reviewed the fourth quarter results we had some inventory corrections in specifically the consumer electronics side of our business, and we do believe that that is a fourth quarter adjustment and as we look going forward that those rates should been improving again.

Realizing of course that that industry will have some time to time adjustments; as always more difficult to forecast when they will be, but that is our expectation.

Okay.

If I could just follow-up, would you size for us what currency did from an EPS standpoint for you in the full year '04 because it clearly was big there and where you stand, what it looks like with all the puts and takes for '05 if the parities were to hold where they are right now?

Of course the question on a going forward basis, Steve, is who knows where the market is going to be.

We have not locked in the whole year and so forth, so it is not quite as certain on an '05 basis.

But if the dollar were to remain weaker than it was in '04 based upon our footprint in our earnings outside the U.S., it would be an additional positive for us in '05.

We described to you in the past that when currency is favorable to us we look at that is an opportunity for us to structure our business on a going forward basis to make it a lot more healthy.

So we will continue to look for opportunities if indeed we have the currency upside that current rates at least year end rates would provide us, of course it has fallen back here in the month of January.

If you look at '04 and again I am cautious because there is a number that we can calculate and we will disclose, which is the technical earnings impact and then of course Jim and I make certain other operational decisions based upon the size of those gains coming our way.

In the fourth quarter the number would have been in the 5, 6 cent range of year-over-year gain on results.

Again, heavily because we have very good operating results outside the U.S. a big piece of that is the translation of foreign results.

For the year numbers in the 20, 23 cent range is what the impact would be if you just did the literal mathematics for the impact of foreign exchange on our results.

So that would be the order of magnitude of FX both on the year and the quarter.

If I could follow one more.

Wait, Steve.

Is it along the same lines?

We want to make sure we get everybody else in.

I just wanted to -- you alluded -- did you, where there any other unusual factors besides -- in any of the operations besides the adjustment to the asbestos stuff?

Nothing that was out of the ordinary.

Everything else would be kind of classified in just our normal course of business.

Okay, thank you.

Robert Ottenstein with Morgan Stanley.

Can you give us a breakout in terms of the healthcare improvement, how much of that specifically came from the new Aldara indications?

Both in terms of the top line and the bottom line, you had a very nice margin.

And what kind of -- the kind of 27 percent plus margins that you had in the fourth quarter, is that sustainable in 2005, or is that an unusual event here?

Well, nice try, Robert.

We are not necessarily going to give you the specific Aldara numbers but I know you guys get the script data update and so forth and the trend continues to improve.

The rate continues to move up for us.

There is a little bit of seasonality in that business which is a little surprising but there is, but it is tracking on an upward path for us.

The overall margin rate in healthcare is something that we want to continue to -- it's a good, healthy rate.

And of course there is a balance here between trying to get growth in that business and through operational efficiency getting obviously some more for bottom line.

So don't look at that as being an aberration.

That's what we want to try to drive that business to.

So you are saying kind of a 27 percent plus margin which is higher than historical is something that we can expect here given the fact that you got the high margin drugs coming in?

That would be a fair comment and of course as we look at the success of the Aldara platform, down the road we have to make some further decisions as to how much we invest back into that drug platform.

But we're looking for that to be a high growth and a high margin business for us going forward.

We don't see any unusual pressures on the rest of the business.

I think we will still see a nice mix of growth in margin, and as Aldara continues to pick up the mix will be favorable to margin I think.

Great and can I ask a question on optical?

Sure.

It looks like the overall pricing was a little bit weaker in international than you had been running.

Has there been any change in the historical pricing pressure which historically has been down 6 to 8 percent on the optical display business?

And can you give us any kind of maybe more granularity in terms of the volumes of that business and your sense in that business specifically where you are in the inventory cycle or inventory correction that you had talked about in the third quarter?

The last part of that question is probably a little more difficult, but pricing did not change sequentially in that business if you kind of look at Q3 to Q4.

Of course there is an ongoing need and of course people get a little too focused on the TV segment of our optical business.

So the monitor business, the notebook business and our cellphone businesses, very rapid growing segments as well.

And those segments other than I'll call it flat screen monitors, which there is a, have a nice price point where they move versus CRTs.

The big issue of course becomes the LCD TV the growth factor there, and to be fair I think there still is some sorting out to be had relative to end market pricing, and there is a lot of capacity coming on this next year in a number of the fab plants.

I think the numbers that we've seen is that as much as 50 percent more capacity coming on by the end of the year.

Some indications we are getting is we are starting to get a better supply demand balance in that industry by the end of the year.

That is our own assessment.

Some feedback that we get from others that we think we kind of work our way through the channel issue.

And we will see where '05 takes us, now unfortunately we do not drive necessarily the end demand volume of this.

They will be determined by the OEMs and the retailers.

Can you give us any sense year-over-year or sequentially what happened to your volumes in optical display?

Well, in my comments basically what I said was that continued very good growth in the fourth quarter year-over-year albeit lower than we've had the last handful of quarters.

Sequentially it was up a little bit.

I don't see how you could have year-over-year growth unless the graphic side of display and graphics was down substantially.

Well, I mentioned a couple of things.

One is the, in my comments we have got two things.

We've got a significantly declining commercial video business;

CRT business is dropping off on the conversion from CRT to micro display technology.

Then if you did look at the fourth quarter and some of the other business commercial graphics a little bit down as well in the fourth quarter.

Part of that has to do with in '03 fourth quarter we had some hardware sales that we had going on that did not repeatedly fourth quarter this year, which is somewhat of a change in our business strategy in that business.

If you look at all those factors what had the greatest impact on the gross margin?

What had the greatest impact on gross margin?

Right.

I guess the question is versus what period you are looking at.

CRT and video.

CRT video has had about a 4 point impact on the yield of growth in that business so we would've been positive if you had backed those out.

So that was a big piece of it.

Thanks a lot, guys.

Jack Kelly with Goldman Sachs.

Just following up on that, on the display and graphics, Pat, year-over-year I thought you mentioned video was a 300 basis point hit and the CRT was 400 or was it a total of --?

It was a combination of the two of them.

On the top line it had a 3 percentage point impact; on the bottom line it was 4 percent.

Got it.

And that will persist for the next couple quarters, is that fair?

I would say the -- we'll be facing the exit of the audio business really through next year because we'll have comps.

Now of course the reason we're exiting it, it doesn't have the same margin structure as some of the other businesses do.

And the CRT business will continue to decline.

And in terms of this 5 to 8 percent overall guidance you've given us, obviously you've factored in --?

Positively, yes.

And then secondly on margins in that group, they fell to the high 20s, I think it was 28 percent.

Does that reflect any charges you might be taking in video or --?

Yes it did.

And that's why I mentioned that on the bottom line affected 4 percentage points of OI growth and a piece of that is a -- it's a relatively small, small charge in the video business.

And just the second question.

In terms of the 5 to 8 percent revenue assumption for '05, can you -- and it gets back to an earlier question -- can you -- which would imply some kind of a pickup.

Can you give us a sense of what areas would be picking up and it doesn't sound like display and graphics will necessarily be doing that given what we just discussed.

But where does the acceleration come and is there any kind of general guidelines you can give us for some of the groups?

First of all, we will give you far more insight at the February meeting when we get into this in more detail.

But if you look at -- we are expected in display and graphics to have a good growth year.

I think we just have to fight our way through timing of inventory adjustments and so forth but we do expect that the growth rate in '05 will be a good one again.

So we are truly not looking at them to be at the bottom.

Healthcare we expect healthcare to have a very good growth rate in '05.

And then the businesses that we talked about which are the core industrial and consumer we expect all of those to continue to perform at good growth rates.

The tough one that we still see, electro and communications will still be a tough business for us from a growth standpoint going into the '05 calendar year.

I think the quick way to look at it is we've got good momentum in the core of this company, the old core industrial, consumer, safety, and we are going to grow D&G faster than we did in the fourth quarter in '05.

Exactly how much depends on some of the timing of the industry related stuff.

And healthcare has fought through a tough comparable year in '04 and is just emerging from that with a fair amount of momentum.

So you can pretty easily get to the 5 to 8 with sort of sustained momentum of the old center of the company with favorability versus the fourth quarter in '05 for both healthcare and D&G.

And Jim when you make the same statement about elctro and communications that '05 will be better than fourth quarter?

Yes, I mean the beaches are littered with people trying to predict what is exactly going to go on in telcom.

But we see slight improvement.

I don't want to predict any meaningful improvement.

I don't think we are assuming big-time improvement in -- I know not we are not assuming in electro and communications top line.

That is not built into the pipe A. That would be upside if we got it.

Got it.

Thanks a lot.

Jeff Sprague with Smith Barney.

Good morning, everyone.

Maybe I ought to throw this one to Jim.

Jim you just closed the year here kind of basically net cash and you stepped up the share repurchase through the year, but obviously got this high-class problem with the cash and the cash flow.

Can you give us any color on what's on your mind in terms of deploying it?

Well, I'll let Pat mop up here, but I think the -- no.

We are always taking a look at our dividend, and I think in today's environment you have to ask that question every quarter and we're going to take a hard look at that as we go into '05.

I think funding our growth programs adequately and targeted acquisitions, the growth programs we think we have adequately funded.

We think we may have more opportunity to invest a little bit in '05.

We will take that on, but that I think could be easily handled.

Acquisitions we try to be pretty disciplined about it.

It is hard to predict what you're going to do and not do so you keep your powder dry.

We have a few things on the radar screen, but we always do.

But we need to be ready for that, and I would characterize share repurchase as something that is not the highest priority, but we have a little room to do more of.

So I think that we're going to take a look at that whole landscape here in the first quarter and sort of move down that priority list.

When we think about acquisitions you have historically talked about a funnel and at one point seemed like it was filling up, but clearly not too much has happened.

Can you give us a little color just in terms of opportunities, valuations, that sort of thing?

We are looking, we have filled up the funnel, we've spent a lot of time looking at all the deals.

We see all the deals, but we have pulled the trigger only a few times, and its valuation has been tough, we are bidding against other companies.

We are bidding against enormous liquidity and hundreds of funds out there that bid against and buy from each other that produce valuations there are kind of silly in some of the high-growth spaces.

So and I don't see an end in sight to overvaluation of a lot of assets out there.

So I think we are fighting that game, but we are going to find a couple here that are going to be meaningful.

But I would rather be criticized for being over disciplined than being under disciplined in this environment.

Just to follow-up on a different topic.

If I remember correctly Pat, the current options program as it stands expires in May of '05 and you are taking another look at that.

You said you're going to give some guidance next month, but should we expect some change that maybe is less diluted than what we have seen historically if we look at kind of the FAS 123 accounting?

Jeff, you're absolutely right, you know our program.

Of course this requires both board and shareholder approval of any modifications to our plan.

That is why really will not be able to give you guidance until probably the second quarter.

Plus we have a reading on what the program is.

We constantly look at the makeup of our compensation program to make sure it is competitive in the marketplace, it meets everybody's needs, shareholder needs, employee needs.

So that is something that we consistently do and then guarantee that we are in that process of looking at the makeup.

I happen to be a believer, Jeff that I don't want accounting guidance to drive what is the right thing to do from a long-term compensation for employees so we remain competitive and so forth.

That's obviously an added element to this.

But we are looking at a few things.

But until we get approval, we are not ready to disclose that.

Thanks a lot.

Robert Cornell with Lehman Brothers.

I see we got Jim on the phone here, let's go back to the point you made about the overall 3M initiatives and go back and you didn't make a comment yet about the new product pipeline; maybe you want to make that comment today or state it at the analyst meeting.

But just in general when I pick up the company R&D as a percent of sales were 7 percent, now it has come down to 5.7 percent.

You know, how would you give guidance with regard to where that R&D level should be, maybe give us some comments around the various 3M initiatives with regard to new product development and the backlog of new products.

It was I think 5.5 billion a year ago.

Yes, we will talk a lot more about it next month.

But I think the, I don't look at R&D as a percent of sales as something that I target necessarily.

I think we just make sure we fund all the things that we need to be funding, and that is -- and with a lot of volume leverage I think we are actually funding a little bit more year-over-year this year than last year.

And we also did in '03 versus '02;

I think the percentages has come down because of growth in revenues.

But the -- I feel good about the amount of money we're spending.

I think if there is a theme you will hear about in February it will be reinvestment in some of our technology platforms a little bit upstream.

I think our pipeline is better.

You'll see a pipeline that is strengthened in terms of its quality versus the last time we talked to you, and I think there is a little bit of a theme of a reinvestment in some of our technology platforms on the front end of that process that we want to talk to you about.

So that is working well.

Also as I mentioned when you add up all the initiatives, you know this $400 million impact on OI number is a number that we've been able to consistently deliver.

I see a clear path to delivering that again in '05.

It makes a significant difference both at the top line and in our productivity.

And I think things like Six Sigma and 3M acceleration and some of our digitization initiatives I think have the capacity to keep delivering those kind of numbers over time.

And we will talk in more depth about them.

I'll be there.

Final question for Pat actually from me anyway, could you just flush out -- you made some comments after the '05 guidance with regard to some earnings numbers that were not in the guidance -- just what, I missed those numbers.

What were they?

There's two specific items that are not in the guidance that we anticipate recurring.

First of all was the provision for the repatriation of foreign dividends.

In that the rules still have not been finalized; it is still difficult for us to really quantify what that is.

We think the way we understand it is very similar to what we told you in the third quarter call.

We think it is going to be in that 5 to 6 cent range.

Until the rules are out, we really don't know.

So we will just have to kind of wait for the final rules to be published rather than trying to roll something into guidance that is based upon our own belief of what is going to happen, decided not to do that, but make sure you understood that.

And the other one is the expensing of stock options.

And the difficulty there of course is that we do not have an approved plan yet that will carry us through most of the '05 calendar year.

And until we actually agree on what that plan is and get it approved, we're not in a position to necessarily giving guidance.

I think you can go back though if you just want to have a proxy and look at what our disclosure has been for black shoals expensing of options.

I am not saying that's what we're going to do, its just out there as far as information.

And then obviously once a rule gets set and I think there still is a question, okay, is this going to be enforced or not?

We would have to adopt in July so at that point in time we would be in a position to kind of give you an indication of what the impact would be.

And there is a belief that you will also restate history.

So then you get into a comparable -- if you are more worried about what the comparison is year-over-year versus the absolute, I just want to let you know from an absolute standpoint either stock options or the tax dividend repatriation are in our guidance number.

Thanks Pat and Jim.

Jeffrey Cianci with UBS.

Maybe I'll ask Jim the guidance question since Pat is usually so good at dancing around the answer -- we will see how good Jim can dance.

You gave guidance last year -- need I remind you, you said about 3.5 you made 3.75.

You are looking at low double-digit growth before these items.

Do you see Jim maybe looking backwards what was better than you thought in the last 12 months that make you come in the high end and what would be your caution then for '05?

Is it economic, is it macro, maybe a little flesh out on backwards and forwards look.

Well, this macroeconomic situation I think it's hard to take a global view and see tailwind.

Okay?

It is hard to take a global view and see tailwind.

I think there is decent momentum in the United States, still not great, but there is still air flowing over the wings.

I think in Europe you see a group of economies that never got off the ground and show no promise of doing it, really.

And I think you see a modest slowdown in Asia.

So when you add that all up, it leads to caution at the macroeconomic level.

I think obviously currency was a tailwind in '04, and Pat mentioned the magnitude of it, although we tend to use that as an opportunity to do smart things with the money, rather than have it all flow through.

But it is, if you just take that gross currency number that explains a lot of the difference in the '04.

What we projected and the projection we gave you didn't have any currency in it.

So that could explain a piece of it even though we spent some of it.

And your guess is as good as mine going forward.

As I mentioned, I think in response to Jack's question, I think in order to offset a cautious view of the global economy we are driving like hell in the core of this Company on execution, and I think we are showing signs of that in consumer and office industrial and safety and security.

And then I think healthcare is improving.

We got the tailwind of the IRMs beginning to come and optical will not be in an inventory industry adjustment forever.

So that is so you will see -- I think favorable operating momentum, cautious macro view sort of produces with a sort of a neutral on currency again, produces still it's pretty good compared to our investment peers, pretty good numbers out in front of us.

And if we get some tailwind we don't anticipate we will be glad to over deliver again.

That is a great answer and the last component of that was the Six Sigma because investors are finding a hard time quantifying that.

Do you look at what, how many projects you finished in '04 versus '05?

You said you are still -- it is not yet halftime in that game.

Is there a way to quantify if we moved now to growth projects more of a top line than a bottom line?

We are mixing toward top line projects from pure productivity, and we're going to give you more detail of this in February, and this is a good question because I think it is always a challenge to communicate the impact of making a big difference on the company that doesn't fit in a line item P&L.

But I think just as a 52,000 foot answer that will give you more detail on mixing toward impact on growth, we really do want to be the first company that can declare Six Sigma as a true growth driver.

And the reason we want to do that is because that is our strategy, organic growth is our strategy and Six Sigma should support that, not do something different than that.

But I think the productivity numbers are still pretty significant.

But we will take that one on for February.

Thanks, guys.

That has got to be the end of the questions.

And again we will see you in February.

If some of you were not able to ask your questions you will obviously please feel free to give us a call and we will follow up with you.

Again, thanks for joining us this morning.

We are looking forward to a successful 2005, and we hope to see all of you on February 18th in New York.

Thanks again.

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

You may all disconnect, and thank you for participating.